The non-farm payroll report last week came in well above projected consensus estimates as private payrolls increased by 254,000. This was received enthusiastically by investors and most commentators viewed the strong number as a sign that there is little chance of an economic recession in the near term. Putting aside the high variability of any one monthly report, we wanted to look at how private payrolls have changed at the end of prior cycles. Looking at the twelve-month period prior to the recessions in July 1981, July 1990, March 2001, and December 2007, we noticed that in each period there were multiple 200,000 or greater payroll reports leading up to the recession. When thinking about how economic cycles end, this would make sense. As the economic cycle progresses, most companies start to see an increase in earnings and increase their payrolls. As the economic cycle matures and starts to slow, company profitability typically starts to decline. Companies normally respond by trying to reduce costs on the margin, which typically leads to a reduction in corporate investment. It is only once corporate managers determine that the slowdown in profits is going to be larger or last longer than expected, that they start to reduce their payrolls.
While labor is often the most expensive cost for companies, it is also normally the largest revenue generating asset. Companies try and hold on to their human resources for as long as they can. Payrolls are typically the last thing to decline at the end of an economic cycle, and a spike in payrolls does not by itself mean recession risks have diminished. Long term payroll growth is a function of profitability. If economic growth continues to slow and corporate profits do not start to grow in 2020, we would not be surprised to see payroll growth start to decline. This is already evident in certain parts of the ADP payroll report, like small employers (where profits have been the weakest).
Rank Dawson, CFA
Vice President, Investment Strategy
Boyd Watterson Asset Management, LLC
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