July’s Employment Report in Three Charts

July’s Employment Situation Report came out Friday, and if you believe the headlines, it was a mixed bag. The unemployment rate fell to a five-year low of 7.4%, but behind the improvement were slower-than-expected payroll gains of 162,000, and a 37,000 drop in the labor force. Some suggest this is evidence the economy is weakening, but in our view, it merely underscores two long-known facts: Monthly data are volatile, and employment is a late-lagging indicator. A close look at the longer-term trend confirms the private sector is healthier than many people appreciate—a sign sentiment remains detached from reality—but that’s about the only takeaway for equity investors.

July was the 41^st straight month of rising private-sector payrolls (Exhibit 1). Granted, it’s a smaller gain than we’ve seen in recent months, but monthly job gains are typically variable and have been throughout this entire recovery (Exhibit 2). High payroll gains in early 2011 gave way to small increases in the summer, but the slowness was short-lived. Ditto for 2012. And with Q1 and Q2’s GDP reports showing significant private sector strength, job growth needn’t necessarily stay muted.

Exhibit 1: Total Private Payrolls

Source: Federal Reserve Bank of St. Louis, Bureau of Labor Statistics, as of 8/2/2013.

Exhibit 2: Monthly Change in Private Payrolls

Source: Federal Reserve Bank of St. Louis, Bureau of Labor Statistics, as of 8/2/2013.

Monthly changes in the labor force are also variable, and July’s drop isn’t the first of this employment recovery. Yet despite the volatility, the civilian labor force has risen by over 2.6 million people since its December 2009 low, and after July’s small drop, it’s only just shy of its all-time high. (Exhibit 3)

Exhibit 3: Civilian Labor Force

Source: Federal Reserve Bank of St. Louis, Bureau of Labor Statistics, as of 8/2/2013.

In short, while July’s employment report was one of the more lackluster in recent months, it’s hardly evidence of a materially weaker economy—in our view, it’s more emblematic of just how volatile monthly data are. In our view, the longer-term trends are more telling. While the labor market isn’t in perfect shape, it is steadily improving over time.

Of course, this merely tells us what we already knew about the economy—the private sector is growing, and because of this growth, businesses are hiring. Granted, neither is happening at a robust pace, but stocks don’t need gangbusters economic or jobs growth to keep on rising. Stocks merely need reality to be better than most investors appreciate. The headline reactions to July jobs data tell us investors don’t quite fathom the private sector’s recent strength, which suggests there is plenty of room for reality to surprise to the upside looking ahead.