The unemployment rate rose 3 percentage points to 9.7% in August. Both the bond and stock markets greeted the monthly employment report as indicating a recovery was near or had already started. Stocks advanced and Treasuries declined (interest rates rose). Both behaviors are expected in an expanding economy, especially in the early stages, as growth is anticipated and inflationary expectations start to rise.
Looking at the past month, however, the stock market and the bond market have been diverging. Since Aug. 6, both stocks and bonds are up. Advances have occurred for the
(up 1.9%) and the
(up 2.6%). Over the same period, Treasuries have risen in value, and the yield on the 10-year Treasury has fallen from 3.89% to 3.45%. That is a 44-basis-point decline, or 11%. Falling interest rates (rising bond prices) are consistent with deflationary expectations.
Which market has the correct picture? Let's dig into the employment data for an answer. The following table shows the data used in unemployment rate calculations, comparing July and August data.
The following table shows additional data, including the nonfarm payrolls report, which provides the jobs gained or lost, one of the headline numbers found in every daily newspaper. Nonfarm payrolls indicated that 216,000 jobs were lost in August.
Note: The U-7 and U-9 unemployment rates are calculated based on a 40-hour week constituting full employment. If someone works a 30 hour week, that counts as 0.75 persons employed (unless they chose to work the shorter hours). U-7 corresponds to U-3, and U-9 corresponds to U-6. Those working part-time by choice are each counted as one full employee regardless of the hours worked.
Following are three lists: one list for data indicating a possible future improvement in the employment picture; a second list for neutral indications; and a third list for data indicating possible future degradation in employment.
List 1: Positive Employment Data
- a. The nonfarm payroll decline is slowing; "only" 216,000 jobs were lost.
- b. The civilian labor force increased by 73,000.
- c. The number of people employed full-time is declining at a slower rate than at the beginning of the year. See Fig. 1.
- d. The year-over-year rate of employment decline is less since March. See Fig. 2.
List 2: Neutral Employment Data
- a. The average weekly hours were unchanged at 33.1.
- b. The number employed part-time for economic reasons (involuntary part-time) has been relatively flat for five months. See Fig. 1.
List 3: Negative Unemployment Data
- a. The number employed part-time for economic reasons (involuntary part-time) had its biggest jump in five months (449,000).
- b. The civilian labor force has declined by 503,000 since May.
- c. The number of people employed full-time continues a steady decline. See Fig. 1.
- d. The year-over-year rate of employment decline has continued at the same rate for five months. See Fig. 2.
- e. The number of people unemployed increased by 466,000 in the population survey.
- f. The number of people employed decreased by 392,000 in the population survey.
Three of the four positive factors (a, c and d) are "less bad", or second derivative improvements. The third positive factor (b) is much less than the measurement error and very small compared to the three-month trend (List 3, factor b)
One of the negative factors (a) comes after a five-month neutral period (List 2, factor b). It should not be considered significant (even though it is larger than measurement error) unless it is the same or larger in future months. The last two factors (e and f), while large, have measurement errors (+/- 300,000), so less significance should be attached these unless subsequent data are supportive.
The four most significant factors in the August report are:
Lessening rate of job loss in the nonfarm payroll data (a second derivative positive);
Continuing steady decline in full-time jobs (a second derivative negative);
Continuing steady decline in employment year over year (a second derivative negative);
The large decrease in the civilian labor force since May.
On balance, there is less bad but still not much good in the latest data. Stocks can continue to look forward optimistically for awhile, but second derivative improvement can not be the only good news forever. One can go asymptotically to zero with second derivative improvements. However, until investors give up hope of first derivative good news, there is no reason why stocks should be driven down by employment news. After all, investors can still hang their hats on improving productivity, while waiting for other good news.
Bond investors can cheer hearing the same news. A continuing contraction of employment is consistent with a deflationary environment. So maybe the behavior of both stocks and bonds over the past month is self-consistent. This would be the case if we had a deflationary recovery. This has happened before, in the 1930s.
There are, of course, three other possibilities:
The bond market is wrong and inflation will begin.
The stock market is wrong and recession will return.
Both markets are wrong and both recession and inflation will occur. This could be the mother of all stagflation if it were to occur under the present circumstances.
At the time of publication, had no positions in securities mentioned.
John B. Lounsbury is a financial planner and investment adviser, providing comprehensive financial planning and investment advisory services to a select group of families on a fee-only basis. He worked for 34 years with IBM, and spent 25 years in R&D management and corporate staff positions. He also was a Series 6, 7, 63 licensed representative with a major insurance company brokerage for nine years.
Specific interests include political and economic history and investment strategy analysis. He holds degrees from the University of Vermont, Columbia University and the Illinois Institute of Technology, where he studied chemistry, physics and mathematics. He is a contributor to Seeking Alpha and his own blog,