Friday, 5 December 2008

Strong increase in US jobless claims

US Labor Department announced today that nonfarm payroll employment fell sharply in November, as 533,000 jobs were lost. The official unemployment rate increased by 0.2% to 6.7% From October to November. At the same time the Nonfarm Payroll number for October was revised for the worse, from an initial reading of 240,000 to 320,000. Not exactly a trivial revision either. Consensus estimates for the November number stood at 350,000 lost jobs.

Since the start of the recession, the economy has lost 1.9 million jobs, the number of unemployed people increased by 2.7 million and the jobless rate rose by 1.7 percentage points.

Not entirely surprising, the stock markets reacted negatively to the publication of such bad numbers. In the tug-of-war between the forces claiming that now it cannot get much worse and those stating that this is only the beginning, the latter scored a hands down victory.

No doubt, the US economic situation is bad enough, and there we will continue to be showered in nasty-looking economic indicators for quite a while to come.

But before panicking over the Nonfarm Payroll statistics as they were released Friday, one has to remember that employment numbers are not an indicator of things to come. They are what in economist-speak is called a lagging indicator. Employment statistics are an indication of how employers were thinking about the future some months ago – before they set in motion the actions that led to the laying off of their employees.

Similarly, do not expect to find the employment statistics to give an early indication of the turn for the better – whenever that may be. When unemployment begins to fall, it will be several months, maybe more than a year after the bottom of the recession.

Hiring or firing on a large scale is in the vast majority of cases expensive business and is usually not undertaken until it really is necessary. There may be various obstacles depending on the jurisdiction, Europe being a case in point. What makes it expensive is, however, not the compensation paid to the leavers. Instead, it is the loss of human capital from the company. An overwhelming majority of jobs require particular skills paired with good dose of experience. Firing on a large scale means that a company waves goodbye to a lot of knowledge, and the laid off employees may not be available next time an upturn comes around.

Similarly, once the economy gets better, many companies will have similar reservations hiring on a large scale. New employees have to be trained for the jobs, and that is often a huge expense, so the companies will prefer to run at capacity or above for as long as possible. Germany is a case in point, where employment still continued to increase in October – as if German companies had not realised what was going on in the rest of the world.

The German unemployment has been steadily falling over the past three years or so. But well before that, in 2004 and 2005 many German companies began to improve their profitability in a meaningful way after a serious wave of restructurings. That in turn led to new hirings from late 2005 and onwards, and it is only now that this trend is likely to be broken.

So why would the market react so strongly to the US nonfarm payrolls. Probably because it is not readily known that it is a lagging indicator. On top of that it appears that the depth of the recession is only now beginning to dawn on a large segment of market participants.

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