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Are Fundamentals Firming for the Job Market?

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

We got the government's September employment report on Friday. The number of jobs added at 114,000 was just at consensus, but the unemployment rate surprisingly dropped to 7.8% from 8.1%. So, what's behind that?

I'm checking in today with Morningstar's Bob Johnson, our director of economic analysis, and Vishnu Lekraj, who is an equity analyst covering the employment sector, to get their take on the report.

Thanks for joining me, guys.

Vishnu Lekraj: Thank you.

Stipp: So, I want to get to the number of jobs added--that's what we usually start with--later, because the unemployment figure itself is really dominating the headlines this morning. It's a pretty big drop to 7.8%. There are lots of different reasons the unemployment rate can drop--some good, some bad. What's your read on that big decline in the unemployment rate?

Lekraj: Well, just to remind everybody that the unemployment rate and nonfarm jobs survey are two different reports from two different subsets, so there can be a divergence between the two.

But the household survey, which measures the unemployment rate, was amazingly good this month, probably the best I've seen. Every single driver within that report was strong and moved in the right direction in a robust way. They measure people if they have a job, if they look for a job, if they are in the employment market, if they are not, how large is the employment market. Everything moved in the positive direction. The participation rate went up with a 30-basis-points drop in the unemployment rate.

When you combine that with some of the revisions with the nonfarm jobs number, and you look at some of the corporate profits that are coming out of some of the quarterly results, the economy seems to be a little stronger than what the nonfarms job survey is saying on the surface right now.

Stipp: So, sometimes the unemployment rate will drop when people drop out of the workforce, but that's not what happened in this particular survey?

Lekraj: No.

Johnson: We added a lot of people since last month. A lot of people came back into the workforce, which is a great indication of consumer confidence. Sometimes the number goes down and you kind of don't want to talk about it, because people dropped out of the labor force, but this time there was a massive increase that offsets some of the decline we saw in the prior month. You have got to keep in mind that August was not a great number on this same report, and so that's partly what happened there. We lost 450,000 jobs according to this report last month, and this month we added 800,000, and I assure you neither one of those numbers is exactly right.

Stipp: So, what do you think the trend would have been if we had seen the results smoother or maybe a more accurate reflection that doesn't get distorted by some of the month-to-month things that can happen?

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Johnson: Well, in terms of rate, I think we would have fallen from the mid-8% to 8%, and … I think we still would have been below 8% this month; I think we'd be at about 7.9%. And I think we are set up to see a [trend of] 7.8%, 7.7%, 7.6% for the rest of the year. I think we're going to see a continued fall in that number.

Stipp: So, you are saying it probably would have still come down but more gradually. We just happened to get it back-loaded a little bit because of some quirks in the data?

Johnson: The quirks and students going back to school is basically what it is. That's what really messed with the numbers.

Stipp: So Vishnu, do you expect that at this point, we will continue to trend down or do you think that it might bounce back up a little bit, just given month-to-month volatility that we see in that unemployment rate?

Lekraj: There is a possibility it could bounce around, but most likely it's going to trend down from here.

The biggest point with the unemployment rate is not necessarily its reliability in terms of forecasting, but its reliability in terms of pushing out the thoughts in the consumers' heads [about] what's going on with the U.S. economy right now; that's more important. It's a very easy number to grasp, to understand. Laypeople can understand the number very easily, and have more confidence in what's going on with the economy. That is the biggest driver.

Stipp: So, the psychology effect is maybe one of the more important things here for the unemployment rate.

Lekraj: Definitely.

Stipp: So let's talk about the nonfarm payrolls; they came in at 114,000 [for September]. Bob, [it was] within your range of expectations. You were hoping for maybe a little bit of a boost from a few factors, but it came in right around that consensus number. What's your take on that?

Johnson: I think this number shows a slowly improving employment market. I think it's probably more representative of reality that maybe the big drop in the unemployment rate.

But it was a good report. There were a lot of really neat things in the report. … Hourly wages were up 0.3%, which indicates some strength in the labor market to me. The number of hours worked was also up 0.1%, which is kind of unusual, and we revised the numbers for the past month. So, you put those together, and it really was quite a positive report, even though the headline 114,000 wasn't just wonderful. But even there, I wonder about some of the temp help [hiring], which Vishnu is going to talk about, was relatively flat. I wonder if more people went on regular full-time employment a little bit.

Stipp: And also I think good news in the report were revisions to the prior months. They revised the last month to 142,000 [jobs added] from 96,000, which is a big increase, and then July went to 181,000 from 141,000 originally. So, it's good to see that those revisions happened. Although, if you looked at that and then you see 114,000 [for September], it looks like maybe we're declining, but do you expect that this number, 114,000, might get revised up in the future?

Johnson: Yes. I think there is a good shot that it might …. [But] we had warned that August numbers are notorious for being revised and that was certainly the case this time, and it even went back and got the July numbers revised.

I think the economy is pretty steady-state right now, something in the 125,000 to 140,000 range. I really hope we get it more up to 160,000 or 180,000, but we're not there yet. And now we've got a seasonal tailwind in the tail half of the year, so maybe that will help us out a little bit.

Stipp: Vishnu, Bob mentioned that temp worker [employment] was a little weaker than we might have expected. What was your take on that, as an area you cover as an equity analyst?

Lekraj: It's a little surprising, because I haven't really seen those numbers out of the temp help guys, especially the ones that are based domestically and staffed domestically. So, that's a little surprising.

Health care, though, was a big, big driver this month, adding about 45,000 jobs, and finance also added about 17,000 jobs. Now, those categories have been talked about a lot over the past six months, about not being able to add jobs because of certain regulations, the health-care bill being passed, but it looks like they are moving, looks like they are going through a very strong phase right now.

Stipp: What about retail? We had some hopes that retail might have at least moderate strength because they've had a pretty good back-to-school season, and I think they have hopes for decent holiday sales. Did retail come in with the strength you expected?

Lekraj: This month was a little disappointing on the retail front. When I go back and look at the numbers, and I back out what's going on with the seasonal hiring from some past analysis, seasonal hiring starts in September usually. So, you can start to see that move in the report, but that wasn't the case this month. So what that means to me is that there should be some good robustness over the next several months, just given what a lot of CEOs and a lot of executives from retail establishments have been talking about in terms of their hiring plans for the holiday season.

Johnson: There's been a lot of news about businesses and their seasonal hiring, and most of them are up, and up quite a bit. So that's why we have been optimistic about this report. But again, it's a little squishy because [the government employment] report is [taken] around the middle of the month, so in probably another week or two, [retailers] probably started doing their holiday hiring. We said that we didn’t know [exactly when the hiring would happen] and it would be close, but it didn’t really get in there [for the September report]. We added about 10,000 retail jobs. So, the good news is that it was up, and they certainly didn't lay people off after the back-to-school season, but the bad news is they didn't start the seasonal hiring just yet.

Stipp: But we may see that made up for when we get to next month.

Johnson: In October.

Stipp: Then, also transportation is one of the stronger categories. What's behind that?

Lekraj: Well, you see a lot of transportation from energy resources and energy firms, so that's understandable. But overall you see goods being shipped around by UPS, FedEx. They have actually lowered their guidance based upon European fears, but domestically they have said everything is pretty steady state, pretty solid, so that's not a surprise at all.

Johnson: I always joke about the school bus drivers; that's another number that goes back and forth. We started back-to-school in September, and obviously we hire the drivers back, and that certainly moves the transportation numbers a little bit.

Stipp: Another one we talked about, Bob, in our preview to this report was manufacturing. We knew that it was going to be under some pressure, but the ADP manufacturing number showed 4,000 private sector manufacturing jobs added. We actually lost 16,000 manufacturing jobs, according to the government report. What's up with that difference? Is manufacturing weaker than we expected or about the same?

Johnson: We'd been hearing a lot from the capital goods side, especially people that are exporting things overseas has been weak, and I had penciled in a small loss. So I was a little surprised on Wednesday when we saw the ADP numbers.

On the other hand, the government-reported 16,000 isn't a horrible loss, and based on some of the ISM purchasing manager numbers that we've seen in terms of hiring, the pickup in the recent orders of capital goods, and a return to more normal non-summer business, I'm thinking manufacturing probably isn't going to hurt us a lot more in the months ahead. I was a little fearful that it would snowball on itself, but between Boeing and the auto industry and the gas industry, manufacturing is holding pretty well, and I think this may be the worst of what we see this year in manufacturing--a 16,000 loss.

Stipp: Also construction is another one you were watching closely. It didn't have quite the strength that maybe you would have expected to see. When are those construction jobs going to come online?

Johnson: That's a real big question for me. Housing starts are up from 500,000 at the bottom to basically 750,000, up 50%. And you look at the government's residential construction employment, and the number is flat year-to-year, not a single job added. And that really doesn't necessarily add up to me. Now maybe there is a seasonal factor in there I have missed or something, but it just seems like the construction numbers have really yet to capture what's going on on the ground, and maybe that will show up in some of the revisions in the months ahead.

Stipp: Maybe we'll get some good news on retail and on construction in the months ahead that we haven't seen captured yet.

Vishnu, I underlined something three times when I was looking through the numbers here, and that's government added 10,000 jobs. I don't think I've seen government adding jobs for, I can't remember when. What's going on with government? Is this a turnaround, and we're going to see them start to contribute to the employment situation?

Lekraj: It could. If you map out the government number, it hasn't fallen as much over the past six months. It's pretty much flattened out.

Now, if you break apart that number in terms of states, federal government, and municipalities the state governments are driving that number. Federal government is pretty flat, and you had some job losses in the local market, but it looks like some state tax receipts are coming in a little higher than what they've had in the past couple of years, which jibes with some of the retail sales numbers, sales tax, all that comes into play. So you see some strengthening within that number, but I won't say it's anything robust at all.

Stipp: Certainly the number of jobs added is not enough to move the needle yet at this point.

Bob, when you look at the numbers going forward, you said we are still stuck in this range of 100,000 to 150,000 or so, and we'd like to see closer to 200,000. Anything in the next few months [to help with that]? We mentioned construction. We mentioned maybe retail will help out. Do you expect we're going to get out of this range and get closer to 200,000 by the end of the year?

Johnson: Well, we were over 200,000 at the beginning of the year; we got pretty close to 300,000. And I think there's a little bit of seasonal factor [noise] still in the numbers that is really a little bit hard to figure out. And this is the time of the year, from now through January or February, when the jobs numbers seem to be a little bit better than we all think they should be, and I think we are going into that part of the cycle. So I am optimistic that some of the seasonal factors will begin to be an aid instead of a depressant to the numbers.

Stipp: Vishnu, will we see fundamental strength improving in the back half of the year besides just maybe some adjustments because of [seasonality] and calculation issues? Will we actually get stronger as an employment market?

Lekraj: I think more in the Q1 2013 versus Q4 2012. You're going to see some seasonal factors, again, some holiday-season hiring push that number up. But in terms of fundamental strength, I think after we see what happens with the election, until after we see what happens with Europe, until the Middle East problems are settled for the most part, or seem to be settling, businesses are just cautious right now. And until they see some good, hard facts coming out of other areas of the U.S. economy, they’re not going to start hiring robustly. But I expect it to happen in Q1 2013.

Johnson: I disagree a little bit. I think that you can't look to all the overseas markets and all these excuses. I think you are seeing the number of hours worked go up. You are seeing the pay rates go up. There is real fundamental strengthening in the underlying market, and businesses have obviously kind of panicked and cut back a little bit, and said, let's wait for the election or whatever. And now they're going, oops, I probably shouldn't have cut back. I think there's some of that going on right there. I think they have overreacted to the international situation, and now they are going to have to play catch-up.

Stipp: We'll see to what extent they do play catch-up in the months ahead.

It's always great to get your views on the employment market. Thanks for joining me and your insights on the September report today.

Jonson: Thank you.

Lekraj: Thank you.

Stipp: For Morningstar I'm Jason Stipp. Thanks for watching.