Friday, April 3, 2015

Today's NFP Miss Means Little For Equities and The Economy

Today, the BLS released its monthly report on labor, commonly referred to by its acronym, NFP (non-farm payroll). This is the single most followed statistic about the state of the economy, giving onlookers a regular view into employment and wage growth.

Employment fell dramatically in March, missing expectations by 120,000.  Equity futures dropped 1% in the half hour following the release of the report.

The drop in employment should not have taken many by surprise.  Let's explain why and what today's miss means for the economy and the stock market.

There are three things to know about the NFP data.

The first is this: it's common for the monthly prints to be volatile. Today's report was nothing unusual at all.

The chart below looks at the 1980s-2000s. It has been a regular feature of monthly reports to vary from zero to over 400,000-500,000. Even during the 1990s bull market, NFP was negative in 1995, 1996 and 1997. It was close to 100,000 several times in 1998 and 1999. 2002-07 was the same, with multiple months near or under 50,000 during the heart of the bull market.

Why is there so much volatility? Leave aside the data collection, seasonal adjustment and "weather" issues; appreciate that a "miss" or a "beat" of 120,000 (like today's) equals just 0.08% of the total US workforce of 160 million. 

Second, what has been so remarkable recently is how consistent the monthly NFP prints have been. March was the first monthly print under 200,000 since February 2014. That's a span of 12 months. Between 1995 and 2000, drops under 200,000 happened about every 4 months; the longest stretch was 8 months. Employment growth has been unusually strong in the past year. A "surprise" drop under 200,000 was well overdue.

Third, what is of far more importance than single month misses or beats is the trend in annual employment growth. In the past three years, the rate has varied from 1.5% to 2% but in the past seven months, growth has consistently exceed 2% for the first time in 15 years. The rate of growth in March was 2.3%, higher than at the 2002-07 bull market peak in March 2006 and close to the highest rate of growth since June 2000.

How will the stock market respond next week?

We looked at every NFP print under 100,000 that followed a drop of at least 100,000 from the prior month, from September 2003 to July 2007. The lines in the chart below are placed on the second week of the month in which the bad NFP report was released. In three cases, the index dropped 5-6% in the next week or so (red lines). In most other cases, the index moved higher (blue lines). Obviously, other factors influence the direction of stock indices, so this is a simplistic look. But on the surface, a huge sell off is possible but hardly a foregone conclusion.

Some of the NFP misses highlighted above were more extreme than today's - the November 2003 NFP print fell to 17,000 from 196,000 the month before; the October 2006 NFP print to 3,000 from 156,000 - yet the stock index was unaffected.

The monthly NFP numbers are usually volatile. That we haven't seen any volatility in the past year perhaps made today's report surprising. The trend in employment is very strong; this is of far more importance.

Again, there were many much worse NFP reports throughout the 1990s and 2000s that did little to upset the larger uptrend in the economy and stock indices. On it's own, today's weaker than expected NFP report is not necessarily a harbinger of bigger troubles ahead.

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