Blog - Investing Notes

July 3, 2008 - The ADP Employment Report and Stock Returns

Does the monthly ADP National Employment Report predict U.S. stock market returns? This report "was developed to help meet the need for additional timely and accurate estimates of short-term movements in the national labor market among economists, financial professionals, and government policy-makers. Because ADP pays 1-in-6 private sector employees in the United States every pay period across a broad range of industries, firm sizes, and geographies, it has a unique and significant perspective on the U.S. labor market." ADP releases the report for each month near the beginning of the following month. Using historical monthly ADP estimates of seasonally adjusted non-farm payrolls for December 2000 through June 2008 (91 months) and contemporaneous monthly S&P 500 index data, we find that:

The following scatter plot relates next-month return for the S&P 500 index to this-month change in ADP's estimate of total non-farm payrolls over the entire sample period, with a best-fit line to characterize the relationship. The Pearson correlation for the two series is 0.12, and the R-squared statistic is 0.02, indicating that the change in estimated employment this month explains just 2% of U.S. stock returns next month.

This relationship is fairly consistent for monthly changes in estimates for: goods-producing employment; services-producing employment; small business employment; medium-size business employment; and, large-business employment.

The distribution appears to be much tighter for job growth than for job loss. Might the relationship be stronger for some ranges of change in payrolls than others?

The next chart is an ordered version of the above scatter plot, with the monthly change in the ADP employment estimate arranged from lowest (most negative) to highest. Results suggest that stock returns next month tend to be very volatile after a negative or very low positive change in this month's employment estimate.

Is there a way to tell whether employment mostly leads or mostly lags stock market behavior?

The final chart shows the Pearson correlations for a range of data offset scenarios ranging from stock returns lead employment by six months (-6) to employment leads stock returns by six months (6). Correlations are highest for scenarios wherein stock returns lead employment changes by two to five months. The argument that the stock market leads employment is therefore a little stronger than the argument that employment predicts stock market behavior.

The fact that correlations are positive for all 13 scenarios suggests that employment and stock returns tend to move together over fairly long periods. Negative correlations occur in this sample only for data offsets well over a year.

In summary, the ADP National Employment Report has little (some) power to predict near-term stock returns (return volatility). Evidence suggests that stock returns predict changes in employment better than vice versa.

See Blog Synthesis: The Economy and the Stock Market for other research on relationships between macroeconomic indicators and stock market behavior.