December Employment Report Preview

Tomorrow's employment situation report is the big statistical release of the week. Most of the attention will focus on the wrong data, reach incorrect conclusions, and miss the best ideas. Here's why.

The Data

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.

We would like to know the net addition of jobs in the month of December. This is actually a fact, but we do not know it right now. It is something we will know with a high degree of certainty, but not for about eight months. State employment offices provide data that is used for the benchmarking of the official BLS data. This information is solid, since businesses do not exaggerate employment when it comes to paying taxes.

By the time we have this information, everyone will treat it as "old news." Markets, news sources, and pundits all want to talk about something, and they want it RIGHT NOW!

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.

I think the BLS is honest and does a good job, which seems to put me in a small minority of observers. Despite this support, I question the general concept. The BLS tries to estimate total employment in one month, total employment in another, and subtract the two to determine the difference. When you are talking total payroll employment of over 130 million jobs, even small errors are in the range of 100K jobs or more. Meanwhile, smaller discrepancies from expectations are unwisely viewed as significant.

Competing Estimates

If you accept the idea that the final benchmarking is accurate, then the BLS approach should be viewed as 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 sees gains of 325K private jobs. There is a continuing trend of losses in government jobs.
  • TrimTabs looks at income tax withholding data. The idea is that this is the best current method for determining real job growth. They see job gains of only 38,000.
  • 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). 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 2.5 million jobs per month) and job destruction (running at about 2.3 million jobs per month). In mid-year 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.

The problem with all of these methods is the scoring system. Everyone foolishly takes the BLS estimate as "official" even if the other approaches eventually turn out to be more accurate.

Trading Advice

My experience has been that you can be conservative going into the employment situation report. Even if the initial report seems strong, there are so many aspects to criticize that we usually get a dip to buy/cover. I have fresh funds to deploy, but I am waiting. [Note to readers — if I thought that earlier action was important, I would have published the story sooner. I try to publish on Wednesday of the employment week, but I wanted to include the ADP release, and I knew it would not matter to my analysis.]

Policy Implications

In the midst of a political campaign where employment is a key issue, the candidates seem starved for ideas. Whether tomorrow's report is strong or weak, there are some excellent ideas that deserve consideration.

Carl Schramm, CEO of the Kauffman Foundation, is a leading expert on job creation and entrerpeneurial activity. [My potential biases: As a board member and advisor for some early-stage companies, this is a subject near to my heart. I also have participated in the annual Kauffman Foundation conference for leading economic bloggers. This has helped my work and that of my colleagues.]

Here is the Schramm prescription — simple and dramatic:

Q: I'm going to name you king for one day. you have authoritarian power to make one change in Washington or policy, what would it be?

A: I would wave my magic wand and send a strong signal to a government that pays no attention to a brand new firm for three years. that means no taxes and no regulation. if you want to be double down, I go to the universities and say any university that has an alumnus that comes back at the 50-year reunion and says I created 25 jobs since I left in my company, nobody works for me who's a member of my family, university says here's your tuition back.

If you watch the link for the entire video, you will learn a lot about job creation.

Some of the same concepts are covered in the Kauffman Sketchbook series. You will be entertained and informed.

 

Prof James Hamilton is also a fount of ideas. His valuable work on energy policy has highlighted a number of key choices.

In June he wrote about Making Jobs Priority One.

In December he advised on Getting the Economy Going and also Costs and Benefits on the Keystone Pipeline.

And finallyideas from the Milken Institute for 6 million new jobs.

The policy suggestions cited here may not find favor with all, but the ideas are a better focus for the discussion.

How about an Employment Friday that was not all about punditry and spin?

 

 

Bespoke Investment Group and Forecasting Follies

'Tis the season for making forecasts — all because of the calendar.  It is an opportunity to look foolish, or to gain edge.  This article will illustrate both.  Here are the ways to go wrong:

  • Opine about subjects where you have no edge
  • Pick a time frame unsuited to your methods
  • Fail to admit the range of uncertainty

There is annual fun where we can (correctly) criticize the forecasters.  Here are some excellent takes on the subject:

I find myself agreeing with nearly every point made in these articles.  Having said this, the overall conclusion feels a bit wrong.  You cannot avoid making forecasts.

Everyone makes forecasts.  Everyone.

You do it through your decisions — every day.

Anyone managing money makes decisions about asset allocation, asset choices, and the evaluation of risk.  Your trading and investment decisions reflect your forecasts.

If you are a real player — investment manager or pundit — you cannot escape this by criticizing everyone else.  Your actions define what you really stand for.

For example….

If you are an individual investor who has chosen to be out of the market, you are making an important forecast.  You believe that every investment opportunity will lose money for your and/or you know when to re-enter.  If you are following some pundit who does not reveal his own record, you are allowing someone to substitute anecdotes for data.  Good luck with that!

As one who both makes forecasts and embraces those of various experts, I look for those who really know about a particular subject and have a proven track record.  I chuckle at those who think they know how the presidential election will turn out.  I know about this subject and I have great sources, but it is a guess — as is the market implication.

But you get the idea.  The real value of the Bespoke Roundtable is the quality of the questions and the nuance in the answers.  Some responding colleagues (wisely) chose not to answer some or all questions.

I view the result as much more valuable than the average "year ahead" look.

 

Here is the summary of forecasts from The Bespoke Investment Group Roundtable

Consensus1

 

The panel is really great — all sources that I regularly read and depend upon to inform my decisions.  I suggest that you set aside a little time to read all of the responses.  Here is the list of participants, with links to their answers:

 

A Dash of Insight - 2012 Bespoke Roundtable Q&A

ETF Prophet - 2012 Bespoke Roundtable Q&A

Footnoted.org - 2012 Bespoke Roundtable Q&A

Investment Postcards - 2012 Bespoke Roundtable Q&A

The Kirk Report - 2012 Bespoke Roundtable Q&A

Random Roger - 2012 Bespoke Roundtable Q&A

The Reformed Broker - 2012 Bespoke Roundtable Q&A

VIX and More - 2012 Bespoke Roundtable Q&A

Wall St. Cheat Sheet - 2012 Bespoke Roundtable Q&A

 

Weighing the Week Ahead: Back to Work!

The investing community goes back to work on Tuesday for a short week that could see plenty of action.

Everyone is doing a review of 2011, so I tried to do something really different — The Year that Wasn’t!  Please take a look at what might have happened (but didn’t) and offer your own take.  I think the theme is worth consideration, so I might do it again if there is interest.

I will have more traditional “year ahead” pieces next week, including some specific ideas for the coming year.

Today’s focus is shorter — the week ahead.  The key question is whether America is also going back to work.  This week will be all about jobs, culminating with the monthly employment situation report on Friday.

Felix remains bullish for the near-term.  While I was skeptical last week, I am more inclined to agree this week.  I’ll explain further in the conclusion, but first, a review of a week that was pretty light on real news.

Background on “Weighing the Week Ahead”

There are many good sources for a comprehensive weekly review.  My mission is different. I single out what will be most important in the coming week.  My theme for the week is 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.

Unlike my other articles at “A Dash” I am not trying to develop a focused, logical argument with supporting data on a single theme.  I am sharing conclusions.  Sometimes these are topics that I have already written about, and others are on my agenda.  I am trying to put 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

There was little on the data front last week, so the temptation was to draw inferences that were not really there.

I’ll just stick to the facts:)  I discuss important data releases, ETF updates, and trading ideas in real time on my new investment diary, but there was not much meat last week from the economic data.

The Good

The Chicago purchasing managers report at 62.5 handily beat expectations.  That is thought to be a good indicator for the widely-followed ISM report.

Consumer confidence was better than expected.  This is important, as is clear from my conclusion.  The improvement must be kept in perspective.  Doug Short’s fine chart tells the story — better, but not good enough.

Conference-Board-consumer-confidence-index

The Notable

There was nothing really bad or ugly, but several events worth noting.

  • Forward earnings are still lagging.  This is a story covered in excellent fashion by my WSAS colleague Brian Gilmartin.  For many years he has carefully tracked the data and monitored the trends.  Earnings estimates have stalled, but are not in a decline.  It is something to watch very carefully.
  • The Italians were selling bonds all week, and we are all watching the 10-year yield.  The early auctions for short-term paper went well.  The longer-term bonds had a mediocre reception.  We are still waiting for the ECB.
  • The Obama approval ratings moved up 4 points.  Most will react to this based upon whether or not they favor Obama.  This is superficial.  From a market perspective, the election is in the distant future.  What I like about this is the warning shot to those who refuse to compromise.  It is pretty obvious that gridlock is not market friendly.  Those of us who want to have successful investments should be paying attention.  We can hope that our legislators are doing the same.
  • Initial jobless claims moved a little higher, but within the noise level.
  • Housing data showed some improvement, but there is so much noise that inferences are difficult.

To summarize, there was little in the way of fresh data last week, but we are at full attention for next week.

The Silver Bullet

A few weeks ago I initiated what I am calling the “Silver Bullet” award.  The basic concept is the willingness to do a careful and thoughtful analysis in difficult circumstances.

Often this means direct engagement, which is difficult to do effectively in the blogosphere.  It also means the willingness to take the unpopular side of the issue.

When you embark on such a story, you are like the Lone Ranger.  In the spirit of encouraging this type of work I hope to mention a “silver bullet” story each week.  I invite readers to send suggestions.  I expect that this will only be an occasional topic.

This week I want to recognize Joe Weisenthal and congratulate him as Talking Biz News’ Business Journalist of the Year for 2011Read their entire citation and you will learn what many of us knew about Joe from his early blogger days as “The Stalwart.”

He had so many important stories this year, that picking a single one is a challenge.  Undaunted, here is my suggestion, which I actually tweeted about a few days before his selection.  The big policy and market question of the year is about government debt.

Many conveniently cite a book that they have not read, covering data that they have not reviewed, employing methodology that they do not understand, and reaching a conclusion that is not shared by many peers.  This happens because the conclusions support a viewpoint that they already hold — quite fervently.  As a result, people are willing to bet real money.

Joe is willing to tweak us all on this subject, so I especially liked his article,  Meet the Two Most Dangerous Economists in the World Right Now.

It is merely an example of something that he does all of the time.

The Indicator Snapshot

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

  • An Economic/Recession Indicator.  I am evaluating several candidates.  None confirm the ECRI forecast of an inevitable and imminent recession.  These are sources that have a similar track record, greater transparency, but less PR.  I realize that I am (long) overdue for making the choice for a new indicator.  It has been a careful research process, and I expect the explanation to require multiple articles.  Meanwhile, if something really bad were taking place, I would make it clear in the weekly updates.  From the strongest candidates, I see the recession odds over the next nine months as being less than 25%.  Barring a market surprise, I expect to start covering this next week.
  • The St. Louis Financial Stress Index.
  • The key measures from our “Felix” ETF model.

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.

 

Indicator Snapshot 12-30-11

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.  We voted “Bullish” this week.

[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 big week for data — mostly about jobs.

I am interested in the ISM report on Tuesday because it correlates with job creation, and it is from the same time frame as the payroll survey.  Thursday’s ADP report seeks the same answers with a different measurement approach.  We also get initial jobless claims on Thursday, which many will incorrectly view as related to the Friday report.

I do not expect much in the way of fresh news from the FOMC minutes on Tuesday, or the other lesser reports.

So —  Tuesday ISM, Thursday ADP and initial claims, and Friday — the big day.

Tuesday also has the Iowa caucuses — the first real voting in the 2012 election.  It also features the Sugar Bowl where the resurgent University of Michigan Wolverines take on the Virginia Tech Hokies.  Tough choice!!  I might manage a tweet or two on the caucus, but what is the rush?

When the choice is Hoke or the Hokies, it is easy for me:)

The WSJ has a nice calendar of upcoming events in Europe — not too much this week.

Trading Time Frame

Our trading accounts were fully invested last week, as indicated from our ratings.   Felix has actually done a little better than the weekly update shows, since the first “bullish” week — a loser — had no trading positions since everything was in the PB.  The entry for this cycle has been very good.

This program has a three-week time horizon for initial purchases, but we run the model every day and change positions when indicated.

Investor Time Frame

Long-term investors should continue to watch the SLFSI.  Even for those of us who see many attractive stocks, it is important to pay attention to risk.  In early October we reduced position sizes because of the elevated SLFSI.  The index has now pulled back out of our “trigger range,” but it is still high.  For investors desiring this risk management approach we raised cash when the trigger  hit the range.  We have also been cautious with new accounts.  We still do not have an “all clear” signal, but I expect the SLFSI to decline next week.

A reader recently suggested that this method reduced position size at a market bottom in October.  This really misses the point.  When the volatility gets too large, you step back a bit.  Those who do not wind up bailing out on the entire position.  Even if stocks have a big rally from that point, it is better to enjoy it with 70% than to bail out completely, as many did, because the size was too great.  Meanwhile, we are on the verge of increasing size.

This is not about market timing.  It is about risk management.

Our Dynamic Asset Allocation model maintains a very conservative posture, featuring bonds and other defensive holdings.  This method reduces overall volatility, so we expect it to be a little slow at the bottom.

To summarize, we have a very conservative approach in most of our programs, recognizing the uncertainty and volatility.  For new accounts we are establishing partial positions, using volatility to buy favored names and selling calls for those in our Enhanced Yield program.  We have high volatility, and that is a source of opportunity.

Take what the market is giving you.

[Interested readers can get information which you can use for your own investing and/or consider us for some help — our approach to limiting risk, coaxing out more yield, and exploiting the current opportunities.  This includes a description of how to do a  year-end tuneup.  Write to main at newarc dot com — no charge, no obligation, and respect for your email privacy.]

Conclusion

Each week I try to find a helpful perspective that is worth consideration.  Zach Karabell has a thoughtful article where he acknowledges all of the main market worries, and then notes the result.

His conclusion is worthy of attention:

We are not in desperate economic times. But we believe that we are, and that is as paralyzing today as it was when Franklin Roosevelt famously intoned on his inauguration that fear itself is the biggest obstacle. In 2012, the American economy will do better than muddle and less than soar. Let’s hope for the new year that Americans can adjust to that reality without succumbing to despair.

This matches my own concept of cautious optimism.