Jobless claims are a superior indicator for the economy not only because they lead economic growth and correlate so closely with it, but they also get reported much earlier.
The GDP/Initial Jobless Claims Connection
The high concentration of the US economy is one reason that the GDP and jobless claims move hand-in-hand. For example, 10 US states account for 54% of the US GDP. Those same states have the same concentrated share of the labor force.
Not surprisingly, those same 10 states drive the bulk of layoffs. In fact, the top five drive almost 50% of total initial claims.
Jobless claims give us a weekly, real-time snapshot of the economy. They move step by step with local economies, and that’s the key point. Since states can individually distort the overall picture (i.e. Texas, where claims are rising due to the collapse in oil prices), an effective reading of jobless claims requires a look into the state-level circumstances. Though, when all is said and done, California is what really matters.
California vs. Not California
California is the major driver of US jobless claims.
- 17% of continued claims
- 16% of initial claims
These figures are, as expected, consistent with California’s 13% share of the US GDP.
As goes California’s claims, so goes national claims, but not necessarily the national economy. This is where it takes effort to maintain an apples-to-apples perspective.
Recently, California’s jobless claims picture is distorted by the record drought.
This is where the nuts-and-bolts of jobless claims matters. Unlike payrolls, jobless claims include agricultural workers. The current drought and heatwave led to an early California harvest and earlier layoffs. So when the national claims jumped last week from 271K to 281K, it’s because California claims rose 4K instead of dropping (-7K) as they did in previous years.
In the most basic signal of economic expansion, California claims continue to drop relative to last year, although the drought affects the pace.
The drought adds a layer of distortion but the basic conditions remain: as long as claims continue to drop relative to last year, the economy is expanding. From a timing perspective, we want to watch for when the gap between 2014 and 2015 starts to close. At this point in time, we expect that gap to continue to shrink over the next few months. That’s a sign of economic expansion growing at a slower and slower pace, but we are still a few months from the bottom.
Excluding California, Initial Jobless Claims Continue to Drop
Ignoring California, this year’s total initial jobless claims are about 25K below last year’s, and that gap is slowly closing. Exclude the oil states as well, and the gap is barely 20K. Even as that gap closes, the Y/Y rate remains in economic expansion territory.
Historically, economic slowdowns are led by two events:
- The Rule of 95%: Jobless claims (not seasonally adjusted) Y/Y is >95% for about two months. When the economy stops growing, labor demand hits equilibrium and jobless claims stop falling. But claims don’t have to be exactly equal to the prior year.
- Number of States >95%: It’s not enough for national claims Y/Y to be 95%. Jobless claims are concentrated and individual state events can easily distort the overall picture (i.e. Texas oil and California farms). Evidence of a widespread economic slowdown is that the majority of states are at the 95%+ threshold.
For example, in late 2006 the GDP downshifted and the majority of states rose above the 95% threshold.
The US economy remains in a good place. Currently, national claims are 89% of last year’s and only 20 states are >95%.
The situation can turn quickly. In the previous cycle, it took only two quarters for the number of states at that 95% threshold to move from 20 to 40. But that was after several quarters in which 20 States were at that level.
What to Expect Going Forward
In 2H of 2015, expect current jobless claims levels to stay consistent with GDP (~2%).
Claims will bottom during 4Q at the current trajectory. At the beginning of 2015, we expected claims to bottom in late 3Q. Current conditions push this out one quarter. Recessions typically start two to three quarters after jobless claims bottom, so a US recession is not likely before 2H 2016 – an election year.
The US economy continues to chug along. Jobless claims are saying that the US economy is getting hit by the California drought and the oil price collapse. However, looking past these local events, the broader economy continues to expand as fewer people are out of work than last year because an expanding economy is driving businesses to hire more people.
The pace of growth is what matters, and the slowly shrinking gap between this year’s layoffs and last year’s layoffs indicates that the pace of growth is slowing.
Thus it’s a matter of timing. As investors we want to get defensive well before that gap shrinks completely, because that’s when growth is stopping and the markets get roiled.