In the age-old parlor game of placing trades around the Labor Department's monthly employment report, a new wrinkle has been introduced on Wall Street that is suddenly receiving fresh scrutiny from investors.
Automatic Data Processing
, which handles payroll duties for large and small companies across the nation, hired a group of respected economists to use its data to produce its own measure of payrolls in the private sector. It comes out two days before the government's report is released on the first Friday of every month.
Since its launch in 2006, the so-called ADP National Employment Report has been adopted by economists and investors -- with encouragement from the company -- as an early indicator of the job market that can help divine which way the official statistics will break in relation to expectations in the market. That said, those who shift around their forecasts based on the ADP report often get burned as a result, leading some to question the report's credibility.
The ADP report keeps getting touted as a curtain-raiser to the government's report, but it simply has not lived up to that," says Jeff Hall, chief U.S. economist with Thomson Financial, a firm that polls Wall Street's economists and analysts and reports their average forecast as representative of expectations on Wall Street. "Despite the temptation, I've never adjusted my numbers based on the ADP report, and I'm glad I haven't. The market needs to move away from its adherence to the ADP report. People are putting way too much stock in it."
Trading on Wall Street is all about expectations, and at no time do those expectations get more attention than in the lead-up to the release of the government's monthly employment report. As far as closely-watched data points on Wall Street go, jobs is probably the most relevant on Main Street, so the release of the government's employment report marks one time every month when financial news is almost guaranteed to be front-page news.
For that reason, the jobs report takes on added significance, and the market's reaction to its frequent surprises can be all the more dramatic. Politicians use the payroll numbers as a way of settling scores in debates over economic policy, and
watchers regularly bat them around as an excuse to call for a change in monetary policy. In times of increased economic uncertainty, the monthly jobs data becomes a key way for economists to determine whether conditions are getting better or worse.
The release of January's report was just such a time, with a debate raging in the markets over whether or not Wall Street's credit crisis and the U.S. housing market downturn is causing an economic recession. With that in mind, expectations for last Friday's data were conservative, with consensus estimates showing economists expecting the economy to have added 65,000 jobs to nonfarm payrolls for the month.
Then, ADP raised hopes for a strong number on the Wednesday leading up to the government's release when it reported that the economy added 130,00 service sector jobs in January. If that was accurate, then the government's report would likely be even larger, since it measures both public and private sector jobs. Several Wall Street economists responded by adjusting their forecasts higher, only to be disappointed when the government's official data arrived Friday morning to show a surprise decline in nonfarm payrolls by 17,000 jobs.
Lehman Brothers economist Ethan Harris responded to the ADP Report by adjusting his estimate in what proved to be the wrong direction, from a gain of 70,000 jobs to a gain of 90,000.
To be fair, predicting monthly jobs gains in the U.S. economy is really an impossible task, and all economists are often wrong in their forecasts from month to month. (Harris actually took top honors in
The Wall Street Journal's
economic-forecasting rankings for 2007.) Moreover, the initial figures are subject to multiple revisions that have been known to change the tone of the report significantly. Last August, for instance, the government first reported a decline in nonfarm payrolls by 4,000 jobs, only to revise the figures later to a gain of 74,000 jobs.
For his part, Harris defends the credibility of the ADP Report as an indicator that can often be helpful in providing a sense of direction that the numbers may take, but hardly a literal predictor of exactly what the government's data will show.
"Its track record over the last two years is mediocre, but it's a big sample and a useful piece of data put together by a good bunch of economists, and two years is a very short period to judge this kind of an indicator," says Harris. "People in the markets go hot and cold on it. It has a good month and everyone thinks it's a great indicator, and then it has a bad month like last month and they don't pay any attention to it. The truth is that you should always give it a modest weight and then lean your forecast in that direction."
While January's results have renewed skepticism about the report's predictive powers, scrutiny of the ADP numbers is hardly new. For November, Wall Street was expecting the government to report a gain of 100,000 jobs for the month. The ADP report showed a gain of 189,000 in just the private sector, only to leave the market disappointed when the government reported a gain of just 94,000 (the number has since been revised even lower to 60,000).
In June of 2006, shortly after the ADP report was launched, it reported a monthly job gain of 368,000, but the government's actual number was 90,000. That came just as the company was being roundly criticized for being duped into giving out confidential client information to someone impersonating a client.
ADP did not respond to phone calls seeking comment for this story. On its Web site, however, the company says its estimates of monthly employment growth are on the "right side" of Wall Street's consensus forecasts roughly 70% of the time and they can be used to "improve significantly upon consensus forecasts."
The report is compiled by an economic advisory firm, Macroeconomic Advisors LLC, where former Fed governor Laurence Meyer serves as vice chairman. Thomson's Hall does not dispute the integrity of the report as an indicator of conditions in the labor market, but he does question whether it's a useful predictor of what the government's figures will be.
"Conceptually, the report has merit," says Hall. "They have extraordinary insight into the labor economy, but the report has not been a good predictor of what the government's numbers will show."
Hall points out since the ADP report's inception in April 2006, the company has reported 2.43 million net new private sector jobs, while the government has reported a gain of only 1.9 million.
"They're over-stating the government figures by about a half-million jobs," says Hall.
The company has an incentive to paint a bright picture of the job market, since its core business benefits when employment conditions are improving. For his part, Harris sees no bias one way or the other in the report's track-record, but he puts more stock in the government's statistics.
"There's no question that the Labor Department number is a better number," says Harris. "There's a mythology on Wall Street that somehow there are these magic private sector numbers that are better than government statistics and that's almost always wrong."