The Big Picture

Column Summary:

*The unemployment rate is a lagging indicator and less useful for predicting future economic trends.

*Initial jobless claims are the key leading indicator for the labor market.

*The four-week moving average for initial jobless claims remains well below recession-like levels.

For obvious reasons, there will be a lot of attention on the U.S. economy in the coming months. It will be judged through the lens of economic data, particularly the hard data.

Last week we discussed why that wait will be hard for the market. It boils down to the time it will take to get a feel for developing trends. One month of data does not a trend make, nor does two months. At a minimum, it will take three months of economic data to gain a better foothold on how the economy is operating in a minefield of tariff bombs.

There is one important piece of hard data, though, that remains very much on the economy's side: initial jobless claims.

A Lagging Indicator

The unemployment rate, typically published on the first Friday of every month, tends to get top billing as the key labor market indicator. That is understandable since the unemployment rate is an indicator that resonates in the popular press, pervades the national psyche, and stands as a make-or-break point in many political campaigns.

It is accorded more cachet than it deserves, much like the Dow Jones Industrial Average is whenever one wonders how "the market" did. The Dow Jones Industrial Average doesn't represent "the market." It is a price-weighted average of just 30 stocks. The market cap-weighted S&P 500 is a far better proxy for "the market," but since the Dow Jones Industrial Average has been around so long, it is often the first thing that comes to mind when one asks, "How did the market do today?"

We digress.

The unemployment rate, currently at 4.2%, doesn't deserve the cachet it naturally receives as a key labor market indicator because it is a lagging indicator, standing out as a measure of changes in the economy that have already occurred.

Employers like to retain their employees. It can be an expensive and unproductive process hiring and training new employees, so they will hold onto employees when business activity starts to weaken, hopeful that the downturn in business will be short-lived.

It might take six or more months of declining sales for an employer to conclude the downturn isn't something that is short-lived, which is when they make the difficult decision to let employees go. Those employees are then unemployed; however, they are counted as newly unemployed after business conditions have already changed. 

The unemployment rate, though, isn't devoid of value. It can be used as a confirmation signal.

When it comes to labor market data and its implications for the economy, initial jobless claims are the key labor market indicator because they are a leading indicator.

Briefing.com Analyst Insight

The value of initial jobless claims as a leading indicator is wrapped up in the understanding that they are timely. They capture on a weekly basis the number of people filing for unemployment benefits for the first time. Accordingly, a notable jump in initial jobless claims can be construed as a sign of a weakening labor market, which has important knock-on effects for the economy.

When people get laid off from their job, they won't spend as much since their regular income stream, excluding unemployment benefits, has essentially been cut off. In turn, employed individuals are apt to spend less and save more out of fear that they could also lose their job.

That is a momentous consideration because consumer spending accounts for close to 70% of GDP. Spending won't grind to a complete halt, but there is a domino effect of reduced spending that includes reduced business investment, reduced construction, and more job losses that weigh further on the economy.

Initial jobless claims, therefore, have a lot of cachet as an economic driver and market mover. Things will change, but just remember it will be the degree of change in initial jobless claims, not the unemployment rate, that matters most as a read on the labor market and economic prospects.

The encouraging news today is that initial jobless claims are nowhere close to levels seen during recessions. For the week ending April 19, the four-week moving average was just 220,250. That is way below the average levels seen during the last six recessions.

That is where we want to leave things with this week's column. It is a dose of good news amid the tumult of tariff talk, and who doesn't like good news?

--Patrick J. O'Hare, Briefing.com