Markets were pleasantly surprised – no, shocked – on Friday morning when they received the Payrolls Report from the Bureau of Labor Statistics (BLS). The consensus of economists was for a loss of 7.5 million jobs and an unemployment rate of 19%, yet the report showed a gain of 2.5 million jobs and an unemployment rate of 13.3%. Regardless of how one values economists and their estimates, it’s quite rare for them to be so incorrect. Investors are craving signs of an economic rebound and are trading as though one is imminent. They were quite pleased to see their views vindicated, and markets reacted accordingly. Stocks soared and bonds plummeted – the type of moves that one would expect from a positive economic surprise.
As it turns out, there were some major discrepancies underlying the staggering headline numbers. Those discrepancies, taken in light of the responses by the markets and various lawmakers, may create subtle and unanticipated risks to the outlooks for the economy and financial markets.
I was immediately flummoxed by the report. Here is a conversation that I had with a reporter shortly before the markets opened on Friday.
Journalist: What do you think of the jobs report?
Me: I don’t know what to truly make of it – it’s a total outlier. If it’s real, it may be too good – meaning that there is less of a case to be made for Fed and fiscal stimulus, and I’m not sure how the markets will react if the prospects of further stimulus is removed. But in the meantime, the market’s [sic] are doing what they should, with equities rallying and bonds sinking.
Journalist: Do you question whether it’s real?
Me: Poor choice of words. Real as opposed to fictional – it’s real. Real as opposed to there being some weird statistical quirks and one-time items that have yet to be explained – not sure.
That conversation sent me on a mission. I needed to see whether my gut reaction was correct, to determine whether there was indeed something quirky in the report.
The first place I looked was the ADP Employment report that was released on Wednesday morning. Like the BLS payrolls report, that statistic reports changes to the workforce. The methodology is different though. The ADP report is based on a subset of anonymous payroll data using approximately 365,000 of the company’s 500,000 US business clients (my company is one). Since ADP typically releases their report two days before the BLS, it is considered a guide to the larger report. The ADP report actually presaged the BLS report quite accurately, showing a decline of 2.76 million jobs versus an expectation of 9 million job losses. Equity markets rallied over 1% that day on that positive surprise, but enthusiasm was tempered by the market’s belief that the narrower ADP survey is less valuable than the broader BLS survey.
I have to admit that my urge to do some fact finding faded after reviewing the ADP report. The two surveys agreed, so that seemed to be confirmation enough. In the meantime, markets continued to rocket higher. The President took a victory lap in the White House Rose Garden, which obscured some of the early commentary from members of his party that the jobs reports reduced or eliminated the need for further fiscal stimulus. Those comments piqued my interest, not only because they confirmed my early assertion to the reporter. Fiscal stimulus played an enormous role in the market rebound. A wide assortment of businesses and households were backstopped by the federal loan programs and direct payments. That arrested much of the market’s panic. Furthermore, it appears that much of the stimulus money found its way into the stock market. It is less clear that there will be another round of fresh money coming into the stock market without another bout of stimulus.
At that point I realized that I needed to delve further into the numbers behind the report. Since markets seem to depend on fiscal and monetary stimulus, and the case for stimulus is reduced, any discrepancy in the labor report moves from an economic quirk to an important market moving factor. This went from something that I would have liked to understand to something that I needed to comprehend.
Of the 8.4 million employed people not at work during the survey reference week in May 2020, 5.4 million people were included in the “other reasons” category, much higher than the average of 549,000 for May 2016–2019 (not seasonally adjusted). BLS analysis of the underlying data suggests that this group included workers affected by the pandemic response who should have been classified as unemployed on temporary layoff. Such a misclassification is an example of nonsampling error and can occur when respondents misunderstand questions or interviewers record answers incorrectly. BLS and the Census Bureau are investigating why this misclassification error continues to occur and are making changes for the June collection.
One assumption might be that these additional 4.9 million workers who were included in the “other reasons” category should have been classified as unemployed on temporary layoff. If these workers were instead considered unemployed on temporary layoff, the number of unemployed people in May (on a not seasonally adjusted basis) would increase by 4.9 million from 20.5 million to 25.4 million. The number of people in the labor force would remain at 158.0 million in May (not seasonally adjusted) as people move from employed to unemployed but stay in the labor force. The resulting unemployment rate for May would be 16.1 percent (not seasonally adjusted)…
There is much two unpack in those two paragraphs and others that surround them. The short version is that the BLS acknowledges that they may have overestimated nearly 5 million workers as being employed when they were not, and that the unemployment rate was perhaps 16.1% instead of the 13.3% that was reported. If we subtract 5 million from the +2.5 million that was reported, we would show a decline of 2.5 million jobs, which is still an extraordinary improvement over the -7.5 million expectation. An unemployment rate of 16.1% would have shown an increase over the prior month’s reported 14.7%. It is hard to imagine that those results – a further decline in payrolls and a rise in the unemployment rate – would have warranted exuberant messaging about the nation’s return to economic health.
I then began to wonder how so many economists could have gotten their estimates so wrong, even when allowing for the potential sampling error. There was a clue in the BLS report, presented in parentheses but with helpful hyperlinks:
That April report was similarly informative, stating the following:
The 8.1 million workers with a job but not at work who were included in the “other reasons” category is about 7.5 million higher than the average of recent April estimates. (While this category contains misclassified workers, not every person in this category was necessarily misclassified. The average for 2016–2019 was 620,000 employed people with a job not at work for “other reasons.”)
One assumption might be that these additional 7.5 million workers who were included in the “other reasons” category should have been classified as unemployed on temporary layoff. If these 7.5 million people were to be considered unemployed on temporary layoff, the number of unemployed people in April (on a not seasonally adjusted basis) would increase by 7.5 million from 22.5 million to 30.0 million. The number of people in the labor force would remain at 155.8 million in April (not seasonally adjusted) as people move from employed to unemployed but stay in the labor force. The resulting unemployment rate for April would be 19.2 percent (not seasonally adjusted), compared with the official estimate of 14.4 percent (not seasonally adjusted).
There are a few takeaways here. Markets were pleased when the April jobs report (released on May 8th) showed unemployment rising from 4.4% to 14.7%. Though a distressing result, that 14.7% was better than the 16% median estimate of economists. The reported change in payrolls was a loss of 20.5 million jobs, also beating the estimate of -22 million. The narrative became that the economy was under distress, but things weren’t as bad as feared. Consider the changes to that narrative if the reported numbers were instead a 19.2% unemployment rate amidst job losses of 30 million. Would markets have been quite so exuberant over the prior month?
Comparing apples to apples, the most recent employment report does indeed show marked improvement over the prior month’s results. Under either circumstances the unemployment rate and payroll declines would have fallen, which is welcome news. Yet it is also appears that economists were assuming that April’s adjustments would be properly accounted for in the May’s report. That made the magnitude of the beat look much larger than it otherwise might have. A set of eye-catching numbers would likely have appeared less so under those circumstances.
We can’t rewrite history, so it is fruitless to dwell on the “what ifs”. Investors and traders need to look forward, and that this the only productive context under which we should analyze the discrepancies in the jobs reports. The following questions are relevant, and markets will need to answer them over the coming weeks:
- Did markets overreact to last week’s jobs report?
- Will legislators be taking cues about the path of future stimulus from an over-optimistic report?
- Will markets be shocked when the BLS is able to resolve the misclassifications?
These are crucial questions that defy an immediate answer. We all need to consider carefully the range of potential outcomes to avoid surprises in the coming weeks.
Disclosure: Interactive Brokers
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