The Birth/Death Model

Posted by Ray on July 10, 2010 under Economy | Be the First to Comment

I just read John Mauldlin’s weekly newsletter and he apparently got into a discussion over the much misunderstood and hated, by myself and many others, birth/death model used by the BLS. I have not been receiving the newsletter on a regular basis, some type of server issue I guess, but someone did not like what he had to say about it and I guess John misspoke about it. The whole thing about the birth/death model is it is meant to be a smoothing mechanism, I know that, everyone knows that, but it stinks and is not accurate which is what John ultimately said it was in his letter or at least it has not been accurate the last few years.

Now, I may have misspoke or led many to misunderstand what the birth/death model is and does. It is this little provision that helps the BLS make up for data they either do not receive back by survey participants or never receive, but it leaves room for interpretation and is never fixed in real time. In fact, they wait until February of the following year to correct any errors in the birth/death model that it may have had on the unemployment rate, fantastic, right? The model is not seasonally adjusted so when the BLS says 83,000 jobs were created it is not as if they added in the 147,000 (June’s B/D adjustment) figure to come up with that figure, that would be lying and a government agency would never do that.

Instead, what they do is add in the not seasonally adjusted B/D figure to the not seasonally adjusted employment figure and THEN seasonally adjust it. Now, you are thinking, big deal that shouldn’t make a big difference. Well, you may be right and you may be wrong. If you are talking 1M as a figure and the B/D adjustment is 50K it is no big deal, but if you are talking about a headline figure of 800K and the B/D adjustment is 147K (June figure) or 241K (May figure) well, you tell me, would that impact the seasonally adjusted figure? I would say yes it would. I have history on my side on this as well.

You see, in the fall of 2008 when Lehman collapsed and the world came to an end we all saw unemployment shoot to the moon, remember? Well, the BLS thought since so many people were losing their jobs and the business environment was so good that must be why so many survey respondents did not get back to them, they were busy making money! So, they added in hundreds of thousands of jobs from September of 2008 until the end of 2009. They were so aggressive in their B/D modeling they underestimated unemployment by 880,000 people, that is a pretty large underestimation by anyone’s standards considering the total ‘official’ unemployment total is 14M people and the underestimate for that time frame was about 10% of the total of the newly unemployed.

One could say, well, that is within the margin of error, but I don’t buy that since the government is the one who processes unemployment benefits and receives the initial claims data. In other words, it is pretty easy to correlate the data within a reasonable time frame, in my mind at least, but I am not a bureaucrat, so what do I know. Basically, if one removes the B/D figures from the non-seasonally figures and seasonally adjusts them you would have a bit of a difference in the monthly numbers. The series would be much more volatile, but it would also, in my mind, be more accurate and real time which seems to be something no one wants anymore with this figure which is why Santelli and Liesman get into screaming matches about it every first Friday of the month.

The bottom line is the adjustments matter, they boost the jobs number every month and they don’t come clean about any adjustments until the next year. That does not help anyone except for politicians and when more and more people are saying employment is now a leading indicator we need a better way to report unemployment. At the very least the BLS can correlate with the state data bases along with the household survey and that might give us a better view of what is going on. I think it is pretty much a proven fact that when we have the government guessing at any figure it is pretty much going to be wrong so why anyone would defend the B/D model is beyond me. The idea is fine, I guess, but how the BLS does it and how no one questions it, especially when it creeps up month after month when it really shouldn’t be, is very odd as, again, the only people who truly benefit from it is the political class.

I was wrong on the employment report, but right

Posted by Ray on July 5, 2010 under Economy, Markets | Be the First to Comment

I was wrong on the numbers on the employment report, kind of, take out the temporary hires and birth/death adjustments and I was very much right. Contrary to popular belief, the birth/death adjustments do matter as those adjustments are responsible for underestimating unemployment by 880,000 people last year and, in my opinion, that rate is probably way underestimated at that. Even Dave Rosenberg lambasted the birth/death adjustment as “fantasy” which means I am not alone in my thinking. Regardless, that employment report was clearly not priced into the market and was very bad news.

We had wages drop and the work week shrink which is very deflationary to say the least. I also believe that the full impact of the Gulf oil leak has not made the rolls either yet which means more bad news ahead. There is also the ban on offshore drilling making its way through the court system which could have some profound implications in the Gulf region adding thousands to the if not temporary unemployed at least the medium term unemployed area of the report. The icing on the cake was the initial claims report of Thursday which came in much higher than anticipated at 472,000 which is not good at all.

Mix that in with the ECRI slipping further and I am comfortable with the double dip scenario, if we were ever really out of the recession to begin with. I am hard pressed to believe any of this is priced into the market even after this massive slide we have seen in equity prices. From my point of view the equity markets had some 4% GDP priced in and flawless earnings with endless positive guidance. So far we have seen some firms pre-warn about a slowdown in the economy and their earnings. This means some of this is priced into equities, but not a 1% GDP print or a negative print which is possible at this rate. Housing is telling us that we have serious problems and the slide in all the housing data means that a full fifth of the economy is in negative territory. We also see that hiring in the manufacturing area, which was giving economists a sense of comfort, is slowing down dramatically. Can we all say this together please, inventory rebuild, but that is now over.

There is simply no end demand for products at this point which is not good. I had called this a depression last fall and received tremendous heat for using that term, but make no mistake about it, this is a depression. Unemployment is telling us that it is a depression and we are, as history seems to be repeating itself, looking at acts that mimic what we did pre-1929 crash, Smoot-Hawley, now called Schumer-Graham for the currency manipulator tariff act. None of this is priced into the equity markets which mean we will have much to worry about on the downside. Be sure, there will be sharp rallies, but you should not buy the dips on this one. I sold everything except for biotech, high yielding stocks with strong balance sheets, high grade bonds, treasuries and I own a tiny position in high yield bonds, I sold 80% at the end of 1Q after the stellar performance. I hold large short positions, which is relatively unchanged from the end of 1Q except I rolled put options out until September and began building a position in some leveraged and unleveraged short ETF’s, TZA, SH, SDS, BGZ to name a few, some I will hold and some I trade.

I expect a rally up to the 104-105 area in the SPY which should prove to be a nice entry point into a short position, if you are aggressive and believe growth will be weak as I do. However, I believe tomorrow we open lower since we could not hold $102.50 on Friday in the SPY, but we should reverse up since everyone is so negative. Depending on what happens, everything always depends, I will more than likely cover my shorts tomorrow and play the long side for that rally and reenter my short positions at higher levels. Volatility is your friend, but we are dominated by certain carry trades, news events and other macro items that one needs to monitor so be careful and don’t just trust the charts, look at everything to make your decisions. My target for the S&P is still at least 900, but it can go as low as 860 and retest the March 2009 lows without any problem whatsoever. I am not even sure quantitative easing can fix this problem since treasury yields are heading lower already. We are in a very bad position and there are no more bullets left from the government. This could get very, very bad.

Employment Report

Posted by Ray on June 4, 2010 under Main | Be the First to Comment

What is there to say? I was closer than most analyst who estimated 500-700K with my 300-400K call. However, as I said before the vast majority were temporary jobs and in this case it was government Census temporary jobs which is a double negative as they create a tax burden and will end very soon. Construction jobs, so much for the 2.7% jump in spending, lost 37K jobs and private temporary jobs also jumped at a healthy rate, all bearish.

On the plus side, hourly income had some increase and the work week had a nice uptick, but that is it. The uptick was also not out of the norm so disinflation is still strong and on a longer term trend the direction is down to flat for income, not good news. Without government we would suffer job losses and we will head into a double dip by 3Q10 for sure. The initial claim data is validating all of this information so I am not out of line or a doomer, it is all data driven.

The Birth/Death model added a stunning 215K, not seasonally adjusted, to the report which helped lower the overall unemployment rate. This was the largest addition via the birth/death model, officially, since the Lehman collapse, why? With a stunning 430K headline number there was little need to pad the B/D model this much, you would think, but there was. You see, the unemployment rate would not have dropped otherwise if they left it alone so with the addition of a little BLS magic Obama and Company have a minor victory. I do not like the model and it needs to go as it underestimates unemployment every year.

Regardless, we are in for a bumpy ride and the markets had reached their highs for the years and had rolled over for good now. I feel good about being short here. Europe is in major trouble and things in America, on the employment front, are in rough shape. The economic data certainly does not support elevated P/E multiples so look for value, dividends and high quality bonds. Moving forward a nice healthy cash position is probably advisable as if some people are right, myself included, we are in real trouble here. My short-term S&P target, 1017 with a medium term target of 900.

The Employment Report is a Fraud

Posted by Ray on May 7, 2010 under Main | Be the First to Comment

Initial read is +290K with adding in 800K into the work force. I call BS since the BLS Birth/Death model added +188K in April. That is a large majority of the +290K and, in my opinion, is fraudulent and the bearded guy on CNBC is a complete moron. Will post a professional post later, but these people are clueless.

A good employment report

Posted by Ray on April 4, 2010 under Main | Be the First to Comment

I am back from a much deserved break and am beginning to catch-up on the economic data that has bulls all geared up for a push to 11,000 and 1,200, for the Dow and S&P respectively. I actually have little doubt that the markets will push higher as investors like watching their stocks go up while they do nothing, which is one reason why up volume is so much lower than down volume because investors will sell fast if stocks head south. Do not get me wrong, I am bearish on the markets, but one has to trade the tape in front of them.

I was just combing through the employment report and it is not too bad, but I see this data as less bullish as the talking heads will on Monday. Why? Well, I did not like the BLS Birth/Death model adding 81K, the government adding 48K and temporary workers brining in another 40K. Those who read follow my writing know that I hate the Birth/Death model because, frankly, they make up these numbers based on some very optimistic assumptions and as you know the B/D model underestimated job losses for 2009 by about 1M. If I had a model that underestimated employment by some 17% I would probably change the methodology or just get rid of it, but not the government because this model postpones the bad news until a later date, like we saw in February with that huge adjustment.

I do not see temporary employment as a bullish signal at all, keep in mind that since September 2009 temporary employment has added 313K jobs. If temporary employment was truly a leading indicator we would see this number coming down as these temporary workers move to permanent, but this is not happening. I admit, I could be wrong about this, but I really do not believe these people will become permanent employees anytime soon. This is kind of confirmed by the hours worked data and the inventory data from the ISM report which shows hours are increasing and the inventory build is still in full force. End demand just is not there and there is still wage deflation.

There is also an uptick in disability claims as well, which is what many apply for when their benefits either run out or they cannot find work because disability pays much more than unemployment. If one looks at the duration of time unemployed they will see that 44% of those seeking a job is on the dole for 27+ weeks, not good for a “V” shaped recovery. Furthermore, 60% of those unemployed are on the dole for 15 weeks or longer, again, not good. On the bright side the participation rate is increasing, but at the same time marginally attached workers has also increased.

Essentially, I view this report as flat, excluding government jobs and the B/D model, which is good news. While this one report is good initial claims are still out of whack at well over 430K a week, that is about 2M people a month, and I believe last week’s downtick was temporary, employers hate to fire people near holidays which is why claims plummeted in December, but resumed afterwards. This will either be confirmed or disproved over the next few weeks. I firmly believe, at best, the labor markets have merely stabilized for now, but the real question is what happens when inventories are completed? We will find out, but I am sure it is not news we actually want.

The fact that we also have so many part-time workers out of necessity pointed to an extremely weak employment situation. I heard a story about a dog kennel owner who placed an ad on Craigslist.org for an “assistant” who would be in charge, this was clearly stated, dog fecal matter. This was an $8.50 an hour job, in Washington State, and he had 218 resume responses from teachers, construction workers, hospitality, and other professionals, the same sectors the BLS’s B/D model says is creating thousands of jobs. I think that story speaks for itself.

We also need some 140K new jobs a month just to keep up with the population growth, that is scary considering there are 15M people unemployed right now. This means we need, keeping the numbers realistic, 300K+ every month for about 6 years, these are back of the envelope figures, to come back up to full employment. Forget all the optimism and look at that figure realistically and you make the conclusion of whether we will reach anywhere even close to that figure in the near future, excluding government jobs as well. In short, we have serious employment problems that will not cure itself and will take a long time to correct itself.

What is going to be odd is the fact that this may cause the market to rally in the short-term, but the markets are very overvalued for anyone using a realistic earnings estimates. The parabolic move has been cheered by the media, but I believe this move is creating undue optimism about future equity prices. Yes, the data is getting better, but not Dow 11,000 better. Of course, I am bearish, but I do have longs in the biotech area, dividend stocks, precious metals, high yield and international holdings, but at the end of the day an 8% rise in frontier markets, 4%+ in high yield and is a bit crazy considering current valuations. Yes, I am making money and complaining about it, go figure, but I also have shorts and VIX calls as well. Let’s hope for better economic news, but I am less optimistic than most that we will get it.