Accumulating Incongruities

By: Michael Ashton | Thu, Sep 16, 2010
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It seems that every day these days I am befuddled by something new. Today's unusual experience was that professional economists actually did a great job at forecasting that the sharp improvement in Initial Claims, which happened to be coincident with the failure by eight states to timely file their reports last week. This week, rather than a bounce and a hefty revision higher as the actual data came in, Initial Claims actually improved further with only a 2k revision to the prior week. That means that the estimates the Department of Labor and the various states made last week in lieu of actual data were actually more accurate than the estimates of professional economists. This week, only 2 states still had to estimate claims because of a backlog, and those two states (Nebraska and Virginia) aren't big enough to imply too much of an error.

So, while it is hard for me to believe, apparently the big improvement in claims happened at exactly the same time that California and some other states had to be estimated, and those estimates happened to be exactly right. The DOL didn't think it was important to mention this week how much the estimates used last week deviated from the actual reports, but they must have been remarkably close.

While the employment situation is clearly doing better than I thought and doesn't appear to be falling apart, let me tell you why I am suspicious that this may not presage a dramatic improvement in the labor market. The Department of Labor indicates that the job market is improving markedly. But when surveyed about their own prospects, consumers reply that jobs remain very hard to get (see Chart of the "Jobs Hard To Get" response in the Consumer Confidence survey, below). Historically, this survey tends to do a good job of measuring actual conditions in the job market, because it is something that consumers are well-positioned to judge accurately (unlike, say, the purchase-dollar-weighted-average price change in their market baskets). When firing stops and hiring starts, it will be normal people who are talking to other normal people that will first detect this fact.

Consumer Confidence Survey Chart

Labor market is probably not really improving, very much anyway, or people would feelit.

What could be happening, although it strikes me as remarkable that no Street economist I am aware of suggested this possibility previously, is that the big Census layoffs have played havoc with the normal seasonal pattern. I can understand why such a phenomenon could lead to a big rise in August claims, but am at a loss to figure out why it would lead to a sharp improvement in September claims.

In any event, while there are now enormous error bars around the estimate of the true pace of Initial Claims, it seems we can reject the hypothesis that the labor market is growing markedly worse. This point, combined with the possibility that some or all of the Bush tax rates could be extended - although that seems an electoral loser to me - decreases the chances of QE2 this year. If the outlook isn't markedly worsening yet, then Bernanke's precondition hasn't been fulfilled. Now, if the Bush tax rates aren't extended so that the fiscal drag in Q1-Q2 is going to be predictably large, then QE2 is still pretty likely, but it would be much cleaner if we were already seeing weakness even before tax hikes and municipal spending cuts went into effect.

I hate to say it, but I have a certain level of sympathy for Chairman Bernanke and the crew at the Federal Reserve. They haven't done a very good job since Bernanke's term began, but he was put at a disadvantage early as a result of inheriting the mess contributed to by the prior occupant of his office. Basically, Chairman Greenspan cut the steering column in half and then handed the wheel to Bernanke and said "Here, you drive." The steering isn't working like it is supposed to be working, but that's partly because the former driver trashed the car.


Tomorrow's data is the cream of the crop for the week. CPI (Consensus: +0.3%/+0.1% ex-food-and-energy) is out at 8:30ET. The mere 0.1% rise in core inflation will pull the year-on-year rise in core CPI back up to 1.0%. This may mark the bottom of the cycle although it is more likely to be set in October. The consensus for headline is odd, because a seasonally-adjusted month-over-month rise of 0.3% should, on my calculations, cause the year-on-year increase in headline prices to rise to +1.3%; Bloomberg has the consensus for the year-on-year figure at +1.1%. In principle, this is a fairly easy calculation. It actually looks like Bloomberg has 76 responses to the month-on-month figure but only 40 responses to the year-on-year figure, and I imagine this explains the discrepancy. A print of 0.2% is roughly consistent with a year-on-year of 1.2% (although it depends if it is a "high" or a "low" 0.2%).

Although CPI is the crucial data for the week, however, the major conundrums these days are all market-related. I think I have some idea why stocks and bonds are moving in the same direction more often now (because both are likely to respond similarly to an increase in the chance of QE), especially when strength in these markets is combined with dollar weakness and commodity strength. And I have a sneaky suspicion that the very low exchange volumes and stubbornly-high VIX are related to the diminishment of liquidity associated with the Volcker Rule and other assaults on market-makers. But these are only guesses, and while they make sense there is very little supporting data right now.

I wrote earlier this summer (here) about the implication of uncertainty for bet size (referring to the Kelly Criterion to illustrate). Back then, I was writing in the context of a VIX that was in the process of rising from 23 to over 35, but the thought process applies similarly when the number of unanswered questions is rising. Odd market behavior sometimes precedes bad market behavior (funny, this sounds a lot like the explanation in the movie The Matrix about the cause of déjà vu), but in any case it lowers one's confidence in the edge one has an investor. The tricky part is noticing when these incongruities are accumulating, and that's where writing a commentary helps. I feel I can't explain a lot of what is happening. That makes me nervous.

Some traders are very systematic. I tend to rely on models myself a great deal of the time. But as I have gained experience, I have learned to listen to my nervousness more. I almost never increase a bet based on gut feel, but I will often decrease a bet if I am nervous. I always want to live to fight another day! Accordingly, I will almost assuredly never have a +100% year. On the other hand, I will also almost assuredly never have a -100% year, and that is much more important to my long-run return.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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