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ADP Sees 114K New Jobs

Dirk van Dijk, CFA

The Automatic Data Processing (NasdaqGS: ADP - News) employment survey was stronger than expected in July. It shows that private sector employment rose by 114,000,  above consensus expectations for a 100,000 increase.However, last month, the ADP numbers were far too optimistic, and showed a gain of 157,000 private sector jobs. The hopes that were raised by those numbers were dashed a few days later when the BLS reported that only 57,000 private sector jobs were created. ADP revised its June numbers in the direction of the BLS numbers, but not very far, lowering its estimate by 12,000 to 145,000.This is a somewhat encouraging report, if confirmed by the BLS on Friday. It is not a great report in an absolute sense, but it is better than expected, and offers reasons for hope after last month’s dismal showing.Over time, the ADP numbers do tend to align with the BLS numbers. There can, however, be substantial differences between the two reports on a month-to-month basis. Thus, it is not a slam dunk that the Friday report will be better than now expected, but that would be the way to bet. The BLS numbers do tend to get revised in the direction of the ADP numbers, so there is a good chance that the June BLS numbers will be revised upwards.As the chart below shows, the ADP (blue) numbers track the BLS (red) numbers pretty well over time, but the BLS numbers tend to be somewhat more volatile month to month.Results by Size of BusinessSmall businesses, defined as those with fewer than 50 employees rose a total of 58,000 jobs in the month. Medium sized firms, those with between 50 and 499 employees, gained 47,000 jobs while large firms with 500 or more employees added 9,000 jobs. Large businesses are a relatively small share of total employment in the country, accounting for just 17.463 million out of a total of 108.764 million private sector jobs in the country (16.1%). Small business is the largest source of employment at 49.267 (45.3%) million, followed by medium businesses at 42.034 million (38.6%).Results by SectorThe goods producing sector lost a total of 7,000 jobs. Overall, goods producing industries are not that big a source of jobs in this country, just 17.821 million (16.4%) in total. Employment in goods producing industries tends to be more volatile than in the service sector, and thus the goods producing industries have an outsized influence on the overall strength of the job market.Goods producing jobs, particularly manufacturing jobs, have been in a secular decline, particularly as a share of total employment for more than 30 years now. It looks like that trend is continuing. The goods producing sector is made up of Manufacturing, Construction and Mining. While construction jobs did increase during the housing bubble, those jobs were particularly hard hit in the Great Recession.Construction industry employment was down by 11,000 in July. Construction jobs peaked well before overall employment in the country, in January 2007. Over that period, employment has shrunk by a total of 2.135 million. That is more than one fourth of the total jobs lost in the entire economy since the recession started.Historically, construction employment (especially residential construction) is one of the first areas to recover when the economy starts to rebound, but that is not happening this time around. With the extraordinary weakness in new home sales in recent months, there is very little reason to believe in that construction employment is going to pick up anytime soon.High vacancy rates in most forms of commercial real estate also means that there is not going to be much of a pick-up in commercial construction anytime soon. Public construction projects have helped a bit over the last year or so, but those will be winding down fast as the spending cuts kick in.On the other hand, eventually higher employment is going to lead to higher rates of household formation. That, combined with population growth, will increase the demand for housing and the massive inventory overhang we have now will be absorbed. That, however, is not a first half of 2011 story, I'd say it's more likely to start late in 2012.Manufacturing was a bright spot in this recovery, but it started to falter last fall. It sort of looks dead in the water, down 1,000 this month. There were 11.672 million manufacturing jobs, or just 10.7% of the overall private sector workforce. Some of the recent weakness in manufacturing is probably related to supply chain disruptions stemming from the Japanese disaster. That has been a particular problem in the Auto industry, but it has not been alone in feeling those effects.Yesterday we found out that Auto sales had picked up in July, so there is reason to hope that the supply chain disruptions are dissipating. ADP does not break out mining jobs separately, but given the overall rise in goods producing jobs, we can surmise that the number of mining jobs was up 5,000 on the month.Within the goods producing sector, the declines were spread out evenly among the three size groups. The small firms lost 3,000 jobs, as did the medium sized firms. Large firms lost only 1,000, but there are only about half as many large firm manufacturing jobs as either small or medium firm jobs, so relative to the base the decline is about equal.The Service sector is far larger, accounting for 90.943 million jobs or 83.6% of the private sector total. It added 121,000. Of the jobs gained in July, 61,000 were added by small service firms, while medium sized firms added 50,000 and large service firms added just 10,000. Far more people are employed by small service firms, (42.627 million) than by either medium sized firms (34.271 million) or by large sized firms (14.045 million).Looking Ahead to Friday's ReportThe ADP report only covers private sector employment, not government jobs at any level. The two series do tend to move in the same direction, and tend to be closer once all of the revisions are in. Government employment has been falling in recent months, particularly at the state and local level, and that trend is widely expected to continue.Thus if the ADP numbers prove accurate for May, it means that the headline number on Friday is probably going to be around 85,000. That is still pretty weak for even an average month. It is sure not very inspiring coming out of a deep recession. That level of job growth will not put much of a dent into the vast army of unemployed and underemployed in this country, and depending on changes in the participation rate could still be consistent with a rise in the unemployment rate.Recent signals on the economy have been lousy. This report can be seen as good news only in that context. If you have seen a string of disasters, such as the GDP report last Friday, the ISM Index on Monday and the Personal Income and Spending Report yesterday, the merely mediocre starts to look great.GDP in the second quarter only grew at 1.3%. I suspect that most forecasters are rapidly downgrading their forecasts for the third quarter. From the recent data and trends, I suspect that it will also be below 2.0%, not well north of 3.0% as many (including the Fed) were calling for just a few weeks ago.The relatively robust ADP number is, however, consistent with last week's initial claims for unemployment insurance report, which once again dipped slightly below the 400,000 level. Housing is still a disaster zone. It seems pretty clear that the economy is not growing nearly fast enough to put a serious dent in the vast army of the unemployed, and the even larger reserve force of the underemployed.The consensus is looking for a gain of 84,000 jobs on Friday, with more than all of the gains coming from the private sector. The ADP numbers should not make a significant change in those expectations. The consensus is looking for a loss of 26,000 government jobs, mostly at the State and Local levels.The apples-to-apples private sector expectations are for a gain of 100,000 jobs on Friday. State and Local governments have been under severe fiscal strain and are likely to be laying off people, and in June, the Federal government also started to drop headcount. The government layoffs were 39,000 in June. It would not shock me if the government losses are greater than expected again this month.The Recent Past in PerspectiveWith the recent debt ceiling catastrophe avoidance agreement, don’t look for any help to the States from the Federal level. After all, such aid made up about one quarter of the ARRA. Not only is that not going to be renewed, the pressure is on to cut $1 Trillion of Federal Spending over the next decade, and then come up with another $1.5 Trillion of deficit reduction by Thanksgiving. If not, meat cleaver spending cuts of $1.2 Trillion go into effect.Given that the Tea Party-sympathetic members of the “super committee are unlikely to agree to any revenue increases, we will either see $1.5 Trillion of targeted spending cuts, or $1.2 Trillion of across the board (with some exceptions) meat-cleaver cuts (and lots of drama as the 11/23 deadline approaches; if you enjoyed the recent circus in Washington, don’t worry, you will get an encore).In either case, a big portion of those cuts are likely to be in reduced funding to the States and localities. Since States are legally not allowed to run operating deficits they either have to raise taxes or cut spending. Raising taxes is less politically popular right now than cutting spending, and the States continue to cut taxes, particularly on businesses.For the most part cutting spending at the state and local level will mean laying people off, or cutting take home pay of public servants. The State and Local cutbacks were a major source of “de-stimulus that offset the stimulus from the ARRA on the Federal side.From the point of view of the overall economy and aggregate demand, it really doesn’t matter if the spending is coming from the Federal government or the State government (it does matter on a couple of other levels, but not in terms of total demand in the economy). Thus, the total amount of stimulus in the economy is much less than is commonly believed. Now the stimulus is all gone, and austerity is taking over. That austerity will further slow the economy.Further complicating the picture, if private sector employment is starting to falter, then overall incomes will stagnate (see "Personal Income Up 0.1%, Quality Very Poor"), and those States with income taxes will see revenues weaken again. Assuming people start to spend less when they don’t have jobs, then sales tax revenues will also fall.The third major source of State and Local revenues, property taxes, are still likely to be strained as housing prices are likely to continue to fall for most of 2011, and that will result in lower assessed values, and hence lower property tax revenues.Better than Expected, but Not GreatThis was an OK report, much better than expected, but only mediocre in an absolute sense. It was much better than May, but well below what we saw in March or April. Those job gains were only slightly above the level needed to keep up with the growth in the labor force to begin with. The numbers implied by this report are below that level.The unemployment rate has fallen sharply relative to last fall, but a big part of it (not all, but a big part) was due to a falling civilian participation rate. And if the economy is really starting to turn around, the participation rate is unlikely to continue to fall, and is more likely to rebound. That would put upward pressure on the unemployment rate even as the economy starts to do better in job creation.With the numbers implied from this report, a continued drop in the participation rate would be the only way to keep the unemployment rate will go down. That might look OK on paper, but would not reflect any improvement in the real world. The civilian participation rate, and the employment-to-population ratio (aka the "employment rate") are two of the most important numbers to look at when the report comes out on Friday.Look for Revisions in BLS ReportWhen the big report comes out on Friday, another important thing to look at will be the revisions to the June and May numbers. Early in the year, the revisions had been running large and positive, but that was not true in May or June. If we get negative revisions again, that will be another sign that something is seriously amiss in this recovery.Total employment in April was still 6.98 million below the January 2008 peak (and private sector jobs were 6.71 million lower). At a rate of 114,000 new jobs a month, it would take 59 more months from here before we passed the prior private sector employment peak -- in other words, the middle of 2016.Add in a growing population and workforce, and bringing down unemployment to what we thought of as normal before the Great Recession appears to be a glacial process at best. No, the pace we were on in the previous few months was glacial, May and June were like the speed of continental drift.The graph below shows the path of employment, both total and private sector over the last thirty years, along with the unemployment rate (right scale). Note that relative to the last two downturns, the increase in private sector job growth has been relatively strong, but not as strong as following the 1982-83 recession, though that the decline was also much larger.The unemployment rate at 9.2% and having been there for such an extended period should be considered a national crisis. It is by far the most pressing economic concern right now. Despite that NOTHING is being done in DC, and it does not even seem to be on the agenda for discussion. Indeed the measures that are most commonly being discussed are those that would be appropriate for an economy that was overheating, or on the verge of doing so.The obsession with the short-term budget deficit is doing serious damage to the economy, and with it the lives of millions of people. On the monetary policy front, the discussion is all about how to unwind the stimulus from QE2 and of fears of inflation.  This despite inflation, especially core inflation, that is running at levels that is far below the average level of the last few decades.People are fretting about the dollar being weak, despite the fact that it is actually very helpful to have a weak currency when you are running massive trade deficits and have very high unemployment. This economy needs stimulus, not austerity and tight money. Fiscal stimulus would be best, but monetary stimulus in the form of QE3 would also be helpful. Unfortunately, the best case realistic scenario right now is that Washington does not take aggressive action that hurts the economy.Zacks Investment Research