Saturday, 3 November 2007

Magical B/D adjustment helps NFP's in October

From the Bureau of Labor Statistics:

Nonfarm payroll employment rose by 166,000 in October, and the unemployment rate was unchanged at 4.7 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Job gains occurred in professional and business services, health care, and leisure and hospitality. Manufacturing employment continued to decline, and construction employment was little changed.

That's the biggest monthly growth in NFP's since May this year. A closer look at the detail reveals jobs were lost in following industries: Goods-producing -24,000, Construction -5,000, Manufacturing -21,000, Retail -21,500.

Jobs were added in: Service providing 190,000, Professional & Business Services 65,000, Education and Health Services 43,000, Leisure & Hospitality 56,000, Government 36,000.

It should be remembered that these numbers are subject to large revisions. August NFP's were initially reported as falling -4k, only now to have been revised to a rise of 93k. Last month's NFP number of 110k has been revised back to 94k.

Magical B/D adjustment fairy strikes again.

(click on chart for sharper image)

Moving on to the ever controversial Birth Death adjustment. We see that 103k jobs were added in October by the B/D adjustment. Now remember that the NFP number is seasonally adjusted whereas the B/D adjustment isn't so you can't just subtract the B/D adjustment from the NFP number.

By way of example, the chart below shows the difference between the seasonally adjusted (SA) numbers and the not seasonally adjusted (NSA) numbers. As you can see the NSA numbers fluctuate wildly compared to the SA figures. However the totals year to date are very similar.

In 2006 NFP's averaged 189k per month. In the 10 months to October 2007 NFP's have averaged 125k per month, a decline of -34%. Clearly job growth has slowed but what hasn't slowed is the B/D adjustment. Why is that?

In the period Jun 2006 - Oct 2006 the B/D adjustment totals 430k whilst in the same period in 2007 the B/D adjustment is 422k. A coincidence? I think not. If you look closely at the month to month changes in the B/D adjustment you can see 2006 and 2007 are very closely correlated.

So what does this mean? Whilst employment has slowed the BLS has not changed the way it calculates the B/D adjustment. The BLS admits as much on it's website where it states:

The most significant potential drawback to this or any model-based approach is that time series modeling assumes a predictable continuation of historical patterns and relationships and therefore is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.

There you have it in bold. The BLS is essentially assuming the same pattern in 2007 that they did in 2006. However we know, because we don't live on another planet, that housing has fallen off a cliff and that mortgage companies have been imploding yet the BLS has shown a net gain of jobs added to new businesses in both construction and financial activities nine consecutive months from February through October.

The graph above shows the three month moving average of NFP growth ticked up to 118k in the period August - October. Also of interest in this graph is that it shows the weakest recovery in jobs growth after a recession out of the last 3 recessions. The graph below, courtesy of the BIG PICTURE, illustrates this point more clearly.

Interestingly the market reacts to a number that is totally unreliable and usually subject to large revisions. What the market should pay more attention to is the revised figures for the previous 2 months which shows growth in NFP's of 93k in August and 96k in September. Not horrible but definitely below trend growth.