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“Why would we spend countless taxpayer dollars on a Death Star with a fundamental flaw that can be exploited by a one-man starship?”

- Paul Shawcross, Official White House response to “Construct a Death Star by 2016” Petition

Multiple times over the last decade, a perturbed American populous has locked arms and garnered large scale petition support for the full prohibition of Di-hydrogen Monoxide. 

This noxious compound is a main component of acid rain, may cause severe burns, is found in tumors, causes electrical failures, is involved in the distribution of deadly pesticides and can be acutely deadly if inhaled. 

Thousands of people, numerous times over, have been compelled to pen their signature in full support of completely banning its use.

You, of course, may know this compound by its more colloquial name of H2O …or, water.  

Back to the Global Macro Grind ….

Of course, tens of thousands have officially supported the Resource Procurement and Construction of a Death Star (HERE) and hundreds of thousands have joined the “Deport Justin Bieber” chorus (HERE), so all hope may not be lost for #WeThePeople (note: If a petition gets at least 25K signatures, the administration will publish an official response …the “Janet Yellen for Fed Chair” petition garnered 327 signatures).

Death Star - start wars cartoon

Outside of being generally awesome, Death Stars (i.e. Tech innovation) anchor an ongoing obstacle for Macrophiles.

If I made two computers this year instead of one, how much more output did I produce?

Not hard arithmetic - particularly if those computers are roughly the same in design, construction and functional capacity. 

Now, suppose my new computer is 60% faster than the one I bought last year … or maybe 50% faster if I’m on the road … or maybe 200% faster under a different set of location and task-specific conditions. Oh and my computer is actually my phone … and I’m producing this Early Look on it while checking the status of my amazon order and walking to get a coffee. 

How much more welfare or utility did that technological advancement create?   

How does one translate that rapidly evolving innovation and quality advancement into GDP equivalents or accurately capture the impact to productivity? 

That, in summary, is the measurement challenge faced by economists and government statisticians as our economy has evolved from producing discrete, tangible industrial output to decidedly less-tangible innovation focused on quality improvement. 

Larry Summers addressed the mismeasurement topic in a recent address to the Peterson Institute. He contextualizes the considerations in largely layman friendly format HERE if you’re interested. 

To summarize, the mismeasurement implication flow goes something like this:

Measured Productivity over the last decade plus has been slow => but what if we’re mis-measuring output => productivity growth (& real GDP) may actually be higher => but if productivity and real GDP is understated, it’s likely that inflation is overstated => which means that (core) inflation has really been running <1% => and if the true underlying inflation rate has been understated (& barely positive in recent years) then:


1. Per capita GDP and Income levels have not been as stagnant as official measures suggest;

2. Real Interest Rates are actually higher than policy makers believe and;

3. A sustained attempt at interest rate normalization becomes an increasingly dubious and injudicious policy course.

I happen to agree with Summers that its overwhelmingly likely that we are mismeasuring the magnitude of quality improvements and, by extension, the level of productivity growth. 

It’s also important to remember that mismeasurement only presents a problem if the error is accelerating or getting worse over-time. Does the nature of our evolving economy present compelling evidence supporting a view that the measurement problem could, in fact, be worsening?

I lean toward “yes” but I’m open to other thoughtful perspectives.  

In other mismeasurement news, the changing structure and/or mismeasurement of corporate income may help to explain another macro issue of growing consternation – Inequality.   

In a recent paper (HERE), Treasury Department and NBER researchers analyzed the rising prevalence of “Pass-Through” business entities. Pass-through business entities, such as partnerships, are structured in such a way that income “passes through” the business and is reported on the individuals’/partners’ tax returns instead of at the business level. 

The major findings of the analysis were as follows:

  1. Relative to traditional business income, pass-through business income is substantially more concentrated among high-earners.
  2. The average federal income tax rate on U.S. pass-through business income is 19%—much lower than the average rate on traditional corporations.
  3. Thirty percent of the income earned by partnerships—the largest pass-through form—cannot be traced unambiguously to identifiable, ultimate owners.

Again, to summarize the income inequality implication flow:

~55% of Business Income now goes through pass-through entities vs. ~20% in 1980 => 69% of pass-through income is earned by individuals in the top 1% (vs ~45% for traditional C-Corp businesses) => Tax rates on pass-through business income are significantly lower than traditional corporate tax rates => Thus, not only is the income more unequally distributed, it’s also taxed at a lower rate … further, the distribution is significantly less transparent as both the source and destination of ~30% of partnership income cannot be uniquely linked using conventional administrative tax data.

The researchers estimate the 2011 impact to tax revenue to be at least $100B. In any case, shifting corporate structures and rising convolution and opaqueness appear to be a real contributing factor in the ongoing rise in income inequality. 

While they don’t offer a solution, the analysis is important as untangling the “why” of rising income inequality has been as elusive as fabricating a fix.

Output mis-measurement and inequality are real and important macro considerations, but they’re not particularly investible across most relevant durations. 

Here’s your rundown of this week in domestic macro: 

Existing Home Sales: EHS declined -3.4% MoM – predictably recoupling to the Trend in Pending Home Sales. Recall, pending home sales = contract signings while existing home sales = closings so Pending sales effectively signals existing sales a month in advance. There are a couple notables. First, inventory held below the traditional balanced market level of 6-months for a 38th consecutive month as continued supply tightness remains supportive of price trends. Second, in contrast to the headline decline in sales, sales to 1st-time buyers rose +3.2% MoM and accelerated +220bps sequentially to +11% year-over-year in October. 

Corporate Profits: Both Aggregate Corporate Profits and S&P500 Margins peaked in late 2014 and with earnings down -4.5% in 3Q15 and projected to decline further in 4Q15 the trend in profitability should remain in backslide.    

Income & Spending: Income and Spending in October will be “good” as the strong October employment report was just sufficient to maintain a flattish trend in aggregate income growth. However, the slope of both the income and consumption lines will hold negative as we lap peak payroll gains recorded in 2H14.   

Initial Jobless Claims: Initial Jobless Claims continue to tread at trough levels although the trend in energy states has been worsening in recent weeks.  Inflections in initial claims have been one the most consistent lead indicators for the cycle and year-over-year improvement continues to converge towards zero as the level of claims backs up off of the low but remains around its frictional floor of ~300K. Seasonal distortions and holiday related noise will convolute a clean reading of the underlying trend in separations for most of the rest of the current year. 

My cousin is in charge of toy creation and production for the Star Wars franchise. I actually have a real light saber straight from Spielberg. If the Death Star actually gets commissioned (Trump?), #IKnowAGuy

In the meantime, Hedgeye’s own Keith McCullough, aka Broda, aka Darth Fader, will be fading consensus and channeling the Macro Force all morning on both Fox Biz and The Hedgeye Macro Show. Tune in. 

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 2.18-2.34%

SPX 2022-2107

VIX 14.31-20.46
USD 98.55-100.18
Oil (WTI) 39.32-43.75

Gold 1060-1089

Have a great holiday.

Christian B. Drake

U.S. Macro Analyst

Death Star - EL 11 24