Which Economy are You Looking at?
10/31/07
We are living in the age of real time information, even if the information that we get in real time is a month old or so. At least this month-old information is distributed in real time. That is the problem with high frequency data. They give you a lot of information frequently, but they do not necessarily make you a better investor. Boom today, bust tomorrow, depending on the data du jour. Gene Epstein has always been a proponent of the use of longer term averages and trend analysis and he writes in Barron's this week: "Economic news can always be dismissed as yesterday's news, irrelevant to the setbacks of tomorrow. What is seen in the rear-view mirror is often out-of-focus anyway, always subject to revision. But you can at least say this about the economic news of the past week, with respect to both production and employment: Most of it occurred after the financial storm that began in August. And so far, it gives evidence of an economy that managed to weather that storm, even if that evidence is eventually revised down. And for all we know, it may even be revised up." Very good point. In fact, the latest GDP report for the 3rd quarter (chart below left) speaks volumes. GDP rebounded from 1.5% in the 1st quarter to 3.8% in the 2nd and reached 3.9% in the 3rd quarter of 2007.
The GDP estimate can and probably will be revised twice in the coming months. Based on its past record, the BEA has found that its usual revision from the advance estimate to the final has been give-or-take 0.4 percentage points. Even if we take 0.4 percentage points from 3.9, then, we still get a robust annual rate of 3.5% and therefore a mighty strong showing. Meanwhile, the GDP Deflator (chart above on the right) which measures price increases in the economy as they happen and is part of the GDP report, continued to fall. The fall in the GDP deflator "artificially" boosted the GDP number, due to the quirk of economic accounting. Alan Abelson's (writing also for Barron's) spin is contrary to the interpretation of Gene Epstein. Abelson says that "... The point, of course, is that save for that miraculous decline in the GDP "deflator," in the third quarter, growth in the economy would have barely topped 3%. And if the number were anywhere near what inflation is actually running at, GDP might have come in at less than 2%." The BEA estimates that the fall in residential investment (which includes the building and renovation of single- and multi-family homes) took more than a full percentage point from overall GDP growth in the third quarter. Even if the GDP deflator had increased according to Abelson's definition of real inflation (I did not know about the "Abelson real inflation indicator" until today) the economy (including housing and credit crunch) would have grown by about 2%. So what? What's not to like, Mister Abelson?
Apart from the GDP report, last week brought Friday's release of the employment report for October. The report was constructive and should quiet down concerns about the possibility that the U.S. economy is slipping toward recession. Recession worries had intensified over the past two weeks following very weak news on the housing sector, a sharp decline in consumer confidence, sluggish chain-store sales, rising jobless claims, and weakness in the ISM index. These worries intensified concerns about financial companies, posing significant risks to the condition of the financial markets. However, here again we have a myriad ways to interpret the data: Mr. Abelson writes: "Supposedly 166,000 jobs were added to payrolls last month, way above what the crystal-ball gazers in the Street predicted. What stirred our suspicions - or shall we say our curiosity?, which, if nothing else, is more polite - was that contributing to the overall gain were 2,100 added jobs in - Are you ready for this? - real estate! And we couldn't help noticing that no fewer than 103,000 of the presumed 166,000 additions came by virtue of the birth/death adjustment. ... In truth, something over 80% of this waning year's reported new jobs are similarly mythical constructs." Tony Crescenzi belongs to the more optimistic (realistic?) camp and writes: "There were no special factors that drove payrolls to expand by 166,000 in October, although a few of the components saw increases that were larger than normal. Stripping out these extra gains, which amount to roughly 30,000 jobs, payrolls still posted a gain large enough that, if sustained, would keep the jobless rate unchanged and result in solid income growth." Makes you wonder if we are all looking at the same data, right?
You know that I lean towards Mr. Crescenzi's point of view. Alan Abelson has been gloomy throughout his career at Barron's and of course got it right on occasion. But his record is as spotty as any other randomly chosen one. Mr. Epstein has the last word today. He says: "Finally, the employment report for October, released Friday by the Bureau of Labor Statistics, showed that non-farm payroll employment rose by 166,000, solidly above the consensus estimate. The unemployment rate was essentially unchanged at 4.7%, since the increase from 4.6% was well within the range of statistical error. ... There was also an increase in the temporary help category - the second in the past three months following a six-month string of declines. Hiring by temp services often indicates a strengthening labor market." He confirms my view and I continue to believe that we are going to somehow avert a recession, despite the credit crunch and the housing downturn. International markets are important, however. Should the world economy slow down significantly, all bets are off. We need the export markets of this world to work our way out of the current slowdown and we need the outside liquidity to keep things humming in this country.
Hermann Vohs
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
