Economic Indicators and the Employment Report
Today’s market decline came after the Institute for Supply Management monthly index was reported. The ISM reading for December was 47.7, the lowest level since a
couple of months in the Spring of 2003. Since economists had expected a reading above 50 the report was worse than expectations. (We wonder how anyone forecasts this series.)
This is a diffusion index, so readings below 50 indicate contraction in manufacturing. If the 47.7 value were annualized, it would imply GDP growth of 1.8%, according to the ISM’s own research. Despite some media efforts to explain the index, many traders still do not realize that the break point for an economic decline is a reading below 42. There was a knee-jerk reaction since the report was below the symbolic "50" and that fits the prevailing gloomy recession forecasts.
For an excellent and complete analysis, check out Between the Hedges.
Later in the day, crude oil futures traded briefly above $100/barrel. This also had a symbolic value, calling attention to inflationary pressures. The scare stories hit the tape.
Economic Facts versus Sentiment
As we look back on 2007, the biggest surprise for us has been the persistence of what we call "misguided gloom" and the astute Gary D. Smith calls a "negativity bubble." The Fed set out to make sure that inflation expectations were firmly anchored. Since then, the chorus of negativity from market commentators has been overwhelming. No one believes that the Fed can help in achieving a "soft landing." The most expensive investment research of 2006 (we have not yet made our 2007 award) was costly for anyone who followed the advice. This has not changed in 2007.
The problem is that no one seems to understand what a soft landing looks like! Did people really expect GDP to descend gracefully to an annualized rate of 3% and then stop? Amazingly, that is pretty close to the growth achieved in 2007. It has occurred in spite of spiking oil prices, declining home prices, and a crisis in credit markets.
We are confident about our methods in the long-term. They have worked for the ten-year history of our business. We also had a great year for individual investors in 2007, but the last three weeks surprised us. Predicting short-term market reaction is always a challenge. In this case, the reaction to the Fed decision three weeks ago seems especially overdone. An observer opined today on CNBC that had the Fed explained the TAF plan before announcing the interest rate decision, the market would not have declined.
Amazing. That was 1000 Dow points ago. There has been time to get the message. As we noted yesterday, there is plenty of distortion about Fed policy. Even astute observers are misrepresenting Fed goals and policy results.
Friday’s Employment Report: Background
The monthly employment report is a subject where we have done significant research and writing. There are two reasons for this. First, the market–quite wrongly–places such great emphasis on the data. Second, it hits all of the elements of our expertise — understanding research methods, surveys, and government.
Before each payroll employment report we look at a group of
indicators which are all collected at about the same time as the report
data, the middle of the preceding month. While the regression model
"predicts" monthly employment changes from the other variables, the
correct interpretation is that they are simultaneous but slightly
different reads on the economy.
The model has a nice fit to the jobs data that is eventually written as history, duly revised and benchmarked. We invite readers to try our Payroll Employment Game, updated monthly. The main point of this site is to demonstrate the wide variation in possible results from the monthly survey. It also has a comprehensive analysis of BLS methods that complements the articles at "A Dash."
Our Own Forecast: A Very Weak Number
Economic growth of less than 2% is certainly below capacity and
costly in many ways, including employment. Last month’s data suggest an employment gain of only 7000. While most reporters fail to mention it, the
90% confidence interval on the monthly change is +/- 100,000. That is
just the sampling error on the survey. It does not include any
non-sampling issues such as the adjustment for new job creation.
Since the market is looking for a gain of 70,000 jobs (according to Briefing.com –some are using 50K after today’s report), the potential
for a negative surprise is larger than usual. Slow growth is not enough
to absorb all of the new workers, so unemployment is likely to move
A No-Win Scenario?
Some suggest that there is no "good" number this week. A strong report will not be believed. Expect the regular chorus of pundits complaining about the birth/death adjustment. A weak number will create the expectation for an inter-meeting move by the Fed, something that we see as quite unlikely.
Briefly put, the negative sentiment may have longer to run. For investors and funds looking to get more market exposure, this week may provide a good opportunity.