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Producing Employment

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet ) -- When April's U.S. unemployment came out, one headline perfectly captured the news and popular reaction: "Unemployment Rate Hits Three-Year Low. Hooray? No, Boo!" Headline unemployment fell to 8.1%, but payroll gains slowed and missed expectations, fueling fears of weaker employment growth from here.

In our view, it's a touch premature to extrapolate a coming employment slowdown from April's data. While payroll gains have slowed since February, that could be partly due to the late 2008/early 2009 sharp slowdown's skewing the seasonal adjustment -- data suggest it artificially inflated January and February payrolls and deflated March and April. Plus, while weekly jobless claims rose in early April, a sharp drop last week suggests the uptick may have been simply temporary volatility amid a longer-term downward trend.

And here's another, more forward-looking indicator for future employment: Labor productivity fell in Q1, and the average annual rate has been under 1% since early 2011 (Exhibit 1). While some observers fretted the decline, in our view, it suggests a hiring increase may be in the offing.

Exhibit 1: US Non-Farm Productivity

Sources: US Bureau of Labor Statistics, Thomson Reuters.

Productivity, which measures output per hours worked, tells us how firms manage their business at various points in the economic cycle. In late 2008, productivity fell as a rapid drop in orders meant quick reductions in output. Later, firms cut headcount as the recession developed.

As demand returned in 2009, rising orders buoyed output at these still-trim firms -- spiking productivity demonstrated how firms were doing more with less. And firms continued squeezing more and more output out of their existing workforce throughout 2009 and 2010 -- one reason increased hiring didn't (and typically doesn't) immediately follow the trajectory of the nascent recovery. When firms can meet demand with the workers they already have, there's not much reason to hire more.

But now, it seems firms have reached the limit of how much more they can extract from staff on hand. As Exhibit 2 shows, productivity regularly trails off in the first few years of a recovery, as large early gains likely cool -- a compounded 8% productivity jump every quarter is simply unrealistic.

Exhibit 2: US Non-Farm Productivity (Recessions Highlighted)

Sources: US Bureau of Labor Statistics, Thomson Reuters.

Q1's productivity drop was thus true to form -- and not at all indicative of flagging demand. Output rose in Q1, but total hours worked rose faster as firms needed more workers to meet rising demand. In fact, Q1 saw some of the strongest hiring in this expansion, a 631,000 increase in private payrolls. As the expansion continues and demand keeps rising, firms will likely need to continue hiring to keep up.

To be sure, there will likely be volatility in both hiring and productivity numbers -- that's a normal facet of even the strongest economic expansion. But overall, the employment and productivity reports confirm the private sector's underlying strength -- firms are producing more, hiring more and seem set to remain profitable. Just another sign of the U.S. economy's underappreciated health.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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