December Employment Report Preview

Tomorrow's employment situation report is the big statistical release of the week. Most of the attention will focus on the wrong data, reach incorrect conclusions, and miss the best ideas. Here's why.

The Data

We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.

We would like to know the net addition of jobs in the month of December. This is actually a fact, but we do not know it right now. It is something we will know with a high degree of certainty, but not for about eight months. State employment offices provide data that is used for the benchmarking of the official BLS data. This information is solid, since businesses do not exaggerate employment when it comes to paying taxes.

By the time we have this information, everyone will treat it as "old news." Markets, news sources, and pundits all want to talk about something, and they want it RIGHT NOW!

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

1. An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
2. The report is revised to reflect additional responses over the next two months.
3. There is an adjustment to account for job creation -- much maligned and misunderstood by nearly everyone.
4. The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low.

I think the BLS is honest and does a good job, which seems to put me in a small minority of observers. Despite this support, I question the general concept. The BLS tries to estimate total employment in one month, total employment in another, and subtract the two to determine the difference. When you are talking total payroll employment of over 130 million jobs, even small errors are in the range of 100K jobs or more. Meanwhile, smaller discrepancies from expectations are unwisely viewed as significant.

Competing Estimates

If you accept the idea that the final benchmarking is accurate, then the BLS approach should be viewed as an initial estimate, not the ultimate answer. What we are all looking for is information about job growth. There are several competing sources using different methods and with different answers.

• ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP sees gains of 325K private jobs. There is a continuing trend of losses in government jobs.

• TrimTabs looks at income tax withholding data. The idea is that this is the best current method for determining real job growth. They see job gains of only 38,000.

• Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating -- you should make an independent estimate). I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.5 million jobs per month) and job destruction (running at about 2.3 million jobs per month). In mid-year the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model.

The problem with all of these methods is the scoring system. Everyone foolishly takes the BLS estimate as "official" even if the other approaches eventually turn out to be more accurate.

Trading Advice

My experience has been that you can be conservative going into the employment situation report. Even if the initial report seems strong, there are so many aspects to criticize that we usually get a dip to buy/cover. I have fresh funds to deploy, but I am waiting. [Note to readers -- if I thought that earlier action was important, I would have published the story sooner. I try to publish on Wednesday of the employment week, but I wanted to include the ADP release, and I knew it would not matter to my analysis.]

Policy Implications

In the midst of a political campaign where employment is a key issue, the candidates seem starved for ideas. Whether tomorrow's report is strong or weak, there are some excellent ideas that deserve consideration.

Carl Schramm, CEO of the Kauffman Foundation, is a leading expert on job creation and entrerpeneurial activity. [My potential biases: As a board member and advisor for some early-stage companies, this is a subject near to my heart. I also have participated in the annual Kauffman Foundation conference for leading economic bloggers. This has helped my work and that of my colleagues.]

Here is the Schramm prescription -- simple and dramatic:

Q: I'm going to name you king for one day. you have authoritarian power to make one change in Washington or policy, what would it be?

A: I would wave my magic wand and send a strong signal to a government that pays no attention to a brand new firm for three years. that means no taxes and no regulation. if you want to be double down, I go to the universities and say any university that has an alumnus that comes back at the 50-year reunion and says I created 25 jobs since I left in my company, nobody works for me who's a member of my family, university says here's your tuition back.

If you watch the link for the entire video, you will learn a lot about job creation.

Some of the same concepts are covered in the Kauffman Sketchbook series. You will be entertained and informed.

 

Prof James Hamilton is also a fount of ideas. His valuable work on energy policy has highlighted a number of key choices.

In June he wrote about Making Jobs Priority One.

In December he advised on Getting the Economy Going and also Costs and Benefits on the Keystone Pipeline.

And finally ... ideas from the Milken Institute for 6 million new jobs.

The policy suggestions cited here may not find favor with all, but the ideas are a better focus for the discussion.

How about an Employment Friday that was not all about punditry and spin?