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Why small businesses and the service sector signal a recovery

Phalguni Soni

Why April 2014 saw the best payroll numbers since January 2012 (Part 3 of 10)

(Continued from Part 2)

ADP’s job report

Continuing from the last part of this series, the National Employment Report for April was issued by Automatic Data Processing (ADP) in collaboration with Moody’s Analytics on Wednesday, April 30. The report estimated non-farm private payroll additions in the U.S. economy at about 220,000 jobs in April. This number came in ahead of consensus market estimates of about 210,000. In the last part of this series, we described the methodology used in compiling the report. In this part, we’ll analyze each of the report’s components.

April’s reading of 220,000 was 70,000 or ~46% higher than the comparable period last year. Job hiring in the private sector was down over 14% from December through February 2014 due an unusually cold winter. In particular, January’s 121,000 level was the lowest since August 2012. So April’s bump is partly due to the slow start the labor market had at the beginning of the year. However, the spike isn’t entirely weather-related, as according to Carlos Rodriguez, ADP’s president and chief executive officer, “The 220,000 U.S. private sector jobs added in April is well above the twelve-month average. Job growth appears to be trending up and hopefully this will continue.”

Small businesses post strong gains

Out of the 220,000 private sector jobs added in April, over 37% of jobs were added in businesses with fewer than 50 employees. About 37% of job gains were recorded in mid-sized companies, while large companies with 500 or more employees accounted for ~26% of the overall gains in employment. The employment gains for small companies, however, are down ~15% year-to-date compared to the same period last year due to the weather-impacted months of January and February, which tilted comparisons. Small business employment gains in March and April were up almost 10% on a year-on-year basis. Small businesses posting healthy employment gains are a sign that the economic recovery is more pervasive.

Mark Zandi, chief economist of Moody’s Analytics, said, “The job market is gaining strength. After a tough winter employers are expanding payrolls across nearly all industries and company sizes. The recent pickup in job growth at mid-sized companies may signal better business confidence. Job market prospects are steadily improving.”

The service sector posts strong gains

Service-sector industries recorded 197,000 new jobs in April, up from 181,000 in March. Out of the service sector industries, professional and business services added the most jobs, at around 77,000—an increase of 10,000 over March. Transportation, trade, and utility companies added 34,000 jobs in April, down by 1,000 compared to March. Financial services firms added 8,000 jobs in April—the most since June 2013.

However, the goods-producing sector, at a level of 24,000, created 4,000 fewer jobs than it had in March. This is due to sluggishness in the manufacturing sector, which created just 1,000 new jobs—3,000 fewer than it had created in March. Construction companies added 19,000 jobs and were responsible for most of the new employment in the goods-producing sector.

Investors can gain exposure to construction company stocks by investing in ETFs like the iShares U.S. Home Construction ETF (ITB), which tracks the performance of the Dow Jones U.S. Select Home Construction Index. The index measures the performance of the home construction sector of the U.S. equity market. With an expense ratio of 0.48% and assets under management (or AUM) of over $1.5 billion, the top holdings in ITB include residential construction companies D.R. Horton (DHI) and KB Homes (KBH).

Implications for fixed income investors

For bond investors, a better-than-expected payrolls report isn’t so rosy. An increase in the pace of job creation would imply economic recovery is gaining traction, which would normally lead to an increase in interest rates. As bond prices move inversely to interest rates, this would be a bearish signal for long fixed income ETFs. However, investors can benefit even in this environment by investing in inverse fixed income ETFs like the ProShares Short 20+ Year Treasury Fund (TBF). Inverse bond ETFs provide the inverse return of the underlying benchmark index.

In the next part of this series, we’ll discuss the Employment Situation report released by the Bureau of Labor Statistics on Friday, May 2. Please read on.

Continue to Part 4

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