Deficits: What is the meaning for the individual investor?

This week has a new avalanche of articles and TV programs about deficits.  All emphasize the maximum in scare tactics.  The sources are readily identifiable:

  • The politcians on the "outside."  This is currently the GOP, but it can work either way.  (Regular readers know that I made similar comments when President Bush was in office).
  • The perma-bears.  They are talking their books.
  • The top bloggers.  They have accurately identified their Internet audience and know how to go for page views.

None of this has anything to do with investment returns — unless you are willing to consider the opposite side.

Let me state this quite simply and clearly:

If you are going to wait for a widely accepted solution to the deficit problem, you are a PermaBear!

We have faced federal budget deficits for decades.  The Clinton Administration was the only surplus producer in recent times.  This problem will eventually be addressed.  As an investor, if you wait for the official solution, you will be far too late.  The key problem is that most observers want to "solve" the deficit question while we are still in the middle of an economic crisis.  Savvy public policy analysts take a different view.

Here are some hints:

  • It is going to take a bi-partisan commission so that neither party can be ostracized for cutting benefits.
  • Benefits will be cut — most prominently for social security recipients.  People are living longer so the ratio of beneficiaries to payees is totally out of proportion.  When the program was started, people only lived to 68 or so on the average.  It is past time to increase the official retirement age.  72 is the new 65!
  • Increased immigration will help.  Immigration has been demonized and mis-represented.  I was surprised at the consensus at Kauffman — supporters of immigration.

Where to Find Information

I am delighted to see the debate about lightweight versus long-form blogging.  Abnormal Returns has an excellent article on the subject.

This is an important subject that deserves some extra time.  Do you want to read short-form, bullet point pieces, or do you want more analysis?  Do you want something that caters to your pre-existing opinion, or something that challenges you to think?

An interesting question is whether gatekeepers like Abnormal Returns will start to make these distinctions.  One of the key lessons from the Kauffman conference was the overwhelming flow of information and the importance of knowing what to read. 

A Suggested Answer

In the aftermath of the passage of the health care legislation, there is renewed interest in deficits.  The actual experts on this subject are specialists in public policy — people who understand how the US government grapples with long-term issues.

To my amazement, the Kauffman Conference on Economic Blogging had a featured panel on this topic with no representation from a political scientist or public policy expert.  No wonder they concluded that we have no hope!  (I am still waiting for the link to the final video.  I'll update when available).

I wrote one of my best pieces on this subject a month ago, before it hit the mainstream radar.  If you want a politically neutral article — policy analysis and investment implications — it is still worth a read.  I got a few emails thanking me for clarifying a scary topic, so at least some have been helped.

Meanwhile, here is a good alternative — a discussion from Modeled Behavior.  Karl Smith is a young Public Policy prof whom I hope to meet some day.  This is a nice departmental discussion that captures many of the current issues.  It goes on for several articles and lots of video time, so it is a nice test of how serious people are about learning.  I recommend that you try it — at least for a few minutes.  Karl makes many strong arguments that deserve a wider audience.  There are a number of practical solutions that will enhance your understanding.


It is easy to write the short takes and the list of bullet points.  Writing a thoughtful, analytical piece takes hours.  Meanwhile, the market treats both equally.  Those sources that rely on revenue and page views have an easy choice of strategy.

As the financial noose tightens, MSM bloggers may be tempted into sensationalism and symbiotic relationships with the most popular "independent" bloggers.  We live in an interesting time.

ETF Update: Midcap Move

In addition to taking a couple of days off, I have had some computer problems.

It is a day late for our regular ETF update, but I will post the basics for our ratings below.  Those interested in a more complete description of our methodology can check any of our prior updates.

When I finish the upgrade to Windows 7 — the Vista experience was not good — I'll devote an article to the transition.

Meanwhile, here are the ratings from last Thursday at the close.  Those who subscribe to our weekly reports received timely updates, but I apologize for missing yesterday online.


The index package is still bearish on the market, but we are slightly long with specific sectors.  If I had written a full post, I would have emphasized the move in the midcaps and small caps.  That may still be the theme for next week.

This is really just a service for those who have interest in the updates, but are not subscribing to the email list (etf at newarc dot com).  Sign up there for a weekend email with the ratings.


February Employment Report Preview

The monthly employment situation report remains the "A list" economic indicator.  Pundits love it.  There are so many facets.  If you want to spin, opportunities abound.

The official data is the best effort of capable and talented people.  They have created a methodology.  When new data are available, the BLS revises the result.

The result?  A happy hunting ground for critics. Since so few understand the methodology, and so many have a deep suspicion of government, the bearish spinners have the upper hand.  Let's start with how I approach the problem.


As regular readers know, I have a unique viewpoint on the payroll report.  I wish I could get more professional colleagues to join me.

There is an actual job change which we might call "TRUTH."  There are many efforts to measure that change, including that of the BLS.  While the BLS does a good job, they are hampered by their approach, including the following:

  • They do not focus directly on the job change.  They attempt to count every job for two different months and subtract one from another.
  • They rely on a survey.  This is a fine method for identifying properties of the surveyed population.  It is much more troublesome when the objective is to COUNT the population.
  • The survey has non-respondents who might be either firms that did not respond, or firms that are out of business.
  • The survey is forced to impute business births, because there are always many business births.  The BLS does it pretty well, but it is inherently difficult.
  • The survey has a sampling error of more than 100K jobs.

To summarize, the BLS result is important not because it is the best measure, but because we are so interested in employment.

Meanwhile, many independent analysts have other approaches.  A fair method of scoring would be to look at the final job changes, after all of the revisions, and see whether anyone did better than the BLS.  Trying to guess the monthly "as reported" data is a different problem.  Nonetheless, billions of dollars will trade on that information.

Our Own Estimate

Each month we ask the question, "What change in payroll employment would be consistent with other economic data from the same time period (the middle of the prior month)?

This is not a forecast, per se, since we do not posit any causal relationship among these variables.  They are all concomitant indicators of economic activity. 

  • We use the four-week moving average of initial unemployment claims, culminating in the week of the employment survey.  This is the best direct indicator of new lob losses.  This has gotten worse in the last month— 468K versus 447K.  Ignore the recent weeks which are not in the survey period.
  • We look at the University of Michigan sentiment survey, which we find to be more useful than the Conference Board's sentiment index.  Michigan uses a panel, where some families are carried over from month to month.  This is a good technique.    Sentiment is influenced by employment.  When people have lost jobs, or are worried about losing jobs, it shows up in sentiment.  It is a good concurrent indicator.  The Michigan index is now at 73.6, down a little from last month.
  • We use the ISM manufacturing index, which came in at 56.5, down from last month's surge to 58.4.  This is still a strongly bullish for the overall economy.

Our long-term record has been pretty good, especially when compared to the final revised data.  This makes sense because our model was derived from the final data.  In recent months we have been too bearish.  The BLS benchmark revisions suggest that we have been much better than first thought.  I am working on a comparison with the final numbers.

This month, our estimate is for a net job loss of 51,000.

Other Forecasts

It is always interesting to compare the job forecasts from different sources.  We follow several because of the interesting and widely varying methods they use.  A wise interpretation would be to consider all of  these disparate sources of information.

ADP has proprietary data because of its payroll management business.  ADP sees losses of 20K.  This estimate does not include government jobs.

TrimTabs has another valuable approach — tax deposits.  Their forecast is for a loss of 30K jobs.

WANTED Technologies has resumed estimating the monthly change after a protest because of the benchmark revisions.  I sympathize with the problem, but I am glad to see them back in action with their unique method.  They bring information from online ads, a source that others miss.  They see a job gain of 5000. cites the consensus as a loss of 20K and their own forecast is a loss of 50K.  I get several other private estimates with similar methods — all in this range.

All of these sources are valuable.  The 90% confidence interval on the BLS estimate, something that no mainstream media sources report, is +/- 100K or so.  And that is after revisions and benchmarking.  It is a survey — a good one — but it has an error band.

Investment and Trading Take

I have frequently recommended being short in front of the payroll number.  This month there has been plenty of advance information about possible weakness.  It is pretty silly.  There will be discussion about weather factors.  Anyone who did not work the week including the 12th was not on a payroll.  Meanwhile, people ignore the large sampling error.

As a result, the data may draw less attention than usual.  Meanwhile, our read on the employment growth is somewhat bearish.  The jobs are not adding up as rapidly as we might hope.

A Final Thought

There are so many, measuring employment change in so many ways.  This month there is a strong consensus.  If the BLS number is at wide variance, it is best to put it aside and await more data and more revisions.