Weak Labor Market, Cheap Stocks

For this installment of our quarterly employment Stock Strategist, we'll highlight a few developing macroeconomic data trends, as well as how they're manifesting in our employment coverage universe via operational trends, management commentary, and stock performance. For additional background on the topic, we recommend reading two Stock Strategist articles we wrote earlier this year: Has Employment Peaked? and Our Picks for a Grim Employment Climate.

In last quarter's article, we noted that several important employment data series were flashing yellow, but now it's safe to say they're glowing red. Monthly job losses have become meaningful, the unemployment rate is rising, and more layoffs are in the pipeline as corporate earnings come under pressure. The outlook is not good either: According to the March Survey of Consumers conducted by Reuters and the University of Michigan, just more than half of all consumers expect the employment situation to weaken in the year ahead. At the moment, we see no reason to believe otherwise.

The Employment Situation from the Top
First, let's look at one of the most widely followed employment numbers, the monthly change in nonfarm payrolls. This data series is generally updated on the first Friday of every month as part of the Bureau of Labor Statistics Employment Situation Report and can move markets as it's one of the most timely and comprehensive updates on the job environment.

As you can see in the chart above, the trend is decidedly negative. Monthly jobs gained and lost can be a volatile number, so we use a three-month moving average, but it's still obvious that the job market is in precarious territory. Not since the 1950s have we experienced sequential monthly job losses without also falling into recession, and even back then hard times were just around the corner.

This chart also provides useful information on magnitude. Even though losing 80,000 jobs each month on average in the first quarter seems pretty bad, we're well short of historical experience. In fact, the average trough for this measure during the last eight recessions was 280,000. Of course, it's not yet a forgone conclusion that we are in recession, and every recession has unique nuances that make comparisons difficult. Still, it's worth noting that further deterioration from here has precedent. Also worrisome, this number has benefited greatly during the last year from birth/death model contributions, which now constitute well more than 100% of new jobs "created" in the last year. (For a detailed description of how this works, please read our previous employment Stock Strategist article, published last January. The short and simple explanation is that recent data may be understating the number of jobs lost in the last few months.)

The unemployment rate continued to rise in the first quarter, and just like the monthly job numbers, we think this measure understates current weakness in employment. For the purpose of generating the unemployment rate, unemployed persons are defined by the BLS as "people aged 16 years and older who had no employment during the reference week, were available for work, except for temporary illness, and had made specific efforts to find employment sometime during the four-week period ending with the reference week." The last part of that sentence is key: If you don't have a job but haven't looked for work in the last month, you are not considered unemployed according to the unemployment rate. The impact of this definition is portrayed in the chart below.

As you can see, the median duration of unemployment was coincidentally about equal to the unemployment rate for many years, but has diverged significantly since the mid-1990s. The 20-year moving averages (represented by the dashed lines) show that the duration of unemployment has steadily ticked up while the unemployment rate has ticked down. In other words, the unemployment rate has been falling partially because people are finding jobs, but also because it's taking longer for many to find work. This brings us to an important attribute of the unemployment rate that is often overlooked: It's driven by both demand and supply. If the supply of aggressive work-seekers increases (let's define aggressive as active in the last four weeks) but the number of jobs stays the same, the unemployment rate increases. If this scenario is combined with less demand for workers (fewer jobs available), the unemployment rate increases even further.

Given that consumers are starting to appear short on cash and there are more frequent mentions of cost-cutting in earnings conference calls, the unemployment rate is likely to see upward pressure from both sides of the supply and demand equation. Also, here's a quick fact: As we are a service economy, about two thirds of corporate costs are labor. When businesses can't increase the bottom line by expanding the top line, they start reducing the lines in between, which is primarily people. This is one reason why labor on the whole is a lagging indicator and also why we need to see improved earnings outlooks for the economy as a whole before the labor market will beneficially reverse course.

What's Our Forecast?
The short answer is we don't have a crystal ball and don't see much benefit in arbitrarily forecasting what the precise employment situation will be in the future. However, commentary from management at employment companies can be very informative in this respect, especially when used in conjunction with the current and historical macroeconomic data. These industry participants usually have invaluable insight regarding recent trends, because their livelihoods depend on it. Before getting to our company-level commentary and a few choice quotes from various management teams, here's an update to a chart from our last employment Stock Strategist article that vividly portrays what these firms are experiencing in aggregate.

As you can see, temporary employment, a good leading indicator for overall employment, accelerated to the downside during the first quarter. Although temporary employment hasn't shown the sharp decline experienced during the 2001 recession, weakness in this market is still worrisome as temporary employees are the first to be let go heading into a downturn and the first to be hired coming out of a downturn. We'll be watching this metric closely as the year progresses.

On the Ground with Employment Companies
Although most employment firms haven't reported first-quarter earnings yet, we've heard some commentary that gives us reason to believe the near term will be difficult for companies in this space.

In the previous chart, it's obvious that permanent employment is substantially less volatile than temporary employment, and this should manifest in company performance.  Paychex (PAYX), a payroll processing company, reported nearly 10% revenue growth in its fiscal third quarter (which includes January and February)--only a slight slowdown from the firm's fiscal second quarter. But in the conference call, management said that they "are seeing signs of a weakening economy indicated by a more-difficult-than-normal third-quarter selling season and increases in business failures." Paychex is one of the strongest employment companies, but even it is not immune to weak employment.

 Administaff , another core employment company, also highlighted signs of upcoming weakness. From the fourth-quarter conference call in early February:

 "...over the last 90 days, we've seen no growth in the client base as layoffs and new hires canceled one another out...Another sign of slowing comes from commissions paid to sales staff at client locations...indicating that the pipeline and pace of new business within the client base has slowed somewhat."

Staffing companies, which primarily operate in temporary employment, should fare much worse if conditions deteriorate further.  Manpower (MAN) and  Kelly Services (KELYA), two of the more internationally diverse staffers, performed reasonably well as foreign labor markets showed less weakness than the U.S. markets, and the U.S. dollar's fall added a significant boost to reported results. However, their U.S. businesses painted a much different picture, with revenue declines in the high single digits to low double digits on a constant currency internal growth basis.

 True Blue (TBI), a blue-collar staffing firm in the U.S., reported same-branch sales declines in the low single digits, which comes on top of a string of tough quarters. From the conference call:

"The rate of decline increased during the final weeks of the quarter and into the first two weeks of the second quarter. Our customers continue to face difficult economic conditions, and growth in the industrial staffing sector will be a challenge in the short term."

 Robert Half (RHI), a strong white-collar staffing firm, reported decent first-quarter results, but forward-looking commentary was less encouraging. From the conference call:

Analyst: "We've seen some negative data from the Bureau of Labor Statistics, [and] I am just trying to understand if you've seen any reflection of those trends."

M. Keith Waddell, CFO: "Well clearly we saw softening over the course of the quarter. It was particularly true late in the quarter and...continued in the first few weeks of April. There is no question about that."

We look forward to learning much more in the next month or so, as companies report earnings and management teams provide their take on the labor environment. Given the overall accelerated decline in temporary staffing during the last few months, we expect unfavorable outlooks to be common. To stay in tune with new developments, we encourage you to watch for updates to our Stock Analyst Reports and our labor market review next quarter. The chart below is a breakdown of our employment coverage universe as of April 22, 2008.

Core Employment
Company	Industry	Moat	Fair Value Uncertainty	Star Rating	P/FV	1-Year Perf.
ADP (ADP)	Payroll	Wide	Low	5	0.82	0%
Paychex (PAYX)	Payroll	Wide	Low	5	0.79	1%
Administaff	PEO	Narrow	Medium	5	0.70	-27%
Gevity	PEO	Narrow	High	5	0.52	-61%
Non-Core Employment
Company	Industry	Moat	Fair Value Uncertainty	Star Rating	P/FV	1-Year Perf.
AMN Healthcare (AHS)	Staffing	Narrow	Medium	5	0.70	-38%
CDI Corporation	Staffing	None	High	2	1.32	-15%
Cross Country (CCRN)	Staffing	None	Medium	4	0.87	-39%
Heidrick & Struggles (HSII)	Staffing	Narrow	High	3	1.17	-32%
Hudson Highland Group (HHGP)	Staffing	None	High	1	1.43	-45%
Kelly Services (KELYA)	Staffing	None	High	3	1.02	-40%
Korn/Ferry Intl. (KFY)	Staffing	Narrow	High	3	1.02	-26%
Kforce (KFRC)	Staffing	None	High	3	0.91	-37%
Manpower (MAN)	Staffing	Narrow	Medium	3	1.10	-19%
MPS Group	Staffing	None	High	3	1.11	-24%
Robert Half (RHI)	Staffing	Narrow	Medium	3	0.88	-28%
Spherion	Staffing	None	High	3	0.77	-41%
Trueblue (TBI)	Staffing	Narrow	Medium	3	0.97	-40%
Volt Information Sciences (VOL)	Staffing	None	High	3	0.86	-45%