ADP Employment Report and Stock Returns

Since May 2006, the monthly ADP National Employment Report has presented “estimates of nonfarm private employment…constructed from ADP’s data on payrolls following a procedure similar to that used by the BLS [Bureau of Labor Statistics] to process its monthly survey of Current Employment Statistics into the ‘official’ estimates of establishment employment. The ADP National Employment Report is released, for public use only, two days prior to the Employment Situation.” Does this report affect or predict U.S. stock market returns on the day of release or during the ensuing month? Using ADP report release dates and estimates of total nonfarm employment for April 2006 through March 2012 (72 months) and contemporaneous daily and monthly dividend-adjusted levels of SPDR S&P 500 (SPY), we find that:

The following scatter plot relates open-to-close SPY returns on monthly release dates to ADP’s estimates of the change in total non-farm payroll (employment growth) over the entire sample period. The Pearson correlation for the two series is 0.00, and the R-squared statistic is 0.000, indicating that monthly variation in ADP employment growth explains none of the SPY open-to-close return on release dates.

The volatility of daily returns appears to be much higher when employment falls than when it rises.

For another perspective, we look at returns for ranges of ADP employment growth.

The next chart shows the average SPY release-date returns for the lower, middle and upper thirds of ADP employment growth estimates over the entire sample period, with one standard deviation variability ranges. The most notable indication is that volatility of returns decreases as employment growth estimate increases.

What about monthly returns?

The next scatter plot relates next-month SPY returns, measured from the market open on each release date to the open on the next release date, to ADP’s employment growth estimates over the entire sample period. The Pearson correlation for the two series is -0.13, and the R-squared statistic is 0.02, indicating that monthly variation in ADP employment growth explains 2% of the variation in SPY returns over the ensuing month. Since the correlation is negative, a strong (weak) employment growth report indicates on average a relatively weak (strong) stock market return.

As for the daily data, the volatility of returns appears to be much higher when employment falls than when it rises.

To gauge non-linearity and materiality of this predictive power, we calculate average next-month SPY returns by range of employment growth estimates.

The next chart summarizes the average next-month SPY returns for the lower, middle and upper thirds of monthly ADP employment growth estimates over the entire sample period, with one standard deviation variability ranges. Again, the most notable indication is that volatility of returns decreases as employment growth estimate increases.

Might there be a delay of more than a month in the relationship between stock market returns and ADP employment growth estimates?

The final chart summarizes relationships between SPY monthly returns (again, measured from the market open after each release date to the open on the next release date) and monthly ADP employment growth estimates for various lead-lag scenarios, ranging from stocks lead ADP estimates by six months (-6) to ADP estimates lead stocks by six months (6), for the entire sample. Results suggest that:

• A strong (weak) stock market indicates strong (weak) employment growth cumulatively over the coming months.
• Less convincingly, a strong (weak) employment growth indicates a weak (strong) stock market cumulatively over the coming months.

In summary, evidence from simple tests indicates that a relatively high (low) monthly ADP employment growth estimate may indicate relatively low (high) volatility of U.S. stock market returns at both daily and monthly horizons.

Cautions regarding findings include:

• Sample and subsample sizes are small for confident inference. If the employment-stock market relationship derives from a fairly long economic/business cycle, a much longer sample period is needed for confidence.
• There are several changes in employment growth estimating methodology/benchmarks during the sample period, potentially disrupting the relationship between estimates and stock returns.
• Since February 2007, there are revisions to prior month employment growth estimates every month. The above analyses use only estimates as originally reported each month, without testing effects of prior-month revisions.
• The above analyses are generally in-sample. An investor using only historical data may have different beliefs regarding what levels of employment growth are high and low at different times. The sample period is not long enough for meaningful out-of-sample testing.
• To the extent that the distribution of SPY returns is wild, interpretation of the average return and standard deviation of returns breaks down.

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