Why the Job Market Shouldn’t Factor in Forecasts

“Soft landing” remains the summer’s hottest phrase, this time courtesy of July’s Employment Situation Report—better known as the US jobs or unemployment report. Slower growth in nonfarm payrolls had everyone buzzing the widely hoped-for return to slower inflation without a recession was even likelier thanks to the “goldilocks” job market.^[i] It all stems from the fallacious Phillips Curve, which (wrongly) purports wage growth drives inflation. But, to us, there is an even broader, less-technical problem at work. Simply, labor markets are late-lagging indicators. They predict nothing, and they don’t determine the economic fundamentals that help drive stocks.

For a perhaps extreme example, consider Exhibit 1, which shows the monthly change in nonfarm payrolls from mid-2007 through 2010. The recession that accompanied the global financial crisis started at the end of 2007 and ran through June 2009. As you will see, employment started falling in February 2008, just by a smidge, which is actually early compared to recessions in the 1970s and 1980s. But at the other end, hiring didn’t turn positive until March 2010, nine months after the recession ended. Jobs lagged bigtime.

Exhibit 1: The Lagging Job Market

Source: St. Louis Fed, as of 8/4/2023.

Consider this from a business owner’s perspective, and jobs’ lag makes sense. You spent a lot of money recruiting, training and keeping your employees, and they are all great. As a (hypothetical) person, maybe you even care about them. When things start turning down, the last thing you want to do is let any of these good people go. So you do everything you can to ride things out with your current headcount, like cutting hours and spending that was a nice-to-have in good times but isn’t essential. Only when all else fails and you have to let someone go for the sake of the business’s survival do you bite the bullet. Then, when things start getting better, you do everything you can to delay the expense of taking on someone new, just in case the recovery is a false dawn. It is only once you have exhausted productivity gains and can’t keep up with demand with your current crew that you will put out the Help Wanted sign.

Or, more simply, economic growth creates jobs, not the reverse. So we don’t think it is correct to draw any forward-looking conclusions from July’s jobs data. The widely hyped slowdown in services hiring? Seems to us like an after-effect of Q2’s slower services spending.^[ii] The Institute for Supply Management’s services Purchasing Managers’ Index has been in the low 50s since March, slowing from a mostly mid-50s range in the months before.^[iii] GDP growth overall slowed in Q1 and Q2 from 2022’s second half, too, while loan growth has cooled.^[iv] The vast majority of coincident and leading indicators have signaled a modest slowdown for months. To us, it seemed like a foregone conclusion that services jobs would eventually tie a shiny bow of confirmation on this. That is what we see here.

We get why people want the jobs report to be predictive. It is that rare thing—a timely set of hard data. It seems like a near-instantaneous read, coming out the first Friday of the new month. But that timely release belies the late-lagging inputs, making it of no use in figuring out what comes next.

So no, we wouldn’t draw big conclusions about the economy’s soft-landing chances or how Goldilocks things are. July’s jobs report simply confirms what we already knew—that the US economy was rolling onward and upward earlier this year. That is nice to know, but stocks are forward-looking and pricing in the likely economic and earnings growth over the next 3 – 30 months. Jobs won’t tell you about this.