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Our Top Pick for a Recovering Job Market

We think one hidden gem could give investors a sweet payday.

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The employment market has improved greatly over the last two quarters. Nonfarm job growth has been positive for five out of the last six months. This marks a dramatic turnaround from the 400,000 average monthly losses witnessed in 2009. We believe April 2010's employment report reaffirms the stabilizing trend for the labor market. However, we do not expect a "V" shaped recovery by any means. Our expectation for the employment market is for a slow pace of improvement throughout most of 2010, and an elevated unemployment rate for an extended period.

So how does an investor play this dynamic? As the employment market has stabilized, many of the names on our employment services coverage list have rallied during the last few quarters. Many firms that we thought were undervalued during the worst of the recession now appear fairly valued to us. Nevertheless, there is one firm we believe is highly undervalued, providing an opportunity for investors to capitalize on an improving employment market. Over the next several paragraphs, we recap the state of the employment market from the most recent data, and provide a sense of what is happening "on-the-ground" from the latest earnings results from several of our employment-related firms. Next, we break down the April employment numbers from the government's latest report. Finally, we lift the veil on one name that we believe currently offers a significant opportunity for investors.

Themes From Our Staffing Coverage List
A majority of our employment-related firms reported results over the last month, and a key theme has emerged. Businesses in general cut their workforces too deeply, and are now scrambling to right-size their staffing levels in line with the recovery in economic activity. Most staffing firms reported results that have improved over the deep double-digit declines of 2009. Additionally, all staffing firms reported that orders are up, and a greater number of customers are demanding staffing services. In particular  TrueBlue (TBI),  Manpower (MAN), and  Kforce (KFRC) all reported relatively solid results, and all three stated they expect gradual revenue growth over the course of 2010.

The HR outsourcing firms also reported solid results.  Automatic Data Processing (ADP),  Hewitt Associates (HEW), and  Concur Technologies (CNQR) all reported positive results. The uncertainty surrounding the recently passed health care bill, and increased business spending, have combined to provide a tailwind for these services, in our opinion.

Nonfarm Jobs Grew 290,000 Over the Month of April
Nonfarm jobs haven't grown at a clip this robust since April 2006. Nearly all categories experienced job growth. Especially helpful was a positive number for the construction sector, which posted its first increase in over three and half years. The subsectors which drove this growth were nonresidential building, and heavy & civil engineering. It seems the stimulus package has finally started to make a noticeable impact.

Encouragingly, many back-office business administration categories added jobs. This dynamic seems to suggest business spending has thawed, at least somewhat. Temporary labor posted solid job gains again, but growth has slowed for the sector. Combining this trend with what we have heard from our staffing coverage list suggests a tempering for this sector in the future. However, we believe this will not be the case for most of 2010. In our opinion, businesses will utilize temporary labor at an increasing rate to keep their workforce costs as variable as possible. Additionally, we believe the uncertainty surrounding the impact of the newly passed health care legislation will provide a long term tailwind for staffers, as businesses outsource their employee administration activities.

Retail was a key sector we've watched recently, and it continued to show job gains. Almost every type of retailer posted job growth except for the general merchandise retailers, whose ranks include  Wal-Mart (WMT),  Target (TGT), and  Dollar General (DG), and that cater to the lower-end consumer. This was one of only a few troubling variables from the payroll survey. There has not been a material increase in wages, and the tighter credit environment will hinder spending from the lower-end consumer if wages fail to increase meaningfully. If higher-end consumers curb their recent spending, and if lower-end consumers are not able to spend, the job market recovery could be weakened.

Unemployment Shows Persistence in April
The unemployment rate did increase 20 basis points, to 9.9%, which has been spun as a bad sign by the press. However, we believe an increase in this rate is actually positive during the early stages of a recovery. Many workers who left the workforce move back in, and this dynamic was reflected by a 30 basis point increase in the participation rate (the percent of the population able to work that are actively in the workforce), to 65.2%. Some of this increase was related to graduating students, as they represent a new influx into the workforce. Nevertheless, the percentage of the population that is employed did also go up by 20 basis points to 58.8%, a very good sign, in our view.

Our Top Sector Pick
Based on the latest data, we believe an employment market recovery has taken hold. Nevertheless, in our opinion, the pace of recovery will be slow. Many of the jobs that were lost during the recession will most likely not return ,and many sectors which were hit extraordinarily hard will not reach pre-recession levels of employment for many years. Of particular concern to us are the long term growth prospects for the construction and financial services sectors.

On the other side of the coin, we believe the health care sector will provide plenty of job growth over the long term. Demographic shifts and medical advances point to a U.S. population base that is growing older rather than younger, and shortages among health-care workers are anticipated. According to the Department of Health and Human Services, the nurse shortage will become severe by 2020, given recent trends. Additionally, the newly passed health care reform bill should help to increase the number individuals that will have access to medical services. We believe these trends are highly positive to firms that supply labor to the health care industry.

Given the positive cyclical and secular tailwinds,  AMN Healthcare (AHS) could be an interesting opportunity for investors, in our opinion. Over the past year, the firm reported weak results as a poor health-care employment market challenged all health-care staffers. Lower admission rates at medical facilities, a lower level of staffing turnover, and lower rates of retirements among health-care workers have combined to provide a steep headwind for AMN. The firm's stock has retreated approximately 50% since the beginning of the most recent recession, and has lagged other employment-related stocks. The firm's solid employment network and narrow economic moat should help it through the difficult short term, however, and we believe it is positioned to prosper for many years.

Vishnu Lekraj does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.