Sunday, January 27, 2008

Monthly Jobs Report & Birth/Death Model

Since a lot of new readers have joined of late, let me spend a minute or two explaining why this monthly job report, while hyperventilated over, is quite useless. (but we must pay attention to it, because it moves the market) - it is important enough to devote an entire entry to.

Barry Ritholtz does a good job explaining on his blog here, so I won't re-create the wheel - but in summary the whole report is based on assumptions, and biggest being the Birth/Death Model (of businesses, not people) which can be off by 100K or 200K in any month (who really knows?) And considering most months the loss to gains range is -150K to +150K, the entire job gain (or loss) is within margin of this assumption which is a "black box" - we are never told how it is even created. So in fact a gain of 150K jobs could really be 250K or 0K. We don't know. But the whole market heaves one way or the other in reaction to it. Useless. Barry's take below: (I've copied the chart from the entry which shows, that the Birth Death model is now approaching almost the entire monthly job gain - meaning, the "black box" assumption is what is leading to almost all job "growth)...

Since 2003, the B/D adjustment has been part and parcel to BLS' Current Employment Statistics (CES) program, the official measure of US employment.

In brief, the Birth Death adjustment imagines (hypothesizes) how many jobs were created by companies too new and/or too small to participate or be found by CES. The model attempts to create what is perceived as a BLS error at the start of any recovery, when many new jobs are created but missed by BLS.

But in fixing one problem, they created another: At the other end of the cycle -- where we are today -- the B/D adjustment potentially will hypothesize lots of phantom job creation.

To give you a better idea of how badly the B/D is currently skewing the data, consider these charts below (via Econbrowser). Looking at the changes of the past 3 years, its apparent that the B/D model went from being a modest portion of the CES data to being the increasingly dominant source of reported new jobs over the past 12 months:

Again, it's an economic report, even more useless than most. But the whole market will spend days analyzing it, calling the Fed either behind the curve or over reaching, blah blah and blah. Not to mention this report gets revised by a magnitude of 50-100%+ many times... yet we use it as gospel. So you have to be aware of it, but when the market goes in a hissy fit the first Friday of each month, just be aware of the background of the model.

As I say with inflation, as I say with "government retail sales", as I say with employment - just keep your ears and eyes open and listen to the companies themselves - they have to report reality. The government can (and does) report fiction.

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