US Perspectives: When Bad News Is Good News

How could bad employment numbers help the market?

Robert Johnson, CFA 12.10.2010
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Poor Labor Report Drives Stock Market Higher

Last week's employment report was bad enough to convince investors that the Federal Reserve will activate its contingency plan to reduce long-term interest rates through so-called quantitative easing. Under these programs, increased Fed direct purchases of debt securities means higher demand for those instruments. With higher demand comes higher bond prices, which means lower yields for borrowers. (Bond prices and yields move in opposite directions.) With headline employment figures down some instead of flat as expected, there was no impetus for the Fed to stop its baby steps toward more monetary easing.


Theoretically, lower rates could help the stock market in many ways. Lower interest rates mean that stocks, especially stable dividend-paying stocks, are more attractive to investors. Second, lower rates, if believed to be sustainable, mean higher price/earnings ratios (a lower discount rate on future earnings). Some could also view lower rates as being stimulative of overall economic growth and a positive for corporate earnings. Hence, recent bad economic news has increased the likelihood of more easing and perversely helped the market.


Further Easing Looks More Likely than Just a Week Ago

Previously I pooh-poohed the probability of extensive easing based on increased inflation prospects and an economy that continues to improve, albeit at a snail's pace. Also in the back of my head was the concept that low rates aren't convincing scared consumers and investors to let loose with their spending. In my opinion, jobs, incomes, and consumer confidence are holding back the economy--not high rates. Combining that with some internal Fed dissension on that issue made me think, just a week ago, that the market was overweighting the probability of more easing. Some statements by Bernanke and other Fed members last week, along with a sloppy employment report, may eventually prove me wrong.


The Jobs Report Wasn't So Bad as to Raise Prospects of a Double Dip

But the employment report wasn't so bad as to scare investors into thinking we were going back into a double-dip recession. Yes, the headline number was down, but a good part of that was the continuing loss of census workers (those layoffs are now pretty much complete). Local government job losses were a lot bigger than I anticipated, harpooning my forecast of no net job losses. Otherwise, the report was as advertised with employment growth in several sectors.


Outside the Employment Data, News Last Week Was Decent

The pending homes sales index managed its second small monthly increase in a row, indicating the worst of the housing credit induced boom and bust may have finally moved into the rearview mirror.


Although I am not a big follower of the ISM nonmanufacturing index, this index managed to show almost a 2-point gain to 53.2 in September. Any reading over 50 suggests growth in that sector. I have noted in past columns that slow growth in services has been an impediment in this economic recovery, so I am particularly pleased to see some improvement in this leading indicator.


In other news, initial unemployment claims fell again after a meaningful runup this summer. Individual retail same-store sales also surprised on the upside, though much of the improvement was induced by sale prices and promotions.


On balance, current data look better. However, I am very fearful about slowing consumer wage growth, which usually turns up in the spending numbers three to six months later. With a lot of the inventory and export-driven improvement behind us, the economy can only move forward in 2011 with better consumer spending and sustained business investment. Without wage growth, the economy is dependent on consumers saving less or exports improving sharply to move us forward.


Employment Growth Disappoints Based on Poor Local Government Hiring

The monthly employment report didn't provide any news to cheer about. The headline employment figure showed 95,000 jobs lost in September, while the market and I had both hoped that growth in private sector employment would exactly offset losses from Census Department layoffs. The difference between expectations and reported employment figures was due almost entirely to local government jobs that declined by 76,000.


The market took the employment report in stride as private sector employment, believed to be a better indicator of the economy than government employment, still managed to show growth of 64,000 people. Private employment growth has been mired in the 0-100,000 level since the beginning of the year. Even at the high end of that range, the economy would add just over a million jobs a year compared to a loss of more than 8 million jobs between 2007 and 2009 during the worst of the recession. The employment numbers are consistent with a slow upward trudge in the economy (not a double dip), but the economy certainly isn't lighting the world on fire in terms of job growth, either.


Nominal Wage Growth Barely Budged

More troubling than the meager private sector employment growth was the extremely sluggish growth in hours worked and hourly wage rates.


The combination of employment growth, hourly wages, and hours worked provides a proxy of consumer wages income that constitutes well over half of consumer income. The hourly wages of production and nonsupervisory employees was particularly disappointing, increasing just $0.01 to $19.10, an increase of less than a tenth of a percent for September.


Given that the consumer price index is predicted to increase 0.2% over the same period, the average worker is seeing real wages go in reverse for the month of September. Looking at the data on a year-over-year basis also paints a picture of slowing improvement.


Real Hourly Wage Growth Slipping Again?


YoY Change Real Hourly Wage (%)

Sept 2009








Jan 2010
















Sept (e)


Source: Bureau of Economic Analysis, Morningstar Calculations
(e) September hourly wage, estimated PCE inflation index of 0.2% for September


Hours Worked Were Flat, Too

The news on hours worked wasn't much better, as the average work week for production and supervisory employees was unchanged from the prior month. The work week is important for two reasons. First, like the hourly wage, hours worked tend to be a precursor to overall employment growth. Employers tend to work current employees longer before they step up and add new employees. Therefore, this month's lack of growth is not a particularly good sign for employment growth in the months ahead. Hours worked are also a driving factor in overall wage income, which eventually drives consumer spending.


Initial Unemployment Claims Looking Better Again

The news on the employment front last week was not all bleak. Weekly initial unemployment claims fell to the lowest level in three months. Theoretically, this weekly report measures a period that falls two weeks after the monthly employment report indicating subsequent improvement in the employment market.


After the four-week moving average of initial claims bottomed in late March at 448,000, initial claims crept up to a high of 488,000 in late August and have now fallen back to 455,750. This is a relatively large short-term runup that has been largely reversed. Unfortunately, the layoffs are still above the 300,000-350,000 level of a "normal" recovery but well below that recession high of 658,750. And there might even be more good news on that front.


Challenger Gray Says Corporate Layoffs Back to 2000 Levels

The Challenger Gray & Christmas corporate layoffs report noted that second-quarter corporate layoffs were now down to their lowest level since the second quarter of 2000. The quarterly total layoff announcements were 53% below the layoff levels of a year ago. So why can these numbers look so good while initial claims haven't showed that dramatic improvement? Part of the answer is that small businesses just aren't doing as well this recovery as they have in the past, probably because of credit issues and smaller exposure to strong export markets than their larger brethren. Smaller business layoffs don't make newspaper headlines and aren't captured in the Challenger Gray report.


Retailers Gear Up for the Holidays

Other good forward-looking news came from retailers last week, many of which announced plans for more retail hiring for this holiday season. Macy's, Toys 'R' Us, and Kohl's all have announced plans to increase holiday hiring over year-ago levels. In a separate Challenger Gray survey, the firm estimated that overall holiday hiring would range from flat to up as much as 20%. A better back-to-school season and recent holiday forecasts could mean that retailers have a shot at the higher end of that range. Some indications from retailers seem to indicate that some of that hiring may come earlier in the season compared to 2009, when hiring really didn't begin in earnest until mid-November.


Retail Sales: Get the Ruler Out

News on the retail front was still consistent, a slow but steady improvement in retail sales. Since May, one can literally lay a ruler down on the same-store sales reports from the International Council of Shopping Centers. While a lot of parts of the economy such as imports, exports, and inventories have been jumping around, consumer spending has managed to hold steady. Even the miniscule slowing in September is explained away by warmer weather depressing fall apparel sales and the fact that the retail rebound got under way last fall, making year-over-year comparisons more difficult.


 Same-Store Sales Ex-Drug Stores


YoY Change

May 2010










Source: International Council of Shopping Centers


However, the respectable September report didn't come without some pain. Promotional activity was high. Additionally, a lot of consumers held out until the last minute to make their back-to school purchases. Nevertheless, a better-than-expected back-to-school season is being widely interpreted as a reason for optimism for this holiday season.


Holiday Sales Forecasts Looking Jollier

Looking ahead, some initial forecasts for the holiday season were announced last week and were relatively bullish. The National Federation of Retailers forecast that same-store sales were likely to be up 2.3% this year compared to a 10-year average of about 2.5%. That's not exactly a barn burner, but it is a lot better than last year's 0.4% growth and 2008's decline of 3.4%. The 2010 forecast from the Federation was relatively consistent with 3.0%-3.5% growth forecast by the International Council of Shopping Centers.


Pending Home Sales Put at Least a Temporary Bottom on the Real Estate Market

News on the real estate market last week was pretty quiet but improved. Pending home sales were up 4.3% sequentially in August, following a July increase of 4.5%. However, last year's credit-inflated pending home sales index was still 20% or so higher. Morningstar's housing team believes the increase in pending home sales will translate into existing home sales in the low 4 million range on a seasonally adjusted annual run rate basis when it is reported later this month.


Apartment Vacancy Rates Plunge

Perhaps the surprise news of the week came from Reis, an impartial provider of real estate market data, who reported that apartment vacancies rates had their sharpest fall on record. Vacancy rates fell from 7.8% in the June quarter to 7.2% for the September quarter, while rental rates increased 0.6%.


Rate increases mean that apartment owners were not stuffing their vacant apartments because of extensive discounting. Combined, a much higher occupancy rate and improved pricing mean that the apartment market has clearly stabilized. That means that apartments may prove to be less competitive with free-standing homes based solely on price. Whether the improved demand is coming from people who have lost their homes or new household formations (as people that doubled up during the recession seek their own, separate living facilities) remains an open question. I also caution that the Reis report does not cover smaller cities and towns.


On the Docket: Prices, Census Department Retail Sales, and Balance of Trade

My biggest worry for this week is the Consumer Price Index, due on Friday. Current expectations are for overall growth of 0.2% over the prior month. Given rising oil prices and rents that are no longer going down, there is an outside chance the CPI could be up 0.3% for the third month in a row. That annualizes to a 3.6% annual rate, which is higher than most market participants seem to believe. Given that both the hourly wage rate and weekly earnings were up less than 0.1%, an inflation rate of 0.3% will not be well-received by consumers.


Will Imports Sink the GDP Report Again?

The normally obscure balance of trade report for August takes on increased importance as this line item single-handedly sank second-quarter GDP by over 3%. The July report reversed most of the huge jump in imports in the second quarter. All eyes will be on the import/export report to determine whether the balance of trade number has finally stabilized. While recently declining demand for consumer electronics and less robust apparel sales point to some improvement, Long Beach/Los Angeles Port data and intermodal/container shipments reported by the rail industry seem to indicate that imports have continued to rise. The consensus is projecting a deficit of $44 billion versus $42 billion in July and June's $49 billion stunner.


Retail Sales on Trajectory to Have Their Best Month since March

The always difficult to project Census Department Retail Sales report is forecast to increase by an impressive 0.6% sequentially, the best showing since March. Auto sales, which had their best month in seasonally adjusted unit volume since September 2009's Cash for Clunkers, will be a big contributor. Even without auto sales, retail sales are expected to show a 0.4% increase.



This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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