Weighing the Week Ahead: Time to Assess the Evidence?

Many times we can plan for the week ahead by considering the calendar of data releases and the schedule for official policy announcements.  This week is extremely light on all fronts.  Even Congress has left town for the "August recess."  It is still a little early for election intensity.  Many are enjoying vacations and the Olympics.

Just as nature abhors a vacuum, the market media must fill all of that space and air time.  How?

I expect a week with a focus on reassessment.  Journalists and pundits (at least those who are not at the beach) can digest the recent economic data, the Q2 earnings results, the promises of policy leaders, and the latest political polls.  With all of this information at hand, I expect a series of stories looking ahead to the rest of the year — economy, politics, and markets.

There are a lot of exciting investment themes right now, but most investors are missing them.  While this weekly article focuses on short-term events, I always include a special section for long-term investors.  This week I have more to say, but I also suggest four ideas that illustrate the many good themes available right now.

I'll offer some of my own expectations in the conclusion, but first let us do our regular review of last week's news.

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

There was plenty of news the market liked, but it is still a mixed picture.

  • ECB chief Mario Draghi (Day 2) Before the ink was dry on stories about Draghi's failure to deliver on last week's promise, the revisionist thinking began.  See one of the best examples here.
  • Initial jobless claims declined 35,000 to 353K.  This continues a wild series of gyrations, possibly influenced by fewer auto plant closings this year.  It does provide another decline in the four-week moving average, and it looks nothing like recession territory (as noted by Bonddad with some great charts well worth checking).  These data were not part of the survey period for next week's employment situation report.
  • Rail traffic is stronger, now at the highest level of the year.  Todd Sullivan writes, "I think the economy is slugging along and growing, not running but certainly not falling backwards. When you couple rail data with what is happening in both the auto sector and now the housing sector we have to discount the recession talk."
  • Earnings reports have continued to beat the lowered expectations, and revenues are also a little better.  (via Bespoke with the expected great chart.)  The recent upturn in economic surprises is good news for earnings expectations.

Eps-revisions-vs-economic-surprise-index-2012-08-03

  • The growth of payroll jobs at 163,000 beat expectations nicely and broke the trend of lower growth.  (See Steven Hansen's strong analysis of the data). Like every monthly report, the story has a lot of complexity (see below in "The Bad).  One factor is the continuing discussion about seasonal adjustments, typically quite large in July.  The key question is whether this year's adjustment is over-stated because of unusually small auto plant closings.  The growth was actually about the same as last year for private employment.  The difference?  The loss of government jobs was lower.  Bob Dieli's clients get his monthly analysis of the jobs data.  This was a key insight.

Employment history - Dieli
If you compare the blue columns from last year and this, and then also compare the red and black columns, you will see the key point.

The Bad

 The was a lot of negative news.  Everything seems to come with spin.

  • Bernanke did nothing — except talk.  Those looking for an instant QE buzz were disappointed.  As i noted in last week's preview, the expectations were too high.  The FOMC statement did seem to indicate higher awareness…..
  • Draghi did nothing  — except talk.  Markets sold off hard on the disappointment.  The initial reaction was that he had made bold and impulsive promises, but could not deliver.  Most market pundits see this as part of a continuing pattern of vague solutions for Europe.
  • ISM Manufacturing was once again below 50, indicating contraction in that sector.  While this is still roughly consistent with other growth indicators, it is discouraging.  Tim Duy has a complete analysis and charts for the overall index and key subgroups.
  • The household component of the employment situation report disappointed on all fronts.  The labor force was smaller.  The number of employed was smaller.  The unemployment rate upticked to 8.3% from 8.2%.  While this change was overstated by rounding, this is the data point that most captures public attention.  While the household survey has "only" 60,000 participants, this is adequate for the purpose of avoiding sampling error.  It is plausible that this survey captures the people who are working outside of traditional jobs.  Scott Grannis notes that the two approaches are coming together in the overall forecast, and that it is not recessionary.

Private Nonfarm Employment

  •  Job gains may be overstated.  Here is some negative news you will not see anywhere else.  Each month I suggest that there are multiple estimates of "the truth" which is not known until we have the reports from state employment agencies.  Since we do not have that for eight months or so, no one pays much attention.  This should be featured as a way of keeping score.  On Thursday we got the most recent update, and it was very disappointing.

QCEW Q411

This shows that job gains were only 368K in Q411, not the 550K or so that we thought.  The ADP estimates of private employment were even higher.  The BLS now tries to do "concurrent adjustments" in the birth/death model to reflect new data.  There will eventually be revisions to job growth, and some may come quickly.

The Ugly

The "Knightmare" trading glitch wins the ugly award for this week.  Professionals (just as in the flash crash) could see quickly that something was wrong in certain stocks.  The average investor requires some protection, so the big story is about risk:

  • Do the computers and algorithms endanger investors?
  • Do exchange procedures offer enough protection?
  • Is government regulation adequate?

These themes are newsworthy, so expect plenty of continuing attention.  It contributes to a sense that the average investor has no chance to succeed in a rigged market.

I especially like the analysis from Tom Brakke, who looks both at Knight Trading and a "high-yield product" that some investors bought:

"I put these different situations together because they seem symptomatic of today’s world.  We are promised wonderful execution in the markets, but can pay a tremendous price when the machinery doesn’t work correctly.  Desperate for yield, we buy the sausage from the structured finance factory and don’t know what is in it, liking the taste of the income and not paying attention to the poisoning that might come our way.

The game is out of control.  We have engineered in everything except common sense."

See Tom's analysis and chart.  My own take is that the biggest dangers are for those who blindly seek yield and those who have inflated ideas about their own short-term trading skills.

The threat to the average long-term investor is exaggerated.

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.

The evidence against the ECRI recession forecast continues to mount.  It is disappointing that those with the best forecasting records get so much less media attention.  The idea that a recession has already started is losing credibility with most observers.  Here are some of the best stories from last week:

  • New Deal Democrat (writing at The Bonddad Blog) does a long, thoughtful and careful analysis of the ever-changing story from the ECRI.  He shows how the story has changed over the last 10 months — timing, which indicators, how to measure the variables, and finally the current claim that the recession has started.  This article is chock-full of detailed evidence and charts.  Here is the key conclusion (but you really need to read the whole article):

"With yesterday's release of June real income, we now have full data through midyear 2012.  Unless there are downward revisions to the critical series upon which the NBER relies, it can confidently be stated that no recession began by that time."

  • Doug Short also does a comprehensive update, with great charts of the NBER's big four factors.  Here is the key summary:

Big-Four-Indicators-Since-2009-Trough

Doug also cites Dwaine van Vuuren of RecessionAlert using a shorter time frame from the one we include each week.  "Dwaine's analysis now puts the implied probability of recession at 2.1%. For more on his analytical approach, see his The NBER co-incident Recession Model – "confirmation of last resort"."

PAYEMS-120803

Readers might also want to review my new Recession Resource Page, which explains many of the concepts people get wrong.

The single best resource for the  ECRI call and the ongoing debate is Doug Short, who has a complete and balanced story with frequent updates.

Indciator snapshot 080412

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 switched to back to bullish.  We have been bullish since June 23rd, with a one-week move to neutral last week.  These are one-month forecasts for the poll, but Felix has a three-week horizon.  This week's decision shows the ratings strength, but we assign a low confidence rating.

[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

This is a very light week for data and also for other news.  On Thursday we have trade data (significant for the current quarter GDP) as well as the weekly installment on initial jobless claims.  We will also get the JOLTS report on labor turnover, but this is older and less significant than last week's data.

In the quiet environment, we can expect any story about Europe or politics to get a bigger play.

Trading Time Frame

Our trading positions continued in fully invested mode last week. This surprised me, since I was expecting a move to the sidelines.  Felix actually became more aggressive in a timely fashion.  Since we only require three buyable sectors, the trading accounts look for the "bull market somewhere" even when the overall picture is neutral.

Having said this, the overall advice from Felix remains cautious.

Investor Time Frame

This is a very important time for the individual investor, so I want to emphasize some key points.  Most individual investors are making serious mistakes.  Here they are:

They try to be traders

The successful investment strategy differs markedly from trading.  It is especially important to establish good, long-term positions when prices are favorable. Most individual investors seriously underperform long-term results by selling low and buying high.  Most successful professionals, of course, do the opposite.

Even successful years have significant drawdowns.  15% is not unusual.  The investor needs to expect this.  If it feels stressful, then your asset allocation is wrong.

They think they are experts on world events

Taking a long-term perspective is easier said than done.  With everyone on TV explaining with great confidence what just happened (please check out my article on the "message of the markets") it is easy for the average person to think he is out of step.  For several weeks I have emphasized the folly of attempts at short-term market timing.

They want to wait too long — until there are no problems

This is the single most costly mistake.  If there were no problems, the market would be at 20K or higher.  Investing requires balancing risk and reward, not waiting for complete safety.

There is no magic moment.  Resolving market worries is a process, not an event.

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 market action in the last three weeks has once again illustrated market moves based on unpredictable factors.  After Bernanke and Draghi, who would have guessed that the market would move 3% in a few hours and finish higher on the week?

They fail to see what is working

Our single best strategy through the various gyrations has been buying dividend stocks and selling calls for enhanced yield.  This week provided great opportunities to set new positions early in the week and sell calls against existing holdings late in the week, just as we suggested last week.  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!

…and here are my examples.

Final Thoughts on the Mid-Year Assessment

There are a number of key themes, all of which are on my agenda.  As usual in the weekly column, I am sharing my conclusions, but I'll write more on the various themes.

  • Recession.  Not close.  Recessions start (by definition) at cycle peaks.  This market cycle will be longer than average.  We might be in the third inning.
  • Europe.  The market is gradually learning how this works.  It is a multi-part bargaining process.  Draghi held out the carrot and then explained the requirements.  The ECB gets a better deal as a result.  It is happening one step at a time, but few of the market pseudo-experts have the vision to see the outcome.
  • Earnings.  Revenues are a bit lower partly due to currency effects (which also helped costs).  Earnings are OK and multiples are low because of expected declines.
  • Politics.  Plenty of news to come, with the market (incorrectly) viewing a Romney victory as bullish.  It is a lot more complicated.  More later.
  • Cliff Diving.  Great media story, but it will not happen.  The election outcome does not matter to this one.  The nature of the solution will change, but something will get done.

Weighing the Week Ahead: How Big is the Economic Slowdown?

After the volatility of last week's "three-ring circus," I expect a quieter trading week.  Based upon evidence from somewhat weaker economic reports and lower corporate revenues, the key question is:  How big is the economic slowdown?

It has taken only a slowing in the rate of growth — not a decline — to convince many that a new recession is upon us.  This is a key question, and we'll have more evidence this week.

I'll offer my own expectations in the conclusion, but first let us do our regular review of last week's news.

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

It was, as expected, a busy week for news and data.

House-price-changes-distribution-by-county-NY-Fed-2912-July-17-400px

  • Bullish sentiment "falls off a cliff" according to Bespoke.  This is a short-term market positive.

AAII Bullish Sentiment 071912

  • Corporate earnings have been beating (lowered) expectations, much as we have expected.  Some major companies (especially GE) have given relatively positive outlooks, despite the expectation that most would be conservative.
  • Rail and sea traffic are positive.  See Steven Hansen's articles (Rail, Sea).  Ports of LA and Long Beach are building at a "furious pace."  (Calculated Risk).

The Bad

 There was plenty of negative news from our three-ring circus last week.

  • Bernanke's testimony showed no immediate inclination for more stimulus.  Since traders are more skeptical about the economy than is the Fed, this caused instant, but temporary, selling.
  • Corporate revenues (contrast with earnings above) are worse than expected.  My colleague Scott Rothbort at Wall Street All Stars writes an excellent daily column.  He notes that the weaker dollar helps costs and hurts revenue for many companies.  This seems to have escaped the notice of less discerning analysts.
  • Earnings expectations for 2012 are still declining.  Brian Gilmartin tracks this carefully at his new blog — highly recommended.
  • Conference Board Leading Economic Indicators moved lower.  Their interpretation is that the economy has a steady but soft pace while sailing through "strong headwinds."  Doug Short has a good analysis and an interesting chart showing the rate of change in this index and past recessions.

CB-LEI-ROC

  • Initial jobless claims spiked higher, back to the 180K  380K range,  reflecting the auto company seasonality.  This suggests that last week's improvement was a one-time effect.
  • Fiscal cliff rhetoric is bad.  No sign of progress before the election.

The Ugly

There was a lot of ugly stuff happening last week, but I want to stick to the world of investments.  The most dangerous thing for the individual investor right now is the apparent safety in the quest for yield.  I warned a month ago that investors should build a ladder from individual bonds rather than owning funds.  Many will be surprised by actual losses from their bond funds, despite the past performance.

I was delighted to read Barry Ritholtz's fine article in the Washington Post, also recommending a bond ladder approach and warning about some alternatives.  This is important and deserves the visibility before it is too late.

In "Con Job," Tom Brakke shows how apparent high-yielding funds are really giving investors their own money back in the guise of yield.  Check out the great chart.

 

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.  Instead of agreeing to this, the ECRI has now raised the notion that there is already a recession, but it has not yet been recognized.  For the last two weeks there have been numerous refutations of this claim.  Meanwhile, I recommend this article where I did a rather comprehensive list leading up to last week and also my new Recession Resource Page, which explains many of the concepts people get wrong.

I'll have more on the most recent work in this week's conclusion.

The single best resource for the  ECRI call and the ongoing debate is Doug Short, who has a complete and balanced story with frequent updates.

  Indicator snapshot 072112

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," although it is a pretty close call.  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

There are a number of minor releases this week, including some regional Fed surveys.  The biggest items are the following:

  • New home sales on Wednesday, since there is plenty of interest in potential housing growth.
  • Initial claims (Thursday) especially given the recent wild fluctuations.
  • Durable goods orders (Thursday).
  • Advance GDP estimates for Q2 (Thursday).  This is important even though it is backward looking and will be subject to significant revisions.

Trading Time Frame

Our trading positions continued in fully invested mode last week.  Felix is not a range trader, but is excellent at getting on the right side for big moves.

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. Most individual investors seriously underperform long-term results by selling low and buying high.  Most successful professionals, of course, do the opposite.

This is easier said than done.  With everyone on TV explaining with great confidence what just happened (please check out my article on the "message of the markets") it is easy for the average person to think he is out of step.

There is no magic moment.  Resolving market worries is a process, not an event.

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 market action last week, once again illustrated market moves based on little change in the underlying information, especially after Bernanke's testimony.

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!

Those who had calls expiring worthless last Friday can now do a new round of sales.

Final Thoughts on the Slowdown

The recession forecasts have a lot of traction, despite the lack of supporting data.  I was reminded of the attraction of intuition by the continuing comments of golf analyst Curtis Strange, talking about the "heavy air" at the British Open.  This seems plausible to most, but is actually wrong.  Humid air is less dense than dry air, and in the absence of other variables, humidity adds slightly to distance.

You cannot get a bet down on that error, but you can act on the misleading recession forecasts.

Many people confuse continuing below-trend growth with a recession.  As investors, we are interested in the effect on corporate earnings and stock prices, both of which have done well despite the sluggish recovery.  A recession starts at a business cycle peak.  A slowing rate of growth does not signal a peak.  This is completely counterintuitive, so it makes the average person vulnerable.

It is in the interest of many to promote the recession talk:

  • The "out" party (and Dems would and did do the same thing when they were out);
  • The media (selling page views and ratings);
  • Those who have made a big reputational play (like the ECRI); and
  • Those selling fear and gold.

There was even more excellent work this week on the recession front, all featuring solid quantitative work.

The Bonddad Blog looked at initial jobless claims before past recessions and found little evidence that current circumstances are similar.

Dwaine van Vuuren looks specifically at the four main indicators used by the NBER in determining the start of recessions.  This is different from the recession forecasting model he has developed, since it is more of an analysis of current conditions, what he calls a "confirmation of last resort."  Most will need to read the article carefully, but the verdict should be pretty clear.

Doug Short also looks at the big four indicators.  As usual, he has many helpful charts showing quite clearly the difference between current conditions and past recessions.  The entire article is great, and recessionistas should study the charts carefully.  Here is one that summarizes the key elements:

Big-Four-Indicator-Average-Since-1959

Here is Doug's answer to his own question of whether the Big Four are rolling over:

"As of the latest data, no, they are not collectively rolling over. Here is the big picture since 1959, the same chart as the one above, but showing the average of the four rather than the individual indicators. This chart clearly shows the savagery of the last recession. It was much deeper than the closest contender in this timeframe, the 1973-1975 Oil Embargo recession. While we've yet to set new highs, the trend has collectively been ever upward."

Investment Conclusion

Most investors spend too much energy trying to form their own conclusions about the economy.  I am surprised by the strong feelings I see in comments, emails, and private conversations.

Unless you have your own macroeconomic model and plenty of experience, you have no basis for your personal opinion about recessions.

Unless you have significant experience in evaluating quantitative models, you have no basis for choosing among the various expert forecasts.

I do not have a macro model, but I try each week to help people find the best experts in various fields.  There will eventually be another recession, of course, but the evidence is not there yet.



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.