Today’s weaker-than-expected employment report sent the financial and commodities markets reeling. But why was this report such a significant surprise to anyone?
I’m not particularly bearish or bullish with respect to stocks right now, but I am a pragmatist. The fact is that the leading indicators of employment have been weakening, yet the consensus has been ready to reap the fruits of the so-called “green shoots.”
First, let’s set the record straight. Employment is NOT a lagging indicator. Some indicators of employment, like jobless claims and the length of the work week, are actually official leading indicators of the economy. Payroll employment is a coincident indicator.
It is actually somewhat odd that investors are currently paying so much attention to true lagging indicators related to inflation. Wage pressures, and not commodity prices, are the true catalysts for inflation. Wage increases, abnormal credit creation, and excess demand relative to supply come first, and inflation comes second. There are no wage pressures, there’s not a lot of credit being created, and output gaps abound, so why is everyone focused on lagging inflation indicators?
Second, the monthly payroll report, like the one issued today, is full of largely coincident data. However, it does have one piece of leading data: the length of the work week. This is generally considered a leading indicator because employers will tend to adjust the number of hours their employees work before hiring or firing them. For example, it would be normal for companies to begin to pay existing workers overtime before they hire additional workers because of the uncertainty related to the initial upturn in a production or service cycle.
However, commentators rarely highlight the length of the work week when discussing the monthly employment report.
What has been happening to the length of the work week? It has hit all-time lows the last two months. That’s right. The only official leading indicator in the employment report has hit all-time lows the last two months. Who has reported that? No one.
Weekly jobless claims are also an official leading indicator, and they remain above 600,000 (why is that the magic number anyhow?). Thus, two leading indicators relating to employment seem quite weak.
These data seem particularly bullish for Treasuries and bearish for Consumer Discretionary stocks. Historically, there is a very strong inverse relationship between jobless claims and the performance of consumer discretionary stocks. Supporting the basic economic principle that one doesn’t buy discretionary goods when one doesn’t have a job, the absolute performance of the S&P 500 Consumer Discretionary index decreases when jobless claims increase.
Treasuries should continue to be a part of any portfolio. Right now they are about the only uncorrelated major asset class available to investors. Investors continue to structure diversification based on the number of asset classes in a portfolio rather than on those asset classes’ correlations. Put simply, alternative investments are NOT diversifying asset classes right now. Treasuries are.
With that in mind, the whole world, excluding China perhaps, is underweight Treasuries. In addition, the Chinese would be quite foolish to sell their Treasury holdings. If the global economy accelerates, Treasuries will indeed sell off, but the Chinese economy will boom. However, if the global economy decelerates, the Chinese economy will likely slump, but the value of the Treasury holdings will probably appreciate. That’s what diversification is all about.
The key question, however, for any serious investor is why was today’s employment report a surprise? Leading employment data have been suggesting on-going weakness for some time.
Could it be that momentum, rather than fundamentals, remains the defining aspect to most investment strategies? Prudent investors should be watching sound leading indicators, and not the markets’ short-term momentum for clues as to whether the “green shoots” will sprout flowers or weeds.
Richard Bernstein is CEO of Richard Bernstein Capital Management. He was previously the Chief Investment Strategist and Head of the Investment Strategy Group at Merrill Lynch. He has written two books on investing: Navigate The Noise: Investing In The New Age Of Media And Hype and Style Investing: Unique Insight Into Equity Management.
Business Insider Emails & Alerts
Site highlights each day to your inbox.