Forecasting the Payroll Employment Number

Each month credit and equity market observers alike pounce on the Employment Situation Report from the Bureau of Labor Statistics.  Markets gyrate wildly when the actual result is 40,000 or 50,000 payroll jobs away from the economic forecasts.

This is a big mistake.  Here is the problem.  The level of change that the market believes to be significant, is not great enough to be measured by the BLS tools.  It is like measuring a hair with a grade-school ruler.

And that is just the measurement issue.  It is even more difficult to forecast the results.  We always enjoy reading Bob McTeer, whose blog is one of our featured sites.  His recent commentary notes that economists are not very good at forecasting.

Unfortunately for the reputation of economists with the general public is that they think the job of economists is forecasting.  That's unfortunate because economists can't forecast very well.  It just can't be done.  Economists know that, and most will admit it, but they are stuck with it, especially if they wish to be employed as an economist outside academia.

His main point is that these predictions are difficult.  People making forecasts should provide probability figures and ranges.  (For a similar argument, check out Barry Ritholtz on The Folly of Forecasting).  The problem is that when the forecaster is honest about the error range, the consumer becomes less interested.  Well, so be it!

McTeer has a number of excellent points on using models and some Greenspan stories, so enjoy reading the entire article.  After noting that most everyone is a "closet extrapolator" he writes as follows:

I've always been amazed at economists who presumed not only to see around a corner, but to see around more than one corner, as in "the economy will pick up through year-end, then slow for several months, and then take off again stronger than ever."  To me that sounds as silly as what they would say to the waiter after sniffing a wine cork.

It is something to think about the next time you hear some elaborate, multiple-turn economic or market forecast.

So with this in mind, here is our monthly update on the employment report, (also appearing in the Columnist Conversation on RealMoney).

The Employment Report

Each month we take a look at the likely change in payroll employment jobs, given other economic data. This is not really a forecast, since the data are all contemporaneous indicators of current economic conditions. We simply use the already reported data to ask what we expect from the payroll number.

Our model takes Michigan Sentiment (hitting new lows), the ISM index (hanging in there at just under 50), and the four-week moving average of initial jobless claims (weak, but not recessionary). Be careful not to consider today's jobless claims numbers. The non-farm payroll report is based on a survey where respondents are asked to tell about employment during the week including the 12th of the month. Revisions to the report come because many employers do not submit the information on time. Some never report, since for many there is no legal requirement to do so. The BLS tries hard to make it easy, and get a complete response.

Our approach suggests a loss of 82,000 jobs, weaker than consensus guesses of -60K or so, and much weaker than the ADP estimate. It may surprise readers to learn that losses in this range are still consistent with modest GDP growth of 1% to 1.5%, as are the other economic numbers. I don't recommend any big bets, since the 90% confidence interval on the survey is +/- 100,000 jobs! And that is after all of the reports are in and revisions done. The excessive attention to this report creates a dangerous trading situation. You can make your own (risk-free!) guesses at our Payroll Employment Game site. This shows you that even if you know the answer in advance, the reported number can be far away. The "official" answers will eventually converge on the "truth" but there is plenty of error along the way. In addition to this resources, you can check out some other little-known facts in this prior article which has links to other references.

Comments

[Nofel Izz]

thanks a lot for the information, I guess I need to visit those links that you have provided.. Looks cool!

[Bill aka NO DooDahs!]

Interesting thought: many pundits were discussing "errors" in the denominator of the unemployment number, stating that the rate of unemployement was artificially held down by a lack of participation in the labor market. Today's report included a rather large increase in labor market participation, spiking the rate. Unemployed as a percentage of the general population had less change.

Do you suppose those pundits will choose to crow now, or do you think they will view increased labor force participation as a sign of (1) driving wages down and decreasing pressure on CPI et al, and (2) sign of increased potential for GDP growth in the next year?

My bet is on them crowing.

[Bill aka NO DooDahs!]

I typically get blank stares from actuaries when I tell them there's no mathematical basis for credibility-weighting an indicator; the proper method would be to use credibility to provide a confidence interval around their point estimate.

Unfortunately, such would not be good sales technique for the value of actuarial services to the company management, and nobody in management wants to hear their actuary say that "I'm 90% certain the PPA program needs between -2.5% and +7.5% of rate increases." Let's not mention loss reserves.

That being said, Beary provides multiple predictions every week, always bearish on the economy or the market, only sometimes bullish on individual stocks/ETFs, which are rarely mentioned on his FREE blog.

Also, a trading position IS a prediction, at least in the statistical sense.