Know Your Economic Statistics: Non-Farm Payroll Employment

For prudent investment decisions, stick to leading economic indicators.  The reporting of non-farm payroll employment is important to media outlets because it reflects the plight of workers.  It is a relevant news story.  However, that does not mean it is a relevant leading economic indicator.

[SOURCE:  Bureau of Labor Statistics]

For example, February saw another significant decline in non-farm payroll employment as the recession’s bite worsens.  This makes for stark news headlines, and it certainly shows the serious effects of the recession.  However, payroll employment should not be used as a gauge of future economic activity.  It is not a leading indicator; employment is a lagging indicator.  Payrolls will continue to drop, as they have in prior recessions, long after the economic recovery has begun.  This is why some forecasts for unemployment rising in 2010 to 10 percent or more (the current unemployment rate is 8.1 percent) should not be met with trepidation about corporate earnings and valuations.  In other words, the stock market will not continue to decline because of job losses.  Rather, the market declines because of depressed corporate earnings and poor economic outlooks, which in turn force job reductions.

There are some who would argue that job losses will result in a further decline in consumer spending, and so, corporate earnings will decrease more.  If that were true, then no economy would ever recover from a recession.  Companies would keep cutting workers, who would then spend less, forcing lower earnings, more jobs cuts, less spending, and so on.  This is a phenomenon known as a vicious circle.

We need only look to our present economic situation to see why payroll cuts do not necessarily result in lower consumer spending.  In the Summer of 2008, consumer spending and borrowing began to decline rapidly.  The credit crisis hit its peak in September/October.  Realizing that demand for goods and services had dropped, and that consumers were no longer borrowing to support their spending habits, businesses began job reductions shortly thereafter, and seem to be peaking in the December 2008-February 2009 period.  Consumer spending and borrowing dropped first.  That is a leading indicator.  Job cuts came last, that is a lagging indicator.  And, in the face of the dramatic loss of jobs, the drop in consumer spending may be leveling out (see chart at the end of this article).

There are payroll numbers that we can look to as leading indicators of economic activity:  average weekly hourly earnings and average weekly hours worked.  These numbers show a trend as to income earned on non-farm payrolls.   The analysis is simple:  increased earnings and increased hours means more spending power, with the reverse being true as well.  Let’s look at a chart of these statistics:

Table A.  Composition of change in real earnings of production and
nonsupervisory workers(1) on private nonfarm payrolls
________________________________________________________________________
            |           |           |           |           |
            |  Average  |  Average  |  Average  |    The    |    Real
            |   hourly  |   weekly  |   weekly  |  Consumer |  average
   Year     |  earnings |   hours   |  earnings |   Price   |   weekly
    and     |           |           |           |  Index(2) |  earnings
   month    |___________|___________|___________|___________|___________
            |
            |  Percent change from preceding month, seasonally adjusted
____________|___________________________________________________________
            |           |           |           |           |
2008:       |           |           |           |           |
    Jan.    |     0.3   |    -0.3   |     0.0   |     0.4   |    -0.4
    Feb.    |      .3   |      .3   |      .6   |      .2   |      .4
    Mar.    |      .4   |      .0   |      .4   |      .4   |     (3)
    Apr.    |      .2   |      .0   |      .2   |      .1   |      .1
    May     |      .3   |     -.3   |     (3)   |      .5   |     -.5
    June    |      .3   |     -.3   |     (3)   |     1.1   |    -1.1
    July    |      .3   |      .0   |      .3   |      .8   |     -.5
    Aug.    |      .4   |      .3   |      .7   |      .0   |      .8
    Sept.   |      .2   |     -.3   |     -.1   |      .0   |     -.2
    Oct.    |      .4   |     -.3   |      .1   |    -1.0   |     1.1
    Nov.    |      .3   |     -.3   |     (3)   |    -2.1   |     2.2
    Dec.(p) |      .4   |     -.3   |      .1   |    -1.0   |     1.1
2009:       |           |           |           |           |
    Jan.(p) |      .3   |      .0   |      .3   |      .3   |     -.1
____________|___________|___________|___________|___________|___________

  1 See footnote 2, table 1.
  2 The deflator for the constant-dollar series presented in this 
release is the Consumer Price Index for Urban Wage Earners and Clerical 
Workers (CPI-W).
  3 Change less than 0.05 percent in magnitude.
  p = preliminary.

[SOURCE: Bureau of Labor Statistics]

Take a look at May and June of last year.  While average hourly earnings were increasing, average weekly hours worked dropped.  Also, thanks to incredibly high oil and gasoline prices, inflation was running rampant.  Thus, real earning was declining rapidly.  Those who were paying attention to these numbers would have known that a severe drop in consumer spending was coming.

Now look at October through December.  Average weekly hours have dropped consistently each month, forecasting a worsening in consumer spending.  However, the inflation rate has dropped, thanks to a sharp drop in commodities and, especially, oil prices due to the global economic crisis.  So even though workers were earning less because they were working less, their spending power increased.  January 2009 shows the possibilty of a bottoming in the average weekly hours decline.  Of course, one data point does not make a trend, so we need to see what the next couple of months show before any reasonable predictions may be made.

The bottom line is that investors must know the difference between economic statistics that offer a glimpse into the future and those that merely reflect the past.