A Dash of Insight

Bias in Bernanke Coverage: Does it Matter?

There is a lot of biased news coverage these days.  Some of it its intentional, and some of it is not.

Today's example is the coverage of the Bernanke reappointment hearings.

The Reality

From the perspective of those whose opinion matters, this is a foregone conclusion.  Chairman Bernanke showed real leadership when it was most required.  Under his guidance, the Fed took many creative steps to avoid an economic collapse.

If one looks to objective sources from both parties, the conclusion seems obvious.  Bernanke was appointed by President Bush and reappointed by President Obama.  His support is broad-based and extensive among professional economists.  He will be confirmed.

As is often the case these days Bob McTeer has the strongest analysis. He provides a good case for the Bernanke reappointment.  Anyone wanting a reality check should watch the video here and read the article here.   Since I know that many readers will not click through to the links (although they should) the following captures the gist:

What I don’t understand is why politicians think their deviant behavior is so appealing back home. They apparently don’t have a very high regard for the home folks, especially those in Kentucky and Vermont. My guess is that those folks are better than their Senators give them credit for. Surely blue grass and autumn leaves have some calming effect.

To my way of thinking, Chairman Bernanke (and Secretary Paulson) deserve the highest praise for saving our financial system and avoiding another great depression. I’ve defended Bernanke in blogs, speeches and TV appearances (see previous post). So have wise people like Warren Buffett. But our way of thinking, apparently, is not making any headway.

I heard yesterday that a major poll showed a majority against Bernanke’s reappointment. I guess that shows the power of financial TV and its guests who compete with each other in outrageousness hoping to be invited back.

We got to watch Congress in action.  Hearings provide a platform for those with eccentric views to spout off and get publicity.  Even the most lightweight of Senators gets to have his moment in the sun.

The practical result?  Some Senators have made an issue of the reappointment, placing a "hold" on it.  This means that there will be a real vote, not approval by voice vote.  It is quite possible that the vote for approval will be lower than in past instances, as noted in this WSJ article.

The Fiction

Internet readers got a totally different picture.  At Seeking Alpha, where I am a contributor, the big story was the "Bruising of Bernanke."  (I want to make it clear that Seeking Alpha tries to present a balanced view of stories.  Most likely the articles showing some balance did not come through in time to provide this balance. Mea culpa -- I could have written about this yesterday, but other duties impinged. The editors react to the flow of stories.  Perhaps they will square it up a bit in the future.)

But let us look at the result of the Bernanke bashers, including the writers of the featured stories and a few others.

When you get criticism of an appointment, it is news, but we need to look at the sources and the biases.  For investors, I recommend looking  beyond the salacious stories and focusing on what is really going to happen.  The attack stories get headlines, similar to the media frenzy about Tiger Woods.  It is good for page views, but not really helpful in understanding the reality.  The critics include the following:

Those running for office.  Some commentators have a clear political agenda.  They think that it would have been a wonderful cleansing experience if the Fed were not to have fought the onset of a depression.  It will be interesting to see how this platform plays in front of the electorate.

Those who have a book to push.  Some pundits lay all of our troubles on past Fed mistakes.  Everything they write is colored by support for this viewpoint.  While their followers accept the premise, the verdict of history will be rendered by those with a more objective stance.

Those who have a blog based upon attacking the Fed.  Most of these arguments include rather simplistic and often inaccurate accounts of the Greenspan Fed, now extending to the Bernanke Fed.  There is little effort to distinguish between the actual tools available, and what was needed when confronted with the collapse of Lehman.

Those citing public opinion.  This is very interesting.  The public can name the Three Stooges, but not the three branches of government.  Any time an issue is technical, we expect true leaders to look beyond polls.  Many of those citing public opinion take the other side of the argument when politicians react to polls.  They call it "pandering."  In fact, most officials make some careful distinctions.

The amateur political scientists.  This includes the commentator who has no known experience in actually making public policy decisions who declared Bernanke to be "politically naive."  He is swinging out of his "happy zone" as the Splendid Splinter called it.

And others with a hobby horse.  This includes the "live blogging" on Bernanke at TheStreet.com's Real Money site (usually helpful when focusing on stocks) where some commentators thought that their own personal viewpoints about public policy should be accepted by all.  The assertion that Bernanke was telling lies was particularly offensive.  One should never substitute personal opinion for fact.  The Bernanke testimony is available to all -- subject to objective analysis.

A Credibility Test

When I read those commenting on economics, I employ a simple test which I recommend for readers.  I call it the "Chalk Test."  Economic analysis can be controversial.  The "big minds" can and do differ, but they share certain basic skills.  If you gave them a piece of chalk and asked them to do a simple problem -- a supply and demand curve, and analyze the effect of an excise tax -- they could all do it.  Most of the popular blog writers cannot pass this test.  They write about economics, but they do not know the basic skills.  Their real skill is in dishing out pop concepts to a group of readers who already agree with their conclusions.

This is dangerous for the average investor -- very dangerous. 

Investment Conclusion

The bashers of the Fed have been wrong for a long time.  Essentially, they argued that the Fed was in a box, and would be ineffective in staving off a depression.  They were wrong.

Instead of recognizing the error, they now want to vote out the leadership and change policy to suit their own viewpoint.  They are wrong again, since this will not happen in the case of Bernanke.

Since the Internet audience is not a representative sample (think about the Dewey defeats Truman headline, where the polls had an unrepresentative sample), the flow of stories, augmented by thumbs up, thumbs down, conveys a false impression to the average investor/reader.

Most of the same sources now suggest that the Fed will soon make many other mistakes (beyond my current scope, but more later).

Repeating an important recurring theme at "A Dash", I suggest that investors should be politically agnostic.  It is better to make money regardless of who is in power, than to lose money, or miss opportunity, while complaining about politics.

A Profitable Pattern

I have noticed a profitable pattern.  I am going to cast this from the bearish perspective, but in theory it could work either way.  I have a few other historical examples, but let us focus on the present.

Background

Investors have many time frames, and so do those managing money.  When you see someone interviewed on CNBC it could be a mutual fund manager, a hedge fund manager, or a trader.  It is natural for everyone to talk his book, but the time frame is relevant.

A mutual fund manager likes to see holding increase, get publicity, and attract new assets.  Having said this, these managers are not likely to sell into rallies.  Instead, new money in their funds gets invested at current prices in current holdings.

A hedge fund manager or trader is different.  Their disclosures warn that they may change opinions and trades in a heartbeat.  They can, and should, do so.  A five percent move in a stock is a major trading profit.

The Process

A portion of the hedge fund community takes a position.  For this example, it is a short in semiconductor stocks.  The position is supported with plenty of reasoning they deem to be rigorous and also by technical analysis.  It is especially desirable to find a situation where a sector has made a big run.  A chart of the SOX tells the story.

I haven't added any lines in this, and readers should ignore the last decline, since that is the end of the story.  The point is that analysts could have a field day with this chart -- before the decline.

Cocking the Hammer

Those establishing a bearish position wish to highlight major concerns.  In this case the "hammer" was the question of double booking of orders.  This occurs when inventories are so low that those building mother boards want to be assured of needed parts.  To do this, the theory holds, they place multiple orders for needed parts in short supply, canceling some orders when their needs are met.

It is an argument that raises a question about the validity of reported orders, and creates fear that the orders will decline.

Pulling the Trigger

One might think that actual evidence of order decline would be necessary to trigger the fear.  That assumption is incorrect.  It is easy to grasp any news as evidence that this prophecy has been fulfilled.

Yesterday the B of A/Merrill analyst downgraded the entire sector.  The resulting report, which I have read carefully, is based upon an inventory model and some assumptions about where we are in the cycle.  It does not specifically refer to any double booking, and the resulting forecasts are still above many other Street observers.  It was a big call, getting a lot of play, and knocking down the stocks by 5 percent or so, as the chart indicates.

Bearish observers incorrectly cited the double booking argument, not actually mentioned in the report.  It talks about a small "overshoot" in inventories, not mentioning any double booking.  It is based upon a theoretical model, without a lot of supporting evidence.  Since few actually read these reports, the inaccurate summaries gain credence.

The Result

Anyone with a short position can cover for a nice trade.  It was a nice setup.  Any downgrade could be cited as evidence.  When the analyst from a big firm downgrades, everyone pays respect, at least in the short term.  That is long enough for traders and hedge fund types.

The Facts

There is plenty of evidence contradicting the double-counting argument:

From iSupplyCorp we have the following:

In their earnings announcements, leading semiconductor suppliers, including Texas Instruments, STMicroelectronics and Intersil, all reported they saw no signs of double-booking during the third quarter, said Ciriello. “This should give the semiconductor industry confidence that the magnitude of the current recovery accurately reflects real demand levels.”

A balanced article at the WSJ mentions the double-booking issue:

Another analyst, FBR Capital's Craig Berger, also cited signs of weakening PC demand, though he said in a note, "We do not want to get overly bearish on the PC space given improving global demand and still-unknown holiday sell-through trends."

Berger said he remains "bullish" on the semiconductor sector. "We think fears of a first half of 2010 estimate cuts from double ordering are overblown, that global supply chain inventories are at or near all-time lows, that global demand trends will continue to recover in 2010." 

Astute tech stock observer Bob Faulkner writes as follows (see the full article for his nice inventory charts and complete analysis):

I've tracked inventory in the electronics-supply chain for years. While it’s too early in earnings season to draw any final conclusions, I think it’s very safe to say that inventory is quite tight on a relative basis.

Steve Ballmer reports that Microsoft sees "fantastic sales" for Windows 7.  If this is accurate, it should stimulate a new cycle of purchases.  More people and businesses replace computers -- especially those who avoided VISTA -- than upgrade existing machines.  The current hardware may not be adequate and is difficult to configure.

Our Take

The trading setup is a real dilemma for managers with a long-run horizon.  It was completely predictable that something -- anything -- would be seized upon as confirmation for the double-booking argument.  There was no need to wait for actual evidence.  Even knowing this, should the manager blow out all of his chip holdings, expecting a pull back of unknown size?

The real answer for those with a longer perspective is to focus on the actual time frame and ignore the bumps in the road.  The traders will make their profits, and eventually the results will tell the story.  It is an opportunity to add to positions for those who disagree with the thesis.

An Interesting Exercise

There was a similar setup -- hammer pulled back -- on car sales after the Cash for Clunkers expired.  Perhaps this is a good topic for an example where we now have more evidence -- an immediate decline, followed by a restoration in sales.

I invite other examples -- both long and short -- from readers.  Look for the setup -- what we all should watch for-- and then look for evidence.

Our position:  Long INTC, MSFT, and AAPL.

Specific Expertise: Insisting on the Best Information

Here at "A Dash" we have emphasized that we are all consumers.  We are consumers of data, of analysis, and of opinion.  Our principal mission is helping readers understand their role as consumers and figure out what sources and information to follow.

Background

Here are two widely-accepted findings to consider.  Both have strong support from empirical evidence on market returns.

1. Stock analyst ratings often lag, so the wise contrarian investor fades the consensus opinion.
2. Chasing performance is a major source of losses.  Those who "called the last move" are often the mean-reverting cases.  One needs to look at long-term performance.

These precepts are widely accepted in the investing community.  (I will add that both are part of my own approach to stock-picking, with a nice long-term return.)

Meredith Whitney

Yesterday afternoon CNBC indicated that Meredith Whitney would be featured on Maria Bartiromo's program.  Regular readers know that we are big fans of Maria.  We think that she asks the right questions and draws out interesting answers from high-profile guests.  Many market participants guessed at the nature of the interview and sold the market before and during her interview.

You can check out the key points of the Whitney interview here.

Our Take

Meredith Whitney, in her prior role as bank analyst with Oppenheimer, did one thing well --- very well.  She accurately predicted that banks would need to write down assets.  She accurately predicted that there would be no FAS 157 relief on mark-to-market accounting, so there would be a death spiral of bank value declines.  Those following her predictions made significant profits and/or avoided losses.

Since starting her own firm, Whitney has expanded her universe of predictions.  She is now making forecasts about the economy, the housing market, and consumer behavior.  (I regularly read her work via my helpful Oppenheimer rep when she worked there, but now I get the information along with everyone else).

It is quite fair to question Whitney's skill at economic forecasting.  Her success related to analyzing bank holdings, not forecasting the economy.  Personally, I prefer a different approach to economic forecasting, and so should you.

Her current bearishness is grounded in valuation -- financial stocks should return to tangible book value.  When asked what would make her bullish, she responded in valuation terms, giving the example of BAC at 3.  She does not believe that banks have sound core earnings, despite an attractive yield curve.

Others have commented on Whitney's bearishness, with varying conclusions.  Quite frankly, most of them use the wrong criterion.  They talk about how well she has predicted the market -- either last year, or this year, or both.  This is a very small universe for inference, dependent on a couple of key conclusions in each case.  The circumstance this year, including marking assets to market, are quite different from last year.  Whether or not one agrees with government policy, the various arms of our Federal government are all on a concerted mission.

A More General Conclusion

We are all bombarded each day with fresh opinions about our investments.  These are now taking the form of the CEO interview.  I modestly suggest the following guidelines:

• CEO's are great at discussing their current business;
• CEO's are sometimes helpful in discussing what is in their pipeline (analyze this skeptically and carefully);
• CEO's have no added advantage when offering opinions about the future of the economy, beyond what they see in their own business.  They are reading and analyzing the same news that we are.

Readers might enjoy revisiting our Ted Williams strike zone article --- emphasizing the importance of staying in your "happy zone."

[I am long GS in personal and client accounts and hold a small BAC position as well.  I am slightly long in trading accounts and remain fully invested in long-term accounts.]

Dollar Weakness and Stock Market Strength -- the Data

Anyone who is following the market on a daily basis is paying attention to the strength of the dollar versus other currencies.  It can be confusing.  While a strong dollar might seem like a good thing, there is actually an inverse market relationship with stocks -- at least in recent times.

I described the basics of the dollar debate here:  Understanding the Debate on the Dollar.  There are many opinions -- prescriptive, political, and descriptive.  The next step is to consider some data.

Dollar Strength and U.S. Equity Market Returns

In my last article I highlighted the inverse relationship between a strong dollar and the stock market.  This chart provides a dramatic illustration of the relationship for calendar 2009.

 
Sometimes a chart tells the story in a glance, but I always like to look at data as well.  I used the Fed's measure of the dollar versus a broad basket of currencies, weighted by trade.  The series started in 1995.

The correlation for this year is an almost perfect negative relationship:   -.96.

A negative relationship sometimes stands out even more if you invert one of the scales.  Here is that chart.

The data are the same, but the tight relationship is especially clear using the inverted scale.

So much for what we know.  An obvious question for investors in stocks is what would happen if the dollar gets stronger.  Perhaps we should look at more data.

A Longer Perspective

Some believe that a strong dollar is consistent with economic growth and a strong stock market.  To examine this concept, we need to consider more data.

If we look at the full data series, we see long periods where dollar strength was consistent with a rising stock market.  In fact, the correlation between the two series is a positive value:  .35.

For an objective analyst of data, the chart suggests three conclusions:

1. The relationship changes over time;
2. The last year is quite atypical;
3. There are other important variables at work.

The Carry Trade

The prevailing hypothesis about the dollar/stock relationship is the "carry trade."  Supposedly there are investors/companies/speculators who are able to borrow in dollars at a very low interest rate.  This makes the dollar the "funding currency."  Most outspoken on this subject is Nouriel Roubini, who sees disaster ahead.  [Full disclosure -- I am a contributor at Nouriel's valuable site.  I respect and appreciate his encouragement of alternative viewpoints.]

The borrowers do not then do the obvious -- lend in another currency, hedging the difference with a forex trade.  Instead they supposedly use the borrowed funds to engage in a variety of speculative trades -- emerging markets, real estate, and, of course, US stocks.

Following this logic, there is now a speculative bubble of major proportions.  This seems implausible.

My skepticism comes partly from the lack of any real data supporting this viewpoint, and partly from the daily trading.  If you really had this trade on, would you really take it off if the dollar moved by 0.4%?  The carry trade hypothesis does not explain the closely calibrated trade between the dollar and stocks, but we see this every day.

For now, let us stick to conclusions supported by data.  There is a strong inverse relationship.  If you are a trader, you had better pay attention.  If you are a long-term investor, you need to understand the long-term relationship.

Meanwhile, I invite reader comments, citations for new data, and fresh hypotheses.  I will pursue this for at least one more article, considering various causal models.

Interpreting Conflicting Information

A wise and valued friend called my attention to an article on municipal bonds, Short Seller:  Dump Munis.

James Chanos, noted for highlighting collapses including Enron, sees bad days ahead for municipalities.  State and local governments already have fiscal pressure.  They have defined benefit pension programs and "platinum" health care plans.  He also raises the specter of the loss of the federal tax exemption if there is a bailout.

To balance this perspective, author Tom Sullivan also cites Gary Pollack, head of fixed-income trading at Deutsche Bank Private Wealth Management.  Pollack sees "headline  and downgrade risk" but notes the power of these governments to raise taxes.

Even if one hates the idea of tax increases, this is an article about the creditworthiness of bonds, not one about politics.  It is easy and tempting to confuse the two.

Our Take

So often these questions are posed in black and white.  Either one should buy municipal bonds -- or not.

The answer might be quite different.  Suppose that both Chanos and Pollack are correct.  Frankly, that is my vote!  We should expect a higher than normal rate of failures by municipalities.  There will probably also be tax increases.

The real investment question is not which of these experts is correct.  It is the following:

Do current municipal bond prices reflect the acknowledged current risks?

The article invites us to choose one side or the other.  The market presents a more nuanced challenge.  Municipal bonds are not right for everyone.  Tax considerations are an important issues.  Having said this, there are two possibilities:

1. An investor who has confidence in a given jurisdiction may find an attractive opportunity; and
2. An investor who thinks the overall market is too pessimistic may find an attractive muni fund, avoiding the locality-specific risk.

A Further Conclusion

Too many market questions are posed in the form of one side being right and the other wrong.  In fact, the market prices usually reflect the debate.  You are only looking for an edge.

Understanding Market Volatility

Investors and traders alike need to understand market volatility.  Many market observers use volatility as a euphemism for price declines.  This is completely wrong.

The astute options analyst Adam Warner (one of our featured sources), does a great job with this concept.  Writing about the Market Vectors Gold Miners (GDX), he makes this important point:

Volatility is about fear of the unknown, and so long as gold and currencies get out of range a bit, there's apparently a bit of fear around of either missing another leg up or missing an about face down. (emphasis added)

A Natural Human Trait

Accepted lore is that markets hate uncertainty.  It is a normal human trait, one that is manifested in collective behavior as well.  Here is a simple example.

Airline passengers are quite sensitive to the unusual.  I was thinking about this on my trip this week to the West Coast.  (I always expect to post an article or two on these business trips, but usually fail.  Sorry!)  My seatmates on both flights had a lot to say about the pilots who somehow missed their destination, flying 150 miles past the airport and losing contact with air traffic control for more than an hour.  Everyone I talked to was confident that the pilots dozed off, and dismissed other explanations.

I fly on United and enjoy the flight deck feed on Channel 9, the conversation with ATC and the towers.  The Wall Street Journal cited the calming effect of this feature:

Many passengers take comfort in the back and forth between pilots and air-traffic control. Mr. Ohnstad, a technology project manager in the banking industry, says he sometimes worries about noises and jolts while in flight. "But I hear the pilot's calm voice telling ATC that 'We're experiencing continuous light chop,' and I can relax more," he said. "It's fear of the unknown that causes apprehension. Pilots can't update you every 30 seconds."

Personally, I have often enjoyed specific benefits from the flight deck commentary--often warning that choppy skies are ahead.  The funniest case was when we were parked at O'Hare waiting for a gate and the pilot asked for a small move to a new parking spot.  His passengers were getting restless!  I was one of the few to know the secret.

Anyone who flies often will enjoy the excellent blog from Captain Dave, who provides inside information from the perspective of the pilot, including an insightful treatment of the recent incident.

Applying the Lesson to the Market

When following the market, an explanation of each day's trading can be a calming influence, just like communication from the pilot.

The problem?  The explanations are all different and generally lack any evidence.  Here are today's candidates.

Business Week explained as follows:

U.S. stocks closed sharply and broadly lower Friday, led by financial issues, as disappointing reports on personal spending and consumer confidence stoked investors' concerns about the economy. Treasuries jumped as stocks skidded.

MarketBeat had a similar take:

For months, investors have worried that the recovery of both the economy and the stock market had more to do with heavy government stimulus than with fundamental economic improvement. Now those fears are raising their heads again.

The concerns sent stocks down sharply back on Wednesday, but seemed to dissipate Thursday, as a stronger-than-expected government estimate of third-quarter economic growth helped stocks erase the week’s losses in a single day. Today, weak reports on consumer spending and consumer sentiment have put the bears in the driver’s seat again.

Briefing.com has a very different viewpoint:

There wasn't any immediate cause for this session's decline, though some market watchers point out that stocks have had an increasingly difficult time of climbing higher since making their strong runs in recent months. Others have pointed out that there may be some month-end portfolio rebalancing and window dressing accounting for the recent whipsaw trade.

Nonetheless, the concerted selling effort brought about a spike in volatility. That sent the Volatility Index, often dubbed the Fear Gauge, up 24%, which marks its sharpest single-session spike by percent this year. Moreover, the VIX now stands at its highest level since July. Complementing the spike in the VIX is an elevated put-to-call ratio of 1.2, which is indicative of positioning for downside protection.

Art Cashin, a great reporter of floor sentiment, emphasizes the relationship between stocks and the dollar.  He notes that there is a high correlation -- weak dollar, stronger stocks.  He believes there is great risk in a dollar spike.  The CNBC interviewer pushes him hard on the nature of this relationship, suggesting that both the dollar and stocks are reacting to a change in appetite for risk.  Watch the video, beginning at 3:21.

Our Take

The question to Cashin was a good one.  It is what is called a "spurious" relationship.  Two variables are highly correlated.  Observers, in this case the NYSE floor traders, infer causation.

Here is an example I used in class.  You have a person in the middle of a traffic intersection with a stoplight.  When the light turns green in a given direction, he waves the traffic to go through.  The actions of the guy doing the waving are perfectly correlated with the traffic movement, but there is no causation.

Now let us suppose that the traffic light is out, and the person in the middle is wearing a police uniform.  The inference of causation is quite different.

Proving causation requires more than showing a correlation.  It requires solid evidence of timing, one variable leading another, and also a strong hypothesis about the logic of causation.  It is also useful to have statistical controls.  Art Cashin is on target when it comes to the floor trader attitudes, but they might all be fooled by a spurious relationship.

Meanwhile, there is plenty of evidence that the market is currently trading on perceptions of economic strength.  It is quite possible that we could see a stronger economy, a stronger dollar, and stronger stocks.  Or the opposite.

This explanation may not be comforting to investors, but at least it suggests what to watch.  That remains our focus.

Four Things You Didn't Know about Unemployment

There is a lot of commentary about the unemployment rate.  Various pundits are determined to find the worst possible interpretation of data, and also to impugn any official reports.  Let us take a closer look.  Many of the answers come from  the following source, helpfully highlighted by Barry Ritholtz at The Big Picture:

Measuring Unemployment in the Nineties
Janet L. Norwood and Judith M. Tanur
The Public Opinion Quarterly, Vol. 58, No. 2 (Summer, 1994
http://www.jstor.org/pss/2749542

Anyone who took a few minutes to read this important article would have some real insight into the world of policy nerds -- people like us!

Since few will be willing to invest the time to do a little real homework, here are the key things you would learn.

#1. Presidents do not dictate changes in statistical procedures.

This flies in the face of the popular "rogue economist" selling his conspiracy theory.  It will also seem implausible to the "B" movies fans.  Nevertheless, it is the boring truth.  The Clinton-era changes in employment measures were the result of a long process, thoroughly examined and challenged by many groups.  The final measures adopted the recommendations of the 1979 Levitan Commission, chaired by the renowned labor economist, Sar A. Levitan.  Here is a glimpse of the process, taken from the Norwood and Tanur Article:

The Process
The leadership of the two agencies [Census and BLS, jm] began a joint effort to develop a comprehensive strategic plan to reaffirm the CPS's leadership in labor
force surveys by using state-of-the-art questionnaire design and advanced technology. A series of meetings with the senior staff of the two agencies, including the BLS commissioner and the Census director, delineated the comprehensive set of tasks that needed to be carried out. Several joint task forces were established to develop the research issues that needed to be addressed and to establish the necessary plans, budget estimates, and time tables for implementation. The work began with efforts to identify areas of the old questionnaire that might need change. First, experts from BLS and the Census, as members of the CPS Questionnaire Redesign Task Force, reviewed problem areas. Based on their experience in developing and analyzing the data, they were often able to see questions that had a high potential for response error or that failed to implement existing definitions properly. They also noted questions needing definitional changes and identified areas of labor force analysis for which more data were needed. They believed that because of the dramatic increase in labor force participation of women and the rise in part-time and temporary workers,more information was needed from the survey about these categories of workers. Bureau of Labor Statistics staff were also eager to develop a more user-friendly processing system so that these and other important analytical issues could be addressed more easily and more quickly than in the past.

Next, the task force recommended a program of preliminary research.
Respondents were brought together in focus groups to explore their understanding of the concepts underlying the questions asked. It was this technique, for example, that confirmed a discrepancy between the respondents' and the CPS's use of the term "on layoff." Another preliminary technique tapped interviewers' experience with other CPS concepts by using card sorts to explore their coding of open-ended questions about job search and other matters (Fracasso 1989).

The next step was to design two new questionnaire....

This goes on for pages.  Any objective reader of this report will immediately dismiss the conspiracy theory.  There is no way that all of these academics, bureaucrats, and observers would have maintained some conspiracy.  They have different ideology and policy preferences.  What they shared was a desire to "get it right."

#2  The changes made the employment measures worse.  Here is a key quotation:

In November 1993, government information suggested that the jobless rate, undoubtedly one of the most politically sensitive of all federal statistics, had been substantially underestimated-by about half a percentage point-for many years. And this, in spite of the fact that the Current Population Survey (CPS), the 53-year-old survey that produces the data to assess the unemployment rate and provides a great deal of other labor force information, has long been used as a model of the best in survey design both in this country and around the world. What had changed?

The biggest factor was the increase of women in the labor force.  The BLS statisticians, like all data lovers, want to see continuous series, unchanged by methodology.  When the world changes, sometimes the questions must follow.  The BLS altered the workforce definition in a way that instantly increased the most common unemployment measure --- because it was the right thing to do.

Part of the change was a clarification of what it meant to be part of the work force.  This list of questions determines what respondents were really doing --  looking for work, attending school, keeping house or going fishing.  The current measures of labor force participation resulted from this work.  In prior years, we have no idea of what the answers might have been.

#3  The Federal Government measured the impact of the changes.

The BLS and the Census Bureau did an "overlap" sample where both the old and new questions were asked of 12,000 respondents.  By comparing these answers, one can infer the impact of the changes.

It is pretty obvious that this thoughtful statistical technique is the work of scientists, trying to find the right answers.  Those who are making accusations about political motives need to explain why this extra care was taken.

#4  Current unemployment, while very bad, does not approach that of the Great Depression.

Here at "A Dash" we have a mission of helping investors to find the best information from the best sources.  Often this means a focus on the change in economic conditions.  Some sources seem determined to find the absolute worst interpretation of every economic report.  This is currently a great way to get popularity on the Internet.  Some others seem to have a bullish spin on everything, perhaps going for a niche market.

Our idea is a bit different.  We try to find the best indicators from believable sources.  We classify these indicators as leading or coincident.  We then stick with the program, unlike others who discard or change measures in a heartbeat when they no longer like the results.

The Great Depression comparisons are erroneous.  They also seem quite unhelpful in recognizing key economic trends.  Here is a source for thoughtful readers:

This Is Not Another Great Depression

In fact, there are no continuous unemployment sources showing that current results are comparable to the Great Depression.  Anyone suggesting otherwise is blowing smoke.

And that is the official answer to our Summer Quiz Question #6.  This is the last of the answers, and we will declare a winner this weekend, awarding a nice prize from Amazon.com.  In practice, anyone who did the homework and got most of these answers right enjoyed the summer rally, and ignored the "sell in September" rhetoric."

Is the Recession Over?

Fed Chair Bernanke tells us that the recession is probably over.  Business Week reports:

From a technical perspective, the recession is very likely over at this point," Bernanke said in responding to questions at the Brookings Institution. "It's still going to feel like a very weak economy for some time because many people will still find that their job security and their employment status is not what they wish it was."

The announcement marks the start of a new "silly season" where people argue about recession dating, and misconstrue statements, taking them out of context.

Here is the issue.

The public goes by the "feel" method, using plenty of anecdotal evidence.  If there are many people feeling the pain from an economy growing below trend, it feels like a recession.  We really sympathize with this practical approach.  It is important to achieve potential.  The economy has been below the potential growth path for years, and will probably not get back there, achieving full employment, for years to come.

This is the cost of the credit collapse.

The media combines anecdotes with the "two quarters" rule.  Two quarter of negative GDP signal a recession.  It is not clear what constitutes a recovery.

The economists take a very different and more complex approach.  Read carefully.  If and only if there is a big decline on various indicators, the recession has been established.  At that point, and only at that point, the NBER committee looks back and finds a peak.  That peak is then designated as the start of the recession.

There is a good reason for this approach.  Economists want to link the actual recession timing to other economic data.  They are not trying to give a real-time signal.  It is all about timing for economic research.

Interpretation

The media and the big-time blogs have a field day with the economists' definition.  They play upon the popular conception, portraying economists as clueless bozos, who cannot see a recession when it is obvious to all.  This is great fun and gets many boo-yah's from the readership.

We did a careful description of this process in April, 2008, How to Win a Recession-Predicting Contest.

In that article we successfully guessed the actual start of the recession.  We urge readers to take a look at that article.   More importantly, we wrote as follows:

It Really Does not Matter

There is no light switch that makes things terrible if the economy is in a recession and acceptable if it is not.  Economic data show that we are experiencing a period of economic weakness.  This means lost jobs and lost profits.  It is a permanent loss and painful to many.  This is true whether or not the economic weakness attains status as an "official" recession.  It is a range of results, not a black or white question.

Now for the Flip Side

We are now entering the "flip side" of this story.  If the economic rebound continues, the dating committee will go back to determine the trough.  It will probably be some time in the last few months.  We will not know the official answer for many more months.

Investment Conclusion

There are some who are very negative on the economy right now.  If it turns out that the recession actually ended last spring, it does not mean that these analysts were foolish.  Similarly, going back to 2008, those who did not predict the recession might have been right.

The key point?  The Lehman failure and the instant freeze of credit markets created the downturn that verified the recession, moving the date back to the prior peak.

It is a cheap shot to take issue with those who did not foresee Lehman and the consequences, just as it will be a cheap shot to criticize those who are not currently predicting the recession end.

Big economic events provide the trigger for a post-dated result.  For investors, it matters little.  It is wise to ignore the "silly season" and focus on the fundamentals of interest rates and expected earnings for stocks, both of which are now becoming much more positive.

A Final Thought

We have frequently cited the ECRI as a source for economic cycles in real time.  Many predicted a recession for years before it occurred.  Since there is a recession every five years or so, this is a broken clock method.  The ECRI made the call in real time.

What about now?  The ECRI leading indicators have been very strong since July.  Most pundits are skeptical, thinking that they have deeper insights.  We shall see.

Revisiting the Stress Test

Early this summer we raised a number of questions in our Summer Quiz.  The objective was both to enlighten and to help investors make wise investment decisions over the summer.  As we hoped, anyone who took the quiz seriously has had a profitable summer.  (We'll try to wrap up the answers and award the prize, since we are now beyond Labor Day).

In Question #7 we asked:

The government stress tests for financial institutions have something called an "adverse scenario."  The conditions from that scenario have already been met, or nearly so.  (True or False)

At the time we posed the question, there was a universal fixation on the unemployment rate.  This was the only readily measurable input, and it seemed artificially low.  It was pretty clear that unemployment was going to lag the rest of the economic recovery.  Meanwhile, the other stress test inputs were not very visible.  On a symbolic basis, it was bad politics from the Obama Administration.

This fact was widely known to anyone paying attention.  A month before our quiz, Tom Brown wrote as follows:

But as unhappy as I am about the stress test, I’m even more shocked by all the commentators who dismiss the test results because they believe it wasn’t stressful enough. Some of these people simply believe the U.S. economy is headed into a death spiral; no how matter how bearish a given forecast is, they’ll tell you it’s not bearish enough. Others have lately built a nice business for themselves by being relentlessly, flamboyantly negative. Still others simply don’t know what they’re talking about.  Let’s look at a few of these people have had to say lately:

Brown went on to analyze several bank critics.  These were the people celebrated as "getting it right."  Brown pointed out that the loss reserves in the test were very aggressive.  His prediction of the result?

The likely result of all this? Just as in the last recession, the big banks will emerge overcapitalized, over-reserved, while their shareholders have been unnecessarily diluted.  It’s a disgrace.

Other source fixated on the employment number in the stress test, ignoring the (more important) loss reserve inputs.  Despite their analysis, several of the big banks are paying back TARP funds.

What Happened?

Since our quiz on June 15th, the big banks are up about 30-35%.  Anyone who did the homework could have participated.  Meanwhile, there has been fresh news about bank failures and additional capital requirements for regional banks.  As part of our series about what to watch, we noted that bank failures are not an important economic indicator.  Many blogs enjoy reporting a few more failures each week, adding to the impression that this is significant.  There has also been news that regional banks may need to add capital.  Maybe so, but it is not the crucial point.

As Tom Brown wrote:

In particular, in the latest quarter, the banks’ NCOs came to 3.16% of loans, far short of the 4.16% laid out in the stress case. And as you can further see, chargeoffs under the stress scenario won’t peak for another three quarters, at which point they’ll top 5%.

He produced the following chart.

We remain very interested in when banks will be willing to do more lending!

A Crucial Question for Investors

A common theme among many pundits is to say something like "X was wrong on subject A, so why listen to any future predictions?"  Some of the more aggressive pundits extrapolate.  If an expert was wrong on "A" you should ignore him/her on "B".

That was the dubious logic for missing one of the biggest rallies in history.

A Dose of Reality

The subject really requires a more extensive article (forthcoming), but the stress test issue highlights the main theme.  Every time we cite Tom Brown we get critical comments, since he "missed it," while Meredith Whitney and others "got it right."

Predictions are not so simple.

Those who "called the crash" are not all geniuses.  The others are not all dummies.  Experts use widely varying methods.

The biggest investor mistake is chasing performance, thinking that someone has a hot hand.

We are about to see this play out in many sectors.  The stress test is a good example.

[Full disclosure -- Our accounts hold GS, BAC, and held at various times, regional bank ETF's.]

August Employment 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, culminating in the week of the employment survey.  This is the best direct indicator of new lob losses.  The average was 571K for this month compared to 567K last month.  No improvement.

• We look at the University of Michigan sentiment survey, which we found 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 65.7, about the same as last month's 66.  Normally there is very high correlation between Michigan and the Conference Board.  In the last month the Conference Board estimate improved from 47.4 to 54.1.  We are surprised at the difference between the two surveys.  (There is a good technical reason for not using both in the model -- something called multi-colinearity.  We might consider combining the two surveys).  Meanwhile, there is some "upside risk" in our estimate.

• We us the ISM manufacturing index, which showed dramatic improvement from 48.9 to 52.9  While this is modest expansion in the manufacturing sector, it is quite bullish for the overall economy.  The ISM's research shows that this rating, if annualized, corresponds to a 3.7% increase in GDP.

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.  We are still evaluating possible reasons for this.  One possibility is unusual seasonal factors in July.

This Month's Prediction

Our indicators suggest a net job loss of over 400,000, significantly worse than the Street estimates of about 225K.  Since the 90% confidence interval on the payroll survey (for sampling error alone) is +/- 100K jobs or so, it is unwise to place much emphasis on small differences, but we are outside this range.

While economic indicators have improved, some showing actual GDP growth, all of the results are far below economic potential.  In addition, businesses may be slow to re-hire, waiting for additional confidence of a recovery.  We are many months away from really good news on employment.

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 298K.

TrimTabs also uses real time data.  Their estimates are based upon tax deposits for salaried employees.  They see a net job loss of 335K.

WANTED Technologies, a relatively new entrant in this field, has a model based upon online help-wanted advertising.  This is an innovative and different approach to real-time data.  They see a net job loss of only 190K

Conclusion

Each of the sources we cite is attempting to measure the actual net job change.  A wise stat prof once said, "Suppose God whispered into your ear and told you the TRUTH."

The BLS is attempting to do the same thing, with dramatically different methods.  The BLS result is not TRUTH.  It is a statistical estimate.  Actual TRUTH for a specific month will not be known for many months, when the state employment data are analyzed.  The BLS tries to count all of the jobs in one month, all of the jobs in the next month, and then report the difference.  They do this very well, but it is inherently difficult.  It does not focus direclty on the actual changes, as other methods attempt to do.

Meanwhile, the forecasters will all be graded by how well they predicted the BLS number -- the BLS estimate of TRUTH.

That is the wrong attitude.  The BLS number is just another estimate -- and one which will not be official until all of the revisions are in.  Despite this, the market will trade on the preliminary estimate revealed Friday morning.

Briefly put, everyone is trying to estimate monthly changes in a work force of over 130 million.  The error band is small.  The BLS -- and all of the other sources -- are doing a great job with various differing approaches.

Market participants would like to have more data, faster data, more accurate data.

Trading Conclusion

There is a very wide spread in this month's estimates.  The non-BLS sources were all too bearish last month.

As usual, the best trade is the short side.  If the number is poor, the market sells off.  Meanwhile, if that prediction is wrong, one can depend upon the Bearish Blogging Network to attack the BLS, seasonal adjustments, the Birth/Death adjustment, or anything else to save the bacon of hedge funds shorting before the number.  Since there will be no one to refute these claims (the BLS only responds to media inquiries), the short trade has good risk/reward.

This proved out last month.  The positive number caused a modest pop in stocks.  (We covered our short hedges at a small loss.)  Then the market moved higher.  Two months ago there were rumors of a "fat finger" error, something that makes no sense to anyone who understands the reporting process.

The market continues to place too much emphasis on an estimate that is very difficult to do in real time.