Today the Labor Department (BLS) reported that the unemployment rate reached the highest level since 1983 even as the pace of job market deterioration continued to improve. U.S. employers cut payrolls by 216,000, less than consensus expectations of a 230,000 drop, but previously reported June and July job losses were revised upward by 49,000. The unemployment rate jumped from 9.4% to 9.7%. The losses were widespread across categories, including construction, manufacturing, and professional services.

Initial reaction to the jobs report followed the typical script we’ve seen all summer: with fewer jobs lost, a recovery must be around the corner. True, August’s loss of 216,000 jobs is a huge improvement over the 750,000 lost in January, but simply drawing an upward trend line fails to give me confidence that the economy will soon begin creating jobs. Digging into the BLS’s release, two important facts, largely overlooked in the press, suggest this report was less robust than the headline suggests.

First, the BLS each month includes a “diffusion index of employment change”, which simply measures the percentage of companies that are hiring workers. This is similar to the Institute for Supply Management manufacturing and services sector sentiment gauges, in that a reading of 50.0 represents a balance between those companies that are increasing and decreasing employment. In August, the BLS diffusion index showed that only 35% of employers are hiring workers, an improvement over July’s 30%, but a sobering number nonetheless.

The second suspect data point in the BLS release is the infamous “Birth/Death” adjustment. As we’ve pointed out before, the government attempts to estimate the number of jobs created or destroyed by the birth or death of employers in any one month. According to the BLS report, 118,000 jobs were “created” in August by the Birth/Death adjustment.

Without a doubt, the employment picture in the U.S. is susbtantially improved from several months ago. As a result, one must not be too bearish, because changes at the margin drive financial markets. But we remain cautious on equities in light of our long held view that too much debt on consumer balance sheets will weigh on economic growth, especially with unemployment approaching 10%.

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