Historically, time and again, employment proves to be a lagging economic indicator.
It's a common mistake to think elevated unemployment can hold back economic recovery—but it's not until the economy improves that firms start hiring again.
Recent reports suggest we may be at the point where businesses need to hire—ADP showed private sector employment rose for the sixth straight month in July, while the ISM's services index rose for the seventh straight month.
One of the most closely followed economic metrics through the recession has understandably been employment. And yet, historically, time and again employment proves to be a lagging economic health indicator. Watching for signs of improvement in this area is like watching a pot of water boil—only after a long wait does water even start to simmer. And all the while, the fire was lit underneath. Relying on employment recovery as an all-clear signal to jump back into stocks likely means waiting until the economic and stock market recovery is well underway.
It's a common mistake to think elevated unemployment will hold back economic recovery. It seems to make intuitive sense: The unemployed spend less, therefore dinging consumption, which makes up the bulk (about 71%) of US GDP. However, firms aren't likely to hire until their business prospects brighten—a result of cost-cutting and a strengthening economy.
Think about it from a firm's perspective. Hiring workers is one of the more costly things a firm does. Employees get salaries, benefits, and possibly a bonus. They require training and someone to manage them. Firms pay payroll taxes and insurance. And if the recovery stalls, it can be expensive to lay them off again. So it makes sense companies feel compelled to wait until they're confident in the state of the economy to hire in a big way. Until then, as business activity picks up, firms cut costs to boost productivity. But they can only rely on productivity gains for so long before asking current employees to work longer hours and hiring temporary help (both overtime and temporary worker hiring are up markedly since early 2009). Increasing business activity eventually necessitates the hiring of additional full-time employees. Of course, employment recovery is still important—an expanding labor force does translate to additional consumer demand, which can further propel business activity recovery—but it's not a precursor to growth.
Recent reports suggest we may be at the point where more businesses need to hire. One of the nation's largest payroll processors, Automatic Data Processing, Inc. (ADP) showed private sector employment rose for the sixth straight month—by 42,000—solidly beating consensus expectations. The firm also revised up the number of jobs added in June. The government will release its own July employment report this Friday, which may be somewhat distorted by the end of temporary census jobs.
Note, Treasury Secretary Timothy Geithner recently observed private jobs growth has returned "at an earlier stage of this recovery than in the last two recoveries" and manufacturing has generated 136,000 new jobs over the past half year. If a turnaround in the labor market is happening at an earlier clip, it could suggest the pace of this economic recovery is likewise moving at more rapid speeds.
Separately, the Institute for Supply Management (ISM) reported its services purchasing managers index rose to 54.3 in July, up from June's 53.8—and could provide another foothold for labor since 80% of the US workforce is employed in service industries. Readings above 50 indicate expansion, and July's uptick (seventh straight monthly gain) indicated more robust expansion (while economists expected a pullback to 53). Businesses also reported new orders grew faster, boding well for future activity.
We've frequently noted employment would recover at a slower slog than the economy—an unfortunate but logical lag. But even a watched pot eventually boils (never mind the idiom), and now there are signs the employment waters are finally starting to simmer. Recovery likely won't be a straight shot up, and pullbacks here and there in data wouldn't surprise us. Still, reports suggest the economy's moving in the right direction.