Private sector tuned out gov't shutdown

INDICATOR: October Employment Report

KEY DATA: Payrolls: +204,000; Private Sector: +212,000; Unemployment Rate: 7.3% (up 0.1 percentage point); Temporary Layoffs: up 448,000; Hourly Earnings: +0.1%

IN A NUTSHELL: "The private sector appears to have tuned out Washington and went about its business of producing goods and creating jobs."

WHAT IT MEANS: Be afraid, be really afraid. Or not. There is little doubt that the government shut down affected the economy but how much is in doubt. The private sector went on a hiring binge in September adding workers at a strong pace. The increases were spread across the entire economy with 61.5% of the industries posting gains. Leisure and hospitality, health care, professional services, retail and wholesale trade, construction and manufacturing were all up solidly. Where we saw the impact of the shut down was in the unemployment numbers and earnings. The unemployment rate ticked up as there was a huge rise in the number of people who were temporarily unemployed. Since most of those people are back at work, that number should fall sharply in the November report so expect the rate to decline. There was also a cut back in the average workweek. With hours worked down and wages rising minimally, average weekly compensation actually dropped. That does not bode well for consumer spending. Indeed, the September consumption numbers showed that household purchases rose modestly, especially when inflation was taken into account. Wage and salary increases were also small. Unless wage gains accelerate, the lackluster economy will remain lackluster.

MARKETS AND FED POLICY IMPLICATIONS: This report was way above estimates. I was at 168,000, which was near the top of the range, and I was not even in the ballpark. There was also an upward revision to the August and September numbers and over the past three months, the economy created an average of about 200,000 new positions. That is enough to push the unemployment rate down on a fairly consistent basis. I would not be surprised if we end the year with a rate of 7.1% and break below 7% by the spring. If that is the case and job growth is in the 200,000 range for the next few months, look for the Fed to signal a start of tapering sometime around the March 18, 19 meeting. How will investors react? The weakness in wages is enough to keep the Fed on hold at least until early next year but tapering is coming. At the same time, a strong economy is really what is needed to sustain earnings growth and current equity price levels. So battle in the markets will be between investors who worry about the Fed forcing liquidity withdrawal on the markets versus those that welcome the prospects that growth will be strong next year. It will be interesting to see how this plays out.