A Dash of Insight

Easy Money

Let us suppose a fantasy world in which we could sit down in a game of chance with a select group of opponents.  The other players had the following characteristics:

• They are drawn randomly from the population.  If you think you are smart, they are less smart.
• They have little education in the relevant subject.  You have an advanced degree, and they either did not take or do not remember Course 101.
• The opponents have no theoretical or conceptual model -- and probably do not understand what that means.
• The opponents are willing to make big bets on their opinions.

Please keep the scenario in mind.

Ritholtz Bets on the Masses

Over at The Big Picture Barry Ritholtz offers the rather astounding suggestion that when all of the experts in a field agree, it is time to take the other side.  Here is a key quote:

As someone who has been skeptical about the artificially low inflation and unemployment rates for quite sometime now, the public's reaction makes a whole lot of sense. If we believe the negative sentiment of the American people, then its likely that Inflation has been much more pervasive than reported by either the top line or the core.  And the same thinking likely applies to the low unemployment rate. If we judge by sentiment, perhaps its not as low as advertised. Ignoring widespread distress in the population is a recipe for major electoral changes.

Does this really make sense?  Should an investor take action based upon public perceptions of economic statistics -- throwing out the opinions of experts?

The Public in Action

To consider the wisdom of betting on the public, let us consider their track record.  We'll have more to say about this in future articles, but for now let us go to a source highlighted by Barry, Michael Shermer.  (We could cite our past articles on the blunders by individual investors, but for today, let us stick with Barry.)

In Shermer's book, Why People Believe Weird Things:  Pseudoscience, Superstition, and Other Confusions of Our Time, the author, the editor of Skeptic, (now on our list of featured readings) writes as follows:

If we are living in the Age of Science, then why do so many pseudo-scientific and non-scientific beliefs abound?...New Age ideas and nonsense of all sorts have penetrated every nook and cranny of both popular and high culture.

He goes on to cite a Gallup poll showing that 52% believe in Astrology, 46% in ESP, 19% in witches, 22% that aliens have landed on earth, 41% that humans and dinosaurs lived simultaneously, 65% belief in Noah's flood, and 67% who have had a psychic experience.  42% think they communicate with the dead.

Shall we bet with the public?

Real Life Applications

One application we know about is the world of tournament bridge, where those who have a sound theory and understand odds routinely beat those who do not.  We suppose this is the same in mind sports like chess.

Another application is poker, where the popular conception loses to the expert on a daily basis.  The expert welcomes those with little background or knowledge.

In other casino games, they send a limo for those with a "system."

Is economics different?

What about the Economy?  And the stock market?

How should we interpret economic data?  Shermer has a useful suggestion:

Science is progressive because its paradigms depend upon the cumulative knowledge gained through experimentation, corroboration, and falsification.  

The key point is that real scientists reveal their theories and data, inviting the criticism and tests of others.  Anyone not offering findings for peer review and analysis is suspect.

The pseudo-science of those criticizing economic data relies on sources that have no peer review.  It is something to think about.

Our Take

There are several easy ways of pandering to public perceptions about the economy, government actions, and stocks.

• Those who have no real economic credentials gain from disparaging those who do.

• Those who have never actually developed econometric models -- or any models -- gain from acting as if these models have no value.

• Those who have no government experience gain from simplistic interpretations (That is a model!).

• Those who start with a world view, and then criticize any inconsistent data, can find support for that perception.

The stock market offers the chance for those who can identify the real experts to make easy money.  Most often, this happens when sentiment is at a bullish or bearish extreme, not supported by reality.

One of our missions is to identify such points.  For now, there is a key question:

When experts and the general public disagree, how do you vote -- with your money?

Send the limo.  (More later -- a lot more.)

(Regular readers will note our current model-based bearish stance.  We write both about fundamentals and current prospects.  Often the sentiment diverges from our sense of opportunity. Our trading reflects the differing time frames).

When the Blogosphere Works -- and When it Doesn't

At "A Dash" we have an ongoing interest in how consumers--especially investors-- can get useful information from the Internet.  It is one of the chapters in our book, where will consider in detail the various Internet sources.  It is important to understand what one can and cannot learn from the Wild West Blogosphere.

Background

Abnormal Returns, one of our long-standing featured sites, helps investors learn what they should be reading.  It takes a lot of work to read and consider scores of different offerings, selecting a few to include in the daily list of readings.  The comments helpfully suggest the nature of the content.  We look for this guidance every day, and so should you.

We think of our "Abnormal Friend" as an editor who considers whatever we present.  While "A Dash" is not a traffic-driven business, we are always interested in the "editor's" reaction to our work, and we appreciate getting some new readers.  Without readers and their comments, our job would be more difficult.

On occasion, the author of Abnormal Returns, an investment professional with impressive credentials, steps out of his normal role and becomes an author.  This is almost always interesting.

The Issue

In a stimulating and provocative article, Abnormal Returns points out the advantage of the blogosphere over mainstream media.  The article cites another of our featured sources, Adam Warner, as follows:

Do you remember the incident last month when a noted writer went off on the editor of one the most successful sports blogs? Adam Warner at the Daily Options Report has a nice post on the topic of how the blogosphere helps sort through competing claims. It is not always a pretty process. A site like ours helps play a small role in this by pointing out the current schools of thought. We like how Adam concludes:

To me, it’s ultimately a meritocracy, albeit an imperfect one. There are some great blogs that get lousy readership and some lousy ones that top the charts. But by and large, it sorts itself out…

This is a strong argument, one well worth our attention.

A Problem?
As we would expect, it does not always work so smoothly.  As so often happens, considering extreme cases helps to highlight the key variables.  Let us consider one of the finest hours for the Internet in action.

They call it "Rathergate."  Too bad.  This was a sad end to a distinguished career.  To summarize briefly (full story here)  in the 2004 Presidential election campaign there was a big issue about George W. Bush's military service. CBS ran with a story about the President's military service, using documents from his commander, then deceased.

Within hours, significant challenges to the story appeared on the Internet in blogs and forums.  Several sources noted discrepancies that called into question the authenticity of the documents.

Key Criteria

The challenge to CBS worked for several reasons:

• There was widespread interest.  This was important news, about an important issue.
• The key question played to the strength of the Internet -- there were relevant experts out there, and this was a good way to reach them.
• The evidence was clear and easy to understand.  The interpretation of various typefaces and other evidence did not require any special training.  The average reader could see, understand, and reach a conclusion.
• CBS could not "stonewall."  Other media sources understood and took up the case.

How Does this work in the Investment Blogosphere?

Simply put, it does not.  Let us suppose that a big-time pundit (think CBS) puts forth an outrageous claim that can be proved to be incorrect.  Of the many thousands reading the claim, a few note the error.  Let us go back to the key criteria.

• There is no widespread interest.  Readers are uninterested in disputes, (he said this, he said that, blah blah).  Unless the specific question is large, it becomes a death by a thousand cuts.  Many distortions build a false picture.
• There are relevant experts, but their incentive to challenge CBS is lacking.  Most of those writing on the Internet are driven by traffic.  It is not wise to "step on Superman's cape" so most experts will not do so.
• The evidence may not be obvious to the lay observer.  It is there, and quite understandable, but it requires a few minutes of reading.  This gets beyond the hurdle for most readers.  It is not the graphic "set shot" of the Rathergate memos.
• Superman can stonewall.  He needs only to act "put upon."  There is no incentive for anyone to challenge him.  In fact, the incentives are the opposite.  Suppose you are writing a relatively new blog for a MSM outlet.  Your success and your job are related to traffic.  Would you rather get some friendly recommendations from Superman or get into his Hall of Shame?

Conclusion

Abnormal Returns has raised on important and provocative question.  We suspect that he might eventually be correct.  It will require something far beyond his normal role.  The gatekeepers will need to be more like movie reviewer par excellence Roger Ebert, willing to criticize and review information instead of merely linking.  For the moment, the blogosphere does not have the self-correcting mechanisms that are needed.

Here is a simple test.  If the New York Times ran a story that had an error -- one that could be proven -- there would be a correction.

Do we see such corrections in investment blogs?

The Unemployment Severity Index

The BLS collects and publishes a massive data collection.  No single researcher can appreciate all of it, but there is something there for nearly everyone.

There is a problem that can come from too much data.  Journalists must make choices about what to report.  How does one determine the real story?

Background:  Measures of Unemployment

Last week we applauded the effort of Barry Ritholtz at The Big Picture, one of our featured sources, to broaden media coverage of unemployment data.  Barry sought to give a lot of publicity to the broadest possible measure of unemployment, a rate much higher than U3, the traditional measure.

We agreed in concept, and proposed that he add his strong voice in proposing that the media also report the BLS measure of those unemployed for more than fifteen weeks.  This measure, while lower in absolute terms, has (like the other measures) moved higher during the current economic weakness.

We were disappointed that Barry did not embrace this proposal. He clarified his position in comments on our post, suggesting as follows:

Does U1 help reach that goal? I guess it does -- if you believe that the U3 measure of employment is OVERSTATING unemployment (which I don't).

To begin with, we realize that the distinctions involved make the eyes of the average reader glaze over.  That makes our task more difficult.  It also makes the reward greater for the (very) few readers who grasp the entire issue.

So we should all understand that Barry uses his own conception of the state of national unemployment as a starting point, and then wants the media to choose a measure which conforms.  He is concerned that the media reports have not grasped the full extent of current economic distress.

We wonder?  Really?  If anything, the general public and the media have overplayed economic problems for several years.  The percentage of the public perceiving negative economic conditions or recession has significantly exceeded the ratio of professional economists.  The bad economy story is "man bites dog."

At "A Dash" we recommend something quite different:  Use data to form your conclusions.  Be willing to change your opinions as you get new data.  It is an old-fashioned idea, but it works.

(We are also disappointed that he did not respond in his comment to our point that he had made a flat-out mistake in asserting that the BLS had changed the definition of the U3 series.)

A Fresh Approach to the Unemployment Question

We were delighted to hear from an old friend and colleague, Marty Finkler.  Marty has the highest and purest of motives -- teaching young people what they really need to know, without bias or preconceived conclusions.  We listen to him carefully, and so should you.

Marty wrote to comment on our unemployment rate article.  First, he agreed with the idea of informing the public about the wide range of measures.  He also highlighted an approach, unemployment severity, which he attributes to a decades-old book by Charles Baird.  (Readers please inform us about good citations.  We know that the ECRI considers unemployment severity).

The unemployment severity index is calculated as follows:

One takes the standard U3 measure of unemployment, multiplies by the mean duration of unemployment (in weeks) and multiplies by 5 to convert to days.  The result is the average number of days someone in the labor force is unemployed during a given year.  Marty's chart, based upon BLS data, is shown below.

One can readily see that by this measure, the unemployment severity is not at an unusually high level.  While it reflects the economic weakness shown by other data, it is nothing like the peaks from prior times of economic distress.

Conclusion

We thank Marty for his observations.  He has shared some other ideas, so readers can look forward to more information from a great source.

Secondarily, but more important to some, is the idea that one can profit from understanding data.  If many are engaged in making things seem worse than they really are ---the conclusion is easy.

Opportunities abound.

A Lesson from Dad

The "Dad" I am talking about is Bill Miller.  No, not the one you already know, although we admire the Legg Mason fund manager.  I lost my Bill Miller last year, but the lessons are still there.  Some of them are quite relevant for investors.  (We did a little father/son bonding at Chez Dash this weekend.  Missions accomplished with only one circuit breaker kicked and a couple of buckets of water.  Dad was smiling.)

A Famous Miller Family Story

Here is a signature moment from the young Bill Miller.  I am quoting the key elements, but the tale is told in more detail in this article, Respect versus Arrogance.

The passing of my father, William H. Miller, last week, and some hours of thought on the road have sparked some introspection.  What we try to do at "A Dash" bears his mark.  In a way, that is strange.  Dad went to war instead of to college.  Growing up in the Detroit area, he understood engines.  The principles are simple:  Fuel, Oxygen, Ignition.  It is amazing how people can get this wrong.

As a sailor on his first ship he found himself in an interesting situation.  The engines had been overhauled, but would not start.  Experienced machinists could not figure out the problem.  Officers were hovering and complaining.  The young sailor asked if he could try something.  There was a lot of skepticism, but he was given his chance.  He knew that the fuel and air were OK, so he removed the spark plug and tapped it on the deck, narrowing the gap.  When the plug was replaced, the engines started!

If you could see a picture of the young sailor, cap tilted at a jaunty angle, you might guess the mixed reaction.  The officers were delighted at a problem solved.  Those in charge of the engines were less enthusiastic.

This story was repeated many times over in his Navy career.  While he never got all of the promotions he deserved, he was a fixture on the boats deployed by his Captains.

No Substitute for Knowledge

A crucial lesson from this is that there is no substitute for actual knowledge about a subject.  It does not matter what your rank is.  It does not matter how many years you have served.  It does not matter how many other people call you "Sir."

If you do not have the knowledge, you cannot make the engine start.

The Investment World

There is an interesting difference between social science and engines.  When a theory about an engine is incorrect, the results show up right away.  When a theory about social science is incorrect, the idea may persist for many months -- even years.

This makes it much more difficult for the consumer of information. How do you know when the engine is not going to start?

Here are some red flags.

Misuse of the word "rigor."  A long causal chain with a lot of unsupported assumptions may seem powerful, but it does not meet the definition of rigorous.  A strong argument begins with an assumption that everyone would share, and then provides evidence at each point.  The longer the chain, the more evidence that is needed.  Whenever someone makes a big argument about "rigor", make sure that he has some credentials for each step in the chain.  Big hint:  Rigor usually means peer review.  Those with thin skins about criticism of their work are usually not rigorous.

Selection Bias.  This happens when one starts with a pre-conceived notion of the world and distorts evidence to fit the conclusion.  It is a characteristic of many of the leading investment blogs.  Ironically, many of the same bloggers talk frequently about behavioral economics and the dangers.

The "Slick" Factor.  Many of the top-ranking pundits are there because -- well -- because they are top ranking pundits.  They are cited as "friend/buddy/pals" of someone, or called "doctor" or "professor" to amplify credentials.  Most of them are good with sound bites on TV.  None of them could actually start the engine.  Most of these guys have never created a quantitative model, and would have no idea how to begin.  They do not know SPSS from American Idol.  Their charts come from others -- those with a world view they want to sell.  Many become famous by making a prediction that works--eventually.  There is no real accounting of the investment impacts.

The "Big Money" Managers. Statements from the "big-time" fund managers carry a special warning.  Does it really need to be stated that these people always have an agenda?  If a manager has a fiduciary responsibility to clients and a fund, and then gets a spot on TV, what do you expect him to say?  It would be irresponsible and deceptive to talk against his own book.

Conclusion:  Strong Voices are Leading You Astray

Here is Bill Miller's lesson, some great principles applied to investing.

• Don't take some long-winded analysis to be "rigorous."  Check whether the author has the relevant expertise -- research methods, economics, government, etc.
• Check your sources.  It is pretty easy.  If your favorite source dishes up a constant stream of one-sided commentary, you should already know the answer.  You can enjoy reading your source for entertainment, but not for investing.
• Look beyond the "talkers" and check the actual predictions.
• Do not conclude that someone in a uniform with braids really knows how to start the engine.

And finally,  realize that everyone is an expert on something.  Learn to listen instead of pretending that you already have all of the answers.  Be willing to challenge, but do not be arrogant.

Thanks, Dad.

Understanding Unemployment Rates

At "A Dash" we are advocates of a careful, balanced consideration of economic data.  We accept the results whether they are hopeful or dismal.  We do not shift our chosen indicators with the wind.  Investors should do the same.

Barry Ritholtz at The Big Picture, one of our featured sites, has made a useful suggestion concerning balanced reporting on unemployment.  While we agree with his general point, there is a bit more to the story.  Barry's opinions are quite important.  The impact of financial blogs has increased, and he has the strongest voice, including his most recent accomplishment, the Gold Medal from an investment publication--nice going, Barry.

The Ritholtz Proposal

In his widely-read article Barry proposes that the financial media focuses too much on a single measure of unemployment, what the BLS calls U-3.  He recommends that the media should also report the broadest measure, U-6, which also captures workers who involuntarily accept part-time employment.

With due modesty, Barry notes that many believe he has influenced the reporting of data in the financial press, and might do so again.  We strongly agree with his conclusion.  We think that the press could do a much better job of showing the nuances of unemployment, and that his voice is a strong one.  The lead paragraphs often do not capture the full  story.

A Point of Disagreement

Barry believes that the definition of U-3 has changed over time to paint a more favorable picture of unemployment.  He writes as follows:

U3 is the "official unemployment rate" according to the BLS website. Due to this, it is the current measure of Unemployment that gets focused upon by most media, and therefore the public. It has, over the years, slowly excluded many of the factors that USED to go into how the US reported unemployment. Hence, there has been a gradual decrease in the Unemployment rate that has occurred regardless of what was happening in the Jobs market.
U3 is now comprised in a way that merely repeating it without a slew of caveats borders on fraud.

We disagree with this conclusion.  If one goes to the source he cites, and actually reads the article, one sees something quite different.  The authors write as follows:

The official measure has withstood the test of time largely because of its objectivity.  As measured via the CPS, the employment status of individuals is determined solely by their work-related and job-search activities during a specific reference week.  In essence, persons who did no work, but who searched for a job (sometime in the 4 weeks prior to the survey) and were currently available to take one had it been offered, are classified as unemployed.  Those who met neither test are "not in the labor force."

The inherent objectivity of the official measure also explains, in part, why it and other statistics are occasionally subject to criticism.  Without question, the consequences of unemployment are more serious for some workers than for others, and some users would like to have a more narrowly targeted measure.  At the other end of the spectrum, there are those who feel that the official statistics understate the full dimensions of the unemployment problem. 

The BLS has provided a range of different measures, beginning in the 70's but has not changed the definition of U-3.  The assertion that this series compares "apples and oranges" is simply incorrect.

Our Own Suggestion

Please consider the table Barry cites, with a small addition from us.

We wish to augment Barry's proposal.  We suggest that the media also report the narrowest measure of unemployment, U-1.  We have circled these values in blue on the table.  Barry's circles are in red.  The U-1 measure has also moved negatively in the last year, rising from 1.5% to 1.8% during the last year.  This is a 20% increase in longer-term unemployment, consistent with a slower rate of economic growth.  It shows an important increase in long-term unemployment.  Having said this, the overall rate of serious unemployment is much lower than the other measures.  Why?

The narrow measure is important because of the concept of frictional employment.  There are always people who are changing jobs because of personal choices, one partner in a marriage moving, or economic dislocation.  At a time of economic change, one would expect frictional employment to be higher.

The narrow measure shows those who remain unemployed for fifteen weeks or longer.  It captures important information about the severity of economic effects versus normal frictional changes.

For these reasons, we hope that Barry will also use his strong voice to advocate that media sources should cite this number, as well as the broadest possible measure.

A Related Matter

Earlier this month we proposed a reader contest related to The Big Picture, where we (somewhat whimsically) offered a reader prize for "an article on The Big Picture where Barry analyzed the data and suggested that the results were more positive for the market or the economy than the official report suggested." 

To our surprise, Barry himself then wrote such an article and claimed the prize!  Our Rules Committee has been sanctioned for poor drafting of the conditions!  Meanwhile, our Prize Committee has determined that Barry won it under the terms stated.  We have selected a nice prize from his "wish list" but wish to describe the Committee debate more fully in a future article.  More later and prize to Barry will be forthcoming.

Measuring Inflation? You try setting the rules!

At " A Dash" we are continually amazed at the difficulty in stimulating anyone to reconsider existing opinions.  This seems especially true on the subject of measuring inflation.  There are plenty of self-proclaimed experts.  Taking a step away often helps us shake off biases and get a fresh look at the problem.

Here is a little test.  Try to give an honest answers to each question below.  We shall suggest the relevance in the conclusion.

Measuring Inflation and Related Concepts

Here are a few interesting situations related to inflation measurement concepts.  Please take a moment to make an actual answer to each question.  Doing so will make the experience much more valuable.

1. A company comes out with a new package size for a product.  The size is 50% larger and the price goes up by 25%.  Should we view the price of the product as lower, unchanged, or higher?
2. The price of homes is going up, but interest rates are moving lower.  One person sells an existing home and buys another.  Both homes increased by 20% in price during the prior year.  The second person remains in the same home with the same mortgage, living next door to a place that went up by 20%.  The third person, who also lives next door, refinances his mortgage to pay off the loan much more quickly with the same monthly payment.  Two of the three people are paying no more for their housing, although the home price went higher.  One is paying of the mortgage faster.  How would you measure the increase in home prices, given the decrease in payments?
3. You are told that a group of 24 other countries has adopted some rules about private accounting.  (Forget things like FAS 157 and marking to market -- those are out!  International accounting does not follow these rules.)  Do you think that this is a good argument for U.S. accounting to follow suit?  What if the other countries had different rules about free speech?  About voting?  About religion and education?  Briefly put, does the fact that a group of other countries does something mean that the U.S. should also, without regard to the actual values and merits?
4. Let us suppose that the price of a car in year X is $15,000.  A few years later the car has the following improvements:
   • Anti-lock brakes -- improving safety.
   • Side bars to protect in side collisions.
   • Air bags to protect in frontal collisions.
   • Fuel injection and computerized sensors to improve fuel economy.
   • Stronger and safer tires.
   • A life expectancy of 150,000 miles instead of 50,000 for the earlier car.
   • Better cup holders, including both warming and cooling.
   • If the car still sold for $15,000, would you say that the actual price had decreased or remained the same?
5. You are trying to measure recreation costs for a typical Chicago family that likes sports.  The Bulls use their #1 draft pick to choose the next Michael Jordan.  To help with costs, they raise ticket and concession prices by 30%.  You give up your Bulls tickets and instead buy more tickets to the Bears, marked down after failing to get a Quarterback in the draft and releasing their top running back. You spend the same amount of money to watch football instead of basketball.  Has there been an increase in the price of recreation?

A Second Look at the Bill Gross Argument

If you gave honest answers to the questions above, you are now qualified to read (again?) the Bill Gross commentary that got so much buzz.  We suspect that few read it carefully the first time, and fewer still read it with a critical eye.

See if the conclusions have the same black-and-white quality that they did when cited in the media.  We shall continue this series with our own analysis.  In particular, we shall review how actual economists (as opposed to non-economist pundits and fund managers) look at these problems.

Inflation measurement is central to many current economic and market questions.  As we have noted, it is important to use unbiased and authoritative sources.

Government Conspiracies and Your Money

At "A Dash" we are amazed almost daily by the haughty and high-handed disrespect from Wall Street when it comes to the everyday workings of government.  So many powerful voices are so confident, and simultaneously so wrong.  This is typical when an expert switches subjects from something he really knows about-- stocks, trading, technical analysis, etc.-- to something he knows nothing about.

CNBC stimulates this with their "guest hosts" who are encouraged to offer an opinion on whatever topic comes up that hour.  Of course, some of their journalists are already participating in that way.  Looking to the frequently-cited wise men, Jonathan Berr runs down a short list, but there are many more good candidates.

When we see the errors, it is a "kid in a candy store" feeling.  Start with a bunch of traders, fund managers, and lawyers.  None has ever developed a quantitative model, and many cannot construct or interpret simple tables or regressions with statistical controls.  They have not taken (or do not remember) the beginning classes in government, economics, statistics, or research methods.

These pseudo-experts cite actual data, developed with great care by the strongest experts, as "a work of fiction."  As if they knew the difference!  Why?  Two reasons.

First, they do not like the result they see.  It does not agree with their own daily experience.  They confuse their own compartmentalized view of the world with reality.  It is also a message they can sell to their audience, often a niche group who share their world view.

Second, diminishing the real experts increases the influence of the pretenders.  If these powerful voices can convince most to ignore data, then anecdotal evidence rules.  It is an alternate data universe.

And the pseudo-expert is also the master of the anecdote.

The most prominent media voices support them.  Why?  It is a good story.   There are very few who choose to educate readers rather than to play to their existing biases.  It is a good business model.  Readers can understand anecdotes, but not statistical methods.

There is a symbiotic relationship between media and the pseudo-expert community.

Conspiracy Theory

Taken to the extreme, the pseudo-expert actually suggests that "government" is acting in a conspiratorial fashion.  It is pretty easy to recognize such superficial analysis.  It is the work of people who have seen too many movies and read too few books.

The biggest red flag?  Look for those who discuss the U.S. "government" as if it were a  unitary actor.  This is seen only in a ruthless dictatorship with a small inner circle.  Those who conclude, for example, that the President is "cooking the books" on inflation or employment data make this mistake.  They do not understand that the actual work is being done by a non-partisan senior executive service.  (Those interested in how government decisions are actually made should consult our summary article.)

A Failed Conspiracy

Actually, conspiratorial moves are rare and for good reason.  Even closely held secrets, like the original Watergate plan, have a way of leaking out.  The recent suppression of the global warming report provides a nice example.  Menzie Chinn at Econbrowser, one of our featured sites, discusses the report that the Bush Administration thought was too dangerous to release, now available after four years.

This Washington Post article shows what happens when the echelon of political appointees tries to tamper with the work of those who serve government regardless of the party in power.

This is an important example to remember the next time someone is selling a conspiracy theory that you should not be buying.

Investment Effect

One of the strongest things an investor can do is to discover information that is poorly understood or appreciated by everyone else.  It is especially ironic that the commonplace viewpoint is offered as "contrarian" by those taking it!

Briefly put, one can gain an investment advantage simply by identifying and believing information from the real experts on various economic topics.  How simple!

Where to start?  Here's a hint.  The "government" as represented by the diverse Congressional and bureaucratic interests has no unified position about the measurement of inflation.  Many members of Congress, for example, would like to increase Social Security benefits and labor cost-of-living increases.  They would be happy to see inflation measurements that would aid these constituent groups. The BLS employees have tenure and are not subject to political pressure.

Meanwhile.....

Big-name fund managers like Bill Gross have a strong financial interest in public perception of inflation and the economy.  Like any smart manager, he talks his book.  Should you be listening?

More later on Bill Gross versus the BLS, now in its fifth year, but still playing on a blog or TV station near you.

Reviewing the Media Pundits: Two Views of the Fed

One of our themes at "A Dash" is the array of challenges to the individual investor.  Interpreting market commentary is one of the most important.  While our readers understand the blogosphere, the influential print media remain far more important.

The MSM articles do not have any comments, so readers are on their own to spot any problems.  To illustrate this, we will contrast today's article by New York Times columnist Gretchen Morgenson with a recent piece by Bloomberg's John M. Berry.

Morgenson on "Trash for Treasuries"

Regional printing has made it possible for people all over the country to enjoy a hard copy of the New York Times with morning coffee.  Our Thursday and Friday editions (during our West coast trip) were printed in Seattle, and today's, delivered at our door, was printed in Chicago.  Many individual investors look to their business coverage.

One of our favorite sources is Pulitzer Prize-winning columnist Gretchen Morgenson.  Her perspective is clear from her background -- history, English, journalism, and a record with publications that make difficult topics clear for average investors.  On most occasions, she does this very well.

Her column today includes all of the hallmarks of good journalism.  She has plenty of sources -- a mortgage guy saying that the Fed is accepting questionable collateral, quotes from Fed officials on the dubious nature of securities ratings, and a pithy quote from the sassy and colorful Joan McCullough calling the Fed a "monetary bordello."  There is a source for every statement.  Every technical point of journalism is covered.

Her conclusion?  The Fed is risking taxpayer money on dubious securities and we might all be left holding the tab.

Her opinion?  "To be sure, crisis times call for creative measures. But as long as Wall Street is allowed to swap trash for Treasuries on the taxpayers’ dime, don’t try to tell me this horror show is over."

Our Analysis

We are disappointed that Morgenson missed the point so badly.  She has written an article where every piece of it is accurate, yet the conclusion is deceptive.

It is not the mission of the Fed to engage in policies with profit in mind, although the net effect of Fed actions does provide "profits" to the taxpayer each year.

The Fed mission is to address the twin goals of economic growth and price stability, while assuring stability in financial markets.

By writing a column that focuses completely on the risk to the taxpayer, without due attention to the Fed mission, she misleads her readers -- mostly average investors.  The colorful language about "trash" emphasizes this viewpoint.

An Alternative View from Berry

John M. Berry has long been recognized as an authority on the Fed, often with an inside glimpse of official thinking.

In a recent article, he makes several important points.  First, the nature of the Fed actions:

The Federal Reserve is supplying the financial system with more than $150 billion in cash, a liquidity cushion that has helped keep enough credit flowing to ensure the economy's growth.    

After another auction of term funds on May 19, the amount of cash from the Fed will probably top $175 billion. And if the system needs still more, Fed Chairman Ben S. Bernanke said in a May 13 speech, the Fed stands ready to supply it.

What has been the effect?  Berry cites some useful data, as follows:

...(T)he unprecedented amount of cash pumped into the system have helped the economy defy predictions of a recession.    

Recent data suggest the economy grew at about a 1 percent annual rate in the first quarter, slightly more than the 0.6 percent estimate released by the Bureau of Economic Analysis on April 30.    

And on May 13, Macroeconomic Advisers predicted that the tax-rebate checks now being sent to many households would spur consumer spending this quarter, boosting growth to 2.5 percent. Third-quarter growth would exceed 3 percent, the forecast said.

The specific lending effects?  More from Berry:

The Fed had no choice except to supply the liquidity that was no longer available in the market. Otherwise, even credit worthy households and businesses wouldn't have been able to borrow, and a recession would have been inevitable.    

Instead, over the 12 months ended in April, commercial and industrial loans rose 20.9 percent at banks, while home-equity loans climbed 9.9 percent and consumer loans increased 9.3 percent. Even other types of real-estate loans were up 6.7 percent over the period.

Our Take

The New York Times readership differs dramatically from that of Bloomberg.  A reader of Morgenson's piece alone may not understand the rationale for Fed actions, nor the important effects on the credit crunch and economic growth.

One of the biggest challenges for readers of opinion articles is to understand what has been left out.

The real story of the Fed initiatives was avoiding the "death spiral" of forced selling into illiquid markets.  Mainstream media have done a poor job in covering this issue.

It is so much easier to write something that will appeal to the "common man" in a way that emphasizes taxpayer risk.  Even if some loans go bad -- far from clear from the data -- the economic benefits dwarf any potential losses.

Investors who do not understand this are fighting the Fed, something we warned about in December.

             

Scooped by Muckdog

On our blog agenda there is a discussion of the "alternate data universe."

There is a rich and thriving discussion of economic data among economists -- that would be the "real economists".  We are talking about those who are (preferably) in the academic world or working on Wall Street.

There is another discussion.  It occurs mostly in the cottage industry of those making a business of criticizing the official government data.  As we have noted, government is an easy target.  The only representatives who speak in public are the political actors.  The hard-working, non-partisan, intelligent staffers do not have any access to the media.  That makes organizations like the BLS an easy target.  They are not paid to go on CNBC.

Attacking the non-farm payroll report, GDP, or inflation data is an inviting target for the gonzo-economists, the non-economists, and those with a paid-site business model.

We were looking for a way to describe this "alternate universe" and even had the Twilight Zone in mind, but we were scooped by Muckdog.  (Regular readers of "A Dash" sometimes ask why we recommend Muckdog, with whom we have never spoken, when his source seems to lack the official credentials we admire and is also anonymous.  The answer is simple.  We are not advocates of credentialism.  We do hold anonymous sources to higher standards of helpfulness.  We include them among featured sites when there is a real investment payoff.)  Muckdog gets to the point much better than we would:

From Barry Ritholtz:  GDP Alternate Measure. It's the whole conspiracy theory thing about understating inflation and overstating GDP.  Maybe "alternate universe?"  Sure, but those make for good Twilight Zone and Star Trek episodes, no?  And Barry's always a good read.

The Choice for Investors and Traders

It is pretty simple.  One can go into the Twilight Zone where no official report means anything -- there is always something wrong.  The prime source for this, which we will not link to, is a paid site on a mission.  The serious economists do not cite this source.  The bearish non-economists frequently do so.  The mainstream media, with a couple of exceptions, do not travel this path.  It is a trail which requires certain dubious assumptions:

• "Government" is some unitary actor, like the manager of a business, with a mission of punishing certain people -- mostly senior citizens, in an effort to cut costs and balance the budget.
• The Boskin Commission was some sort of conspiracy with this aim in mind.
• Various Administrations and the Fed have joined forces to foster this approach.

In the beginning government classes students learn that we have a pluralistic society.  Many different interests are represented, and quite effectively.  Senior citizens have a special  pull with Congress, since they represent a powerful voting block.

In fact, the Boskin reforms, discussed in a bipartisan Commission, have been reviewed by economists.  If anything, the adjustments to CPI are still inadequate.  CPI remains overstated.  As we have noted, that is what the Fed believes.

Investors have a simple choice.  They can choose to follow the alternate universe, where  everything has gotten  much worse over many years during a time when wealth increased.  This is an ideological choice, not an investment choice.

Alternatively, investors can accept the debate among real economists, those trying to generate accurate data, and those offering real public policy alternatives about economic issues.

Conclusion

Like the many economic sources available on the Internet, we are not going to engage in a debate on specific calculations.  It is too time-consuming  to fight this battle when the alternative universe has this as a single-minded mission.

A trader or investor who wants to profit is well-advised to deal with the data generally accepted in the economic and investment community.  If no one with real credentials chooses to engage in a discussion of the findings, that is meaningful and should be respected.

An Anecdotal Afterthought

Our mission at "A Dash" is helping investors and traders.  We were in some doubt about whether this was an important issue until we had a recent visit from one of our most intelligent and informed investors.  He asserted that some of these issues were "controversial."

We were surprised.  We suggested an analogy of the debate over cold fusion.  This theory, suggesting a potential for vast energy creation, was almost universally disputed by a broad spectrum of scientists.  Nonetheless, it won popular support, some grant money, and some academic followers.  This was a controversy principally among non-scientists.

There is plenty of room for debate over data and findings.  Unless you are yourself an expert, your mission should be in discovering and following the real experts.

That is what we do at "A Dash."

Informational Power: Interpreting the Payroll Employment Report

What is the market impact from the interpretation of data?

It is an open and free debate, but there is a problem.  The results follow from advanced statistical methods and processes.  Even the smartest hedge fund managers, columnists, and pundits cannot draw independent conclusions.  They did not take the right classes.  They never did any time series modeling or survey research.  Briefly put, they lack the necessary skills to evaluate most data.

The result:  Nearly everyone relies upon the analysis of those accepted as experts.  What choice is there?

This is a recognized principle in social science, called the two-step flow of communications.

Application to the Monthly Payroll Employment Report

When do we know that data interpretation has a market impact?  One test might be the widespread citation of a conclusion.

Our "go to guy" for those on the NYSE floor is Art Cashin.  In his daily comment (very valuable and available to UBS customers) he wrote as follows:

Payroll Numbers – Three pros, Dennis Gartman, John Mauldin and Greg Weldon each deconstructed the non-farm payroll data. Their conclusions were that the data was, actually, anything but bullish. Things are not always what they seem at first glance.

So the perception on the floor relies on these influential interpreters of data.  What are their sources?

John Mauldin

John Mauldin does a number on the number!  Even though this is an extended excerpt, readers need to check out the entire analysis.

Without that addition from the birth/death number, total private employment would have dropped by 296,000. Now, if that had been the headline number, the market would have tanked. Now, I have no doubt that the economy did create a lot of new jobs last month. But when the final revisions are in, we will see that job losses were well south of 100,000. If memory serves me correctly, the BLS had to add about 800,000 jobs that they missed during the recovery in 2003-4. (The birth/death model misses job growth during recoveries, the opposite result of the miss in slowing periods.) They did this just last year, in a major revision of the data. We will see the same type of revisions in 2010, only this time it will be downward.

And even the BLS says that the birth/death numbers have little statistical meaning. The following is from their own website (courtesy of Dennis Gartman) [emphasis obviously mine]:

“Birth/death factors are a component of the not seasonally adjusted estimate and therefore are not directly comparable to the seasonally adjusted monthly changes. Instead, the birth/death factor should be assessed in the context of its effect on the not seasonally adjusted estimate... The components are not seasonally adjusted separately because they do not have particular economic meaning in and of themselves.”

Mauldin also cites Gartman and The Liscio Report.

Barry Ritholtz

Barry Ritholtz did his regular review of the employment numbers, with, as usual, a special focus on the birth/death adjustment.  The overall conclusion is that employment growth is overstated and the BLS methods are seriously flawed.

He also quotes at length from Alan Abelson, doing his monthly bearish take on the BLS report.

David Merkel

David Merkel undertakes his typical thoughtful analysis of the problem, well worth reading in the entirety.  David looks at the addition of jobs from the B/D adjustment and compares these to the net job change over time.  He graciously notes our dissent on some of the key issues.

Importance

The significance of these analyses is demonstrated by Art Cashin's citation.  The notion that the BLS methodology is wrong has become accepted as conventional wisdom.  Nearly everyone thinks that these are "phantom jobs", added by a flawed methodology, and that "turning points" in  the market are missed.

It is not part of the job description for BLS employees to write on blogs or to appear on CNBC.  As a result, there is no spokesman for their method.  It is a one-sided debate.

All of the sources cited in this article have significant power.  Their arguments have influenced active traders to believe that economic data have been artificially inflated.

Our Approach

After many months of attempting to refute specific claims about the BLS approach, we have decided to take a different tack.  More to come....