June Employment Report Preview

We rely too much on the monthly employment outlook report.  It is a natural mistake.  We all want to know whether the economy is improving and, if so, by how much. Employment is the key metric since it is fundamental for consumption, corporate profits, tax revenues, deficit reduction, and financial markets.

Since the subject is so important, most people place too much emphasis on the official (preliminary) report, which is really only an estimate.  In about eight months, we'll have an accurate count from state employment offices, but by then no one will care.

There are several competing methods that provide independent approaches to analyzing employment.

I will first summarize the BLS official methodology.  Next I will review alternative approaches and those forecasts.  I will conclude with some ideas about what to watch for.

The Data

We would like to know the net addition of jobs in the month of May.

To provide an estimate of monthly job changes the BLS has a complex methodology that includes the following steps:

  1. An initial report of a survey of establishments. Even if the survey sample was perfect (and we all know that it is not) and the response rate was 100% (which it is not) the sampling error alone for a 90% confidence interval is +/- 100K jobs.
  2. The report is revised to reflect additional responses over the next two months.
  3. There is an adjustment to account for job creation — much maligned and misunderstood by nearly everyone.
  4. The final data are benchmarked against the state employment data every year. This usually shows that the overall process was very good, but it led to major downward adjustments at the time of the recession. More recently, the BLS estimates have been too low. (See here for a more detailed account of this, along with supporting data).

Competing Estimates

The BLS report is really an initial estimate, not the ultimate answer. What we are all looking for is information about job growth. There are several competing sources using different methods and with different answers.

  • ADP has actual, real-time data from firms that use their services. The firms are not completely representative of the entire universe, but it is a different and interesting source. ADP reports gains of 176K private jobs on a seasonally adjusted basis.  In general, the ADP results correlate well with the final data from the BLS, but not always the initial estimate.
  • Economic correlations. Most Wall Street economists use a method that employs data from various inputs, sometimes including ADP (which I think is cheating — you should make an independent estimate).
    • Jeff Method.  I use the four-week moving average of initial claims, the ISM manufacturing index, and the University of Michigan sentiment index. I do this to embrace both job creation (running at over 2.3 million jobs per month) and job destruction (running at about 2.1 million jobs per month). In mid-2011 the sentiment index started reflecting gas prices and the debt ceiling debate rather than broader concerns. When you know there is a problem with an input variable, you need to review the model. For the moment, the Jeff model is on the sidelines.  From my perspective, the decline in consumer confidence, even with lower gas prices, is disturbing.  It is difficult to account for the effect of headlines about Europe and the fiscal cliff.
    • Street estimates generally follow my method, but few reveal much about the specific approach.  Have a little fun by looking at the specific forecasts from many firms, along with a picture of the spokesperson!  Thanks to Business Insider.  Joe Weisenthal, in a good story about Goldman,  notes that some of these estimates are already responding to the ADP report.
  • Briefing.com cites the consensus estimate as 100K, the same as their own forecast.
  • Gallup sees unemployment as falling on a seasonally adjusted basis (but flat if unadjusted).  This is interesting since they have a different survey from the government, a relatively new approach to seasonal adjustment, and an extremely bearish and political approach in past commentaries.  Gallup's methods deserve respect, so I am watching closely.

Partial Indicators 

A problem with forecasting net employment changes is that you need to look at all of the following:

  1. Both hiring and firing;
  2. Companies of all sizes; and
  3. Failing companies and new businesses.

There are many interesting pieces to the puzzle, but it is easy to over-react without the context listed above.  The respected Challenger survey reports fewer layoffs.  Excellent!  But does that mean hiring?  Initial jobless claims move higher.  That tells us about job losses at certain types of firms, but nothing about job creation.

An interesting idea comes from Michael Mandel, who astutely notes the disparity in help-wanted ads according to the occupation.  Harkening back to The Graduate, Michael (one of my favorite acquaintances from my Kauffman meetings), writes as follows:

"If you have a college student in your family who is looking for a job, remember this one word: 'Data.'"

For Dustin Hoffman it was "plastics."  Michael says to watch this, so I am and you should, too.

Men on a Mission

(And women too, of course, but I could not resist the alliteration.  Biased female economists should feel free to accept equal blame!)

Here at "A Dash" we have great respect for those who make objective, independent forecasts.  We know that methods may lead to different conclusions, and that debate is healthy.

With this in mind, here are two examples:

  1. TrimTabs confidently asserts that the BLS data will be wrong!  Amazing, without knowing the content of the report or the revisions.  They assert that we are in a "depression" and are confident about the direction of later revisions.  While I have been sympathetic to their own mistakes, and agree about revisions, they do not seem to realize that the BLS has been understating growth for a couple of years.  Why the agenda?
  2. David Rosenberg is out with a list of reasons why the jobs report will "stink."  He cites a number of interesting indicators.  A serious economist would do research with a time series on each, discarding those that reflected multi-collinearity.  That is what my team did.  He cherry picks reports and plays the same tune, always finding new data.  He has an audience, and one much bigger than mine!  [Will someone please remind me of who first said that the crowd expects Neil Diamond to sing Sweet Caroline?  I want to give credit where it is due.]

Failures of Understanding

There is a list of repeated monthly mistakes by the assembled jobs punditry:

  • Focus on net job creation.  This is the most important.  The big story is the teeming stew of job gains and losses.  It is never mentioned on employment Friday.  The US economy creates over 7 million jobs every quarter.
  • Failure to recognize sampling error.  The payroll number has a confidence interval of +/- 105K jobs.  The household survey is +/- 450K jobs.  We take small deviations from expectations too seriously — far too seriously.
  • False emphasis on "the internals."  Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy.  In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
  • Negative spin on the BLS methods.  There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment.  This is a propaganda war that seems to have ended years ago with a huge bearish spin.  For anyone who really wants to know, the BLS methods have been under-estimating new job creation.  This was demonstrated in the latest benchmark revisions, which added more jobs, as well as the most recent report from state employment offices.

It would be a refreshing change if your top news sources featured any of these ideas, but don't hold your breath!

Trading Implications

My experience with employment Fridays is that there is little benefit to being aggressively long before the report.  The spinfest usually provides shorts with a morning "dip to cover" when the number is surprisingly good.

I also expect some dampening in either direction.  A really bad number will be met with expectations for Fed action.  A strong number will get the opposite result, and maybe a stronger dollar.

Unless there is a massive discrepancy from expectations, my guess is that we will move on to earnings season and option volatility will be reduced.

And most important…..investors should not let this become political, even though the pundits will.

Progress, Technology, and Economic Fundamentals

There is a popular idea that economic growth only comes from stimulus.  Wrong!

This mistaken view of economics can be costly to the average investor.  The US economy, and others that follow a free market approach, grow through population increases and productivity gains.  Normal trend growth in the US, allowing for inflation, is a bit over 3%.  Even in the absence of any stimulus, we would eventually get there as various factors reverted to mean levels.

This is difficult to explain without a full course in economics, so today I will offer an alternative approach.  Any reasonable person can see the changes in societal well being, but it is easy to forget.but there is a thriving industry claiming that traditional economic statistics overstate the economy.

Let us consider a simple example that we can easily understand as a starting point.

A Simple Example

I was already thinking about this subject last week because of a promotional item that I received in the mail.  It reminded me of an interesting theme of progress — the calculator.

When I was a college student, we used slide rules for calculation.  I was a student engineer at Union Carbide.  They had a few mechanical calculators that did rudimentary functions (with a lot of noise).  The calculators were perched between two desks, shared by the engineers on either side to save on costs.

Images

A few years later I was a quant guy in the Michigan PhD program, hoping for my own calculator.  They now had electronic versions, and some could perform the basic math functions and even store a value in memory.  That was my minimum spec, and I wanted one for less than $100.  That would be the equivalent of over $500 today.  The price point was finally met with a device about the size of a paperback book, requiring a few C batteries to power it.

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Both of these devices were major improvements, increasing user productivity tremendously.  Before that, we wrote down columns of figures and did the math by hand.

The same engineer could do much more work because of the improvement in technology – – a simple concept.

My alert readers have already guessed the conclusion of this little story.  The promotional item in the mail was a featherweight calculator, superior in function to the model depicted above.  It has a small battery that will last forever.  Best of all, it was free.

And this theme does not even explore the added value of the spreadsheet or computer programs that combined the required calculations.

And Now …. Add the Internet

Thanks to Al Gore (!!) we now have a new dimension of productivity.  I am astounded to discover that there are more iPhones sold each day than babies born, and I don't suppose that the 15 minutes of porn watching adds to productivity, but those are just the sidelights.

I can do work in minutes that would have taken days in a library a few years ago.  Take a look at these interesting facts from MBAOnline.com and I'll provide an investment idea in the conclusion.

 

A Day in the Internet
Created by: MBAOnline.com

All of this would have been unthinkable a few years ago — an explosion in communications and information access.

Investment Themes

There are several important ideas to think about.

  • Economic growth is fueled by technological progress.
  • Every major corporation has improved business with improved robotics, communication, planning, customer acquisition and service, logistics, supply chain, and I'm just getting started.
  • These elements are part of the explanation for high profit margins, and also for the recent success of some companies in bringing jobs back from offshore.
  • While it is easy to forget, the quality of life is better through progress — better in agriculture, motor vehicles, clothing, health care.

Those with offbeat theories of economics need to explain this progress.  The rest of us can enjoy investing in companies that participate in economic growth and the technology companies that help to create it.

My current tech favorites are Apple (AAPL), Oracle (ORCL), and Microsoft (MSFT), but I also like innovative companies in medical devices.

I invite readers to weigh in with their own favorites!

 

Weighing the Week Ahead: Fireworks in the Forecast?

Forecasting fireworks this week should be pretty safe!

I will have trouble outdoing last week's WTWA theme:  Upside Surprises.  Nearly everyone in the comments disagreed with me.  Sentiment is so negative that you can hardly get a good discussion about what might go right.

We could have more fireworks this week, and not just those on the 4th.  Friday is shaping up to be a big day, with expectations for employment gains pretty low.

Background

The current climate is a torture test for the average investor!

It invites people to act on their least-effective instincts, leading to the worst results.  I tried to explain why this happens in an article last week about those who "explain" the message of the market.  The key point is that most pundits talk about things after the fact and pretend that they predicted it.  Contrast this with last week where I was pretty much alone in suggesting that things might go right.

In sharp contrast, if you look at the markets objectively, most of the big-shot pundits have been proven wrong:

  • Wrong on recession forecasts – -made as imminent and unavoidable over nine months ago;
  • Wrong on earnings and profit margins — a multi-year prediction of disaster;
  • Wrong on Europe;
  • And soon to be wrong on upcoming worries like the "fiscal cliff."

I love Barry Ritholtz's blast from the past.  He questions the current worries about "uncertainty" and compares it to the cold war era.  We both remember that time.  Most people thought that their lives would end from a nuclear war.  Can things possibly be worse now?  He wisely notes that markets thrive on uncertainty.

This is a nice way of describing the "wall of worry" concept that many investors have found to be a valuable idea (0nce they get it).

The fireworks this week may illuminate events and reduce uncertainty.  Only losers will wait for all of the answers.  It is not that easy!

I'll offer some more thoughts on this in the conclusion, but first let's do our regular review of the events and data from last week.

Background on "Weighing the Week Ahead"

There are many good sources for a list of upcoming events.  With foreign markets setting the tone for US trading on many days, I especially like the comprehensive calendar from Forexpros.  There is also helpful descriptive and historical information on each item.

In contrast, I highlight a smaller group of events.  My theme is an expert guess about what we will be watching on TV and reading in the mainstream media.  It is a focus on what I think is important for my trading and client portfolios.

This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.

Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially — no politics.
  2. It is better than expectations.

The Good

The most important news of the week was very good.

  • Important steps in Europe.  Last week's EU Summit significantly reduces the immediate contagion threat that has affected US stocks.  It improves prospects for European economic growth.  It demonstrates that the process of negotiation and compromise is working.  This is exactly what I have been predicting for over a year — a process of incremental change with concessions by many parties.  The next thing to expect is more action by the ECB as well as the IMF and others.  (See here for past articles with more detail on what to expect).
  • Congress passed legislation on transportation and student loans.  It was a bipartisan effort with significant margins.  Now what about that fiscal cliff?
  • US household deleveraging is nearly over.  It shows a path that Europe could follow.  The result is potential for spending if confidence improves.  The entire Scott Grannis article deserves attention and you should enjoy the great charts.  Here is a key quote:

"In any event, households' aggregate debt and financial burdens are now about as low as they have been for the past three decades. That amounts to some considerable adjustments, and I would argue that these adjustments have set the stage for some big changes in the years to come. For example, if confidence in the future increases, households' risk aversion is likely to decline, and the demand for money is likely to decline as well. There are trillions of dollars in savings deposits that households could decide to spend."

  • New home sales are stronger.  Bill McBride at Calculated Risk has taken the lead on forecasting this.  He is not getting carried away on the rate of the rebound.  It is the thoughtful and careful analysis that you would expect from him.  I also like Steven Hansen's discussion.  My own role is in helping investors find the best sources.  The key point to keep in mind is that just getting a bottom in housing — not a rebound — will help GDP by 1 to 1.5%.

NHSMonthMay2012

…and by the way, for those who expect an avalanche of foreclosure homes on the market, Bill does not see that either.

  • Rail traffic was good, if one adjusts for the coal distortion.  Todd Sullivan has an innovative chart on a topic we have reviewed on past weeks.

Capture571

  • US Consumers have another $250 billion to spend through reduced energy costs.  Great analysis from Prof. James Hamilton.

The Bad

Most of the economic data was a little weaker than expected.  This continues the pattern of sluggish growth we have seen for several months.

  • Initial jobless claims remain at the 385K level.  This rate of job loss is inconsistent with more robust growth and solid net job gains.  (contra – Scott Grannis looks at year-over-year and sees nothing close to recession levels).
  • Personal consumption is weakening.  See Steven Hansen's balanced analysis of all factors and also note the contrast with the deleveraging cited in the good news.
  • Corporate profits fell last quarter for the first time since the recession — on a seasonally adjusted basis.  (via Catherine Rampell in the NYT).
  • Consumer confidence remains weak — in spite of falling gasoline prices.  This suggests continuing weak employment, concern about poor policy decisions, or both.  There are many charts of this, but I prefer Doug Short's analysis.  It compares the principal confidence measures and also shows past recessions.  Here is the Conference Board chart:

Conference-Board-consumer-confidence-index

  • US Consumers are bearish on stocks via Bespoke.  This impacts spending, so it is not contrarian.

Consumer confidence

  • Earnings estimates are declining.  The Q212 forecast now calls for a decline of 1.1% via Bespoke.

Eps626

Dr. Ed shows the impact on forward earnings.

FIGURE190

The estimates are a bit lower, but there are still solid growth forecasts for the year.  This bears watching.

 

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events.  It uses data, mostly from credit markets, to reach an objective risk assessment.  The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I'll explain more about the C-Score soon.  We are working on a modification that will make this method even more sensitive.  None of the recession methods are worrisome.  Bob also has a group of coincident indicators. Like most of the top recession forecasters, he uses these to confirm the long-term prediction. These indicators are also not close to a recession signal.

There is a lot of activity from the recession forecasters.  The basic summary is that those with the best records still see little chance of a recession in the next six months or so.  The people that get featured  in the press and on TV are sticking by their guns, even though the evidence is mounting against them.

We are now at the end of the nine-month forecast window that the ECRI adjusted to after their September, 2011 call (recession imminent, maybe already here, and unavoidable) seemed to prove wrong.  Since then they have been adjusting indicators and trying to extend the window, which supposedly ends right now — mid-year 2012.  Here are some good updates:

There are many threads on this theme, and I am overdue for a full update.  I'll try to bring them together.

 

Indicator snapshot 063012

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions.  This week we continued as "bullish." These are 30-day forecasts.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list.  You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

Last week was one of our best in identifying both the focus and the potential outcomes.  This week is very different.  For many firms the "A Team" will be on vacation.  Some will take five days off going through the mid-week holiday.  Others will take five days starting with Wednesday.  Still others will take all week!  Here at "A Dash" we'll be on duty all week:)

This may dampen trading activity.  Monday morning will  provide the ISM manufacturing index, which is an important indicator.  Then things will get quiet until Thursday.

On Thursday we will get the ECB rate decision, ADP private payrolls, and initial jobless claims.  Friday will bring the employment situation report.

To summarize, the fireworks will come on Thursday and Friday.

Trading Time Frame

Our trading positions geared up last week.  After Monday we were fully invested.  Felix is not a range trader, but is excellent at getting on the right side for big moves.  As I predicted last week, this was the week of opportunity for trading.

Investor Time Frame

The successful investment strategy differs markedly from trading.  It is especially important to establish good, long-term positions when prices are favorable.  I tried to explain the most important concept for individual investors in this article about the Wall of Worry. I have had many emails from people who had a personal breakthrough in their investing when they understood this concept. If you missed it, I urge you to take a look.  You can contrast this with the many  pundits who claim miracles of market timing.

The best strategy through the various gyrations has been buying dividend stocks and selling calls for enhanced yield.  Anyone unhappy with bonds should be doing this for a yield of 8-10% with greater safety than pure stock ownership.  Take what the market is offering!

Final Thoughts on Fireworks

This week marks an especially important time for most individual investors.  While my audience includes traders and investment advisors, it is the individual investor who is most likely to be led astray.  I often try to write as if I were speaking directly to one of my clients or friends, face-to face.  I relate to their biggest fears and try to provide some reassurance.

Here is the dilemma:

The best investment advice comes from contrarian approaches.

  Most investors pay too much attention to recent results.

This provides a challenge for investment advisors.

When I interview a new client, I have six different programs available.  They all beat their benchmarkrs on a long-term basis, but they differ widely in risk and reward.  To take two simple examples:

  • If you want to make 8-9% a year with reduced risk, I have a program for that.
  • If you want complete safety, we can do that also.

These are not the right moves for most people who have a longer time horizon.  Even older investors need a touch of octane in the tank!

And that is where we are right now.  Most of the people you read or see on TV are looking at the past and pretendingbad advice.

While I do not give specific investment advice on the blog, my general assessment is that each investor should be a little more aggressive than usual (adjusted for personal circumstances).  When I speak with individuals, I find that most are scared witless (TM OldProf euphemism), and therefore not prepared to participate in the upcoming rally as problems are solved.

This week is a good example.

Best Investment Advice of the Week

For my strongest advice this week I recommend Matt Busigin's first rate article, The REAL Cult Of Equity.

This is the single best piece I saw last week, and I read hundreds of articles.  Take a few minutes.  No, take more than a few minutes and read it twice.

Matt covers the key quesitons about whether we are in a recession,  why stocks are cheap, the risk/reward for stocks, and some refutation about those "bad times to invest" guys — although he is too polite to name them.

He is especially powerful in explaining marginal forces on asset allocation — something totally ignored by most pundits.  Here is one example:

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If the chart seems a little wonky and does not make immediate sense to you, all the more reason to read the article.  You will see why!  (It shows the powerful mean reversion of stocks and bonds — a key concept).