Tech: Back In Action

Technology (XLK) moved back into bullish formation today after being dragged down in large part by Apple (AAPL) over the past few months. It's only up +8.0% year-to-date, compared with the S&P 500 and Healthcare (XLV), which are up +13.4% and 19.8%, respectively. Still, the switch back into bullish formation is a welcome surprise for investors. After today's non-farm payroll numbers, the market is soaring like nobody's business and taking XLK along for the ride.


Tech: Back In Action - XLKtechytd

Will We See 6.5% Unemployment in 2013?

Takeaway: Editor's Note: No one saw a 6-handle move in the unemployment rate coming back in January except us. Here's our highlight from January 23rd.

This note was originally published January 23, 2013 at 14:05 in Macro

As global macro data continues to confirm that growth is stabilizing, we’ve been discussing the possibility of seeing a 6-handle in the unemployment rate in 2013.   With Bernanke offering an explicit employment target of 6.5% for a cessation in QE initiatives, a significant decline in unemployment over the NTM may augur higher yields as the bond market attempts to front-run a prospective Fed exit.  


With market expectations for rates likely to follow the slope in unemployment rather than the actual realization of a 6.5% unemployment rate, we attempted to put some math around how the principal variables driving the Unemployment rate would have to trend for Unemployment to breach the 7% threshold over the next twelve months.  Below we include a quick review of the variables driving the unemployment rate, the summary conclusions, and some other considerations as it relates to the go forward dynamics likely to directionally impact unemployment.   


Of course, Bernanke could effectively hold the exit timeline hostage by again changing the rules mid-game and attaching conditions that a the sub-6.5% unemployment rate be accompanied by a “normalized Labor Force Participation Rate” or a “sustained, negligible output gap”.  We’ve ignored this potentiality here as its largely unmodelable and because the bond market could well move ahead of the Federal Reserve realizing their growth forecast batting average isn’t going to improve from 0%.  


Note that rather than attempting to provide an explicit year-end or 7% unemployment target date, the broader goal of this risk management exercise is to frame up the variable dynamics and quantify the magnitude of change in the relevant unemployment rate drivers necessary to take unemployment below 7.0% and towards 6.5% over the NTM.  Certainly, any number of variable assumptions and scenario iterations can be contemplated.  If you’d like to observe the impact of your own growth and participation rate assumptions on the unemployment rate timeline you can link to the associated model here >> Unemployment Rate Variable Analysis_HEDGEYE



UNEMPLOYMENT 101 - THE VARIABLES:  Below is a summary review of the variables that drive the unemployment rate.  Here, we’ve broken them down into the Input and the Dependent variables based on how we model them.   


Independent/Input Variable Description:

  1. Civilian Non-institutional Population Growth (CNP): The CNP represents persons 16 years of age and older residing in the 50 States and the District of Columbia who are not inmates of institutions, such as penal and mental facilities, and homes for the aged, and who are not on active duty in the Armed Forces.
  2. Employment Growth:  Growth in Employed workers as measured by the BLS Household (CPS) Survey.
  3. Labor Force Participation Rate (LFPR):  Represents the Civilian labor Force as a percentage of the Civilian Non-institutional Population.  Equal to the sum of employed & unemployed workers. 


Dependent Variables:

4. Total Labor Force:  The Civilian Labor force is a product of the Civilian Non-institutional Population & the labor force participation rate

5. Unemployed Workers:   The total number of unemployed workers is the difference between the Labor Force and total employed workers. 


Unemployment Rate = the number of unemployed workers as a % of the Total Labor Force (i.e. the sum of employed and unemployed workers)


So, assumptions need to be made for the growth in the Civilian Non-institutional Population (CNP),  growth in the number of Employed Workers and the Labor Force Participation Rate (LFPR).  The Total Labor Force and the Total Number of Unemployed become a function of the three input variables and the direction in the unemployment rate is determined by the participation rate and the delta between CNP growth and growth in the employed.    



The CONCLUSION:  Can we get 2 out of 3?

In the chart below we provide a timeline view of the 2013 Unemployment Rate under a selection of scenarios.  Obviously, any number of iterations can be envisaged with respect to growth rates and interaction between the principle drivers of the unemployment rate but, in general, 2 of the 3 variables need to trend positively with respect to the unemployment rate for a move to 7% and below to be a 2013 event.  


It’s notable that the NTM moves don’t have to be extraordinary for this to occur.  For example, scenarios in which Employment growth accelerates 30bps (2Y basis) on average in 2013 and CNP growth declines linearly to the historical average over the NTM or the Labor Force Participation rate continues to decline at the 3Y CAGR both result in a move to/below the 7% unemployment level in 4Q13. 


If, however, positive acceleration occurs in just a single variable while the other two flat-line or trend negatively, the timeline for <7.0% unemployment extends significantly.  For example, if employment accelerates 50bps (2Y basis) on average in 2013 while Labor force participation remains static at the current level and CNP growth holds at the current rate, the implied unemployment rate would reach a 2013 low of 7.3% in December. 


In terms of thinking about the directional trend in the relevant variables – with housing continuing to accelerate, the domestic jobs data continuing to trend positively and our #growthstabilzing theme extending itself, we could make a credible case for seeing a modest acceleration in employment growth.  Given that growth in the civilian non-institutional population generally tracks population growth in the 16YOA+ cohort over the longer term and that volatility in active duty military status should be more subdued going forward, the assumption that CNP growth decelerates towards population growth probably represents the baseline case. 


The Labor Force participation rate, and the structural and behavorial psychology dynamics underpinning it, remains the largest wildcard.   The consensus logic goes that in a typical recovery, economic growth and employment growth drive renewed worker interest in employment in a reflexive fashion.  Discouraged workers, who are not currently seeking employment and are not included in the Labor force totals, again begin to actively seek employment.  To the extent that growth in workers coming back to actively look for work outpaces actual employment gains, the unemployment rate is negatively impacted despite the improved economic conditions/outlook.  Here, the transient increase in the unemployment rate would belie a positive economic inflection.


The current situation is complicated by the fact  that despite the ongoing, albeit tepid employment recovery, the resurgence in job seeking, which typifies the back end of business cycle slowdowns, has yet to materialize and the LFPR continues to slide.  Whether this behavioral dynamic continues and to the extent that structural unemployment/length of unemployment is a contributing factor remains an unknown.    Also unknown is the extent to which protracted fiscal policy uncertainty (Health Law, Fiscal Cliff, Budget Control Act/Sequestration, etc) has dragged on employer hiring decisions.  Regardless of the outstanding questions, labor force participation will continue as the real wild-card variable to watch relative to its impact on the unemployment rate.


Will We See 6.5% Unemployment in 2013? - Unemployment Scenario Analysis


Will We See 6.5% Unemployment in 2013? - 16YOA Population Growth


Other Considerations:

  • Annual Benchmark Revision:  the Census Bureau applies an annual population control adjustment to the Civilian Non-institutional Population alongside the January release every year.  Historically, the magnitude of the January adjustment has ranged from tens to hundreds of thousands or even millions of individuals.  An outsized revision to the January 2013 data could shift the unemployment variable dynamics from their current trend.
  • Employment – Growth Connection:  The historical frequency distribution for Employment and growth suggests we’d need to see #growthstabilizing transition to growth accelerating for a concurrent acceleration in employment to manifest.  While employment growth could run ahead of economic growth at the onset of a recovery, historically, employment growth >2% is typically associated with real GDP growth north of 3%.  We show the historical relationship between real GDP Growth  and y/y employment growth as measured by the BLS’s Household Survey below. 
  • Energy/Commodity Inflation:  In our 1Q13 themes call we highlighted the top 3 risks to #growthstabilizing as 1. Rising Oil Prices 2. Japan & 3. Earnings Slowing.  As it relates to risk #1 - as of this morning, both Brent and WTIC have re-captured their respective long-term TAIL risk lines of $92.04 and $111.48 support.  A continued reflation in oil and commodity prices broadly represents a real time tax on consumers, an input cost related margin drag on business, and a material headwind to growth accelerating from here.  


Will We See 6.5% Unemployment in 2013? - Employmet vs GDP Growth


Will We See 6.5% Unemployment in 2013? - Employmet vs GDP Frequency Distribution

Morning Reads From Our Sector Heads

Keith McCullough (CEO):


Rat Meat Sold as Lamb Highlights Food Fears in China (via NY Times)


Gold Traders Most Bearish in Three Years After Drop: Commodities (via Bloomberg)


Matthew Hedrick (Europe):


Slovenia Sells Bonds Despite Ratings Downgrade (via WSJ)


Brian McGough (Retail):


Impact on Bangladesh Victims Weighed (via WWD)


Kevin Kaiser (Energy):


Angola Plans to Simplify Tax Codes to Boost Non-Oil Revenue (via Bloomberg)


Josh Steiner (Financials):


MBIA Settles Flagstar Mortgage Lawsuit for $110 Million (via Bloomberg Businessweek)


Regulators Scrutinize Auto Lenders Over Add-Ons (via WSJ)


Jay Van Sciver (Industrials):


Fastenal April 2013 Report (via Fastenal)



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Big Moves

Client Talking Points

Strong Dollar

The US dollar remains in bullish formation and had a big move to the upside yesterday to the tune of +0.7%. The Yen is coming down further while the dollar is appreciating and taking down commodities with it. This continues to be a bullish catalyst for US consumption stocks which is part of our growth thesis.

Tech Mate

Tech has lagged the broader market and select sectors considerably and is only up +7.2% year-to-date via XLK. Meanwhile, the S&P 500 is up +12% pre-NFP report. The sector has been lagging in large part due to Apple (AAPL) but that's starting to change and the sector is turning bullish. Keep an eye on it over the next week.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company 


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow.


With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

Three for the Road


"Big upside revision for US nonfarm payrolls. Last month was an anomaly" -@NicTrades


"Talk sense to a fool and he calls you foolish." -Euripides


U.S. adds 165,000 jobs; unemployment 7.5% in latest NFP report.

Renaissance Man

“Self-control is more indispensible than gunpowder.”

-Henry Morton Stanley   


Henry Morton Stanley was one the most well known African explorers of the late 19th century.  He is probably most famous for finding the lost Scottish missionary David Livingstone in the small village of Ujiji after an eight month search.  Stanley reported that the first words he uttered when finding Livingstone were the now famous, “Dr. Livingstone, I presume?”


To say Stanley was a remarkable man would be an understatement.  He was orphaned at an early age and spent his formative years in a work house in Wales.  At the age of 15, he crossed the Atlantic as a crewman of a merchant ship and jumped off in New Orleans where he befriended a local merchant and took his name.  He then fought in the Civil War before launching a career in journalism.  Clearly, Stanley was a bit of a 19th century “Renaissance Man”.


His expeditions into Africa, which among other things established the sources of the Nile and Congo, were widely considered the most grueling of that era.  Unlike many of his contemporaries, observers marveled that Stanley never lost his discipline or civility on these long perilous expeditions in the dark heart of Africa.  Biographers discovered an interesting fact about Stanley – he spent most of life, as he called it, “experimenting with will.”


As Roy Baumeister writes in “Rediscovering the Greatest Human Strength – Willpower”:


“Having piously lectured his men about the perils of drunkenness and the need to shun sexual temptations in Arica, he knew how conscious his own lapses would be.  By creating the public persona of himself as Bula Matari, the unyielding Breaker of Rocks, he forced himself to live up to it. As a result of his oaths and image, Jeal said, “Stanley made it impossible in advance to fail through weakness of will.”


This concept of pre-commitment as a way of maintaining discipline and hitting goals has been proven in spades by Yale economists Ian Ayres through a company he started called  Ayres’ company allows individuals to create commitment contracts.  The company has found that when a contract is drawn up without a penalty, the person succeeds about 35% of the time.  Conversely, when the contract includes a referee (so is public) and a monetary penalty (so accountable) the individual succeeds 80% of the time.


So for you young hedge fund analysts that spend too much time partying in the wilds of Manhattan on the weekends, a quick stop at may not be the worst idea to re-establish some discipline. 


Back to the global macro grind . . .


This market year has certainly been one that has required the willpower of sticking with what works.  There have been many times that all of us could have been shaken out of the investment themes that have been effective this year, but growth stabilizing and strong dollar continue to play out in spades.  Nowhere is this seen more clearly than within U.S. sector performance.  On the positive have been healthcare and consumer staples which have outperformed the SP500 by about 50%.  On the negative, materials is up less than half of the SP500.  Unless the macro trends change meaningfully, the right discipline will be to continue to stick with what has been working.


My colleague, and Hedgeye’s U.S. focused economic guru Christian Drake, gave an update on this key theme of growth stabilizing yesterday when he looked at the trifecta of housing, labor and consumer confidence.  Specifically, he highlighted:

  • Employment - The positive acceleration in labor market trends continued this week with both the seasonally adjusted and non-seasonally adjusted Initial Jobless Claims series showing sharp sequential improvement.   The headline number fell 15K to 324K w/w versus the prior week’s unrevised number while the 4-week rolling average in SA claims fell -16.5K w/w to 342K.
  • Confidence - The Bloomberg Consumer Confidence Index (Chart of the Day) made a new 5Y high two weeks ago with confidence measures across age and income demographics showing broad improvement.  The index held those gains last week and made a new 5Y with this morning’s reading improving to -28.9 from -29.9 w/w.  The Conference Board Consumer Confidence as well as the University of Michigan Consumer Sentiment readings were confirmatory with the latest April readings accelerating sequentially to 68.1 and 76.4, respectively. 
  • Housing - Incremental data over the past week has reflected more of the same as Mortgage Purchase Applications remained at their YTD highs while the Pending Home Sales and Case-Shiller HPI data both accelerated sequentially.  The Purchase application data and Pending Home sales numbers both suggest forward housing demand should remain strong.  Additionally, President Obama’s likely nomination of Congressman Mel Watt to replace Ed DeMarco as head of the FHFA should be taken as a positive catalyst for housing.  DeMarco has opposed underwater principal forgiveness for GSE borrowers – a stance that may be lightened should Watt be confirmed.  

Now to be clear, not all economic data has been positive and certainly much of the European data has been depressing.  The primary push back we got with this update yesterday is that regional PMIs have been decelerating and sequestration remains a major headwind. 


While these points are valid, we continue to believe that the performance of consumer related economic indicators trump other weakness in an economy that is 70% consumption.  Last week’s GDP report validated our view as Consumption was up +3.2% year-over-year versus +2.8% and contributed +2.24% of the growth (or 90% of the incremental growth).


Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, VIX, and the SP500 are now $1, $98.13-103.85, $81.46-83.29, $1.29-1.32, 97.11-100.63, 1.63-1.71%, 12.06-14.51, and 1, respectively.


Enjoy your weekends and stay disciplined!


Keep your head up and stick on the ice,


Daryl G. Jones

Renaissance Man


Renaissance Man - Chart of the Day


Renaissance Man - Virtual Portfolio

Early Look

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