SERIOUS MONEY:The diehard bull market cheerleaders on Wall Street are partying again following the release of the US employment report for September last Friday. The numbers were broadly in line with expectations but revisions to previous releases showed that the drop in employment previously reported for August never happened.
The perennial optimists view the data as a poke in the eye to the merchants of doom and believe that the fourth-longest economic expansion in US history is back on track, while the second-longest bull market advance without a 10 per cent setback is set to move onward and upward.
It should come as no surprise against this background that the Dow Jones Industrial Average reached an all-time high following the latest report on the employment situation, but is the belief that happy days are here again truly justified?
It is beyond dispute that the latest employment numbers are a welcome surprise for an economy that has been growing below trend for several quarters and seemed to be on course for an economic recession.
Unfortunately, September's report of conditions in the labour market is far less encouraging than that espoused by the perma-bulls. Indeed, even the upwardly revised numbers of July and August, alongside the 110,000 net new jobs created in September, are little cause for comfort, as the three-monthly average of just 90,000 net additions falls well short of the level required to maintain a stable employment market in the face of an expanding labour force.
Furthermore, almost all of the upward revisions are attributable to public sector employment, teachers in particular. The fact of the matter is that government positions accounted for the bulk of net job creation last month, while openings in the private sector continued to disappoint.
As the so-called bullish employment report reached the tape and stock prices edged higher, the US Bureau of Labor Statistics' annual benchmark revision of employment figures in the year to March 2007 went largely unnoticed. The revision showed that there were 297,000 fewer jobs created, or roughly 25,000 a month, than initially estimated.
Of course, history is irrelevant for asset price determination in theory, but the Bureau of Labor Statistics revisions should never be ignored for good reason - the so- called birth/death adjustment.
The birth/death adjustment attempts to account for the net new jobs created by small businesses that have not as yet reported to the Bureau of Labor Statistics. Unfortunately, the adjustment is estimated from the actual births and deaths in businesses over the previous five years, which means that the payroll numbers reported are decidedly lagging. The data released consistently overestimates labour market reality during the late stages of an economic expansion and reveals that employment is recovering long after an economic recession has ended.
The adjustment indicates that more than 80 per cent of all the jobs created since the start of the year were in net new business, as against 35 per cent in 2005, a clear indication that the labour market is not holding up as well as the bulls believe. In this context, the focus on payroll numbers on the first Friday of each month by economists across the investment community is bizarre - its unreliability is legendary.
Those who pay for the services of economists should demand that they ignore the headline numbers and dig deeper. An in-depth analysis of last week's numbers is revealing and, as leading indicators of economic activity, they point in one direction - an economic downturn.
The median duration of unemployment continues to move higher, up almost eight weeks since the end of 2006; the employment-to-population ratio is edging lower, while the lagging unemployment rate is rising. Furthermore, temporary help workers continue to suffer, with a cumulative loss of 74,000 jobs over the past year.
Historically, trends in temporary employment have been a good leading indicator of payrolls, which is not surprising since contract or part-time workers tend to be the first out the door when economic conditions slow.
Each of the measures mentioned above has considerable predictive ability at the peak of an economic cycle with few false signals over the past 40 years.
Indeed, a composite measure based on labour market data has an unblemished record at business peaks and currently suggests that the probability of recession in the near future is roughly 70 per cent. In combination with other indicators, the odds remain close to one in two.
The financial markets appear to believe that an economic downturn is out of the question following the lowering of interest rates by the US Federal Reserve in September and the upbeat employment report last Friday. But the bull market cheerleaders are either negligent or downright lazy, as the housing bust is far from an end.
Mortgage rates have moved higher, while lending standards have tightened considerably. Perhaps more importantly, leading employment indicators suggest a recession is not far away. It is simply too soon to argue that the US economy is out of the woods. Investors are well-advised to remind their advisers and managers that the devil is in the details.
charliefell@sequoia1.ie
