2023-05-02 08:30:38 ET
Summary
- The WARN Notices are suggesting an imminent spike in Initial Claims, which is consistent with a recession.
- The April employment report is still likely to show a strong, but slowing labor market, and sticky inflation.
- S&P 500 is not priced for a recession, with analysts expecting strong earnings growth in the second half of 2023.
The labor market preview for April
The U.S. Bureau of Labor Statistics will release April 2023's labor market data on Friday. Expectations suggest that the labor market is slowing down but remains strong. The unemployment rate is expected to rise slightly to 3.6%, still near a 50-year low, while non-farm payrolls are expected to increase by 180K, lower than March's 236K.
Inflation-related readings are expected to remain unchanged from March, with average hourly earnings expected at 4.2%.
Overall, this supports recent data indicating a slowing economy and sticky inflation, which some view as an unfolding stagflation.
The Leading Indicator
However, the unemployment rate is a lagging indicator, and it doesn't really provide timely information about the labor market, and thus economy.
The initial claims for unemployment is widely accepted as the leading indicator for the unemployment rate, especially during economic downturns. The initial claims data is released on weekly basis every Thursday, which also makes it a high-frequency data.
Thus, based on the recent trend in the initial clams, it appears that the labor market has been slowing since March, with the initial claims repeatedly "pushing" the 250K level.
The WARN Notices
However, very few are aware that there is a leading indicator for the initial claims, which makes it a leading-leading indicator for the unemployment rate.
Specifically, it called the WARN Indicator , based on the Worker Adjustment and Retraining Notification Act:
The Worker Adjustment and Retraining Notification Act (WARN, the statute, or the Act), Pub. L. 100-379, 102 Stat. 890, was enacted on August 4, 1988. 29 U.S.C. 2101 et seq. Section 11 of the Act provides that WARN goes into effect on February 4, 1989. WARN provides that, with certain exceptions, employers of 100 or more workers must give at least 60 days' advance notice of a plant closing or mass layoff to affected workers or their representatives, to the State dislocated worker unit (see 29 U.S.C. 1661(b)(2)), and to the appropriate local government.
Essentially, the WARN Act requires companies to give at least a 60-day notice for any mass layoffs. A WARN Notice is issued about 2 months before a person is laid off and applies for unemployment benefits. Thus, based on the timeline, the WARN Notice is a valid leading indicator for the initial claims.
However, WARN Notices are issued at the state or local level, and are not aggregated and reported nationally. Further, aggregating the data is reportedly difficult.
The Cleveland Fed has conducted a study Using Advance Layoff Notices as a Labor Market Indicator in 2019 to determine whether nationally aggregated WARN data can be useful as the leading indicator, and find:
We use advance layoff notices filed under the Worker Adjustment and Retraining Notification (WARN) Act as an indicator of current and imminent labor market conditions. We have constructed a database of establishment-level notices starting in 1990 by scraping state government websites, contacting state officials, and retrieving historical data. We find evidence that these notices, aggregated to the national level, lead other prominent labor market indicators, such as initial unemployment insurance claims, the change in the unemployment rate, and changes in private employment. The lead relationship seems strongest at one month with economically meaningful magnitudes .
The WARN is flashing red
Recently, authors from the Cleveland Fed updated their study to include the data up to March 2023. The findings of this study have been reported by Bloomberg and circulated on Twitter.
The study shows that the WARN Notices have been significantly rising in 2023. Thus, the initial claims will likely spike over the next few months. This is consistent with the predictions of the recession in Q2 2023 or Q3 2023 at the latest. Here is the chart.
This is the summary of the updated study provided by: Pawel Krolikowski, Federal Reserve Bank of Cleveland; Kurt Lunsford, Federal Reserve Bank of Cleveland
Summary: We collect novel and timely data from advance layoff notices filed under the Worker Adjustment and Retraining Notification (WARN) Act. The act requires larger employers to notify affected workers at least 60 days before a potential mass layoff. We assemble WARN data from across the United States, and for many large states our data begin in the 1990s. We aggregate these data into an unbalanced, monthly panel of the state-level number of workers affected by WARN notices, and we update this panel twice a month. We also aggregate this panel to a national-level indicator of job loss (the "WARN factor") using a dynamic factor model.
The authors also provide the aggregated WARN data. I wanted to verify the Bloomberg Chart that circulated on Tweeter, and I accessed this data. Here is the raw WARN data (the chart above is reporting YOY change) for the last 2 years. The WARN data spiked from just above 5000 in February 2022 to nearly 20000 by January 2023. The spike at end of 2022 definitely explains the spike in the initial claims in March 2023. Here is the chart:
Implications
The labor market appears to be strong, and the March numbers will likely confirm a strong but slowing labor market.
However, the initial clams started to rise in March, which signals that the labor market may show more serious weakness over the coming months.
But more importantly, the WARN data indicates that the initial claims are about to spike, which is consistent with expectations that we are in a recession or will be in a recession in Q3 2023.
S&P 500 ( SPY ) ( SP500 ) ( SPX ) is not priced for a recession. According to FactSet, "for Q3 2023 and Q4 2023, analysts are projecting earnings growth of 1.7% and 8.8%, respectively, and for all of CY 2023, analysts predict earnings growth of 1.2%." These earnings growth estimates will have to be revised significantly lower to reflect an imminent recession.
The Fed is targeting the 4.5% unemployment rate level before considering pausing the rate hikes. Given the lags, the Fed could be forced to hike into the recession as the inflation remains sticky, despite the weakening labor market.
SPY Sector Performance YTD
The popular ETF ( SPY ) that tracks S&P500 is up almost 10% YTD. Yet, that performance has been concentrated in the three speculative sectors, Communications ( XLC ) up by 25%, Technology ( XLK ) up by 21%, and Discretionary ( XLY ) up by 15%. These are cyclical sectors, expected to perform poorly in a recession, thus, the recent performance is clearly unsustainable. Based on the WARN Notices, we are possibly already in a recession, or a recession is imminent. Thus, my outlook for SPY is bearish.
Reference:
Krolikowski, Pawel, and Lunsford, Kurt. Advance Layoff Notice Data from the WARN Act. Ann Arbor, MI: Inter-university Consortium for Political and Social Research [distributor], 2023-04-28.
For further details see:
The WARN Notices Are Predicting An Imminent Recession