What To Make Of This?

By: Michael Ashton | Thu, Jan 27, 2011
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Initial Claims at 454k?

This is a curveball! We are reaching the end of the most difficult period of seasonal adjustment, so this jump is quite a surprise. Two explanations were immediately possible: (1) everyone waited until much later than usual to start laying off Christmas-season staff, or (2) state unemployment departments were running behind in prior weeks and just catching up now.

The Labor Department says it was the latter. Snow in four southern states in previous weeks created a backlog of claims that were processed last week. The Labor Department deserves a nice resounding raspberry for this, since in prior weeks they reported "no unusual factors" contributing to the surprising declines in Claims. Well, it turns out there was an unusual factor: some states were running behind. That might have been worth pointing out. Economic forecasting is hard enough when you think the data is clean. It's almost impossible when you're being fed bad data. Garbage In, Garbage Out.

So, we have to mark-to-market our expectations for Claims again. Averaging over the last 8 weeks, Claims is running around 421k (see Chart). This is an apparent improvement over the prior range of 435k-475k, but it isn't the dramatic and steady improvement the numbers had suggested. On January 13 I wrote:

Again we see that forecasters have gotten a bit too ebullient about the recent data. While our eyes tend to see on the chart (see below) a clear downtrend since August, statistically that downtrend isn't there - because in August, the true underlying level of Claims wasn't 500k, but more like 460k... It does appear, though, that we have enough data to suggest that the underlying pace of Claims has improved from the 440-480k range it had held for nearly a year, but consider how much we actually know about that improvement. This week's 445k figure was probably higher than it should have been because claims offices were catching up on last year's paperwork, so the last several weeks should be considered together. The 8-week average is at 420k, and I think that's probably a reasonable estimate of where we are. But if we have moved from a 440k-480k range to a distribution with 420k as the central tendency, that isn't so dramatic. The eye creates a trend here, but in fact all we can say is that the underling pace of Claims has moved from "about" 460k to "about" 420k over the last couple of months.

So the downtrend was really a downtrickle, and the estimate of 420k as the central tendency looks to be approximately right. Clearly, though, there is enormous uncertainty about that estimate given the recent data volatility (and the continuing snowstorms!). Do note that in the chart below, in the same way that our eyes wanted to see a downtrend before they will now want to see a "bottoming" and a bounce. That phenomenon isn't statistically there either. Remember that these weekly data are only experiments - periodic measurements of an uncertain underlying reality!

US Initial Jobless Claims SA
420k looks like, to a VERY rough approximation, the current central tendency of Initial Claims

Durable Goods Orders showed a weak December (headline -2.5% against +1.5% expected, ex-transportation +0.5% vs +0.9% expected), but if anything Q4 growth estimates may be revised higher by a smidge because the upward revisions to November were substantial (since GDP is coming out tomorrow, though, this will manifest for those of us without access to the real-time revisions as slightly less downside risk to the consensus forecast). Ex-trans Durables in November had originally been reported +2.4% and are now +4.5%. So December looks a little weak, but Durables is also a volatile number that needs to be taken with a pinch of salt; snow may also have been a factor. Manufacturing isn't booming, but it isn't failing at the moment either.

Market activity was muted on Thursday. In a not-unrelated note, Central Park snowfall totals for this storm reached 19 inches. That was just a wee bit more than was being forecast 72 hours ago (3-6") and more than was being forecast in the middle of the day yesterday (it had been upgraded to 6-10"). Ironically, the best estimate was from last weekend, when forecasters were saying this could be another Christmas-weekend-type storm. Yep. Mayor Bloomberg encouraged people to stay home, and many of them did so. My mailbox is just barely atop the snowplow-aided drift, which now consists of parts of the last four snowfalls. It's entertaining, but it leads to lethargic and illiquid trading. (It isn't this snowy everywhere, though. My friends in Canada and the north central U.S. states tell me that while it's bitter cold, snowfall totals are low this year. You know it's cold when even snow goes south for the winter!)

Stocks edged higher, bonds edged higher, and the credits of the Euro periphery slid.

On Friday we get our first glance at the estimates of Q4 GDP (Consensus: +3.5% vs +2.6% in Q3; Price Index seen +1.6% vs +2.1% and core PCE +0.4% vs +0.5%), as well as the Q4 Employment Cost Index (Consensus: +0.5% vs +0.4% in Q3). In short, it is expected to be a day of good feelings, showing that the economy strengthened from Q3 to Q4.

Should the results from the 4th quarter matter very much, when we've already gotten most of the historical information that we as investors need in the form of just-released earnings? Not really, but I expect it will be hard to resist the general sense of relief from warm and fuzzy numbers like this. The market's piercing of 12,000 on the Dow and 1300 on the S&P will also, I suspect, be cause for much shameful celebration on the Cheerleading, Never Bearish Channel (I assume that's what CNBC stands for), so I think we will end the week on a high note.

I don't think we will hold those levels for very long, for two reasons. One is that markets very often relax when they reach a long-sought goal - I don't really know why this happens, but it happens regularly. Whether it is simply that round numbers or obvious technical targets provide a natural place where many investors put "profit taking" goals, or whether it is the loss of focus that ensues after the goal is reached (though I really want to resist being too anthropomorphic here), I don't know.

The second reason that I think stocks are finally going to take their breather is anticipation of the ultimate withdrawal of QE2. I probably have the timing here all wrong. But I know that whether the cessation of QE2 in June tears out a support beam from the market or not, intelligent and cautious investors will not wait to ride out the last few points. Mid-May to mid-June is usually a terrible time for fixed-income, so the natural time to set a bond or equity short is in mid-May, but the market is already up 3.5% one month into the year and is about to hit a milestone. Yes, it is probably far too early to worry about June, but I just want to make sure I am the first investor to worry about it...not one of the last ones.

I think that also means bonds will find increasingly tough sledding. Again, the reasoning is that right now, I have a willing buyer in the form of the Fed, but after June that buyer will be gone. And well before that, there will be a lot of investors with paper to sell him. $400bln (or whatever is left) sounds like a lot, and it is, but the Treasury market is thirty or forty times as large as that and growing $100bln a month! I don't know when the bough breaks. But I know that when it does, the cradle will fall. Timing matters in trading, but implied volatilities are cheap and buying insurance makes the timing matter less.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

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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