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Jobs report more noise than signal

As Ed Lazear points out in a very timely op-ed in today's WSJ, "Beware the Monthly Jobs-Report Chatter," the numbers are estimates that:

... are subject to significant revision, they are volatile, and they tell us very little about the direction of the labor market. There are subsequent revisions, one and two months after the first announcement, until the number becomes final, sometimes up to two years later. The error in any given month tends to be very large, which means that its reliability is low.

I have lived through perhaps 300 jobs reports, and I have seen the numbers revised time and again, often by very large amounts. As Ed correctly notes, "... the average error in the initial report is almost as large as average job creation itself."

So today's jobs number "miss" (95K private jobs vs. 200K expected) could well turn out, after revisions are made over the next few months and years, to be not a miss at all. At the very least, we know that one weaker-than-expected jobs report does not a recession make. Are there other signs of a significant slowdown in the economy? None that I can see. In fact, there are many areas of the economy that are growing at decent rates, with no sign of any significant or sudden disruption. Besides, the March shortfall needs to be put in the context of the previous 5 months' worth of private sector job gains which averaged 223K per month. Today's number is most likely just noise. The signal—that jobs continue to grow at a moderate rate—is unchanged.


This first chart shows the monthly change in private sector jobs. Note that the "noise" in this series—the average magnitude of month-to-month variations—can be almost 200K per month. The March number falls well within the range of normal fluctuations.


Taken in the context of the past six months, the annualized growth in jobs is about 2%, the same as it has been on average for the past two years.


The tepid growth in the labor force continues to be the most disappointing aspect of the jobs market. The labor force grew only 0.21% in the past year, and it has grown only 0.24% since the end of 2008. We've never seen anything like this. Upwards of 10 million people have "dropped out" of the jobs market; they've either retired or given up looking for a job. Until we can somehow entice many of these folks to come back to work—by offering more and better job opportunities—the economy is going to be growing at a disappointingly slow pace. The decline in the unemployment rate to 7.6% is a by-product of the very slow grow in the labor force, not a sign of a healthier economy.


This last chart reminds us of the trends that are still likely in place. This recovery has seen a fairly large decline (about 735K) in the number of public sector jobs, but that decline appears to be leveling out. The private sector continues to create jobs at a pace of about 2% per year, or about 190K per month. That combination is enough to give us real growth of 2-3% per year. Not every exciting, but certainly better than a recession.

Dollar update: still weak, but improving


The Fed's calculation of the inflation-adjusted value of the dollar against both major currencies and a very large basket of currencies shows the dollar has improved on the margin over the past two years, but it is still fairly close to its all-time lows. This is a reminder that optimism about the prospects for the U.S. economy, at least insofar as it is reflected in the world's desire to own dollars, is in relatively short supply. The outlook is not good, but at least it is improving on the margin (i.e., things are getting less bad).


One helpful development is the recent weakness in the yen, propelled today by the Bank of Japan's strenuous efforts to weaken the currency in order to reduce and perhaps eliminate the deflationary pressures that have plagued the economy for decades. As the chart above shows, the yen rose significantly (even awesomely) beginning in 1985. It reached a peak about a year ago, by which time its had more than tripled in value vis a vis the dollar (put another way, the dollar lost about 80% of its value vis a vis the yen).


As I've noted before, the yen's recent weakness has been a source of great cheer for the Japanese stock market. This is not the result of Japan engaging in "competitive devaluation." Rather, it is a case of Japan attempting to reverse the crippling, relentless revaluation of the yen that has made life miserable for the country's exporters for decades.


UPDATE: The Nikkei is up almost 4% in Friday trading, and the yen has fallen to 97. This is the hottest trade on the planet right now: long Nikkei/short yen.

Stockman is wrong about Doomsday


Times must still be bad if publishers think that yet another Doomsday book will sell, especially David Stockman’s The Great Deformation; The Corruptions of Capitalism in America. The NY Times last week published a short version, just a few days before the book’s recent release, and you can read an excerpt from the book here.

Stockman has been predicting the-end-of-the-world-as-we-know-it for a long time, ever since 1985, when he left the post of OMB Director in the Reagan administration and warned that federal budget deficits and the failure to raise tax rates would be disastrous. His first Doomsday book was published in January, 1987: The Triumph of Politics: Why the Reagan Revolution Failed. Around that same time, Reagan pushed through another significant tax reform, including a reduction in top tax rates. Contrary to Stockman’s warnings, the economy grew at a 3-4% pace for the next several years, tax revenues soared some 30%, and the burden of the federal deficit dropped from 5% of GDP to 3%. After a brief recession in 1990-91, precipitated by a tightening of monetary policy, the economy went on to boom for most of the next decade thanks to spending restraint, welfare reform, lower taxes, and a strong dollar. And the deficit briefly turned into a surplus.

His message today hasn’t changed much, except that the coming Apocalypse will not be just the Republican’s fault, as it was back in the 1980s, but the fault of all of Washington: the Fed, the Congress, and our ever-growing entitlement programs. He’s right on many counts, but wrong on others, and I’d like to think we can avoid a calamity once again.

He’s right that we are “piling a soaring debt burden on our descendants,” and he’s right that Washington seems “unable to rein in either the warfare state or the welfare state.” But he’s wrong to suggest that the only solution is to raise taxes. We need more growth-friendly policies, such as a lower, flatter tax rate structure with fewer exemptions and loopholes, lower corporate tax rates, and reduced regulatory burdens. We need to reform social security by privatizing it and/or extending the retirement age. We need to introduce market-based reforms to healthcare, not more government controls. This is not rocket science, it’s just letting the market take over many of the functions that government has tried and failed to manage.

He’s dead wrong when he says “the Fed has resorted to a radical, uncharted spree of money printing.” I explain here why this is not true. The Fed is only swapping bank reserves for notes and bonds, and the evidence suggests that they have been doing this to satisfy the world’s demand for safe assets. The Fed may well make an inflationary mistake in the future if it fails to unwind its QE in a timely fashion, but that remains to be seen—it is not yet baked in the cake.

He’s right when he argues “we’ve had eight decades of increasingly frenetic fiscal and monetary policy activism.” Fiscal and monetary policy mistakes are at the root of almost every major economic problem this country has faced. Keynesian “stimulus” policies have proven not to work, and monetary policy is a very poor tool for fine-tuning economic growth. The Fed undoubtedly contributed to the housing bubble by keeping interest rates very low in the early- to mid-2000s. As government has grown in size and power, it has created a culture of crony capitalism (e.g., Solyndra), and by promoting housing with easy money from Freddie and Fannie and subsidized mortgage rates, it also contributed to the housing bubble. 

The list of government failures is unfortunately long and depressing. Where it looks like the market has failed and is corrupt, it's because government has not allowed the market to work. For a superb discussion of how and why government is the culprit behind the housing bubble and the financial crisis of 2008, I highly recommend John Allison's book The Financial Crisis and the Free Market Cure.  

Stockman’s fatalism is on display when he says we are at “an end-stage metastasis [and] the way out would be so radical it can’t happen.” What does he recommend? “If this sounds like advice to get out of the markets and hide out in cash, it is.” Unfortunately, most of his doomsday arguments have been the subject of headlines for years. It’s no secret that the U.S. suffers from some seemingly intractable problems. But it’s an underappreciated fact that the economy is growing and the burden of the federal deficit has declined significantly in the past three years, from 10.5% of GDP to less than 7%. I explain this here and here. It’s due to the simple combination of a growing economy and spending restraint. 

In any event, it’s arguably a little late to worry now that the end of the world is upon us. “Hiding out in cash” is extremely expensive, since it means forgoing much higher yields in other assets as long as the economy fails to crash. As I explain here, risk-free short-term interest rates are zero or very close to zero in most of the world’s major economies because investors are very risk-averse, not because the Fed is artificially driving rates to zero. Investors everywhere are already “hiding out” in cash: savings deposits at U.S. banks have swelled from $4 trillion to almost $7 trillion in the past four years, despite the fact that they pay almost no interest. U.S. currency in circulation has increased by over $300 billion since 2008, with much of that increase going overseas where $100 bills are seen as the ultimate safe haven. In the past 5 years, domestic equity mutual funds have suffered net outflows of over $500 billion, while much safer but very low-yielding bond funds have enjoyed over $1 trillion in net inflows.

Should concerned investors seek out the safety of gold instead? Here again it may be too late. Investors who fear the type of Apocalypse that Stockman is predicting have already bid up the price of gold to 3 times its inflation-adjusted price over the last 100 years.

In the end, Stockman is right to call our attention to the central problem we face, which is too much government. But there is no reason to think that calamity is unavoidable. Government can be fixed. Monetary policy is not a preordained disaster. The economy is growing and can continue to grow in spite of the fiscal and monetary policy headwinds it faces.

The jump in claims is bogus

Weekly claims for unemployment last week jumped far above expectations. This is one of those times when seasonal adjustment factors are the cause, not any fundamental deterioration in the health of the labor market



The first chart above shows weekly claims on a seasonally adjusted basis. Note the significant rise in claims in the past week. The second chart shows the non-seasonally adjusted (i.e., actual) level of claims. Note that there was no increase at all in the actual number of claims in the past two weeks and very little change during the month of March. Note also how claims this past month have behaved very similarly to claims in March of last year. The problem apparently lies with the timing of the Easter holiday and Good Friday. I expect claims next week will fall back to former levels. 


The Challenger tally of announced corporate layoffs revealed nothing unusual in March.


The number of people receiving unemployment compensation insurance continues to decline, down 1.3 million in the past year. The important and healthy trends in the labor market remain in place.

Service sector muddles along, but that's good news

Today's release of the March ISM survey of the service sector shed no new light on the economy. It's slow and steady as she goes. The economy is probably growing at a 2-3% rate.


In the above chart of the ISM survey of service sector business activity, there is no sign of any pickup, but no sign of distress either. This would be a yawner if not for the fact that risk-free interest rates are extraordinarily low. THAT is the real story.


Today the yield on 2-yr German bonds is -0.01%. Call it zero. It's not strange that short-term rates in the Eurozone should be extremely low, since the Eurozone economy has been in a recession for more than a year, the Cyprus banking crisis has given rise to new fears of a Euro breakup, and the Club Med economies of the Eurozone are really struggling. On the other side of the world, 2-yr Japanese bonds pay only slightly better: 0.07%. There's talk of Japan finally defeating deflation and starting to grow again, but as yet little evidence.

The yield on 2-yr Treasuries is 0.23%, which is less than the 0.25% interest the Fed pays on bank reserves. That's better than what's on offer in the Eurozone and in Japan, but not by much. Especially considering that the US economy has been growing for almost four years and shows no sign of an impending recession. And considering that the S&P 500 index has outperformed its Eurozone equivalent by over 60% since the recession lows. And considering that Japan's economy has been mired in a deflationary/recessionary quicksand for most of the past decade.


From a long-term perspective, 10-yr yields in Europe and the U.S. have been converging in seemingly inexorable fashion with those of Japan. U.S. and German 10-yr yields are only separated from those of Japan by a mere 100 bps, equivalent to today's dip in equity prices. Is the message here that we are all doomed to a decade of Japanese-style deflation and zero growth?


That's the same message you find in the 5-yr real yields on TIPS, which—at -1.8%—are now guaranteed by the U.S. government to rob you of 1.8% of your purchasing power every year. In the chart above I show how the real yield on TIPS tends to correspond to the real growth rate of the U.S. economy over time. In the late 1990s, when the economy was booming along at 4% growth, investors weren't interested in TIPS unless they could compete with the growth outlook, which back then called for 4% growth and a booming stock market for as far as the eye could see. Today the outlook for growth is dismal, so people are willing to accept a very low or even negative real yield on TIPS because they fear that the risk of owning alternative assets is even greater. The chart suggests that TIPS investors are bracing for zero real economic growth in the U.S. over the next 2 years. Zero growth for the next several years would indeed be very bad for a lot of risky asset prices.

Sovereign yields throughout the developed world are extraordinarily low, and that can only be explained by understanding that the demand for relatively risk-free assets is extraordinarily strong. By the same logic, the demand for risky assets is unusually weak, and that in turn reflects the widespread view that the world's developed economies are fundamentally weak and unlikely to improve much, if at all, for the foreseeable future.

So it is noteworthy that there are so many signs of ongoing growth in the U.S. economy: strong auto sales; rising housing starts; ISM indices over 50; 2.5% growth in industrial production; rising factory orders; 4.6% growth in retail sales; 200K per month jobs growth; very low unemployment claims; record corporate profits; double-digit growth in bank lending to small and medium-sized business; healthier consumer balance sheets; soaring crude oil production; and very cheap and abundant natural gas, to name just a few.

Conventional wisdom explains this disconnect—so many signs of growth, yet widespread fears of stagnation and decline—by first pointing to the Fed. Zero interest rates don't reflect a strong demand for safe assets, they are simply the by-product of the Fed's massive money printing. Interest rates would be much higher, and consistent with the evidence of continuing U.S. economic growth, if the Fed weren't pegging them at zero via its Quantitative Easing efforts. Housing would be collapsing if the Fed weren't propping it up via its purchases of MBS. And what this means, as the theory goes, is that it will all end in tears. If the Fed ever tries to raise rates, the economy will then surely crash, snuffed out by tight money the same as has happened with every recession in modern times. In the meantime, the Fed is seriously distorting the capital markets and fostering malinvestments (aka "bubbles") that will inevitably lead to a bust. The Fed's flood of excess money will eventually collapse the dollar, followed by a hyperinflation that will inevitably lead to the destruction of the world as we know it. In short, conventional wisdom holds that the Fed can't do what it's doing without there being huge downside risk.

But of course, this logic leads to the conclusion that the world is doomed no matter what, and that is consistent with my interpretation of why sovereign yields are so low.

The inescapable conclusion, regardless of your assumptions about the Fed or the economy, is that today's extraordinarily low interest rates are symptomatic of a world that is very risk averse.


How else to explain why the earnings yield on the S&P 500 is substantially higher than the yield on the average BAA corporate bond? Investors are willing to give up lots of yield and potential price appreciation for the relative safety of corporate bonds because they fear that corporate profits, now at record-high levels, are at great risk. The last time we saw this behavior was in the late 1970s, when global economies were beset by high and rising inflation and collapsing stock markets—a time of great pessimism.


How else to explain why the price of gold today, in inflation-adjusted terms, is almost as high as it was at the height of the inflationary panic of early 1980, and almost three times higher than its average real price over the past century? If gold has one message for the world, it is that there is a tremendous demand for its supposed safety.

No matter how you look at it, today's market is effectively priced to the expectation that some kind of economic calamity is in our destiny. Against that backdrop, today's ISM service sector release was very reassuring.

Factory orders jump



February factory orders rose 3%, and January's level was revised upwards by 1%. Orders are now at a new all-time high, and have risen 2.7% in the past year. Factory orders last summer were quite weak, but they have now rebounded convincingly, thus removing one of the few sources of doubt about the economy's ability to continue to grow. Even after excluding defense orders (see chart above), orders are up 3.8% in the past two months and 3% in the past year. Slowly but surely, the economy continues to improve on the margin.


In this next chart I've added the S&P 500 index, which has had a pretty good correlation with the changes in factory orders. I think this shows that the stock market is on much firmer ground these days than it was at its 2000 peak. Back then, equity valuations had clearly overshot the fundamentals. Today, equity valuations are improving very much in line with improvement in the underlying economic fundamentals. The recovery and the rally are for real.

Manufacturing index points to 2-3% GDP growth


The March ISM survey of the manufacturing sector came in weaker than expected (51.3 vs. 54), but as the chart above suggests, the level of the index is nevertheless consistent with economic growth in the first quarter of 2-3%. That would be a welcome acceleration from the previous quarter's anemic 0.4% growth.


The export orders subcomponent jumped substantially in March, suggesting that conditions overseas have improved noticeably this year after a weak second half.


The employment subcomponent remains modestly positive. Overall, nothing much to cheer about, just more of the same: modest growth, with little or no sign of any emerging weakness.