2023-05-31 07:30:00 ET
Summary
- Temporary help service jobs have been contracting since December 2022, signaling a potential recession.
- Initial claims for unemployment have been trending higher, suggesting a weakening labor market.
- The labor market is gradually slowing down, while inflation remains elevated, with leading indicators pointing to a weaker labor market.
- The discretionary sector is likely to sell off as the overly optimistic earnings expectations get revised lower.
Despite a very aggressive monetary policy tightening since March 2022, the labor market is still very tight with a 3.4% unemployment rate and nearly 10M job openings. However, under the surface, the leading indicator of the labor market strength has been flashing a very strong recessionary signal since December 2022, suggesting that the headline labor market data is likely to turn negative soon.
Temporary help service jobs contracting
Specifically, the temporary help service jobs have been contracting since December 2022, currently declining at 3-4% per month. As the chart below shows, the temporary service jobs usually decline only during the recession, in 1991, 2000, 2008, and 2020. Thus, given the current trend of decline in temp jobs, it is very likely that we are in a recession, or near one.
The "temp jobs leading indicator" thesis is based on the assumption that employees cut temporary jobs first before starting firing full-time employees. The table below shows the actual number of temporary job services lost during the last 3 months - during which the broad measures of the labor market remained fairly strong.
Feb | March | April | |
Temporary help services | -9.6 | -18.9 | -23.3 |
The initial claims for unemployment
The initial claims for unemployment, the weekly leading indicator of the labor market strength, has also been indicating a weakening jobs situation. The claims usually spike right at the onset of a recession. Recently, the initial claims have been trending higher, as the charts below show.
However, the claims data has been subject to significant revisions, and thus, it's very difficult to use to time a recession. The chart below shows the clams data on May 11th, which indicated the breakout above the 250K level, and the potential spike-in-progress, which would support an unfolding recession. But the chart on the right shows the data on May 25th after the significant revisions, which revised the reading above the 250K level much lower, and delayed the expected recessionary spike.
Either way, the trend in the initial claims is up, which suggests the weakening labor market, and supports the recessionary signal from the temporary job services data.
The Labor Market Report for May
The BLS will report the labor market data for May on Friday. But, leading to the Fridays' report, the job openings data JOLS will be released on Wed. The market consensus expectations are for a gradual decrease from 9.59M to 9.375M, which is still a very high number, well above the pre-pandemic numbers. Apparently, there is still a serious labor shortage.
On Thursday, the private ADP employment data will be released, and it's expected to show a fairly steep decline in jobs created from 296K to 170K. We will also get a fresh reading on the initial claims for unemployment, and the consensus expectation is for a small increase, but still below the 250K level.
Finally, the BLS Report on Friday is expected to show a slight uptick in the unemployment rate to 3.5%, and a modest drop in new jobs created to 195K. The average weekly hours are expected to remain unchanged at 34.4/week.
On the inflation front, the average hourly earnings are expected to remain unchanged at 4.4%, which is still consistent with the elevated core inflation.
Overall, it appears that the labor market is gradually slowing down, while inflation remains sticky. Note, the unemployment rate and the payrolls are considered to be lagging indicators. The leading indicators, as previously discussed are pointing to a much weaker labor market.
What employment data to focus on?
These are the important levels/variables to focus on in evaluating the labor market and timing the potential recession:
- Goods-producing jobs. The interest-rate sensitive and cyclical sectors should start seeing a more pronounced weakness, particularly construction jobs, and manufacturing jobs. Goods-producing jobs were negative in March, but turned positive in April. This trend could reverse back to negative in May.
- The decline in the temporary job services should accelerate as the job market weakens.
- The initial claims should break above the 250K level.
- The weekly hours worked should start decreasing, which is also a leading indicator of the labor market strength (employers cut the hours worked first, before firing the workers).
Market implications
The stock market, as proxied by S&P 500 ( SP500 ) is not priced for a recession, as 1) earnings expectations are exceedingly optimistic, and 2) the valuation metrics are high, even when considering the optimistic expectations.
Specifically, S&P 500 is trading at PE ratio of 19.2 for 2023, with expected earnings per share at 218, which is only 0.3% decrease from 2022. Further, the S&P500 EPS is expected to grow by 11.8% in 2024.
But, underneath the surface, the major inefficiency appears to be in the Consumer Discretionary Select Sector SPDR® Fund ETF ( XLY ). The earnings for the Consumer Discretionary sector are expected to grow at 18.1% for 2023, the highest growth rate among all other sectors.
The Discretionary sector is interest rate sensitive and cyclical sector. It includes stocks such as homebuilders, retailers, leisure and entertainment, and automakers. These stocks should be negatively affected by a recession. And yet, the analyst expects 18.1% earnings growth.
Thus, I expect that the Discretionary sector will underperform as the recession becomes more obvious - the companies within the Discretionary sector are likely to have the significant earnings misses, and thus the significant earnings revisions to the downside.
Here is the XLY long-term performance - after the 2020 pandemic boost, the Discretionary sector sold off sharply in 2022 as the Fed started to tighten the monetary policy. I expect the next leg lower as the overly earnings expectations get revised much lower as the recession hits.
For further details see:
XLY: The Labor Market Is Flashing A Strong Recessionary Signal