Conclusion: We expect tomorrow’s employment report to affirm our call that Jobless Stagflation will continue to percolate domestically. We don’t see the growing bifurcation between the equity market and the direction of the economy as one that will exist in perpetuity – particularly given a Global Macro backdrop infused with Fed-sponsored Correlation Risk, Housing Headwinds, and the Sovereign Debt Dichotomy.
Position: Short US Equities (SPY).
Without question, this morning’s Jobless Claims number was a bomb. Josh Steiner, the Managing Director of our Financials Team, had this to say in his weekly analysis of this data series:
“The headline initial claims number rose 45k WoW to 474k (43k after a 2k upward revision to last week’s data). Rolling claims rose 22k to 431k. A Labor Department spokesman said that the increase was due to temporary layoffs in the auto sector, and also noted an effect from some New York school employees, who can claim unemployment during spring break. On a non-seasonally-adjusted basis, reported claims rose 27k WoW, an atypical seasonal move… Big picture, regardless of whether this week's number was artificially higher due to one-time events, the takeaway from this morning's data is that rolling jobless claims are now up for the past 9 weeks, and even more importantly we're now at the YTD high in rolling claims.”
Irrespective of whether or not this week’s huge miss is a statistical anomaly, the larger takeaway here is that rolling claims have been trending higher for nine consecutive weeks and are now at their YTD high of 431k. That doesn’t bode well for continued improvement in the overall employment picture. To this point, Steiner writes:
“We have been looking for claims in the 375-400k range as the level that can begin to bring unemployment down. If claims return to this level, we expect to see unemployment improve. We consider unemployment to be ~200 bps higher than the headline rate due to decreases in the labor force participation rate. In other words, if the labor force participation rate were at the long-term average level of the last decade, unemployment rate would be 10.8% rather than 8.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 10.8% actual rate.”
The takeaway from this deteriorating trend is that the bulls are running out of bullets. At the start of the year, “employment growth” was among the major factors supporting what we called out at the time as overly optimistic GDP growth forecasts. The others, including “continued strength in manufacturing” and a “pickup in exports”, have yet to have a meaningful impact on the overall economy, as evidenced by 1Q11 Real GDP growth coming in around half of what consensus expectations were in early February (+1.8% QoQ SAAR vs. +3.5%).
As the market braces for tomorrow’s employment report, we think it’s important to widen the analytical lens by which we contextualize this data series. We’re coming off a +230k MoM gain in Private Payrolls, which slowed from +240k MoM in February. Interestingly, February’s Private Payroll number was the highest rate of MoM growth this country has seen since March 2006 – roughly halfway through the largest consumer leverage buildup in economic history.
For many reasons, don’t expect the April 2011 Private Payrolls report to show a reacceleration to the upside. In addition to Initial Unemployment Claims consistently highlighting a developing trend of weakness in this sector, our proprietary Hedgeye ISM Employment Index lends credence to our thesis.
Using a GDP-weighted average of the Employment subcomponents within the ISM Manufacturing and Non-Manufacturing Reports on Business Surveys, we’ve created an index that accurately tracks Private Payrolls growth on a concurrent basis. It’s interesting to note that this index has backed off its current-cycle high of 56.6 in February ’11 to 54.8 in March and now down to 53.2 in April. While, in theory, the index could continue to make higher-lows and higher-highs from here, the balance of risks remain skewed to the downside given that February’s high was 1.3 standard deviations above the long run average. Thus, reversion to the mean seems likely for this series – just as slowing jobs and wage growth seems likely for the slowing US economy.
A linear regression analysis of these two series produces a predicted value of +128k for tomorrow’s Private Payrolls series – which would be a noteworthy sequential deceleration and not supportive of current consensus expectations for +3.2% GDP growth in 2Q11. While +128k appears aggressive at face value considering that it would be a rather large miss relative to consensus expectations of +200k, we do believe the risks to Private Payrolls growth is skewed to the downside given the persistent weakness in Jobless Claims and increased corporate visibility on how the run-up in raw materials and energy prices over the last 7-8 months will negatively impact margins from a COGS standpoint. As such, we’ve done our best to define probable downside risk using 1x and 2x standard deviation bands as outlined on the chart below.
As also depicted in the chart, we’ve attempted to define the potential upside risk to our model’s +128k output. Supporting the case for upside risks is April’s +4% gain in the DJIA, which helped boost US CEO sentiment to the second highest level (64.1) since the Young Presidents’ Organization survey began back in 2Q09. In addition, 42% of those surveyed said they intend to increase hiring throughout the year while only 3.7% expected to reduce employee head count. While our process flags survey results like these as contra-indicators and indicative of the tops of economic cycles, we cannot strongly argue any bullish spin as it relates to very near-term job growth.
All told, tomorrow’s jobs report should be a pretty telling gauge as to whether or not the US economy is, in fact, on firmer footing and whether or not we will see calls for additional stimulus ahead of QE2’s end-of-June expiration. With the US Dollar trading up over a full percent today, it will be interesting to see whether or not this is a leading indicator for a beat relative to expectations for tomorrow’s employment report (suggesting a pull-back in market expectations for QE3). On the contrary, falling US Treasury yields are not confirming this theory behind today’s dollar strength. In fact, yields on the short end of the curve are trading in what our models define as the quantitative equivalent of calls for additional easing.
Tomorrow we'll get more clues as to whether market participants will call on The Bernank to try to inflate his way into more job creation via additional support for the equity market. For now, enjoy what's left of your Cinco de Mayo.