|South Africa, Canada, and La Jolla|
"There are three kinds of lies: lies, damn lies, and statistics." -- commonly attributed to Benjamin Disraeli
we are to believe the government statistics, the GDP of the US grew by
0.6% in the first quarter of this year. And unemployment actually fell.
And there were only 20,000 job losses. This week we do a quick review
of why the statistics can be so misleading. We also look at why I was
wrong about the housing number last week, and I highlight what could be
a very serious Black Swan lurking in the agricultural bushes. It should
make for an interesting letter. It's hard to know where to begin, there
are just so many tempting targets; so let's take the statistical
aberrations in the order they came out this week.
Who Is Inflating the Numbers?
my January 2007 annual forecast, I said that we would see a recession
or a serious slowdown by the end of 2007 and that it would be mild as
these things go, triggered by a bursting of the housing bubble and a
slowdown in consumer spending. During the summer and specifically in
October I wrote that we were facing a Slow Motion Recession -- that the
recovery process would be lengthy and take several years before we got
back to the 3% growth rate that is more typical of the US economy.
were lots of people who made fun of my forecasts, and some were quite
snide. I really let stuff like that roll off my back. But I have yet to
see those writers admit they were wrong (as I will at the end of this
letter). And I doubt I will. I take little pleasure in being right on
the recession call, as recessions are not fun for those in harm's way,
but I call it as I see it. We'll just have to wait and see if some of
my other forecasts come to pass. I am sure I will miss a few things.
Part of the nature of the business.
Last week I suggested that
this week's release of the GDP would be slightly positive, as the BEA
would have a much lower number for inflation than our common experience
suggests to be the case in the real world. It turns out my cynicism was
The Bureau of Economic Analysis (BEA) of the
Department of Commerce publishes the GDP statistics. They tell us the
US economy grew by 0.6% in each of the last two quarters. They come by
that number by taking the nominal or "current dollar" measure of the
economy and subtracting their figure for inflation, which gives us
"real GDP," or after-inflation GDP.
Nominal GDP in the fourth
quarter grew by 3%. In the first quarter it was 3.2%. They figure that
inflation was 2.4% in the fourth quarter and 2.6% this quarter, giving
us the slightly positive growth numbers.
There are several
government agencies which track inflation. And in fairness, inflation
in an economy as large as that of the US is a very tricky thing to
measure. The Consumer Price Index (CPI) is done by another division of
the Department of Commerce, the Bureau of Labor Statistics. Let's look
at what they calculate inflation to be since last August, in the
the string of five consecutive months of 4%-plus inflation, and that
the average for the 4th quarter was 4%, while for the first quarter of
2008 it was over 4.1%. Never mind whether that is the right number or
whether there are problems with how they calculate it -- that is a
story for another letter. The key here is that if the BEA used the BLS
number (remember, both groups are in the same Department of Commerce),
it would show the economy shrinking by 1% in the 4th quarter and by
almost 1% in the first quarter. That is not what the happy-talk
analysts are saying.
But let's use the Fed's favorite measure of
inflation, personal consumption expenditures, or PCE. The PCE has been
about one-third less than the CPI since about 1992. The difference is
in the way they are calculated. The CPI uses a weighted average of
expenditures over several years. As I understand it, the PCE tracks
changes in relative expenditures from one quarter to the next, assuming
that consumers change their habits as prices rise and fall. In
simplistic terms, if steak gets expensive, we substitute with hamburger
or chicken. One index tracks those changes over years and the other
(PCE) does it over quarters. Also, the PCE only tracks personal
consumption and not imports or inventories.
If we use the PCE
numbers (yet another measure using Commerce Department data), inflation
was about 3.3% for both quarters, which would mean negative growth
quarters by a few tenths of a percent. That would also mean two
quarters of negative growth and a recession.
Further, GDP in the
first quarter was helped by inventory build-up to the tune of 0.8%. In
times of expansion it is good to see inventories grow, as that means
companies are optimistic. But when the economy begins to slow, growing
inventories mean that companies anticipated sales that did not
materialize. That means that as inventories are allowed to fall in the
second quarter, they will show up as a negative factor in
But all these numbers will be changed in a
few years, as looking back over several years is the only way we can
get somewhat accurate numbers. My bet is that the numbers for GDP will
be revised down when the economy is well on its way to recovery. It
will show up on page 16 of the Wall Street Journal and no one
will care. That is what happened when we found out a few years later
that the last recession started in the third quarter of 2000. The
initial numbers were positive.
The "official" arbiter of whether
or not we are in a recession is the National Bureau of Economic
Research. And they do not use the GDP numbers. If they did, then what
would be the point of asking them? We could just look at the government
statistics. But we don't. Normally, we think of two consecutive
quarters of negative GDP as a recession. But NBER has other ways to
look at it.
Barry Ritholtz sent this note to me:
consecutive quarters of GDP contraction is not the only metric for
identifying recessions. According to the econo-geeks at the National Bureau of Economic Research, a recession is defined as a "significant decline in economic activity spread across the economy, lasting more than a few months." Here's their specific language:
'Most of the recessions identified by our procedures do consist of two
or more quarters of declining real GDP, but not all of them. Our
procedure differs from the two-quarter rule in a number of ways. First,
we consider the depth as well as the duration of the decline in
economic activity. Recall that our definition includes the phrase, 'a
significant decline in economic activity.' Second, we use a broader
array of indicators than just real GDP. One reason for this is that the
GDP data are subject to considerable revision. Third, we use monthly
indicators to arrive at a monthly chronology.'"
"Hence, if we
follow what the people who actually determine what is and isn't a
recession say about the matter, and not just limit our analysis to GDP,
then it's pretty clear we are now experiencing an economic contraction."
(inflation-adjusted) retail sales have been flat for the last six
months. Incomes are stagnant. Consumer spending is showing every sign
of slowing even more. Unemployment is rising (see more below). Consumer
sentiment is at 25-year lows. You can count on it that the NBER will
show a recession starting the fourth quarter of last year and
continuing at the least through the first quarter of this year. This
one could last another six months. I still think long and shallow with
a very slow recovery.
One last point. The US population grows by
about 1% a year. Thus economic growth should increase by at least 1%
for the US to stay even on a per capita basis. Thus, at least with
regard to GDP per capita, the US is definitely in a recession. And if
you use real-world inflation data, we are also in a mild recession.
Honey, I Blew up the Employment Numbers
readers know the problems I have demonstrated with the monthly
employment report. It is one of the most revised reports released by
any government agency, and for some reason the market seems to react to
it like it means something immediate.
Let's take today's release.
It showed a drop of only 20,000 jobs, well above the more negative
consensus. The market immediately rallied, taking the thought that the
economy may be on its way to recovery. But when you look at the
numbers, that optimism evaporates.
The birth/death ratio is the
BLS's attempt to figure out how many jobs were created by small
businesses that do not show up in their survey of established
businesses. It is a simple estimate based on past trends. You have to
have this estimate to have any hope of getting the actual number right.
And most of the time, the estimates are pretty good. Over time the
numbers are revised and in a few years will be pretty close. But in
times when the economy is slowing down, the birth/death ratio tends to
overstate job growth because the trend is backward-looking. This
month's birth/death number was particularly egregious.
whatever statistical reason, has shown the highest number of
birth/death jobs for any month. In 2007, the BLS estimated that 262,000
were created in April that they could not account for in the survey of
businesses. Somehow, the spreadsheets at BLS had them add 267,000 jobs
in April of 2008. That number includes an estimated 45,000 new jobs in
construction! And this in a time when both residential and commercial
construction are contracting. The actual survey results showed that
construction jobs fell by 61,000.
And somewhere, they estimate
that 8,000 new jobs in finance were created. As Philippa Dunne notes:
"It may be that the gains in our old friend, bars and restaurants, are
the [birth/death] model's creation; it added 83,000 to the leisure and
hospitality sector. With vacation plans at near-record lows, and
restaurants reporting reduced traffic, many of these job gains could
disappear in the next benchmark revision."
Without that addition
from the birth/death number, total private employment would have
dropped by 296,000. Now, if that had been the headline number, the
market would have tanked. Now, I have no doubt that the economy did
create a lot of new jobs last month. But when the final revisions are
in, we will see that job losses were well south of 100,000. If memory
serves me correctly, the BLS had to add about 800,000 jobs that they
missed during the recovery in 2003-4. (The birth/death model misses job
growth during recoveries, the opposite result of the miss in slowing
periods.) They did this just last year, in a major revision of the
data. We will see the same type of revisions in 2010, only this time it
will be downward.
And even the BLS says that the birth/death
numbers have little statistical meaning. The following is from their
own website (courtesy of Dennis Gartman) [emphasis obviously mine]:
factors are a component of the not seasonally adjusted estimate and
therefore are not directly comparable to the seasonally adjusted
monthly changes. Instead, the birth/death factor should be assessed in
the context of its effect on the not seasonally adjusted estimate... The components are not seasonally adjusted separately because they do not have particular economic meaning in and of themselves."
supposedly dropped last month by 0.1%, to 5%. How could a loss of jobs
mean a rise in employment? Because the statistics mask a rather
disturbing trend. The number of people working part-time is rising
rapidly, and they are counted as employed. Again, From Philippa Dunne
of The Liscio Report:
"Almost 3/4 of the gain in
non-agricultural household employment [from the household survey] came
from those working part-time for economic reasons, and another 83% came
from what used to be called 'willing' part-timers. Yes, that adds to
more than 100% -- 154% to be precise -- because fulltime employment
declined by 375,000. The increase in those working part-time for
economic reasons was at the 93rd percentile of all months since the
series began in 1955; the decline in fulltime employment was at the
This employment report was ugly, when you look
at the numbers under the headline statistics. It is no wonder consumer
sentiment is down.
A Black Swan in Food
Coxe, chief strategist of Harris Investment Management and one of my
favorite analysts, spoke at my recent Strategic Investment Conference.
He shared a statistic that has given me pause for concern as I watch
food prices shoot up all over the world.
North America has
experienced great weather for the last 18 consecutive years, which,
combined with other improvements in agriculture, has resulted in
abundant crops. According to Don, you have to go back 800 years to find
a period of such favorable weather for so long a time.
stocks in corn, wheat, rice, etc. are dangerously low. We are just one
bad weather season from a potential worldwide food disaster. And Dennis
Gartman has been pointing out almost daily how far behind US farmers
are in getting their corn crops planted, due to bad weather:
the corn crop really is behind schedule. Corn is not like wheat. Wheat
can survive drought; it can survive cold; wheat, as we were taught by
our mentor, Mr. Melvin Ford, many years ago, is a weed. It is an
amazing, resilient plant. But corn is temperamental; it needs rain when
it needs rain; it needs dry conditions when it needs dry conditions. It
needs to not be hit by early season frost, or it will suffer, and it
needs a rather archly set number of days to grow. Each day lost at the
front end of the planting/growing season puts pressure upon the corn
plant to finish its job before the autumn frosts, and puts increased
soybean acreage and decreased corn acreage before us.
of the Midwest this morning have it raining once again, with more rain
likely over the weekend. There will be some field work done in some
areas, of course, but the several straight days of corn planting that
everyone had hoped for simply are not going to take place. The ethanol
mandates may be in jeopardy in the long run, but in the short run, this
year's corn crop is swiftly becoming problematic ... and short."
had a note from a reader relating the experience of a member of his
family. The gentleman runs a rather large feed lot in West Texas. He is
running half the cattle he normally does, as he is losing money on
every head he sells. Ranchers are reducing their herds, as they cannot
afford to feed them due to high grain prices.
The same thing is
happening with chickens. Producers are losing money on every chicken
they sell, and they have to reduce inventories; thus meat of all types
has not risen as much as the cost of producing it.
sometime this fall supplies of meat of all types are going to be
reduced, but demand will not. And that means that meat prices have the
potential to rise substantially during an election season. Maybe
someone will point out that using corn to produce ethanol has the
unwanted and unintended consequence of driving up food prices all over
the world. It is not the sole source, but it is significant.
when we finally experience a year of bad weather (whether too much rain
or too little, too cold or too hot, it will be blamed on global
warming), food supplies and prices are going to skyrocket. And a
developing world will not look kindly on the US and Europe's use of
food for fuel when so many are starving. Don says that this is not a
matter of if, but when.
Housing Numbers Are Better Than I Wrote
I just flat out get things wrong. And last week I blew it. William
Helman, among others, pointed out to me that the 974,000 new-home
construction number I used includes multi-family dwellings as well. I
knew that, and just forgot. So, let me let William give you the real
"I am a loyal reader and I enjoy your weekly letters. Now
and then there is an interpretation of the data that I fail to agree
with. The letter of April 26, 2008 is a case in point.
section headed 'If You Are in a Hole, Stop Digging' you state that the
building industry is building over 400,000 more homes than they are
selling. You infer this by subtraction new home sales (single-family)
for March of 526,000 from housing starts for the month of 947,000.
you should note that single-family housing starts for March were
680,000 (annual rate) and 267,000 (annual rate) were multi-family, or
apartments/condos, thus totaling 947,000. The comparison with home
sales, which are single-family home sales, should be with single family
"Second, single-family home sales exclude the
construction of single-family homes by owners -- persons who buy a lot
and contract to have a house built on the lot to live in and not to
When you subtract out apparent construction of homes by
owners and not builders, William presents data that suggests builders
are building less than they are selling, which would make sense.
However, when we consider the apparent inventory of existing homes for
sale along with newly constructed homes, there is a very large excess
supply. That suggests that the excess supply of single-family homes on
the market, relative to past norms, is between one and 1.5 million
units. This is equal to about one year of 'trend' single-family home
production. At the current rate of new single-family home construction
(a 680,000 annual rate, or about 400,000 to 500,000 below 'trend
demand'), it would take at least two years and possibly three years or
more to work off the excess.
"Of course there is a lot of
uncertainty in trying to estimate future home construction in this way.
The demand and the supply are not necessarily, and probably not, at the
same places. Thus some of the inventory may remain in excess for a much
extended period, while in other places the excess may become exhausted
quickly, thus spurring increased new construction more quickly.
balance it seems clear that housing starts are likely to remain subdued
and well below trend for an extended period. But this is because of the
large inventory of new and existing homes for sale. It is not, as you
indicated, because builders are currently building more homes than they
are selling. Builders are building less than they are selling. Still,
this is not to say that sales will not decline further, causing an even
further decline of starts before leveling or beginning a gradual
I stand corrected.
South Africa, Canada, and La Jolla
leave for South Africa tomorrow morning. While not looking forward to
the 16-hour flight (plus the flight to Dulles and a long layover), I am
really looking forward to once again being in the country. Cape Town
gets my vote for the most beautiful city in the world. I have never
been to Sun City Resorts, but I hear they are magnificent. I will get
to spend a few days there at a conference where I will be speaking. As
always, partner Prieur du Plessis makes sure my week is packed, but I
will sneak in some time for a few game runs and some sight-seeing. If
you want to attend one of my presentations, just drop a note to Prieur
I get back from South Africa, I will head out the next Monday for a
quick trip to La Jolla to meet with my partners at Altegris Investments
and Thomas Fischer of Jyske Bank, and then back the next day. And it
seems that in the second week of June I will be traveling with my
daughter Tiffani in Canada, crisscrossing the country starting in
Vancouver. I will end up in Montreal where I will speak for my friends
at Canaccord. But what a pleasant time of the year to do so. There is
just so much opportunity that I feel I simply must take the time and
travel needed to develop it. And that is, as they say, a good thing. I
am a very happy man and realize how blessed I am.
And speaking of travel, International Living remains one of my very favorite newletters. You can get your own subscription by going to their website.
am going to hit the send button, as my young son wants to see me before
I get away. I think Iron Man is in our future. And maybe a visit to the
Have a great week!
Your looking forward to South African wines and lions analyst,
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