Wednesday, June 20, 2012

Separating Fact from Fiction in Rhode Island's Labor Market Data

This is an article I wrote several weeks ago that the ProJo chose not to publish in its printed edition.

I've always admired weather forecasters. Whenever they want to know precisely what the current conditions are, all they have to do is look out the window. Things aren't quite that simple for economists. A great deal of the data we use is survey based. And, predictably, survey data are often revised, occasionally in ways that tell a very different story than what the originally released data showed.

This is the case Rhode Island right now. After my March Current Conditions Index report release, which showed that based on the existing data Rhode Island was flirting with the double-dip recession, I was informed by the Rhode Island Department of Labor and Training (DLT) that the likely upcoming revisions to their data will tell a strikingly different story. Instead of seven or eight months of consecutively declining employment, the upcoming data revisions apparently show that employment actually rose throughout that time period. What they did not say, but that is every bit as important, is that if employment has actually been rising, a number of other key indicators will also be affected, not the least of which is our state's unemployment rate.

Some of this was apparently discussed at the recent Revenue Estimating Conference and reported by the local media. However, with the release of the April labor market data, we only heard about the existing labor market data, which we now know is faulty. Whenever anyone turned on their television or read the local newspapers, they were told that Rhode Island's unemployment rate rose to 11.2 percent as employment fell yet again.

What an extraordinary time! I honestly can't remember ever being informed this close to the most recent rebenchmarking (data revisions) that such dramatic changes were coming. This placed the local media in quite a predicament, as they chose to report the April data as released by the DLT even though, as I pointed out to a number of them, we shouldn't put very much confidence in that data or the obvious conclusions that emerge from analyzing it.

So, at this point it is appropriate to quote the character Emily Litella of Saturday Night Live fame concerning Rhode Island’s large number of employment declines and the increase in our unemployment rate above 11 percent: Never Mind!

The origin of the situation we now find ourselves in is the result of cost cutting at the US Bureau of Labor Statistics (BLS). Soon, it will be taking over the task of producing the monthly employment numbers that was historically done by our DLT (this is also true for all other states). While this may well lower costs, its greatest cost to the people of Rhode Island will be the loss of all the experience and expertise of our DLT possesses. Furthermore, the way the BLS will produce their estimated labor market values will not incorporate as much known data as the DLT has in the past. Instead of beginning projections after the third quarter of the prior year, the BLS will start after the second quarter. Furthermore, and more troubling, Rhode Island will apparently be homogenized. By this I mean that exceptional circumstances or events that would routinely be analyzed and meaningfully incorporated into the labor market data by our DLT will now often be ignored by the BLS. As Rhode Island has an extremely idiosyncratic economy, this homogenization will make our state’s labor market performance appear to be very different from what it actually is at times. Ironically, the most obvious impact of this homogenization will be to make Rhode Island appear to more closely resemble overall US economy. If you don’t believe that, take one look at what the BLS has done with their estimation of our state’s manufacturing wage (especially look at the charts after Read More ...)!

Because of these extraordinary circumstances, I found it necessary to build a small econometric model of Rhode Island’s labor market in order to estimate and simulate various labor market indicators. According to my model, payroll employment has not been consecutively declining, as the existing data show, but is in a mild uptrend. At the Revenue Estimating Conference, the DLT offered tentative projections of where they believed payroll employment might be as of March. My model produces slightly more optimistic numbers. As of April, my estimate of payroll employment is slightly above 462,000, which is higher than the official April value of around 458,000. Instead of having eight consecutive employment declines in the last nine months, as indicated by the current DLT data, my model shows consecutive increases for seven of the past eight months, although not necessarily by large amounts. Along with this, my estimate of the April unemployment rate shows it declining to 10.7 percent, not rising to 11.2 percent. Even though my estimated jobless rate may appear to be “better” than the DLT’s official value, its foundations are less than flattering -- it is accompanied by declines in both our labor force and resident employment.

The current divergences in labor market data are not the fault of our state’s DLT, but the result of something forced upon them by the federal government -- a different methodology. While I continue to have the utmost faith in our state’s DLT, I am very irritated by the apparent attempt to politicize our state’s jobless numbers by the DLT’s spokesperson, Laura Hart. She recently offered an utterly ridiculous explanation as to why our state’s jobless rate is so high -- Rhode Island doesn’t have the economies of scale that states like Massachusetts have. If her hypothesis were correct, Delaware, another small state, would have a very high jobless rate, while California, an extremely large state, would have a very low jobless rate. For April, Delaware had a 6.8 percent jobless rate while that for California was 10.9 percent.

It’s bad enough that the diverging data exists. Having DLT’s spokesperson offer such ad hoc rationalizations only makes things worse.

Tuesday, June 12, 2012

Current Conditions Index Report: April 2012

This is an abbreviated version of my Current Conditions Index report for April (it excludes tables and The Bottom Line). I you want to read the full version, please go to my web site: .

Analyzing and forecasting an economy has always been part science and part art. In light of the situation Rhode Island currently finds itself in, based on the likelihood that the “official” labor market data for this state is inaccurate, I guess you can add navigating through fact versus fiction to the above list. 

Since existing labor market data are very likely understating two CCI indicators, Private Service Producing Employment and Employment Service Jobs, and overstating one other, the Unemployment Rate, I will now be providing two CCI estimates each month as the likely range for the CCI. This will continue until the flawed data disappears, hopefully next February.

So, in spite of what you continue to hear in this state, payroll employment has not fallen for eight consecutive months. Nor is Rhode Island close to a double-dip recession. Interestingly, though, with that many alleged consecutive drops in employment, why haven’t those analysts who believe the currently released labor market data actually made the recession call? I had avoided doing that prior to the revelation of the flawed labor market data, since the Current Conditions Index failed then, as it continues now, to show the requisite signal for a recession: six or more consecutive values in the contraction range of below 50.

With all of this in mind, Rhode Island entered the second quarter of 2012 on a positive note, as its re-acceleration from the mid-2011 doldrums continued. In spite of the fact that Current Conditions Index values based on the faulty existing labor market data (upper values) continue to show readings barely above stall speed, allowing for likely data revisions, the CCI has moved into the range of 67—75 throughout this entire year. This should not be construed as indicating that this recent acceleration is particularly rapid. Rhode Island continues to find itself in a sluggish recovery. It is the persistence of these higher CCI values that matters the most for now. We have moved above stall speed. As of April, Rhode Island’s recovery reached its 26th month.

On a year-over-year basis, four of the five non-survey-based CCI indicators improved. Only three of the five showed improvement on a monthly basis, though — something for us to keep an eye on. Retail Sales increased by 1.6 percent, its eighth consecutive improvement compared to year-earlier values. Part of this is no doubt related to the skilled Rhode Islanders we rent out to neighboring states who bring their income home with them from states whose jobless rates we can only fantasize about here. Clearly, though, Retail Sales momentum is continuing. Along with this, US Consumer Sentiment rose as well, by 9.2 percent. For both of these indicators, April values exceeded their March levels. New home construction, based on Single-Unit Permits, continued its roller coaster ride, rising by 7.5 percent in April relative to last year. It too rose relative to March. New Claims for Unemployment Insurance, a leading labor market indicator that reflects layoffs, declined by 8.8 percent, its fifth improvement in the last six months. Finally, Benefit Exhaustions, reflective of longer-term unemployment, failed to improve for the first time in almost a year.

Friday, June 1, 2012

A Crash Course in Making Sense of the Stock Market: Part 1

Today, the May labor market data for the US were released. The stock market tanked, continuing a strong downtrend that has persisted for a few weeks now. How can you make sense of what is happening now or what might occur in the future? First, let me recommend a very well written and readable book about following the stock market: Fire Your Stock Analyst (2nd ed.) by Harry Domash. I also have a link on my web page with numerous references about the the stock market: .

To start with, let me outline an important principle about the stock market's performance:

Principle #1: Over the long term, the primary determinant of stock price movements is the expectation of future profits.

Of course, in the short-term, emotion and a host of other factors may dominate stock price movements. I don't recommend that you attempt to anticipate very short-term movements.

You are no doubt already aware of the fact that in a global economy, the performance of US corporations is not immune to events overseas, since many US corporations receive a substantial portion of their revenues and profits from overseas operations. Thus, the macro performances of Europe and Asia have a major bearing on what will likely happen to future US corporate profits. We know that Europe is now in a recession and Asian growth has slowed. Add to this a very disappointing US employment report for May, and there have been lots of negatives already factored into profit expectations, which have been much of the driving force behind the recent stock market declines.

The real question, though, is what will happen to growth and profit from here? This brings me to a second principle:

Principle #2: Because the expectation of future profits tends to be the driving force underlying stock market prices, stock price changes tend to occur before (lead) changes that will ultimately occur in the overall economy. Based on this, the stock market is called a leading economic indicator.

The recent decline in the stock market therefore indicates the expectation that the rate of growth of the US economy will slow further in the coming months. One should be careful not to make too much of this, however, since, as the old saying goes, "The stock market has predicted eleven of the last six recessions." Indeed, the stock market tends to do a better job of predicting upticks in economic activity than downturns. So, I do NOT recommend that you use the stock market's behavior as the basis for predicting if a recession is coming.

Since we now live in a truly global economy, to truly understand what is happening in the stock market, or what may occur in the future, it is necessary to look beyond stocks.

Principle #3: Different types of markets are linked (interrelated), so that clues for future changes in the stock market can often be gleaned by observing what is happening in those other markets. This is called intermarket analysis. You should follow at least the stock market, the bond market (for interest rates), and commodity prices. Currency markets also matter as well.

The stock, bond, and currency markets are all leading economic indicators. Commodity prices, however, tend to lag. I will focus on the bond market here.

Interest rates are determined in the bond market. Bonds, if you are not up on these, are debt obligations. The entity issuing the bond  (ex: government, corporation, etc.) wishes to borrow money for some purpose. So they issue bonds, which in exchange for the money they receive from the bond investor, pay a fixed amount of nominal income over their term. There is a bond value, let's say $1,000, a stated interest rate, say 3%, and a term until the bond matures, lets assume 10 years. So, for when this bond is newly issued, you pay the $1,000. In return you receive a fixed income stream of $30 per year (the stated interest rate times the bond value = .03x$1,000) every year until the bond matures, then you receive the $1,000 back when the bond matures. Because bonds pay fixed amounts of income, these are called fixed income assets. Furthermore, the income is a nominal value. So, the greatest threat to bond holders is inflation, which lowers the real, or inflation-adjusted value, of the bond's fixed income.

Principle #4: Anything that raises actual or expected inflation makes bonds less attractive, since their fixed income then has a lower real (i.e., inflation adjusted) value.

As bonds are often sold before they mature (in secondary markets), higher expected inflation leads to some combination of lower bond demand (fewer buyers), and greater supply as some bondholders wish to unload their existing bonds. Both cause bond prices to fall in what is called a bond market sell-off.

The interesting thing concerns what causes expected inflation to rise. Generally, this is the expectation of more rapid economic growth.

Principle #5: Good economic news, which signals the likelihood of more rapid future growth, leads to higher expected inflation, which results in a bond market sell-off and lower bond prices.

Principle #51/2: Bad economic news, like the discouraging employment report today, signals the likelihood of slower future growth, which lowers expected future inflation, causing a bond market rally and higher bond prices.

These principles take a while to get used to: bonds tend to do well with bad economic news and the prospects for a weak economy. For this reason, bonds are referred to as a recession hedge.

Principle #6: When bad economic news occurs and expected growth falls (like today), the stock market sells off (due to lower expected future profits) while the bond market rallies (based on the expectation of higher real income from holding bonds). Money thus moves from stocks to bonds. This is called a flight to safety.

The stock market weakness over the past several weeks has therefore been a flight to safety. You are no doubt aware that the stock market has been declining. And, I will guess, you probably think there is no way to make money when the stock market is declining. WRONG!!! The bond market has been rallying.

Below is a chart of stock prices (the Dow-Jones Industrial Average) and bond prices (the 10-year US Government Bond Price) which illustrates what a flight to safety has looked like (click to enlarge).

Let me conclude by noting a principle I use all the time: which market changed direction first? Both stocks and bonds are leading economic indicators, but bonds have a longer lead time. In the next installment, I will discuss how to use changes in interest rates to help predict future stock price changes.