Tuesday, July 31, 2012

Track Starts Friday, But Don't Forget the Jobs Report

The world's attention (and mine) has turned to the Olympics. The most outstanding performance so far was Mr. Bean's during the opening ceremonies. However, I'm really looking forward to the track & field events, which begin on Friday, the same day that July's jobs report is released. Economists are expecting an increase of about 100,000 in nonfarm payrolls. They also expect the unemployment rate to remain steady at 8.2%. However, last week's GDP figure portends weaker results. Real GDP increased at an annual rate of just 1.5% during the second quarter. This beat the expectations of some economists, but fell well short of the revised 2.0% growth figure for the first quarter, indicating a general slowdown in economic activity from Q1 to Q2. Particularly worrisome was the anemic 1.5% growth in personal consumption expenditures. That was down from 2.4% in Q1. Expenditures on durable goods actually fell 1.0%.

We'll get a better idea of what the jobs report might look when the ADP Employment Report comes out tomorrow. Although the ADP report is based on actual payroll figures, it does not always accurately predict what the nonfarm payrolls might look like. Over time, however, there is a strong correlation between the two. 

Initial jobless claims come out Thursday and the ISM Indexes will be released on Wednesday and Friday. These also have the potential to move the markets. The former gives us an indication of layoffs. While many companies are still reluctant to hire workers, layoffs appear to have slowed. As a result, initial jobless claims could be better than the expected 365,000. As for ISM, the manufacturing index is expected to come in around 50 while the services index is expected to be a bit stronger. Yet these are extremely weak expectations since any number below 50 suggests contraction. 

The S&P 500 rallied 3.6% from last Wednesday to Friday. That's a nice move, but the gain had nothing to do with outstanding economic results or corporate profits. On the contrary, the economy is still struggling and corporations are reducing guidance. But stocks are rallying on hopes that European leaders will finally get serious about addressing their problems and that the Federal Reserve is about to initiate a new round of quantitative easing. Rallies based on these kinds of expectations are likely to fizzle out. 

As for the Olympics, nothing is for certain. Yet if I had to put my money on just one athlete, it would be David Rudisha of Kenya in the 800 meters. He is the current world record holder. One of these days he may become the first man to break 1:40. 

Thursday, July 19, 2012

Improving Jobless Claims Hide Real Story

A number of pundits argue that President Obama's reelection prospects rest largely on the employment market. Some predict that unless the unemployment rate falls to below 7.0% by November, an unlikely outcome, he won't get reelected. Today we learned that initial jobless claims jumped up 34,000 to 386,000 for the week ended July 14. Despite the increase, the Obama camp can at least make a case that initial jobless claims have improved significantly since they took control of the White House in January 2009. The number peaked at 667,000 for the week ended March 28, 2009, but as shown in the graph below, things have certainly been moving in the right direction ever since.

Unfortunately, the situation looks much worse when you examine the employment participation rate. This figure has dropped from 65.7% in January 2009 to just 63.8% in June 2012.

To put this decline in context, the civilian noninstitutional population over the age of 16 totaled 234,739,000 in January 2009, of which 154,236,000 million were in the labor force. Since then, the population has grown by 3.6% to 243,155,000, but the labor force has grown by just 0.6% to 155,163,000. In other words, had the labor participation rate remained constant, there would be approximately 4.6 million more individuals in the labor force.

Where did all these people go? They simply dropped out. Because the employment market is so bad, some gave up looking for work. Others "chose" to retire early. Still others decided to stay in school, hoping things would improve by the time they got yet another degree. The official unemployment rate of 8.2% is bad enough, but if we were to account for the missing 4.6 million, the unemployment rate would be a much higher 10.9%. It is not the improving trend in initial jobless claims, but the deteriorating labor participation rate that tells the real story about the dismal state of the U.S. employment market.

Tuesday, July 17, 2012

The Fed is Willing But Unable; Congress is Able But Unwilling

Ben Bernanke answered questions from the Senate Banking Committee today. A few items really stuck out. The first is how obvious it should be to everyone, even the politicians, that economic problems in the U.S. cannot be solved by tweaking monetary policy. They can only be addressed by fiscal policy. The second was how hard some of the committee members tried to change the subject. Instead of focusing on important economic problems here in the U.S. and how to solve them, members with their heads stuck in the sand chose to attack banks for manipulating LIBOR. They wanted to know what the Fed was doing about this; as if it could do anything.

Economic problems in the U.S. have nothing to do with interest rates being too high. They have everything to do with the so-called fiscal cliff, something only Congress can fix. Perhaps the most enlightening moment was provided by Senator Charles Schumer of New York. Addressing Chairman Bernanke as if he were a bad schoolboy who had not done his homework, Schumer first forced Bernanke to admit that the Fed was not out of tools then he told Bernanke to go back and do his job. Why? Because Congress refuses to do its fiscal job.

Monday, July 16, 2012

The Increasingly Elusive Level Playing Field

According to finance theory, a stock's price at any moment in time represents the present value of future expected cash flows. Prices fluctuate because investors disagree on what those cash flows will be or at what rate they should be discounted. When new information hits the market, stock prices can exhibit tremendous volatility.

As most investors know, it is extremely difficult to earn excess returns by relying solely on publicly available information, yet it is very easy to make a lot of money by relying on material and non-public information; what is often referred to as inside information. The problem, of course, is that using inside information is illegal. As a result, some investors looking for an edge try to access material information that is not necessarily coming from "inside" the corporation. Today's New York Times provides an excellent example of hedge funds operating in this gray area.

In Surveys Give Big Investors Early View From Analysts, Gretchen Morgenson explains how some of the biggest hedge funds are getting an early peek at what analysts think about the companies they cover. Morgenson claims that certain documents actually "state that the goal is to receive nonpublic information." What's worse, she says that documents state that surveys filled out by analysts for hedge fund clients "allow for front-running analyst recommendations."

While it is not clear if this practice of surveying analysts constitutes a violation of law, it certainly adds to the suspicion and unease that many ordinary investors share that the stock market is not operating on a level playing field. Hedge funds, in particular, are using more and more sophisticated technologies that allow them to buy or sell large amounts of stock in milliseconds, before other investors can access or process information. This explains in part why so many retail investors are either out of the market entirely or investing solely through mutual funds or exchange-traded funds. Morgenson's article will no doubt prompt regulators to ask a whole lot of questions.