The guest commentary below was written by written by Mitchel Krause. This piece does not necessarily reflect the opinions of Hedgeye.
“Der Teufel steckt im Detail.”
While nearly impossible to pinpoint with 100% accuracy its origin, historians suggest it was the controversial German philosopher and poet Friedrich Wilhelm Nietzsche (1844 - 1900) who uttered the above phrase in the late 1880s … most likely a variation of French novelist, Gustave Flaubert’s (1821 – 1880), "Le bon Dieu est dans le detail" … or "the good God is in the detail"!
Conjecture or not, you’ve all heard this quote at some point in time over the course of your lives: “The devil is in the details!”
It’s a phrase from which so many other phrases are derived; think the ROOT that so many other branches grow from. Consider:
- The smallest of things often make the largest of differences.
- Little things matter the most.
- At times, slower is faster.
There are just so many variations of the phase, yet at its core, they boil down to saying the same thing: pay attention to ALL of the details!
Month in and out, we make all efforts to pay attention to the details the majority overlook. Our time is spent sifting through, analyzing and subsequently presenting our readers with as much of the data as we can.
At the same time, we also do our best to do it in a way as to where we’re showing you what’s under the hood of the car rather than just showing you a blemish free body and a shiny coat of paint. Plenty of cars can be dent free and shine, but did you take the time to see if the check engine light is on possibly revealing a bad catalytic converter? Did you drive the car? Did the transmission fluid temp move through 205° reaching 220°, suggesting you’re about to lose your transmission at any second?
While that shiny vehicle may have some life left in it, details like these suggest it will most likely become an extremely costly endeavor in the VERY near future; this analogy holds true when investing. This is why we present the data in a way that not only shows you the rate of change directionality, but also how the numbers are derived.
Early warning indicators do exist and are extremely important!
Looking Under the Hood
On the surface, labor markets are tight. With the unemployment rate near historical lows (cough) – most recently ticking down to 3.5% from May’s 3.6% – life is good in the eyes of the Fed! The labor force participation is hovering around 62.6% given July’s Non-Farm Payrolls coming in at +187K and the slight miss on expectations, which sat at the +200k level did, in fact, equate to an acceleration off of June’s +185K print (cough … cough).
We’ve been writing about the distortions in labor markets for well over 18 months now, screaming “Labor is the latest of late cycle indicators”; that by the time the Fed (or most anyone else for that matter) acknowledges we’re in a “recession,” the reality is that we’ve, most likely, already been in one for some time.
There is a reason why we not only focus on the data, but the details within. It’s why we’ve remained consistent in citing the weakness and deterioration in data despite headline numbers "beating expectations."
"My critiques of the Birth/Death model for payrolls is well known, but suffice it to say that we know it does a terrible job at economic turning points due to its use of a trailing trend (ARIMA) approach. This maximizes estimates of jobs created by net firm births at precisely the point the economy is entering a recession. Post-pandemic estimates of the proportion of jobs coming from new businesses being created are the highest in history. Fodder for future downward revisions."
What is the Birth/Death model one might ask? Statistics!
Per the BLS: “(The) Birth-death adjustment is an adjustment made to survey-based estimates to account for the net effect of businesses opening and going out of business … “They are model-based estimates. They are based on the history of business births and deaths as observed in the Quarterly Census of Employment and Wages (QCEW).”
Also, per the BLS: “Birth/Death forecasts are NOT seasonally adjusted … they are calculated using population data that is not seasonally adjusted, and the forecasts are applied to the sample-based not seasonally adjusted estimates. Months with generally strong seasonal increases such as April, May, and June generally have a relatively large positive forecast.”
In these two quotes directly from the BLS, we learn the Birth/Death model is a “guesstimate,” basically allowing them to adjust or “play with” the raw data. Stated slightly differently … “lie with statistics.”
With that in mind, not only have Non-Farm Payrolls for both May and June been revised LOWER by roughly 25K jobs respectively; per the most recent BLS report:
“The change in total nonfarm payroll employment for May was revised down by 25,000, from +306,000 to +281,000, and the change for June was revised down by 24,000, from +209,000 to +185,000. With these revisions, employment in May and June combined is 49,000 lower than previously reported.”
So, when one starts to get a bit more granular, sifting through the data via a different lens, and not just focus on the headline number, a MUCH different story begins to unfold.
These downward revisions are taking place at the same time the Birth/Death adjustment for July juiced numbers significantly higher by +280k new jobs; this being the second largest Birth/Death adjustment to be reported in 2023 (remember, that whole, fairly important: non-seasonally adjusted numbers with generally strong seasonal increases) … like the months they’re currently reporting?!
Consider, all these new jobs the BLS arbitrarily claims are being created, coming at the hands of recently “birthed” businesses, as both personal and corporate bankruptcies are accelerating at their fastest pace in nearly 13 years (2010); a time when businesses were still in recovery from the Great Financial Crisis.
When considering the "positive" headline data vs. the underlying trending data (which is stark), it might just lead those who peak under the hood of the vehicle to wonder … what’s going on? Is it intentional? Malicious?!
It’s the granularity of the data that leads us to early warning signals and the importance of such data as it relates to labor markets cannot be overstated.
In the end, those who are most “shocked” when things come crashing down are those who most often overlook the details. They lack patience and most often believe that price action dictates where we are in the economic cycle. Markets ebb and flow within cycles, but it doesn’t mean the cycle is over and all is clear when the structure and mechanics of markets temporarily rally them.
Do yourselves a favor, don’t take short cuts. Engulf yourselves in the details or work with someone who does. “Wir sind der Meinung dass Sie uns am Ende danken werden!” (It’s our opinion that you’ll thank us in the end!)
Click here to read Mitchel's note in its entirety on the Other Side Asset Management website.
This is a Hedgeye guest contributor piece written by Mitchel Krause and reposted from his most recent monthly report. Krause is an industry veteran of nearly 28 years, where he’s seen the industry from the inside out. Nearly a decade of private wealth service, followed by just under seven years with an institutional group focused on banks and thrift stocks. He’s been managing discretionary money since 2015. His career began at, Ryan, Beck & Company in 1996, a boutique firm specializing in financials and municipal bonds, which was later bought by Stifel Financial Corp in 2007. He opened the doors to Other Side Asset Management in 2018 in an effort to tell the “other side” of the investing story to those willing to listen. He continues to manage discretionary assets while publishing these notes monthly. His archives are open to the public. Currently, he both works and resides in Raleigh, North Carolina.
Twitter handle: @OtherSide_AM
LinkedIn: Mitchel Krause