This note was originally published at 8am on August 23, 2013 for Hedgeye subscribers.
“We are almost entirely incapable of predicting the future.”
That’s the closing sentence to the opening paragraph to “The Need For A New Economics”, which is Chapter 1 of George Gilder’s latest book, Knowledge And Power.
The opening sentence is better: “Most human beings understand that their economic life is full of surprises.” And it’s better because it’s more in line with reality than an all-or-nothing statement about forecasting.
For me, risk management isn’t about predicting the future. It’s about probability weighting our decisions within a repeatable, but flexible, process. If you establish a multi-factor, multi-duration process, you’ll find yourself forecasting when you are about to be right and wrong, faster. Changing your mind is more important than anchoring on predictions.
Back to the Global Macro Grind…
As I was flying back from Los Angeles last night, I was thinking about everything I always think about when I have time to think – my family, my firm, and the Fed.
What on God’s good earth is the Fed going to do to my family and firm next?
It’s sad, but this is what our said free-market life has become. I was on the road all week seeing clients in California and I couldn’t go through 20 minutes of long-cycle (40-60 years) macro research without having to debate how the Fed can interrupt our analysis of things like economic gravity.
Never mind predicting the future, some of these un-elected central planners think they can “smooth” it! That’s just dumb. And I can only thank progressive information innovations like Google and Twitter for expediting the world’s education on that.
Bernanke’s Fed thought they’d be able to smooth the long-end of the yield curve – nope. Bond Yields continue to rip a series of higher-lows and higher-highs on accelerating US employment growth data. I know, after seeing the Nasdaq and SP500 correct -1.5-3% from their YTD highs, that must be the new bear case for US Equities. The data is now too good.
Got good data? Here’s how the most important leading economic indicator for US bond yields did this week:
In other words, the bond market has it right. The Fed and bond bulls are still fighting both the data and the market. NSA (non-seasonal adjusted claims) remain our preferred leading indicator, primarily because it fits the 10yr Yield like a glove.
BREAKING: the Fed’s new “forward guidance” model is called the market front-running them.
From our latest Hedgeye Jedi hire, Jonathan Casteleyn, check out this week’s fund flows (i.e. outflow data) in Fixed Income:
That’s not a typo.
Since President Obama is, allegedly, saying “no more bubbles” now, let me write that one more time – this past week’s #RatesRising Fixed Income OUTFLOWS were -$3.9B versus the 2012 Bernanke Bond Bubble weekly avg INFLOW of +$5.8B in 2012.
Nah. This ain’t cool bro. This is what we call another disaster for Americans who got jammed into everything yield chasing from Gold, to MLPs, to anything that looked and/or acted like a low-beta bond used to.
But don’t worry, Bernanke didn’t have anything to do with that or growth oriented investments pulverizing the slow-growth Yield Chasers (like Utilities) since bonds went over The Hedgeye Waterfall in June.
We use the thermodynamic model of the volume and velocity of water approaching its point of entropy (The Waterfall) as an alternative to the broken economic and market forecasting models of the Federal Reserve.
Rather than a crystal ball model, it’s a real-time probability weighted model that embraces uncertainty. And it works. What doesn’t work is attempting to ban and/or smooth things like free-market gravity.
As a result, the only long-term future prediction I will hang my hat on is that American monetary policy will evolve. If I’m wrong on that, as their old boy Keynes would say, in the long-run we’ll all be dead anyway.
UST 10yr 2.78-2.97%
Best of luck out there today and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – September 6, 2013
As we look at today's setup for the S&P 500, the range is 24 points or 0.73% downside to 1643 and 0.72% upside to 1667.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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“To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride.”
I’ve only ever bet on a fight once. It was for no money and with a guy who just happened to be standing next to the keg with me at the time. The fight itself was a late night, inebriated 3 vs. 1 event in the back of the ‘football house’ in Springfield, MA.
I bet on the “1”.
The #Tell, so to speak, was when the “1” stealthily, but deliberately, led the “3” to the fence in the back corner of the yard.
“Find the nearest fence and put your back to it” is Getting Jumped 101 material - but a person would probably only know that if getting jumped had actually been an acute risk in life for some protracted period.
If one’s collective life experience was capable of driving a self-defense instinct to be so ingrained as to be fully active on the back end of a 6 hour binge drinking session, then the odds of an upset victory are probably better than backyard consensus has them set.
Taking high probability swings at mispriced circumstances isn’t confined to markets. I’ll probably retire from amateur fight betting with my 1-0 record.
Professionally, we recently found ourselves in a stirring analytical scrap of sorts with an elite hedge fund manager over the conclusion on an investing idea. In this particular instance, we turned out to be right.
In defeat, the aforementioned manager didn’t become embarrassed, inimical or spiteful. He became a client.
Being wrong is okay, “I don’t know” is the right answer more of the time than most would admit, and egoless-ness and honest self-reflection in defeat is not a #Process (or person) you want to bet against longer term.
Back to the Global Macro Grind….
Regardless of the flavor of this morning’s employment data, we’ll be invariably deluged with sound bites lamenting the low level of labor force participation. Despite its descent to old-hat, punditry talking point over the last five years, Trend movement in labor participation remains critical to the forward growth outlook.
After all, if population growth is slowing and the share of that population that is working is declining, productivity has some heavier lifting to do to keep real per capita output going in the right direction.
Demographic, cultural, and institutional trends are generally glacial and collectively serve to drive the broader, directional Trend in the Labor Force Participation Rate (LFPR). Over the last 5 years, the straightforward, central question facing economists is what temporary (& potentially permanent) impact the shock of the Great Recession had on labor participation.
From a research perspective, the aspirational goal has been to discern what the prevailing gap is between where we are currently on the LFPR and where we would have been without the cyclical impacts.
Academic literature over the last 5 years is replete with analyses attempting to decompose the cyclical and secular components impacting labor force participation. On average, the research suggests around 40-60% of the decline in the LFPR since 2007 could be attributed to cyclical factors.
The truth is that attempting to parse the Cyclical and Trend components of Labor Force Participation, with precision, is a quixotic pursuit. It’s some amorphous combination of the two.
From an investment perspective, understanding the principal drivers of the LFPR, the key considerations facing the forward outlook, and the highest probability TREND trajectory hold more practical significance than decomposing the Cycle/Trend impacts with exact precision.
With that in mind, let’s take an abbreviated, Socratic tour of Labor Force Participation.
What has been the larger Trend in Labor Force Participation?
Taking a long-term view, the Chart of the Day below illustrates the 3 primary labor participation trends which have prevailed over the last 65 years. Briefly, from 1948 to the mid 1960’s, participation was largely stable.
From the 1960’s until the turn of the century, driven by Baby Boomers (born 1) entering prime working age (24 – 54) and a secular increase in female participation, LFPR showed a persistent increase.
From 2000 to present, the trend has been one of decline as the median age of the workforce rose, Boomers began matriculating towards retirement and dual recessions all weighed on the participation rate.
Is Labor Force Participation sensitive to the Business Cycle?
The correlations aren’t exceedingly strong, but yes. Here, it’s sufficient to simply observe the LFPR in the post-recessionary periods in the chart below. In each instance, the participation rate dips in the wake of the cyclical downturn.
So, labor participation shows some economic/business cycle dependence and the broader Trend since the turn of the century has been one of decline. With no peri-recession tailwinds from cyclical or secular factors, the fact that Labor Force Participation declined in the wake of the Great Recession is not a surprise.
What has been the impact of domestic demographic Trends?
We’ll explore the multitude of factors impacting the LFPR in more detail in a subsequent note. Here, we’ll consider the impact of age demographics on the Trend movement in the LFPR.
Historically, different age groups have shown typical, largely fixed, participation rates. Labor Participation peaks progressively from age 16 into the mid 40’s, gradually declines to age 64, then drops precipitously. Thus, as population shares of the different age groups change it impacts the prevailing, aggregate participation rate.
In addition to plotting the actual LFPR (blue line), in the Chart of the Day, we show the estimated trajectory of participation based on the average 1 participation rate by age for those aged 16 years and older (orange line). The extrapolation suggests greater than ~40% of the decline in the LFPR post-2007 could be attributed purely to age demographic trends.
Extending the forecast, demographic trends, in isolation, would predict LFPR to decline to 64.1% in 2015 and a further decline to 62.5% in 2020. Clearly, the Trend remains one of decline.
What sits as a primary swing factor for LFPR over the intermediate term?
The level of long-term unemployed associated with the great recession was unprecedented. If the long-term unemployed do come back then we can expect upward ‘cyclical’ pressure on labor force participation as economic conditions improve.
If, however, the LT unemployed fail to return to the labor force, the recessionary shock could be viewed to have changed the structural and secular outlook for labor market participation. In effect, shifting the LFPR Trend line lower, compressing the existent cyclical gap (i.e. the spread between the orange & blue lines below), and lowering the potential upward pressure on the LFPR (& unemployment rate) as economic conditions improve.
Regardless of the cyclical impacts on Labor Participation, growth in the supply of labor will continue to slow vs the multi-decade average.
A TREND deceleration in working age population growth alongside a decline/flattening in labor force participation rate will put secular pressure on domestic labor supply, serving as a headwind to potential GDP and a tailwind to real wage growth. As a result, productivity gains will be an increasingly important driver of real output growth over the coming decade(s).
Innovation drives productivity. Human Capital drives innovation. Circumstance will necessarily drive our collective pursuit of human capital. We’ll be increasingly responsible for our own (economic) fate – fancy that.
Our immediate-term Macro Risk Ranges are now:
UST 10yr Yield 2.82-3.06%
Enjoy the weekend.
Christian B. Drake
THE MACAU METRO MONITOR, SEPTEMBER 6, 2013
ONE-THIRD OF GAMING VENUES FAIL AIR QUALITY TESTS Macau Business
Smoking areas at 16 gaming venues will be scaled back after the venues failed the government’s air quality tests for a second time. The government tested 46 venues. Penalties would be announced this month, along with the test results.
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