2007-04-18 Follow-up

Had a follow-up discussion with the CIO:

As I told him, while we obviously don’t quite agree on what it all means,  the debate is worth the effort, as it could be crucial for determining economic and market prospects.

If, like him, you find the 0.9% income growth # startling, and maybe even hard to believe.

Lets put aside the issue of whether the data from a census based on 98% of U.S. jobs, which takes six months after the end of the quarter to be produced and released, is more reliable/believable than the data based on sampling 160,000 of the country’s 8.8 million employers, and then using a statistical model, etc., and releasing it on the first Friday after the month.

But, just given all the other economic facts, is 0.9% really more startling and hard to believe than 4.1%?

I.E. If we assume inflation expectations are typically around 2.0-2.5% (and that labour compensation agreements would, as you said, typically have that as a benchmark), is it more believable that income growth has exceeded that by 1.5-2.0% (your thesis) or trailed it by 1.0-1.5% (mine), given that:

-         Income growth is distinct from (i.e. a subset of) total compensation growth, which includes benefits on top of wages and salaries, and we know companies’ benefit costs (i.e. healthcare) have been growing substantially – are companies really paying out wages faster than inflation even while also paying health and other benefits at increasing rate?

-         And have they been doing that while also generating record profits? -- corporate profits as % of GDP are at record highs (see attached from StLooFed), so its hard to believe that income growth has exceeded total economic growth (4% vs 2.5)

-         personal savings rates are negative, so its hard to believe that income growth has exceeded personal consumption expenditures growth (which has been 3.2%, 3.5%, 3.5% and 3.7% in last four quarters) – if income growth was really greater than PCE growth, then why would savings be negative (particularly even while people still extracting home equity)

-         the manufacturing sector, particularly autos, is seriously struggling, and has had layoffs over course of last year

-         globalization and outsourcing have limited unions’ bargaining power

So, what seems more consistent with all the other evidence, income growth below or above inflation?

As for indicators (without waiting for a raft of massive layoff notices) that payrolls will be declining, how about:

1) Housing starts and completions signal loss of over ¾ of a million residential construction jobs:

 

2) weakening durable goods orders signal pending further losses in manufacturing jobs

2007-04-17 Post Investment Strategy Meeting Notes

 In our inv mtg today, I talked about U.S. job growth but I'm not sure the team was very receptive to my message.  As I didn’t want to waste the hours I spent researching this, I will post a few brief thoughts here:

1)      labour market has not been at all “robust” during this cycle

a)      payrolls growth has barely surpassed population growth since end of 2001 recession, and, of course, has trended further down

b)      this truly has been a jobless recovery, as payrolls growth since end of '01 recession is way under that of '90s, '80s, '70s, etc. post-recessionary periods

c)      since end of recession (Nov01), jobs are up only 0.9% annualized

d)      and since trough of payrolls (May03) (jobs kept being lost for year-and-half even after end of recession), jobs up only 1.5% annually

e)      obvious conclusion – job growth had little to do with economic strength of last four years (perhaps consumer debt, at record high, thanks to MEW, was the real key?)

2)      NFP estimates not particularly reliable at turning points in economy, says BLS itself

a)      I was trying to make sense of the recent 180k print, as we discussed, as it doesn't yet fit our expectations, so wondered if we needed to refine our assumptions, so started investigating how NFP actually gets produced monthly (http://www.bls.gov/web/cesbd.htm)

i)        First, they do a sampling of 160,000 businesses, representing about 1/3 of total jobs in the economy

ii)       Second, they use their birth/death model (estimation procedure) to impute employment for new businesses (and then use an econometric model to estimate the residual that can’t be accounted for by using dying businesses to estimate new businesses) --- the model assumes a seasonal pattern, which, on net for the year from Apr06-Mar07, assumes creation of 963,000 jobs (80k/mth)

iii)      Third, they take the result of the sampling and the modeling and apply their seasonal adjustment

iv)     They admit the procedure “is likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend… [the birth/death estimation] is likely to remain as the most problematic part of the estimation process”

v)      March payrolls growth of 180,000 (seasonally adjusted) embeds an assumption of 128,000 just from the birth/death model (prior to the SeasAdj)

b)      BLS first does their monthly process as above, but over time they also do a census to update their data; this census covers 8.8 million employers (vs 160,000), and 135.0 million F/T and P/T workers, or 98% of U.S. employees (vs about 1/3)

i)        On Apr 11 they released the results for Q3 (http://www.bls.gov/news.release/cewqtr.nr0.htm)

ii)       these showed job growth in year to Sep06 of only 1.5% (vs 1.8% from NFP) and average wage growth of just 0.9% (vs 4.1% from NFP estimates) (http://www.bls.gov/news.release/cewqtr.t01.htm)

iii)      in total for the 12mth period, according to the census, jobs increased 2.01 million – compare this to the total birth/death adjustment that NFP uses in its estimates (0.96 mil), and the latter that they “assume” in their model represents almost half of confirmed job growth – so the model’s validity is crucial if the NFP data is to be taken at face value

iv)     another obvious conclusion: the census #s are clearly more robust than the NFP estimates, albeit delayed, but hardly indicate that income growth will support consumption when confronted with sagging home prices, higher interest rates, higher energy bills, resetting ARMs, tighter lending standards, auto and housing recessions, rising food prices