Rebel Traders – Analysis Without The Hype

Unemployment statistics are flawed.

What have I been saying ever sine the recession began, the Bureau of Labor Statistics use of the “birth/death” model is flawed. To adjust the monthly jobs data by a number which is computed from a ‘model’ of how many businesses were created and how many closed up during any given month is simply asking for trouble in maintaining any sense of accuracy.

The main purpose of the birth/death model is an attempt to offset the jobs data by what the BLS believes to be happening in the real world, the only problem is that the model relies on assumptions. And assumptions are worthless in an economic collapse.

When the Government releases Friday’s employment report, nearly a million jobs could be erased. The change won’t show up in the monthly report. Rather, the expected drop will show up in the government’s revised job losses from April 2008 to March 2009, showing the labor market was in much worse shape than we knew at the time.[…]

Blame the birth/death model for the revision. Built on years of research, the model’s key assumption is fairly simple: most of the time jobs created at new companies make up for losses at companies that close. In October, Keith Hall, Commissioner of the Bureau of Labor Statistics, said most of the coming revision “appears to be due in part to an increase in the number of business closings,” short-circuiting the model’s assumption that deaths are offset by births.[…]

The Labor Department says there are flaws in its models and its monthly employment survey but it defends the process, saying the annual employment revisions are small and stable. […] (Source: Bloomberg)

Small and stable? I don’t think a calculation error of 800,000 to 1 million additional job losses is ‘small and stable’.

The birth/death model should be shelved, permanently.

As I stated in a previous market update video several weeks ago; it would not surprise me if the December 4th unemployment data notched back down to 10.0%. Well I was correct, the unemployment report released this morning put the official unemployment rate at 10.0% which is down from 10.2% last month.

The number of job losses reported in this data was the lowest of the year thus far (- 11,000 ), although the U-6 unemployment data (17.2%) is still at historic levels.

The reasoning behind my statement of not being surprised if the unemployment data dropped a notch in today’s report is extremely simple. The nation needs to feel better about the economy at the most important time of the year; the holiday shopping period. With November comps already pointing to weaker sales, and the outlook for the remainder of the holiday shopping season projected to be even worse than in 2008 something had to be done to save Christmas.The nation needed a confidence booster so people will open up their wallets and purse strings.

The Bureau of Labor Statistics (BLS) uses the black box ‘birth/death’ adjustment each month to alter upward or downward the actual data by an estimate of the number of businesses that have been newly opened or ones that have died. This birth/death adjustment for November was a net add of 30,000, and estimation that the BLS believes more businesses were opened vs. were closed in the previous month.

The birth/death adjustment is based in part on previous business trends and not as estimation of current realities. If you have been a long time reader of this site then you already are aware of the birth/death model as it has been discussed in great detail. The application of any black box modeling data that offsets the actual data remains a major issue for us who follow the employment situation closely. It remains my view that the BLS birth/death table is still extremely over optimistic and the real data will not be reflected for some time to come.

This mornings report is still missing the 824,000 benchmark revision that had been previously announced by the BLS. The benchmark revision; when applied, will increase the unemployment rate as the 824,000 revision is a negative number. At this time it appears that the benchmark revisions will not appear in the data until the release scheduled for February 5, 2010.

Reasons for having little faith in the birth/death model accuracy are many, such as the still rising corporate bankruptcy rate, credit contraction for main street businesses and consumers, and leading economic confidence data. The leading indicator of small business confidence dropped 13.6% from just last month.

Economic confidence among America’s small business owners plummeted in November, as more owners cited serious concerns about cash flow and saw economic conditions for their own businesses getting worse. The Discover Small Business Watch index fell 12 points in November to 76.5 from 88.5 in October. [...]

[...]

• 52 percent of owners say they have experienced cash flow issues in the past 90 days, up from 44 percent in October. Forty-one percent of owners say they have not experienced cash flow issues, which is the lowest response in this category since the Watch began. The remaining 6 percent said they weren’t sure.
• 53 percent of small business owners see conditions getting worse in the next six months, up from 43 percent in October; while 19 percent report that conditions are improving, a sharp decline from 29 percent in October; 23 percent see conditions as the same, and 5 percent weren’t sure.
• 62 percent of small business owners rate the economy as poor, an increase from 55 percent in October; 30 percent rate it as fair, and 8 percent say it is good or excellent. (Source: Discover Market Watch)

[...]

If business owners are more pessimistic about the future then they will not be hiring any time soon. Even large companies will be facing more layoffs in the future. Take for example the situation facing large (and small) utility companies as the winter arrives and the ‘no cut off’ rules go into effect. Utility companies are facing the same crisis as the banks and credit card companies with delinquent or non payment on accounts due to the extremely high unemployment rate and credit contraction.

In the winter months many utility companies have policies in place that forbids them from cutting off gas and electricity due to the cold even when the account is delinquent or has not paid at all. As such, the utility companies will be eating the cost of providing services while revenue intake declines and as such staff reductions will be forthcoming to adjust for those imbalances.

I will have more over the weekend on the market reaction to today’s data and what may be in store for next week.

BTE (Better Than Expected) has been the norm these last times… Pushing the market always higher. Now, how about some WTE (Worse Than Expected)?

The earnings of BAC and of GE this morning have left some bitter taste for the bulls as BAC pulled up a huge loss and GE did not perform as well as could have been expected. Now it would appear that the “real” unemployment numbers have been actually worse than reported as the BLS (Bureau of Labor Statistics) announced it would have to revise the numbers downward because of issues with the “birth/death model”…

It is not useless to recall that Chuck pointed out several times in his videos the issues with this “model” to explain those BTE employment numbers.

The Bureau of Labor Statistics (BLS) recently announced that they will be making downward benchmark revisions to past monthly nonfarm employment data that casts doubt on the validity of the recent figures as well. As we will explain, it is highly likely that substantially more jobs are now being lost than is currently reported.

The BLS makes annual revisions to the previously announced payroll reports to account for job increases or decreases that were not picked up in the initial data.  The main reason for the differences in the preliminary and final reports is the difficulty in getting numbers from the many small and medium sized business and accounting for new startups and firms going out of business.  To make an educated guess at the data that they are missing, the BLS uses something called the ARIMA time series model (commonly called the birth/death model) to estimate employment changes resulting from business births and deaths that are not accounted for by other methods.  The model is based on the actual births and deaths over the five prior years.

As you can imagine, when the prior five years encompassed a period of economic expansion, the application of these numbers to a period of recession can result in a substantial overestimation of job changes, and that is evidently what happened recently.  The BLS candidly acknowledges this and states that it is “likely to have some difficulty producing reliable estimates at economic turning points or during periods when there are sudden changes in trend.”

In the current instance the BLS announced that preliminary tabulations indicated they would have to reduce the estimate of total nonfarm employment by about 824,000 for the year ended March 31, 2009.  On average, therefore, the net change in payrolls for the period was overstated by about 68,000 per month.  Interestingly enough, the birth/death adjustment had added about 717,000 jobs during the same period.  So it’s apparent that the benchmark revision will more than wipe out the entire amount added by the model.

What does this mean for the period following March 31, 2009, which will not be revised until next October?  For the six months since March 31^st the birth/death adjustment has added 815,000 jobs, an average of 135,000 per month.  Since small and medium sized firms are suffering from severe credit restrictions, they are much more likely to have reduced employment significantly rather to have added that many jobs.  That means current monthly job losses may be running as much as 135,000 higher than is currently being reported.  While we won’t know the true number for another year, those being laid off will know, and they will be reducing their spending accordingly.  The Fed certainly knows what’s happening and that’s one reason they are promising near-zero interest rates indefinitely.

When we combine the weak job numbers with declining wages, tight credit, record household debt and the impending explosion of home foreclosures, the chances of a sustainable economic recovery looks exceedingly slim.  Yet, for the third time in this decade the stock market is off on another binge not based on reality.  Such flights into fantasy always end badly.