A Dash of Insight

Confidence, the Economy, and the Fed Balance Sheet

Poll reports show that President Obama's confidence ratings are falling.  This should not be a surprise, given the record positive levels at the time of the Inauguration.  Current polls show continued popularity for the man, but increasing skepticism about his policies.

For the economy and for investors, there are some specific issues that will play out over the summer.  We set these up in our "Summer Quiz."  Those who have good information and market savvy will score well on the quiz, and also profit in the markets.  We believe that this summer is a key time for investors.  As we reveal the answers, the significance will become crystal clear.

We will continue to reveal the answers and announce our prize winner at the conclusion of the article series.

Background

Economic growth is strongly related to confidence.  When CEO's get worried, as they did after the demise of Lehman last fall, they cut costs first and ask questions later.  Economic confidence is closely tied to employment, a topic we follow closely at "A Dash."  Employment indicators often lag actual economic progress when employers are quick to fire and slow to hire.

We do not all share a common interest.  It would be nice to think that all hope for an economic recovery, but that perspective is mistaken.  Here are some obvious exceptions.

Political Opponents

Perhaps in a perfect world there would be a few years in a political cycle where everyone in the country all pulled together.  It occasionally happens when there is a specific and imminent common enemy -- after 9-11 for example.  Most of the time private motives dominate over the public interest.

Partisan Politics

Quite frankly, there are many who hope for the economic recovery plans to fail.  There are strong partisan reasons.  The most important members of this group are running for office in 2010.  Their personal stake is huge.  There will be a constant barrage of partisan economic criticism.

Bearish Pundits, Commentators, and Fund Managers

There are many who stand to profit from a market decline.  The many bearish pundits have credibility and book royalties on the line.  The commentators have prestige, jobs, salary, and bonuses at stake.  Sometimes personal motives outweigh a national interest.

Some hedge fund managers have aggressively short positions.  Anyone paying attention knows that these positions are always supported by the Bearish Blogging Network (BBN) where there is direct or indirect compensation for supportive bloggers.

With so many providing so much negative commentary, it is easy to be led astray.  Let us consider a specific example.

The Fed Balance Sheet

A good way to begin is by removing the most obvious issue, question #4 from our quiz.  Information about the Fed balance sheet is readily available, specific, and timely.  Those taking a bearish viewpoint have emphasized the growth in the Fed balance sheet, including loans to various financial institutions.  The critics have suggested that this growth was part of the Obama Administration efforts and also that it puts taxpayers at risk.

Here is a recent report from Macroblog, one of our featured sites:

There are three key facts from this report:

1. The increase in the Fed balance sheet dates from the Lehman failure and the aggressive response, not from the start of the Obama Administration.
2. The overall size is declining slightly.
3. The distribution of assets has shifted from the riskier short-term lending to non-bank financials, moving to agency paper.

Conclusion

From a public policy perspective, the Fed has attempted to restore what we refer to as "normal lending".  The Fed recognized a market failure, where credit markets seized up.  This step is aggressive and temporary.

From an investment perspective it is crucial to understand the nature of the policy.  Some portray the balance sheet expansion as a "bailout" or an unlimited commitment.  This portrayal is calculated to frighten the individual investor.  It it not accurate.

Restoring confidence will be an uphill battle.  It begins with better understanding of the policy.

Full disclosure:  Our current posture, reported weekly, is bearish, reflecting market sentiment.  We see the bearish case as overstated, but realize the evidence will come one piece at a time.

We are working to find the catalysts for a changed perspective.

Intuition and Economics

(This is the second installment of our series describing how the BLS might respond to critics of the Birth/Death adjustment.  See Part One here.)

Everyone uses intuition, making decisions that seem instinctive rather than the result of a carefully reasoned process.  This type of decision making has actually been the subject of formal study.  For example, Yehezkel Dror's Public Policymaking Reexamined highlighted the use of "extra-rational" processes to make decisions.

The TV version of this is almost a cliche', but we can still learn from it.  The veteran cop and the rookie are on patrol.  The savvy vet senses something wrong.  A few questions make clear that there is a serious criminal behind someone's bland exterior.  There are even some studies supporting the cliche'.

It is noteworthy that those whose intuition is helpful are those most experienced and adept in their business.  A top poker player or bridge player has great "table feel."  Many famous traders are noted for their ability to read the tape.

So here is a question:  Why do people who are not expert in economics believe that they have such great economic intuition?  For most of us, it is better to rely upon data.

Intuition about Job Creation

A case in point is the vise-like grip of misinformation about measuring job creation.  Here is an example relating to the last employment report.  Regular readers of "A Dash" know that we respect the work and the significant influence of John Mauldin.  Many people rely upon his weekly letters.  We were disappointed to read the following:

...Last month saw the number of unemployed rise by 345,000. What was not in the headline data was that 217,000 of those jobs were estimated from the "birth-death" ratio. The US economy creates new businesses that do not get counted in the data, so the BLS estimates what that number is, using previous data patterns. When the economy turns, it overestimates new jobs in recessions and underestimates them in recoveries. No conspiracy, it is just the best methodology we currently have.

But does anyone really think 200,000 jobs were created last month? The real number of lost jobs is worse than the headline. And next month the birth-death number will likely be over 200,000 again.

Mr. Mauldin clearly believes that new jobs are not being created.  He is so confident that he poses it as a rhetorical question.  He shares this intuition with nearly everyone.  It seems obvious.  If labor conditions are tight, there are no new jobs.

Intuition about economics leads people to think in black and white terms, rather than seeing quantitative responses and changes at the margin.  Instead, let us consider actual data, the most recent available from the Business Dynamics series.  It uses the records from state unemployment offices -- no projections, and no one is paying insurance premiums on non-existent jobs.  Here is the summary table of seasonally adjusted data.  (The full year data illustrate the same point).

Table A. Three-month private sector gross job gains and losses,
seasonally adjusted

------------------------------------------------------------------------
     |  3 months ended  
     |-------------------------------------
     | Sept. | Dec. | Mar. | June | Sept. 
  Category  | 2007 | 2007 | 2008 | 2008 | 2008 
     |-------------------------------------
     |  Levels (in thousands) 
----------------------------------|-------------------------------------
     | | | | | 
Gross job gains...................| 7,323| 7,676| 7,130| 7,258| 6,822 
 At expanding establishments.....| 5,849| 6,220| 5,731| 5,858| 5,504 
 At opening establishments.......| 1,474| 1,456| 1,399| 1,400| 1,318 
     | | | | | 
Gross job losses..................| 7,564| 7,366| 7,400| 7,751| 7,754 
 At contracting establishments...| 6,209| 6,010| 6,047| 6,277| 6,383 
 At closing establishments.......| 1,355| 1,356| 1,353| 1,474| 1,371 
     | | | | | 
Net employment change (1).........| -241| 310| -270| -493| -932 
     |-------------------------------------
     |  Rates (percent)  
     |-------------------------------------
Gross job gains...................| 6.4| 6.8| 6.2| 6.4| 6.1 
 At expanding establishments.....| 5.1| 5.5| 5.0| 5.2| 4.9 
 At opening establishments.......| 1.3| 1.3| 1.2| 1.2| 1.2 
     | | | | | 
Gross job losses..................| 6.7| 6.5| 6.5| 6.8| 6.9 
 At contracting establishments...| 5.5| 5.3| 5.3| 5.5| 5.7 
 At closing establishments.......| 1.2| 1.2| 1.2| 1.3| 1.2 
     | | | | | 
Net employment change (1).........| -.3| .3| -.3| -.4| -.8 
------------------------------------------------------------------------
 1 The net employment change is the difference between total gross job
gains and total gross job losses. See the Technical Note for further
information.

{Emphasis added to the line showing job gains at opening establishments}

We can see that in the third quarter of 2008, there were over 1.3 million job gains at new establishments and 5.5 million new jobs at continuing businesses.  The entire table covers data during the current recession.  The results from the 2001 recession were similar.

Briefly put, there is a massive turnover of jobs lost and jobs created every quarter.  The net changes that we see in the news are much smaller by comparison.

Measuring New Jobs

How should the BLS account for the job gains at new establishments?  

Most readers will be surprised to learn that the Birth/Death adjustment is not the principal method.  More importantly, the BLS basically ignores non-responding firms in the business survey.  It knows that some of these are business deaths, but not which nor how many.

The BLS uses a two-step process, described as follows:

Step One - Employment losses from business deaths are excluded from the sample in order to offset the missing employment gains from new business births. Because employment increases from births nearly offset employment decreases from deaths in most months (as illustrated above by the BED data), this step accounts for most of the net of business birth and death employment.

Operationally this is accomplished in the following manner each month. Business deaths that are non-respondents to the survey are automatically excluded because they have no current month data. Death establishments that report zero employment to the survey for the current month are treated the same as non-respondents and also excluded. As a result, the over-the-month change calculation from the sample is based solely on continuing businesses.

For the months subsequent to a business death, the deaths are "kept alive" in the CES estimation process; the growth rate of the continuing units in the sample is applied to them each month. This estimates for the growth of the new business births in the months after their birth but before they can be brought into the sample.

This step accounts for most of the net birth/death employment but not all of it. The residual net employment that is not captured by this step is estimated through an econometric model, described below as Step 2.

Step Two - Modeling for the residual of net/birth death employment change. In this step, the CES adjusts its sample-based estimates for the residual net birth/death employment that step 1 misses. This adjustment is derived from an econometric technique known as Auto Regressive Integrated Moving Average (ARIMA) modeling. ARIMA is a standard econometric modeling technique that is often used to estimate relatively stable series. CES refits the ARIMA models each year, for each basic estimation cell, as part of its annual benchmarking process.

The inputs to the ARIMA model are historical observations of the residual net birth/death employment that is not captured by either the sample or the step 1 imputation described above. These historical observations are derived empirically, from the most recent five years of QCEW historical data.

The Birth/Death adjustment that gets so much attention is Step Two in the process.  The critics mistakenly ignore Step One, even though that is the more significant part of the process.  Step One is also sensitive to economic changes, as noted in this paper:

The imputation part of the procedure is directly related to the current sample and is
therefore sensitive to employment trend shifts and turning points.

Summary

In Part One of this series we showed data proving that the BLS Birth/Death adjustment has improved the monthly estimates of payroll employment changes for every quarter since it has been used.

This article, Part Two, shows the reason behind the result.

• There is massive new job creation at all times, even in recessions.  In bad economic times the job gains are offset by even larger losses.
• The BLS estimates most of the job creation by "keeping alive" some of the business deaths.  This process helps to reflect economic turning points since it follows the results from the rest of the sample.
• The Birth/Death adjustment deals only with the residual new jobs.  It has no separate economic meaning.

The BLS critics are mistaken in looking only at the Birth/Death adjustment, when that is only part of the two-step process --- and the less significant part at that.

In Part Three of this series we will look at a few of the specific claims by critics.

The BLS Responds to Birth/Death Adjustment Critics

OK, our title is false advertising.  The Bureau of Labor Statistics crew is not allowed to surf the Net making comments on blogs, nor do they have a blog of their own.  It might be a good idea, but it is an unlikely move given budget constraints.

This is too bad, since there is near-universal criticism of their methodology. Many go much further.  A Google search will reveal plenty of aggressive name-calling critics.  The criticism has been so loud and pervasive that hardly anyone in the blogosphere or trading worlds believes in the monthly non-farm payroll report.  Many sites routinely mention the birth/death adjustment so that the reader can mentally subtract these "phantom" or "magical" jobs.

This presents an interesting situation.  What if the BLS approach is correct and accurate?  Those understanding this would do better in gauging economic changes.

Our Mission

Since the BLS is not going to respond directly to critics, we propose to use their existing results and words to address some of the key points.  In this article, we will show the strength of the BLS methods with only indirect references to the many critics.  In future articles we will directly analyze and expose pervasive errors on this topic.  Reader questions are invited.

We have three steps:  Showing the accuracy of the birth/death adjustment, explaining the b/d role in job creation, and showing how the research design effectively captures economic changes.

This article takes up the first of these issues.

Accuracy

Estimating the number of jobs and the monthly change in jobs is a daunting challenge.  There is a way of keeping score.  As we wrote last October:

Each year the BLS makes a "benchmark revision" to the payroll employment series based on the establishment survey.  The purpose of this is to make sure the survey data are consistent with the actual count of jobs from state unemployment insurance tax records.

The state data is much better, of course, but it is not available in a timely fashion.  The benchmarking is a reality check.  It allows the BLS to see how well they did with the monthly estimates.  Each October, along with the report on September employment, the BLS releases the preliminary version of these benchmark revisions.

This is the report card for the BLS.

This should be a non-controversial test, since it relies upon actual state data, not projections.  No employer is going to pay extra taxes, so this count does not include any "phantom jobs."

The better the BLS methods, the smaller the benchmark revisions.  If the Birth/Death adjustment is effective, it makes the revisions smaller.

And it does!!

Here is a nice chart showing the effects.

The blue line is the actual count.  Just compare the red line to the green line.  The red line shows what the estimate would have reported without any birth/death adjustment.  The green line shows the effect of birth/death.

The birth/death adjustment improves the job change estimate in every quarter since it has been introduced.

Conclusion to Part One

Most of the BLS critics have been offering the same complaints for many years, but no one ever asks whether they were correct.  The closest the BLS team will come is the paper they published last October.

In this article we have emphasized that something about the birth/death adjustment is good, very good.  It improves the job change estimates in every quarter.

This seems counter-intuitive.  How can we have new job creation in such difficult economic times?  Most people believe their intuition rather than the data.

In the next article in this series we will explain this mystery.

Employment Situation Report Preview

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, the University of Michigan sentiment survey, and the ISM manufacturing report.  We carefully choose data from the correct time period.  Even though the ISM report was released today, the survey is obviously from earlier in the month.

None of these indicators have improved very much, so we continue our negative outlook on employment.  We were surprised last month when the job losses were less than we (and nearly everyone else) expected.  We are still looking for losses over 550K, much worse than the consensus loss of about 400 K.

Since our analysis is based upon the final data, after all revisions, the ultimate accuracy may not be known until next year!  That is when final benchmark revisions are done.  Also, the sampling error (90% confidence interval) alone on the payroll survey is more than +/-100K jobs.

Other Predictions

In addition to the consensus forecasts, there are various predictions using proprietary data.  These are all interesting.

TrimTabs uses data from income tax deposits of salaried employees.  They expect job losses of 472,000.

ADP uses data from their payroll administration business, information that no one else has.  They have attempted to gear their results to the "official" government report.  They forecast a loss of 473,000 jobs, amazingly close to TrimTabs.

New entrant Wanted Technologies uses an algorithm reflecting online job ads.  They have a startling forecast:  a loss of "only" 260,000 jobs.  Furthermore, they made their call on June 19th.  And why not?  That was the right time frame to match the payroll survey, and their online job data is more readily available in real time.

Conclusions

Our own prediction of the jobs report has no special inputs -- just the analysis of concurrent economic data.  We are surprised to be the most bearish of the group.  As noted, the error band is wide.  The market will react wildly without regard to the sampling error or other issues.

We do have a few predictions that we can make with more confidence:

• Whatever the job loss, the unemployment rate will move higher.  The demographic factors at work require job gains of at least 150,000 (and probably more) just to maintain current unemployment levels.  The unemployment rate is an important social and political indicator, but it will lag in reflecting an economic change.
• The assembled punditry will state, whatever the number, that it should have been worse because the government is incorrectly projecting job creation. 
• If the result is really good, the rumor mill will start, as it did last month.  When the market spiked on a better-than-expected report for May, the rumors quickly circulated that it was an error -- a government worker had a "fat finger."  Those circulating this rumor (and those believing it) have absolutely no concept about how government reports are assembled, how many people are involved, and how many check points there are.

It just shows that if you want to be short going into this report, you can have confidence that the Bearish Blogging Network (TM OldProf) will have your back.  They will take advantage of the blogosphere to spin at high speed.  The official sources have to wait for a news conference or an interview to reply.  This is plenty of time to cover your shorts.

It is an attractive trade for any hedge fund manager.  Take last month as an example.  You could come in short and be an instant winner on a bad number.  If the report was positive,  you sell more on the spike (averaging up in price).  You then cash in on the silly "fat finger" rumor and the expected monthly spin on the birth/death adjustment.

How Can this Work?

It is amazing.  Take a roomful of traders.  Ask them whether government or a trading desk is more efficient.  We know what they would say.  Trading desks can execute baskets with a keystroke.  There are "fat finger" examples and also stories about interns sitting on keyboards.

Does anyone really think that a very complicated government report is generated in the same way?  Well the silly story was good enough to move the market last month.

A Crib Sheet for Government Data

Most sources -- even big-time media types -- provide no guidance about sources of information from the federal government.  There is a a useful advantage in knowing more.

We realize that there are many who reject any government information.  Here at "A Dash" we believe that this is an extreme viewpoint, and provides an opportunity for a trading advantage.

In particular, we distinguish between reporting data and offering projections.  Those rejecting the data reports are just fighting the mainstream interpretations accepted by nearly all economists and by the mutual fund managers.  Projections are quite different.  They come from different sources, and the results vary.

A Reader's Guide

Here are some typical examples of government information.  Our reaction varies dramatically and so should yours.

The Bureau of Labor Statistics (BLS).  This is a non-partisan agency.  The key professionals have tenure and earn respect from peers and supervisors by doing a good job.  A new President cannot fire them nor significantly affect their pay.  From their perspective, Presidents come and go but their work goes on.  They try to do a good job, and we think that they generally succeed.  The methods are subject to great debate before acceptance.  Once accepted, they are followed in a rather mechanical fashion.  Those suggesting that these reports are subject to partisan politics are just wrong.  They simply do not understand how government works.

The Office of Management and Budget is under the control of the current Administration, so it is partisan.  This does not mean that forecasts and comments are wrong, but consumers must consider the source.  At this time it means that forecasts reflect the Obama perspective.  Any forecasts should be carefully tested against outside sources.  For an illustration of how OMB can be slanted to a particular perspective, we recommend the Reagan era example of David Stockman.  In an interview he admitted a clear bias in forecasts and was "taken to the woodshed" by the President after he spilled the beans.  We are not suggesting that Obama is "cooking the books" with current forecasts, but we view them with appropriate skepticism, testing against other sources.  We plan to write much more about forecasts from the Administration.

The Congressional Budget Office is a source deserving respect.  We call this a bipartisan source, since it must earn and keep the respect of Congress, no matter which party is in power. Initiated in 1975 under the leadership of Alice Rivlin and later Rudolph Penner, the CBO analyses earned the respect of both parties in Congress.  Any young professional wanting to do objective policy analysis should see the CBO as a dream job.  In the current policy debates the CBO is responsible for evaluating every proposal.  This is especially crucial to the health care initiatives and the Congressional agreements concerning PAYGO, where there must be a revenue offset for new initiatives.  Here is a great current example.

Summary

The mainstream media does not explain these differences nor reflect them in reports.  A CNBC anchor recently kept referring to the CBO as the CBOE (an options exchange).  A top source at TheStreet.com recently attributed a CBO analysis to the GAO, even using the "old name" for the GAO.

They just don't get it.  The big-time sources do not distinguish between various government sources.  They do not provide any background or context.  They do not grasp the distinctions.

You can do better!  You can start by printing out this article and using it as a handy reference.

Summer of '09 -- A Crucial Time for the Investor

Investors face some important decisions.  For those approaching retirement it is a crucial time.

There is plenty of advice.  The television commercials, blogs, and email messages include a variety of appeals:

• Those telling you to buy an annuity to lock in your income, marketing to the fear of market losses, and perhaps playing down the death by a thousand cuts from inflation.
• Those telling you that you can do better than your financial advisor.  Go on your own!  You have a "feel" for the market.
• Those advising gold.  Everything is about to go wrong, so you need to have hard assets.
• Those offering speculative gains.  Here are some stock ideas that are "home-run" ideas, where you can triple your money in a couple of months.  Often these are penny stocks.

Any of these strategies could be right --- as a part of an overall plan.  For those with adequate resources for retirement, a defensive posture might be correct.  Some investors might be willing to learn what they need to know and execute with discipline.  Inflation protection will play a role at some point.  Some speculative ideas will work, but most will not.

It is a minefield.  You need a plan.  Here is a nice article asking a key question about when you should plan to retire.

You also need to know how to interpret data and modify the plan as the evidence changes.  Many of the sources of information are selling something -- annuities, brokerage services, gold, or complex structured products that play upon investor fear.  In a typically excellent article, David Merkel writes as follows:

I have three bits of advice for readers.  First, don’t buy any financial instruments tht you don’t understand well. This especially applies when the party selling them to you has options that they can exercise against you.  Wall Street excels at products that give with the right hand and take with the left, so beware structured products sold to retail investors.

Read the entire article for some additional helpful advice.

Our Approach

Every investor has a different problem and requires a specific plan.  All face the same challenge, but individual needs, goals, and risk tolerance vary widely.

We must interpret a recession that does not fit the prior molds very well.  The causes were complex with many interactions.  The attempted solutions are also complex.  It is not a cookie cutter where we can say it will all play out like some prior year.

Many make predictions with great confidence, often drawing more from their political opinions than economic evidence.

At "A Dash" we are seeking objective economic indicators with proven value.  No one knows how it will all play out, so it is a week-by-week process.  The answer will come from a combination of interpreting economic data in a dispassionate manner and recognizing the effect of public policy initiatives.

The Investor Challenge

Any investor navigating the minefield must do three things, all major themes at "A Dash":

1. Overcome the psychological pull identified in the behavior finance literature.  These are the reasons that most investors significantly lag market averages.
2. Monitor economic data in an objective fashion, getting past both the "green shoots" crowd and those who always find the worst take on any information.
3. Put politics aside, figuring out how to make investment returns no matter which party is in power.

In an effort to help investors with these points we suggested a little quiz.  Apparently we did not present the problem effectively, since our fine editors at Seeking Alpha did not see the significance of the questions.  We know from our classroom days that everyone hates quizzes, especially when they do not know the answers!

Perhaps we should have stated it more strongly.  Anyone who cannot do well on the quiz, and we strongly believe most would fail, will be out of touch with the economy and the market over the next few months.  They will also make psychological mistakes that will lead to failure.

We were alarmed that our smart neighbors had so many ideas -- most of them wrong -- and were all acting decisively on their opinions.

Over the next two weeks we will reveal the answers to the questions -- each of which was carefully chosen to reflect an important issue.

We could have just written an article about "The Eight Big Mistakes You are about to Make."

Our experience in education tells us that people learn more when they try to answer a question themselves before getting the answer.  It is a tried-and-true technique.  We urge readers to take a look at the quiz and make some private notes of the answers, even if they do not choose to enter the contest.  Official entries for our prize will close on Thursday.

As we explain each answer, the significance of the questions will become clear.

And finally, while our focus is on the individual investor, most of the concepts are equally important for traders.

Timing the Trade in "Obama Stocks"

The insatiable hunger for stories motivates financial media.  At the first hint of a new development the process begins -- hard news, analysis, critics, and long-term effects.  The cycle is so fast that we sometimes get the criticism before most have digested the original news.

This is the nature of a highly competitive news environment where everyone wants to get a scoop.  It is completely understandable both for mainstream media and for bloggers who all want to weigh in on the story of the day.

Is this a useful time frame for market participants?

For traders, the answer might be "yes."  There will be opinions and reactions.  Anyone who can "game" the market reaction may make a point or two in trading profits.

For investors, we believe the answer is "no."  The initial, knee-jerk reaction may have nothing to do with the actual investment potential.  Let us consider a current example.

The Obama Health Care Trade

Understanding public policy can provide a real advantage in predicting policy outcomes.  Since that is the starting point, let us review what we expected about Obama and health policy.

1. We understood the difference between campaign issues and actual policy.  There are many steps and many compromises.
2. We noted the early reluctance of Congressional Democrats to get on board with Obama health initiatives.
3. We have been skeptical about the ability to put together the coalition necessary for a "big" health policy bill.
4. There is growing attention to future budget deficits.

These conclusions would not be surprising for anyone who has studied Congress and health policy.  In our case, we have done it  since the days of Wilbur Mills, but analysts with less experience might easily reach the same conclusion.

Contrasting the Media Time Frame

Media needs relate to the story of the day.  If President Obama is giving a speech on health policy in Green Bay, Wisconsin (a wonderful town!) then that is the media story of the day.  The Fast Money gang brings on their go-to guy, Dan Clifton, and asks what stocks will be affected by the Obama plan.  Clifton, whom we respect and cite frequently on our sister site Election Stocks, gave exactly the answer we would have given -- as the question was posed.    He was invited to comment, and he answered the questions from the gang.

The problem is the context.  We would have emphasized that many of these changes were unlikely.  In particular, the health insurance companies will do well if the final plan generates more customers, a result we see as likely.  Briefly put, anyone following the media take would have been an instant loser.  The insurance stocks rallied ten percent as news of opposition emerged.  Anyone looking at the actual politics can see the potential for these companies.  (We are analyzing and shopping for our clients.  There is plenty of potential.)

Conclusion

The health policy issues are one of many initiatives where investors can score some big gains.  It is a complex political situation, and it will change during the summer.  There is no official Obama plan.  It is not easy to follow, and that is the source of the opportunity.

Cost control seems to be a part of any proposal, and that weighs on existing pharma, new products.  and aspiring pharma (biotech).

This is a minefield for the media and for casual observers.  It is an opportunity for anyone following the nuances of the politics, picking the right time to get involved.

Obviously, this story has many more twists and turns.  Finding the right time to play is crucial.  The major media time frame is quite wrong, and provides an opportunity for long-term investors.

There are numerous other policy issues, all of which we are tracking closely.

How to Profit from the Obama Stocks

Understanding public policy decisions is crucial to investment success.

This has never been more true.  Government intervention is changing the nature of every business.  As an investor, you need to figure out what is going to happen, and whether it affects the companies in which you own stock.

Over the last several days we have emphasized how easy it is to make mistakes in the minefield of politics.

• You can misunderstand the difference between politically controlled agencies and the civil service.  We will explain how to tell the difference.
• You can confuse your role as citizen with your desire to make money as an investor.
• You can ignore good sources of information, just because you disagree with their politics.

We have some more mistakes to highlight in this series, but there is a positive side.  We strongly encourage readers wanting to follow this approach to review the links above.

We are going to show how to figure out where to get information, and how to use it.  Part of our success in client portfolios relates to a disciplined approach to public policy analysis:

We want to succeed no matter who is in power.  We put personal opinions aside.  We analyze the likely results, and figure out which stocks will gain.

It sounds simple, but hardly anyone can resist the temptation to confuse opinion with analysis.  Most of the current pundits are offering opinions about politics at the very time that stimulus dollars are starting to hit.  This is good for their ratings, but bad for your portfolio.

They jumped the gun months ago picking "Obama stocks" on his inauguration.  The earnings effects have yet to show.  Meanwhile, companies have gotten lean and mean.  Many are showing reasonable earnings even in a time of economic distress.  Let us find these winning stocks.

As background, here is a recent article we wrote for TheStreet.com's RealMoney site.  It is a bit  introspective, but regular readers of "A Dash" may find it useful.

From RealMoney.com, 4/30/2009

When I started writing for RealMoney, I had an idea: I wanted to study how the nexus of politics, public policy and specific stocks could provide a big edge to readers. Almost two years ago, I launched a Web site, ElectionStocks.com, and hired some staff support. Since I watch political news and the markets for most of the day, I feed ideas to the team; I also write some pieces and review the work.  We started by covering about 20 candidates from both parties. We identified issues and stocks for each of them. As the field narrowed, we focused on stocks that could work regardless of who was elected. I was looking for names I could suggest as good stocks with great potential political drivers.

The Best Advice?

Sometimes the best advice is a warning against any particular action. We had no precedent for an election and transition in the middle of an economic crisis. Many analysts and researchers were going on TV with their "Obama stocks" at the time of the election, at the start of the year and on the day of the Inauguration -- the election cycle offered three chances for publicity.

The cold reality? This time was really different. Even when the election results were certain, no one could know which of the Obama proposals would survive in the Senate, nor how quickly they would be passed. More important, a single issue dominated all others: dealing with the "toxic" assets. The new administration did not seem to understand that this was the keystone for all problems. The first approach to the problem of price discovery was Treasury Secretary Tim Geithner's maiden voyage ... and a stock market disaster.

The biggest Obama mistake has been the failure to deal with this problem; no one on the team appreciated the significance. The result? We are getting the announcement about the particulars of the Public-Private Investment Program on May 15, more than six months after the election; Hank Paulson went to Congress in September. This will go down in history as one of the worst responses to a financial crisis, partly caused by the transition in administrations.

Simply put, this was not a time to buy stocks because of the winning candidate's positions. Those who did so had big losses, because the general economic questions overwhelmed any specific stock ideas.

I've been watching elections for 40 years and studying how the election cycle affects stocks for more than 20 years -- I taught political science and public policy for 13 years before entering the investment business in 1987. I also devoted particular focus to this cycle -- I'm confident that I'm among the most qualified analysts on the subject -- and still I refrained from pushing the investment ideas our team developed.

It was not right, and I knew it.

How to Make Money

Part of investment success is avoiding losses. I hope that readers of my commentary on Obama policies have shared my caution. When the stimulus package was passed, we identified some stocks that would benefit. As is often the case, the problem was the time lag. While the market attempts to look ahead, there are very few experts on government spending. It is very complicated. I follow everything said about Obama and stocks and filter the prospects through almost 40 years of training and experience. Here is my general conclusion:

• Initiating new policies is more difficult than you think -- much more difficult. Be skeptical.
• I always look for the "default policy" -- what will happen if nothing changes in the law.

Now Is the Time

It may seem silly to some, but now -- 100 days into the administration -- is the correct time to start thinking about Obama stocks. Here's my reasoning:

• The stimulus package was widely dismissed by market pundit, mostly because it did not do what they preferred. The actual spending is starting to hit, and will show up in corporate earnings.
• The budget process is prolonged. The Street hated the proposals as "too liberal." We are now about to learn -- for the first time -- what will really get passed. It is time to pay attention.
• We are getting policy details. People do not realize how long it takes to make a transition. The new secretary of Health and Human Services was approved just yesterday; how could we project health policy before this? The Specter party switch also affects prospects, especially for every health stock.

Unless you are monitoring factors like these, you are out of step with reality.

What to Buy

Over the next few weeks I plan to highlight several different groups of stocks, each of which may benefit from Obama policies. I will downplay those where I think congressional prospects are poor and emphasize those where prospects are good.

Meanwhile, my team has constructed a stimulus package portfolio. We have carefully monitored opinions from a wide range of experts featured on financial media. (RealMoney's own James Altucher's ideas are prominent in the portfolio.) The portfolio has had a positive result, but the results are nothing special so far. That's good -- most people bought the Obama stocks too early, got discouraged, and bailed out. This relative loneliness in the space provides a good opportunity.

Here is a preview of our coming articles:

• Health care: Information technology stocks will definitely do well. Other health stocks depend upon the yet-unknown details of the plans. Look at Athenahealth (ATHN) 
• Alternative energy: We like First Solar (FSLR) , and it is part of the portfolio. A number of other good choices (courtesy of James A.) are also included. 
• Infrastructure: There are several choices in this space -- check out KBR (KBR) . 
• Defense stocks: This is a surprise to many who see Obama as cutting defense, but cutting the costs for Iraq may not translate into lower returns for specific contractors. We see good prospects for many defense holdings. Jim Cramer also is noting this strength on earnings calls.

It is hard to believe. I would not have predicted it in advance. The best time to buy the Obama stocks is after the first 100 days. Stay tuned for more specific picks and how you can use Obama's policies as you craft your portfolio.

How to Make Money on Barney Frank

Barney Frank, (D Mass), the Chair of the House Financial Services Committee, is a polarizing figure.

He is the bête noire of the conservative punditry.  Whenever he does or says anything, there will be a chorus of objections from those who disagree with his politics or his lifestyle.

Over at Zero Hedge, one of the several "Tyler Durdens" managed to work in a couple of offensive remarks in a very brief post.  (We're not repeating them.  It will be interesting to see if the Seeking Alpha editorial team publishes this one!)

The issue?  CNBC scored one of their "First on CNBC Interviews" by getting Rep. Frank on Squawk Box right before the hearing on executive pay.  It all started OK, but then Mark Haines started to weave from straight questions into a discussion of his own opinion.  He often does this, and his viewers like it.  With a rookie on the show, it can be devastating.  With Barney Frank, who showed very little tolerance for this.  In fact, he seemed pretty testy about the questioning.  For CNBC, it just meant that they lost the interview.

You can see it yourself right here:

Why Listen to Barney Frank?

Barney Frank is one of the most polarizing figures in Congress, at least to a national audience.  His constituents think he is great, and he has a very safe seat.  (This means that those who believe that he took various actions for small campaign contributions do not understand the political process).

As a funny-sounding, very liberal, and openly gay member of Congress, Frank is an easy target.  He is no stranger to controversy, providing more ammunition to right wingers and gay bashers.

Our question is the same, practical, relentless one we have been offering for some months:

Do you want to make a political statement, or would you rather make money?

The blog writers who want some boo-yah's from their audience bash away on Barney.  While avoiding explicit criticism of Frank, Mark Haines probably scored points with his own audience by offering his personal viewpoint on executive compensation and shareholder influence.

The Attitude of the Smart Investor

Let us suppose for a moment that you do not agree with Rep. Frank's politics.  Here are a few facts:

• He is one of the most powerful people in Congress, at the epicenter of various decisions on financial regulation;
• He is (perhaps) the smartest person in Congress, according to a poll of Congressional staffers.  (If you do not see this, then maybe you need to review your personal biases.  He regularly runs rings around interviewers, as he was doing with CNBC this morning.)
• He has been accepted by the Street and the GOP (Hat Tip Charles Kirk).

Here is what Crains New York has to say:

Just about everyone in banking wants to be Barney Frank's friend nowadays......

Mr. Frank ambles around the halls of Congress in the type of pin-striped suit familiar to any banker—although his untucked shirt betrays any notion that he might be one. Yet financial executives credit him with reining in his fellow Democrats' angriest impulses about how to handle Wall Street. He can charm Republicans, too: Last month, he was the only congressman ranked among the “most partisan” and the “most bipartisan” in a survey of members by The Hill newspaper.

“He finds a way to negotiate,” says Scott Talbot, senior vice president of government affairs at the Financial Services Roundtable.

Of course, it also behooves bankers to play nice with Mr. Frank. Asked if bankers have come to grips with new realities, he tartly answers: “I think they understand a new set of regulations is coming. And it's better to sit down and get it right than get it wrong.”

You really need to read the entire article to understand how serious financial executives view Frank.

The Simple Question

So it is a pretty simple question.  When you are watching CNBC do you want to hear the viewpoint of one of the most powerful Congressional leaders, or do you want to hear opinions from Mark Haines?

Do you want to read some politically oriented bashing of Barney, or would you like to make money?

Investors should be agnostic with respect to politics and to life style.  Those who insist on injecting politics as part of their analysis are facing (at least) four tough years of investing.

There are investment stories that will work.  It does not matter if you agree with Frank, or Pelosi, or Obama.  As long as we can predict what they will do, we can find an edge.  Even though we absolutely hate government control of business, we have found winning investments this year.

How?

Be practical, not political.

The Most Important Stat: Bloggers versus Experts

Market pundits always try to explain modest changes in the broad averages.  Today their stories are all wrong.

Today, the most important statistic came from Jack Hough at Smart Money

The Story

Hough did a piece on the credibility of government statistics.  It is a nice job compared to most prior discussions.  He provides a viewpoint on each of the key issues, citing arguments from the BLS and the principal conspiracy theorist.

It would be interesting for investors to read the entire article and also to read the supporting documents from the conspiracy guy and the BLS.

Almost no one will do this, since they are too lazy to do any real work.  We are now addressing to the handful of people still thinking and reading.

Of the few who try, most will not be able to evaluate the arguments, since it requires some understanding of data analysis to reach a real conclusion.

It is possible for someone to sell snake oil and the reader will not know the difference.

Basically, it comes down to how people feel about government.  Most students enter college -- we know, we taught them -- with a negative bias.  They see movies.  They make the mistake of thinking of Congress -- 535 people with different motives, coalitions, and partnerships, as if it were a rational unitary actor. Simple and facile interpretations can be persuasive.

The Data

As observers of the investment scene, we have documented a long-term process of dis-information.  To our amazement, the story was even worse. 

The data show that 85% of readers do not believe government data.  Wow!

This is an astounding result.  We knew that the big-time blogs were unduly influential.  We knew that the mainstream media sources accorded undue recognition to the extremists.  We also knew that every time we discussed government data in a positive light, we got hate mail -- both aggressive and plenty of it.

We are still astonished.  Normally the highest people in socio-economic-status (SES) also have a higher score on questions related to Confidence in Government.

But it is  an online poll -- tracking an audience known to be unrepresentative, wealthy and conservative. Does this matter?  What interests us here is that the unrepresentative sample  is so far out of touch with reality.

To Summarize

The data are complex.  We believe that any of the Internet pundits (name your candidate) or the conspiracy guy would be beaten like a drum if engaged in a fair fight with someone from the BLS or another suitable representative.

BEATEN LIKE A DRUM.  Any media source wanting to try this could do it.

We cannot cover this in one article, but it is an open challenge to government critics.  Any time, any place.

Investor Implications

Many individual investors are attempting to monitor economic developments.  There is a choice in data sources.

You can take information from one of two sources:

The first source consists of career professionals whose salary and benefits have no relationship to politics.  They develop methods and write articles for peer-reviewed journals. Their career chances depend upon professional performance as evaluated by others in the field.  You already pay millions of dollars for this information.

The second source has a profit motive.  None of the assertions are reviewed by peers or published.  Everything plays upon emotions and pre-conceptions.  There is plenty of support from bloggers who share these motives.

To us the choice seems obvious.  When we learn that nearly everyone disagrees, it makes the trade even more attractive.