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.

Dumb Comments on Energy Prices and Manipulation

There are so many silly assertions and so little time!

One of our missions at "A Dash" is to identify strong sources of information and analysis.  Even the most intelligent reader needs some expertise to make the key distinctions.  Let us consider some examples.

Oil Demand and Price

The Statement:  One of the CNBC talking heads repeatedly stated that oil prices fell by 80% but demand did not drop that much.  To her, this was evidence of an inaccurate market.  None of the many CNBC panelists contradicted her.

The Reality:  Introductory Econ classes start with how markets clear, showing a supply function (a curve) and a demand function (also a curve).  The markets clear at the intersection of the two curves.  A lecture or two later there is a discussion of elasticity -- how much demand (or supply) changes with a unit change in price.  There are examples of inelastic demand (insulin is a favorite) and more responsive demand.

The Conclusion:  It is not proportional or linear.  It is another case of pop economics intuition leading one astray.  Let us suppose that the oil market is near a tipping point.  A demand curve intersecting slightly above the production capacity leads to a price spike.  At a slightly lower point, producers may still want to generate some revenue.  It is all about the shape of the supply and demand curves.

Oil and Stock Correlation

The Statement:  An expert says that stocks are trading based upon oil.  There is a chart showing a correspondence between stock prices and energy prices.

The Reality:  The relationship between energy prices and stock prices is situationally dependent.  In general, high energy prices are a tax on the consumer.  There is no reason for higher oil prices to cause higher stock prices.

The Conclusion:  This is a classic case of a spurious relationship.  This is a technical statistics term meaning that Factor A (in this case perceptions about the economy) is driving the behavior of both Factors B and C.  The apparent relationship is not causal.  In addition, this would make sense only if stock traders thought that energy prices were a more accurate read of the economic prospects.

Rogue Trading and Energy Manipulation

The Statement:  There are some rogue energy traders who made drunken or mistaken trades.  These needed to be unwound.  This shows manipulation of the energy markets.

The Reality:  Mistakes are discovered and corrected.  It is not manipulation.

The Conclusion:  It has no lasting impact on prices, despite the media hype.

Speculation drives Energy Prices

The Statement:  Speculators have exacerbated price swings in energy.  Some government officials in several countries want to hold hearings and consider legislation to curb speculation.

The Reality:  Speculators are trying to make profits.  They add liquidity to the market, acting based upon many sources of information about all conditions.  Think "The Wisdom of Crowds."

The Conclusion:  There is very good evidence on this point, from some excellent sources.  Astute economist James Hamilton took a close look at this when energy prices spiked, and wrote as follows:

I personally do accept the view that the "paper oil" speculation has made a contribution in recent months to the increase in the price of physical oil. I believe that this speculation has resulted in a slight decrease in the quantity demanded that has required some modest supply reductions or accumulation of inventory by producers. But I expect that producers will find these changes not to be in their best interests as the demand adjustments become more prominent, at which point the price must return to that governed by the underlying physical fundamentals.

Ultimately, the price must be such that the quantity of physical oil demanded at that price is equal to the quantity of physical oil supplied. Any speculator who promises on paper to buy oil for more than the physical stuff is actually selling for will find themselves at that point with a big, fat paper loss.

Here is another take from noted investment advisor Dr. Stephen Leeb:

The real force at work behind last year’s run-up in prices, the subsequent decline and the rebound that has followed is the market’s invisible hand. In other words, good old fashioned supply and demand was the culprit. Unprecedented synchronized global growth between 2005 and early 2008 caused demand to soar, yet producers were unable to meet the call to increase production by anything more than a token amount.

Readers should check out his entire review of the history and his argument.  Government intervention to distort markets is the last thing we need.

Our Overall Take

There is an active market in conspiracies and manipulation.  It makes an ideal media story, whatever the reality.  Commentators also seem to have a bias toward the legitimacy of equity markets and against futures markets, often citing off-hours trading.  Perhaps those of us with more "Chicago" experience better appreciate the depth and liquidity of futures trading.

Those doing "pop economics" have a field day.  It takes careful analysis to sort out the reality.

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.

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.

Popular and Critical Acclaim

Over at The Big Picture Barry Ritholtz has some great suggestions about improving financial television.  We agree with the entire list, but especially like the following:

1. Stop Yelling. Stop interrupting. Stop Talking Over Each Other:  This is not Jerry Springer, its serious business. People’s retirement and investments are at stake. Please treat it that way.

5.  Lose the Octobox. Fire whoever came up with the Decabox.   ‘Nuff said.

6. Separate the Signal from the Noise.  Understand that most of the day-to-day action is simply noise. Look at a long term chart, you can barely see 9187 or 9/11. If those major events get lost in the long term trend, what does the intraday jags, kinks and reversals mean? Very little. Recognize that not every data release, slice of news, or rumor is at all significant. Stop treating them as if they were.

7.  Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

9. Bring Back Louis Rukeyser: Not the man, but rather, his style. Wall $treet Week — Rukeyser hosted it from 1970 to 2005 — was plain-spoken, thoughtful and accessible. Quiet, contemplative, discussions, with intelligent market participants, revealing helpful information. The investing public would appreciate something of that sort — again.

Improvements Unlikely?

There is a reason for the current TV programming:  Ratings!

The experts know what sells.  Everyone on TV is asked to state an aggressive and controversial opinion.  It is entertainment.

Would the current investing world give a high rating to Uncle Lou, no matter what the quality of the program?

Popular versus Critical Acclaim

We recently watched an old film for which a reviewer had noted that it achieved both popular and critical acclaim.

That is certainly great news for a movie, and one can easily see the distinction.  At nearly any time one can find a very popular movie (the "date movie" from back in the day) that has little artistic merit.  At the same time, there is something playing at the local Art Theater that scores high on artistic merit, but does not attract many teenagers.

It is a delight when a film can satisfy both criteria.  It is also a great challenge.

The Investment Audience

Here are a couple of key facts about the audience for investment news:

• Individual investors have dropped out.  (We'll get them back after another 25% or so in the major averages).
• Most readers are obsessed with the negative.  That is how to seem smart at a cocktail party.
• One can measure this with objective indicators, like our Seeking Alpha sentiment indicator.

The reader will note that we are moving beyond financial television, and considering all sorts of information.

The Conclusion?

With newspaper ad revenues disappearing, MSM are all turning to blogs.  Blog revenue is all about hit count.

If times were more prosperous, business managers could afford to think about the actual merits of analysis.  In times of stress, they look for the most popular.

So what happens?  We all know from behavioral finance that investors chase what worked most recently.   Today, that means that all of the doom-and-gloom predictors are geniuses.  Many of those writing and appearing on TV search relentlessly to find the most negative spin on any piece of information.

It is those people who are now featured.  It is not because of editorial bias on the merits.  It is financially driven.  These are the writers who are "popular."

This is what happens editors become pollsters.

Forecasting the Jobs Report

MarketWatch tells us that today's selling was concern about the labor market and the resulting economic contribution of consumers.

We sympathize with journalists who need a daily lead to explain modest market moves.  We are amazed that market participants suddenly started to worry about Friday's jobless report.

"Forecasting" the Employment Report

Here at "A Dash"  we have a good model for payroll employment changes, but it is not really a forecast.  We look at concurrent economic data and ask what change in employment would be consistent with the other indicators.

Other people also make forecasts or predictions.  It is a strange game, because the "truth" does not matter.  Everyone is trying to forecast the BLS version of truth.  Here is how we put it in an explanation from two years ago:

• The Bureau of Labor Statistics (BLS) does not actually measure the change in jobs from month to month!  We know this may seem confusing.  The change in jobs is what everyone talks about, but it is not what the BLS measures.  They try to estimate the total number of jobs, using survey techniques.  They then compare the estimate from one month to the estimate from the next to calculate the change.

The result:  They can be great at estimating the total, and still have a huge error band for the change.  If you want more explanation on this point, we covered it here.

• The original report is revised for two reasons, but not because the government is cooking the books.  The first reason is that many of the businesses in the survey do not send their reports in on time.  What a surprise!  Some businesses NEVER respond.  The BLS does two revisions, based on more complete returns, and then declares the result to be final -- for a time.  The second reason for revision is that the BLS sample for the survey includes only businesses that existed at the start of the year.  The dynamic economy is gaining and losing businesses all of the time.  The BLS eventually takes actual data from state employment offices and compares it to their own count.  They adjust the methodology based upon the actual count, using something called a birth/death model.

We now believe that there is a recent negative pattern in revisions.  We think it is related to the seasonal adjustment methodology, and we invited other researchers to collaborate with us in investigating this premise.

Current "Predictions"

As we noted, our own approach looks at several other economic variables from the same time frame as the survey.  Our model is linked to the final data series.  There is no point in trying to model the first report, which is known to be either biased or less accurate.

Given the continuing weak picture in initial jobless claims, University of Michigan sentiment, and the ISM report, we expect May job losses of over 600K, greater than the consensus.

Most economists do not reveal the basis for their forecasts, but there are some exceptions.

Today's ADP data draw upon proprietary information about actual job changes, an excellent source.  It is completely possible that ADP could do better on job changes than the BLS, if only because that is exactly what they measure.  Since the initial BLS report is the "official" number, that has become the ADP target.  ADP sees job losses of 536,000 in the private sector.

Wanted Technologies forecasts a job loss of 565,000.  Their method is a proprietary regression model including online advertising for jobs and prior BLS data.  Their methodology is careful and accurate.  Like the rest of us, they are looking at the final revised data.  Interestingly, they show that their "forecasts" are more accurate in calling the final revision than the BLS does itself from initial data.

Good idea.  We should test that on our own results!

Our Take

It is interesting that our approach and those using different methods are so close in the predictions.  Our own estimates have been too bearish, but later revisions have shown us to be very accurate.  And remember, the sampling error alone is more than 100K jobs.

Whatever the exact number, we are a long way from significant improvement in employment.  We expect the old, big-firm employers to add workers only slowly.  While there is vibrant job creation, misunderstood by most, it is fighting a losing battle with job losses.

Problems with Housing Data

US equities responded favorably to morning news about pending home sales.  The data showed a third consecutive month of gains, actually up 6.7% over the prior month.  Some pundits favor the year-over-year comparison, which was up 3.2%.  It certainly seems like good news.

Commentators quickly pointed out some problems with the data ---- the sample size is small and sampling error is large.  Pending sales do not always translate into actual sales.  It is only one month.  Etc.

The Sad Truth about Housing Data

Housing is at the epicenter of the financial crisis.  Home values affect wealth, personal consumption, and the need for further write downs in "legacy" (formerly known as toxic) assets.  We would love to have good data about housing.

Forget it.  Nearly all of the housing series are flawed with significant discontinuities or conceptual problems.  No matter what the data report, there will be plenty of opportunity for pundits to dispute the results for the next year or so.

Here are some of the problems:

• Pent-up supply, and pent-up demand.  Most pundits claim that there are many homes ready to hit the market as soon as things improve a bit.  We believe that there are also many latent buyers, waiting for the right combination of loan availability and price.  Neither of these assertions has any hard data.
• Foreclosures.  The principal media and blog observations show the percentage increase in foreclosures.  This is an alarming increase from a small base.  Interpreting this series is guesswork.  There was a moratorium on foreclosures as the Obama proposals worked through the legislative process.  That gave a false sense that foreclosures were lower.  Since non-foreclosure sales are generally at higher prices, it made prices seem higher.  Now that the moratorium has ended, we are seeing the opposite -- more foreclosures and lower prices.  Those looking at the data series will be deceived by both effects.
• Tax credit effects.  New buyers have until the end of November to collect a tax credit of $8000.  It is reasonable to expect any first-time buyer considering a home purchase to act in the next few months.  This may draw forward demand, leading to a reduction in purchasers after the credit expires.
• Financing effects.  There is a sense that mortgage rates have bottomed, and moved higher.  This may stimulate some to act more quickly.  The increase in pending sales was quite dramatic in some regions -- over 30% in the Northeast.

Our Take

Like everyone, we watch housing data closely.  We also solicit anecdotal evidence from many sources.  We know of first-time buyers, using the credit, who put 5% down via FHA and got the seller to cover closing costs.  It is a great opportunity for qualified young buyers.  There is some Internet mythology that there are no 5% loans.  That is incorrect.

Our major conclusion?  Most of the pundits are too confident in their predictions.  We see so many who expect prices to move much lower, but there is little supporting data.

We continue to look for good indicators on housing, and welcome comments.  Our major observation relates to the calculation of "months of inventory."  This measure takes the known inventory and divides by the annualized rate of sales.

At this point, the rate of sales is so low that even modest increases will dramatically reduce the months of inventory.

Investment Implications of the GM Bankruptcy

The GM news is a big business story, the largest industrial bankruptcy in history.

Is it a big investment story?

We encourage investors to be politically agnostic, to distinguish between interesting political stories and their own investment decisions.  We acknowledge, with thanks, the comments from Abnormal Returns on this distinction, as well as reader emails.

The Business Pitch

Those doing business stories -- television, print media, or online, have an audience.  Their consumers are more affluent, more educated, and more conservative than the average reader.  One result of the current economic downturn is that every media source is playing to the existing audience in a quest for hit count and ratings.

The result is predictable.  Here are the main business themes (sources omitted since there are so many):

• This is a huge government bailout, destined for failure;
• The union is getting a gift, bondholders are getting shortchanged;
• Obama is setting a precedent for future actions;
• The government will be deciding which cars should be built;
• The taxpayer will lose this investment, and perhaps more.

We are not going to disagree with these positions, since that is not our mission.  Each point is hotly contested by Obama supporters.  We shall leave it as that, although regular readers know that we believe in free markets and generally support only government actions that create useful private incentives.

The Investment Implications

The first question is obvious.  Did any skepticism about the expected GM bailout help an investor?  If it caused you to sell short GM stock, the answer is "Yes."  If it caused you to sell short the rest of the market, the answer is "No."

Why the disparity?

The market critics are relying upon a long causal chain, where something bad is going to happen many months in the future, often requiring several different events.

Meanwhile, the immediate impact is that fewer jobs will be lost, auto parts suppliers will stay in business, and the general adverse economic impact will be mitigated.

Thirty billion dollars was viewed as a lot of money at the time of the Bear Stearns buyout.  Here at "A Dash" we think it is still important, despite the massive scale of other government interventions.

Our own time horizon is one year or less.  This viewpoint is widely shared by investors, so it is no use fighting it.  Most people see the immediate economic impacts as positive, despite the pounding criticism from the punditry.

Perhaps it will all play out badly in a year or so.  We will have time to adjust our positions as the story plays out.  If Obama and Barney Frank start dictating the details of auto production, there will be time to react.

Meanwhile, investors must decide whether they want to use their politics as the basis for their investments.