Blowout ADP Report

In this article, I will review the latest economic reports and review some data on buybacks. The ADP private sector payrolls report came in better than expected, but there was a large negative revision in the February report. The ISM non-manufacturing report missed expectations. This could be sign the strong survey data trend is starting to crack. It’s too early to make that proclamation based on one weaker than expected report. The reason why I note this possibility is because the survey data will inevitably fall given the weakness seen in the hard data and the lack of a fiscal stimulus. The argument in favor of believing the survey data was that fiscal stimulus was going to prove the optimists correct. It’s still early in the president’s term, so it’s not surprising that nothing has gotten done. However, if a small business hired workers in December in the anticipation of strong demand provided by stimulus, the business will be feeling heat without any stimulus.

Going into the ADP report, I was expecting a strong report which showed some deceleration from February because of the slight weakness in the jobless claims data and the winter storm which hit the northeast in mid-March. From the information we had yesterday, this prediction was accurate because 263,000 jobs were created which was less than the 298,000 originally reported. However, February’s report was revised down to 245,000, so March’s report showed acceleration making it the best report in the past twelve months as you can see in the chart below.

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The best summary of the ADP report is to say it was a blowout. It beat expectations for 170,000 jobs created. This great report is causing economists to increase their forecasts for the BLS report on Friday. This strong report makes me expect accelerated hourly earnings growth in the report on Friday. At this point in the cycle, even with the large slack in the labor market, we should be seeing pay raises to non-supervisory workers. The Fed wants to see an increase in hourly wages, but its response to that increase would be more hawkishness which will squash the bubble economy.

The blockbuster ADP report for March was driven by small business hiring which confirms the strong small business survey data. Small businesses added 118,000 jobs. Breaking that number down further, very small businesses with 1-19 employees added 60,000 jobs. The optimism small businesses are showing is exceeding my expectations. Pro-business rhetoric from government has encouraged employers even without much action being taken. There have been regulatory cuts, but healthcare and tax reform still isn’t close to finished.

We’re seeing that businesses are excited by a small glimmer of hope that these issues are at least trying to be solved in a manner which considers the effects on employers. As well-meaning as some politicians may be, when they try to improve workers’ conditions and pay through actions such as raising the minimum wage, it hurts the workers they are trying to help because it makes jobs more scarce. These actions can also hurt wage growth because they limit business expansion.

As I touched on earlier, the non-manufacturing ISM report missed expectations which is rare of a soft data report. The report came in at 55.2 which was below expectations for 57.0 and below February’s report of 57.6. The 55.2 report is consistent with 2.4% GDP growth. Finally, there is an ISM report which is close to what the economy is growing at. The reports showing GDP is growing at above 4% need to be discounted for their wild inaccuracy.

The healthcare & services industry and the finance & insurance industry were quoted as being uncertain about future changes to Obamacare. Firms in this report described their business growth as positive. No one wants to forecast a negative future unless they see business slowing. My thesis is that optimism not being met with real fiscal changes will cause some businesses to start to slowdown which will cause a negative domino effect in the economy just like the positive one helped the economy after Trump was elected.

The chart below beaks down the manufacturing and non-manufacturing ISM reports. Most of the components in the non-manufacturing survey showed slowing, but it was a still a good report. One noteworthy thing I saw was that a construction firm was quoted as saying many projects saw slowing growth. This is surprising because President Trump has targeted cutting regulations which have been slowing down infrastructure projects. We also have seen pending home sales metrics improving. It’s possible the business quoted isn’t reflecting the strength in the industry. It’s also possible that the industry has seen recent slowness which hasn’t been helped by regulatory cuts.

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As you can see from the chart below, buybacks as a percent of the S&P 500’s market cap never reached the peak which was seen in 2007. However, this cycle had a spread-out plateau of buybacks making the total percentage of stock repurchased higher than last cycle. Buybacks have hurt productivity growth and boosted stock prices beyond their fair value. The two groups which have pushed stocks beyond their fair value are passive ETF investors and firms buying their shares back. It makes sense they would push stocks too high because neither care much about valuations. Firms may claim they care about valuations when they buy their own stock, but that care hasn’t been reflected in reality as firms bought the most stock at the peak of the market in 2007 and are currently buying a large amount even though we’re at peak margins and the Shiller PE is at its 3rd highest peak ever.

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Conclusion

The great jobs report is going to cause the Fed to become more hawkish. Bulls better hope the slowing buybacks start to accelerate higher as the earnings recession has now ended. The weaker than expected ISM non-manufacturing report promotes the possibility that soft economic reports may no longer beat expectations at the rate they were doing so earlier in the year. That’s the bearish catalyst which I have been looking for. The other potential catalyst is a weakening labor market. So far that catalyst isn’t coming through as the sterling ADP report is clearly supporting the bullish argument. It will likely be further supported by a strong BLS report on Friday.