Weak ADP Report - Signal The Labor Market is Turning?

Weak ADP Report - Big May ADP Miss

Let's review the Weak ADP report for May. It was a disaster as it missed estimates by the most since December 2008. There were 271,000 jobs created in March and only 27,000 jobs created in April. That missed estimates by 158,000. Normally, I would dismiss this report because in the past 2 years, the average difference from the BLS report has been 66,000. It also doesn’t change the 6 month average job creation much and it can be revised next month anyway. 

However, I’m more concerned than usual because we’ve seen a few terrible economic reports recently. It’s possible that these few bad reports are a signal of what’s to come. You don’t see GDP growth expectations fall to 1.7% if the reports have been mostly solid.

While we’ve seen some bad economic reports, few of them have been labor reports. Net percentage of consumers in the Conference Board survey describing the labor market positively hit a cycle high. Plus, jobless claims have been low. The report from the week of June 1st showed claims were 218,000 which was the same as the previous week. Employment index in the ISM non-manufacturing PMI report was the only component that was up year over year.

Details Of The Report

Weak ADP Report - To summarize, the economy looks weak, but most labor reports have been solid. This makes it tough to figure out if you should trust the terrible ADP report. We’ve seen examples earlier in the year where small business hiring was modest. I discounted those reports. 

In May, small business hiring was worse than any of those readings. It’s important to follow this in the coming months to see if it is an early recession warning sign. Small businesses lost 52,000 jobs. That’s the first drop in 20 months and the worst reading since March 2010 which was the start of the jobs recovery. 

Very small businesses, which have 1-19 employees had 50,000 of the 52,000 job losses. The smaller the company, the worse the employment reading was. Mid-sized firms added 11,000 jobs and large firms added 68,000 jobs.

The chart below breaks down the details of this report by size and sector. Small businesses and goods producing firms did the worst. That makes sense because the manufacturing sector has been in a slowdown. This isn’t a manufacturing recession yet. But it can turn into one this summer if the data keeps getting worse. Goods producing sector lost 43,000 jobs and the service providing sector added 71,000 jobs.

ADP Correlations With BLS

Weak ADP Report - It’s interesting to review how each industry did because they each have different correlations with the BLS report. For example, the education industry’s job creation in the ADP report has an 80% correlation with the BLS report. That might be because this industry isn’t as economically sensitive as the others. It’s easier to predict where this industry is headed. 

The ADP report showed education lost 1,000 jobs. That’s down from its gain of 12,000 jobs last month. It’s obviously bad news that the most accurate part of the ADP report showed job losses. Leisure and hospitality, natural resources and mining, and other services, have correlations of 67.8%, 63.6%, and 63.6%. They added 16,000 jobs, -4,000 jobs, and -9,000 jobs. It’s bad to see that of the industries with the 4 highest correlations, 3 showed negative job creation.

Now let’s review the industries with the lowest correlations. Construction employment has a 46% correlation and it lost 36,000 jobs. Therefore, the decline might not be that bad. Manufacturing has a 39.5% correlation and it lost 3,000 jobs. I think manufacturing will show negative job creation. Even hough the BLS reading isn’t highly correlated because both the ISM and Markit manufacturing PMIs were weak. 

Finally, the professional business services segment actually has an inverse correlation of 35.1%. This segment is the main reason the two labor reports differ by so much as it is often one of the biggest job creating segments. In May, the ADP report showed it added 22,000 jobs. It added 66,000 jobs in April. BLS headline number could vary from the ADP report if much more jobs are added in this category.

Weak ADP Report - Weak Services PMI

After the flash Markit PMI came out, I said it could be a fluke because sometimes the results shift in the 2nd half of the month. I wasn’t wrong to point that out, but this time the flash reading was almost perfectly in line with the final reading. The manufacturing PMI was 0.1 lower than the initial reading. 

Services PMI was the same as it was 50.9. This was the weakest services PMI since February 2016 as you can see from the chart below. It fell from 53 in April.

Business expectations fell to the lowest level since June 2016 and input cost inflation fell to the lowest level since September 2016. The only good part of this report was the employment reading increased from April as the labor market was deemed moderate. 

With the weakness in both manufacturing and services, the composite PMI was 50.9 which was the weakest reading since May 2016. This report is consistent with just 1.2% GDP growth. April report was consistent with 1.9% growth, making the average 1.5%. That’s slightly below the consensus. May reading is consistent with 150,000 jobs added which is also slightly below the consensus of 180,000.

Weak ADP Report - Conclusion

The ADP report and the Markit services PMI were weak. They’re showing us this slowdown is nearly as bad as the one from 2015-2016. Risk of a recession is elevated. That being said, jobless claims are low and the non-manufacturing ISM PMI was solid. 

If the BLS report ends up being consistent with the ADP report, the Fed will have no problem announcing rate cuts are coming soon and might even cut rates in June. Since I don’t think the BLS report will be a disaster, I’m confident in my expectation that the Fed won’t cut rates in June. 

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