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Fudge Factors: The Labor Force Participation Rate

Yesterday Howard Penney and Rory Green of the Hedgeye Macro team presented their insight on how significant the decline in the labor force participation rate has been in understating unemployment. To summarize, the marked reduction in labor participation has shaved around 200 basis points off the reported unemployment rate. Said differently, unemployment will need to improve 200 basis points before the unemployment rate begins to move lower. While claims improved sharply this morning, they remain in their YTD range of 450-470k, which is 50-75k above where they need to be for unemployment to improve, suggesting we are still a long, long way off from any meaningful drop in unemployment. The following is taken from their note yesterday.


There are two ways (maybe more) the government can manipulate the jobs data to make things look better than they appear.  The first way was highlighted in a post entitled, “FRIDAY MACRO MIXER: THE PAYROLL FUDGE FACTOR”, where I discussed the implications of the Birth/Death model on the credibility (or lack thereof) of the payroll data.  As I wrote on Friday, the last benchmark revision released by the BLS indicated that the Birth/Death model numbers were grossly understating job losses and, as such, is not reliable. 


The second way the BLS distorts the numbers is through the headline unemployment rate, which is being deflated by changes in the Labor Force Participation Rate. 


Since BLS unemployment data begins, 1948, the proportion of the civilian population working or seeking work has generally been growing.  This is largely as a result of women entering the workplace and long-term growth in the U.S. economy through the 20th century.  The 1950’s saw year over year increases in the labor force participation rate of 210 bps – more than three standard deviations from the mean of all available data (January 1948 to present).  Recently, there has been a period of precipitous decline in labor force participation rate, peaking at a year-over-year decline of 120 bps – two standard deviations from the mean – which is important to note. 


The chart below details where the unemployment rate would be if the labor force participation rate was at its ten-year average level of 66.1%; for the year-to-date, it has been averaging 64.8%.  This implies that many folks are losing heart and dropping out of the job hunt.”







Initial Claims Fall 27k Last Week - Progress to be Sure

Initial claims fell 27k last week to 451k (falling 21k net of the revision).  Rolling claims came in at 478k, a decline of 9k over the previous week. Reported claims have moved to the low end of the YTD range of 450-470k that the series has occupied for all of 2010, while rolling claims remain on the high end of the range. This is a big step in the right direction.  Ultimately, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves.


This being said, the reality is that we've seen two better than expected data points in the last two days: yesterday mortgage applications were up 6.3% and today jobless claims were down 27k. For investors interested in how best to play a short-term sentiment reversal on the long side, the table below shows Financial subsector performance over multiple periods. Investors interested in beta exposure may want to consider those subsectors near the bottom of the column on the far right as these are the highest beta names that have come under the most significant pressure since the April 14 high in the XLF.






Short term rallies notwithstanding, our firm remains of the view that US economic growth is slowing markedly between now and into 2011. We think this will keep a lid on new hiring activity as management teams focus on cost control. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.


2-10 Spread a Headwind for 3Q Margins

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has been coming under growing pressure in the past two quarters.  Yesterday’s closing value of 214 bps is up from 208 bps last week. For reference, 3Q to date is tracking down 36 bps sequentially vs. a sequential decline of 19 bps in 2Q10.






The table below shows the stock performance of each Financial subsector over four durations. 




Below we show the correlations between initial claims and each of the 30 Financial Subsectors. We have refreshed this table to reflect prices through the end of July. Using this updated measure, Credit Card and Payment Processing companies remain the most correlated to initial claims, with R-squared values of .63 and .65 over the last year, respectively. Surprisingly, some subsectors show a positive correlation coefficient to initial claims - i.e. Financials that go up as unemployment claims go up.  These names are concentrated in the Pacific Northwest Banks and Construction Banks, though these correlations are usually not very high.  


LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - init. claims subsector correlation analysis as of 8.4.10


Some investors will note that in some cases the R-squared doesn't seem to reconcile with the square of the correlation coefficient. This is a result of finding the correlation and then averaging. For example, Pacific Northwest Banks have an average correlation coefficient of .33 and an average R-squared of .52 (with CACB, CTBK, FTBK, and STSA strongly positively correlated and UMPQ strongly negatively correlated). The different directions have the effect of canceling out each other out when finding the average correlation coefficient, but do not cancel out when finding the average R-squared. 


The following table shows the most highly correlated stocks (both positively and negatively correlated) with initial claims. Note that the top 15 negatively correlated stocks have a much stronger correlation on average than the top 15 positively correlated stocks - as you would expect, given that most of the Financial space is pro-cyclical. 


LABOR FORCE PARTICIPATION DROP A 200 BPS HEADWIND TO UNEMPLOYMENT - init. claims company correlation analysis as of 8.4.10


As a reminder, May was the peak month of Census hiring, and it will continue to be a headwind through the end of the month as the Census winds down.  After September, it should mostly cease to be a factor. 




Joshua Steiner, CFA


Allison Kaptur


TODAY’S S&P 500 SET-UP - September 9, 2010

As we look at today’s set up for the S&P 500, the range is 21 points or 1.17% (1,086) downside and 0.74% (1,107) upside.  Equity futures are trading higher tracking gains across European equities as the region’s banking and mining stocks rebound. Today's macro highlights include: Initial Jobless Claims and July Trade Balance.

  • AvalonBay Communities (AVB) said its AvalonBay Value Added Fund II unit bought an apartment community in Calif. for $98.5m
  • Fuqi International Inc. (FUQI) got SEC subpoena from for failing to file periodic reports on time
  • Men’s Wearhouse (MW) forecast 3Q adj. EPS 40c-47c vs est. 41c
  • Questcor Pharmaceuticals (QCOR) said FDA delayed a decision on its application to sell its Acthar drug as treatment for seizures in babies
  • TNS (TNS) agreed to buy Cequint for as much as $112.5m and said it will buy back up to $50m of its stock



  • One day: Dow +0.45%, S&P +0.64%, Nasdaq +0.90%, Russell 2000 +0.79%
  • Month-to-date: Dow +3.72%, S&P +4.72%, Nasdaq +5.43%, Russell +5.35%
  • Quarter-to-date: Dow +6.27%, S&P +6.61%, Nasdaq +5.67%, Russell +4.06%
  • Year-to-date: Dow (0.39%), S&P (1.46%), Nasdaq (1.78%), Russell +1.42%


  • ADVANCE/DECLINE LINE: 1183 (+2599)
  • VOLUME: NYSE - 879.91 (+5.96%) - No conviction and a light economic calendar
  • SECTOR PERFORMANCE: All sectors were up yesterday except XLU.  Tough to find a specific catalyst for yesterday’s performance, though an improvement in the risk backdrop surrounding Europe and the momentum behind the M&A rumor mill also offered some upside.
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: NY Times +7.99%, Priceline +5.53% and Huntington Bank +4.48%/Visa -4.13%, Nisource -3.86% and Tereadyne -3.53%
  • VIX: 23.25 -2.31% - YTD PERFORMANCE: (+7.24%)            
  • SPX PUT/CALL RATIO: 2.04 from 2.00  


  • TED SPREAD: 16.67 -0.101 (-0.604%)
  •  3-MONTH T-BILL YIELD: .14% trading flat
  • YIELD CURVE: 2.14 from 2.12  


  • CRB: 274.27 +0.17% - Coffee at a 13 year high
  • Oil: 74.67 +0.78% up for the first day in three
  • COPPER: 344.65 +0.86%
  • GOLD: 1,255 -0.07%


  • EURO: 1.2750 +0.14%
  • DOLLAR: 82.585 -0.28%



  • Nikkei +0.82%; Shanghai Composite (1.44%)
  • Asian markets were mixed today even though concerns about European debt problems were addressed by successful bond auctions yesterday.



  • FTSE 100: +0.51%; DAX: +0.12%; CAC 40: +0.35% (as of 04:55 ET)
  • European markets opened lower, seeing some profit taking after yesterday's strong gains.
  • Ireland's Finance Minister looked to reassure markets over Anglo Irish Bank saying the government hopes to produce definitive figures on the cost of its restructuring by the end of October.
  • No movement on the part of the BOE; 0.5% benchmark interest rate and the £200B asset purchase program remains unchanged.
  • Banks and technology groups are amongst the leading gainers with all but four sectors trading higher. US futures trade higher.
Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends













Feeling Strange

“Is it not strange that desire should so many years outlive performance?”

-William Shakespeare


This morning’s global macro risk management setup feels as strange as it has since September of 2007.


As most market historians will recall, the S&P 500’s run from Labor Day of 2007 until the first week of October 2007 was the final countdown to get out. That’s not to say that the shorts who pressed the August of 2007 lows didn’t get run over in September of 2007 by the way. I, for one, got crushed.


I’m not one to say that market history repeats, but I am a big believer that patterns of market behavior rhyme. Think about both the absurdity of the prices paid by Private Equity and LBO firms in 2007 and then rewind the quality of yesterday’s “rumor mill” about everybody buying everybody. The sad reality of our business is that the hopes and desires of low quality market players trying to make a living on rumors is many years outlived by actual performance.


The performance of the S&P 500 from September 4th – October 8th of 2007 was +4.3%. The month-to-date performance of the S&P 500 for September of 2010 is +4.7%. You can tell me what parts of the “M&A” rumor mill is driving this low-volume rally to lower-highs. I can tell you that it’s not insignificant.


I can also tell you that there are significant and strange developments occurring across global markets this morning. Remember, managing the risk associated with a rally in US Equities requires analyzing the multi-factor and multi-duration price action that’s driving this globally interconnected ecosystem. The best I can do this morning is summarize how strange this is all feeling by major geography.


Before I dig in geographically, it’s worth mentioning that there is one major factor governing news-flow worldwide right now – professional politicians fundamentally believing that they are the arbitrators of all our desires. Strange.


1.       Asia


Other than Japanese equities crashing again (Nikkei 225 down -20% from its April peak) and few in the Manic Media acknowledging that Japan is a much larger long term issue than Greece, isn’t the following comment from Japan’s Finance Minister, Yoshihko Noda, this morning strange?


“I feel strange that China can buy Japanese government bonds while Japan can’t buy theirs.”


Capitalistic note to bureaucratic self: the world’s largest creditor can buy whatever they damn well please. You, Captain Debtor Nation, shouldn’t feel strange at all now that you have compromised and constrained your economic system with systemically impairing levels of leverage.


By the way, this is how a spokesman at China’s Foreign Ministry, replied in Beijing today. “We will decide whether or not to buy one country’s bonds according to our own needs.” There’s nothing strange about that.


2.       Europe


Watching Bloomberg TV’s Andrea Catherwood interview Greece’s Director General of Public Debt Management Agency, Petros Christodoulou, this morning was beyond strange. Never mind what a professional politician is doing with a title that long, what in God’s good name do market participants expect him to say about Greece’s debt?


In Q2 of this year, we introduced a Hedgeye Macro Theme called “The Sovereign Debt Dichotomy.” The long term cycle work on the sovereign debt default cycle was backed by Reinhart & Rogoff and our core thesis remains long term as cycles like these are. The bottom line is that sovereign debtor nations will be forced into restructuring or default at different points in time for the balance of the next 3 years. They won’t all happen at once!


Is it strange that Denmark (up +22% YTD) is trading up +0.79% this morning and Greece (down -28% YTD) is trading down again after getting clocked yesterday? Is it strange that Petros “rules out restructuring”? or is it just strange that a professional politician like this actually matters to markets?


3.       USA


Price action in US Equities is definitely improving. I can call that strange – I certainly did in 2007! But strange can remain longer than a short seller can remain solvent. Learning from my mistakes and evolving the risk management process is where I’m focused on improving.


Both the weekly ABC/Washington Post Consumer confidence (-43 vs -45) and MBA Mortgage Application (+6.3% week-over-week) reports were better than expected yesterday. For the two big things that matter for US economic growth (consumer spending and housing), there should be nothing strange about the fact that the only moves I made in the Hedgeye Portfolio yesterday were buys and covers. As facts change, I need to.


While these data points appear strange in the immediate term, they are real. It’s also important to Distinguish Our Immediate Term Duration from the Intermediate Term bearish TRENDs we continue to forecast in both US consumer spending and housing.


While I don’t think it’s strange that the US market won’t focus on something like Harrisburgh, PA defaulting on its September 15th payment until they actually miss the payment, it’s sometimes strange to just think about these things out loud from the fishbowl that is my office in New Haven, CT.


Whether its in CT, IL, or AZ, these states and the municipalities that they house are going to be feeling more and more strange as they march down the Road To Perdition that many European states have already trekked. Will Illinois be the next Greece?  Will the US Federal Government be forced to bail out municipalities and states like the EU had to with Greece, Spain, and Portugal?


If China is selling US Treasuries and buying Japanese Government Bonds, where will we get the money? There should be nothing strange about asking yourself these risk management questions.


My immediate term support and resistance levels for the SP500 are now 1086 and 1107, respectively. If 1086 can hold, I’ll continue to be far less aggressive with my shorts this September than I was in 2007. This Time Is Different.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Feeling Strange - 1

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The Macau Metro Monitor, September 9th 2010



A spokesperson for the Ministry of Community Development, Youth and Sports (MCYS) said, "We're investigating the provision of free transport by the IR operators. The IR operators will not be allowed to target the local market or provide incentives in any form for Singaporeans to patronise the casinos."  But RWS spokesman Robin Goh said the free services are the result of feedback and "the age-old perception that Sentosa was too far and inaccessible ... " The shuttle buses deliver about 2,500 people per day to the resort, and in surveys of passengers, more than 60% of them indicate they are not going to the casino, but to Universal Studios or "others", said Mr Goh.


The free shuttle of RWS are available at two spots in the Central Business District as well as 12 HDB town centres, including Ang Mo Kio, Jurong East, Tampines and Bedok.  MBS's free shuttle runs between the resort and Changi Airport and hotels in the Marina Bay area.  MBS recently introduced premium bus services to Orchard Road, the Central Business District and Chinatown.


Higher commissions may be driving the junket switch from the Peninsula to Cotai, but that doesn’t explain the Mass shift.



The following charts show monthly market share of Mass revenue, VIP revenue, and Rolling Chip volume generated on the Cotai Strip as a percentage of total Macau.  It is clear that Cotai has been gaining share sequentially throughout most of this year in all three categories.  The gains cannot be attributable to new supply since City of Dreams opened on June 1st, 2009.  The other major new supply actually opened off Cotai:  Wynn Encore, L’Arc, and Oceanus. 


The Cotai bears (mostly Wynn bulls) will point out that City of Dreams has probably been more generous in recent months with their junket commission rate and we would agree.  That certainly would pull VIP revenue away from the Peninsula since that is where most of that type of revenue is generated.  However, a higher junket commission rate at CoD does not explain the Mass shift.  The Cotai gains in Mass revenues have been as strong as the VIP shifts.  With more entertainment options and bigger facilities, could it be that Cotai is becoming the “in” place to congregate for the lucrative Mass customer?


We also included Wynn’s market share in each segment.  Wynn has lost a little Mass share this year, especially in August and we think in September thus far.  What’s surprising is that despite the opening of Encore in April, VIP and RC share has stayed fairly constant, after normalizing for the obvious hold volatility.  We would’ve expected better.







PVH: The Ultimate Consensus Long?

PVH: The Ultimate Consensus Long?


PVH is a consensus long. Period. The interesting thing is that the Tommy deal structurally makes sense, but the narrative behind how, why and when is not pretty by any means. While the world loves PVH, bears might have to wait another 3-quarters until the $300mm cookie jar is empty for some thesis validation.


This is one of those consensus longs that bugs me so many levels, but to fight the tape on a name that has a $300mm cookie jar to fuel earnings over the next year is a tough one. I love how management says that the Tommy Hilfiger deal will be $0.30-$0.35ps (10-12%) accretive, but this excludes $3.21 per share in integration costs. So let me get this straight… they’re going to INCLUDE the revenue and operating profit on the base business – but will EXCLUDE the costs to realize it. The only thing that’s worse is that the Street is taking the bait.


The irony here is that I actually think that the combination makes sense. It gives PVH significantly greater exposure to Europe – where the Tommy brand has always been exceptionally strong (despite its roller coaster ride in the US), and further diversifies PVH away from its legacy dress shirt business – which might be dominant with 46% share in department stores, but it is a price taker in a commodity category. Now the legacy biz is down to 10% of sales and 8% of EBIT vs. 23% and 22%, respectively last year (and over 75% before Calvin).


But as much as I can justify the deal, let’s not forget the fact that PVH NEEDED this. This is not Manny’s first rodeo. He saw what was coming. PVH is capping off a period where CK drove the business and then – like most other companies in retail – relied on extremely tight inventory management pushing peaky gross margins. Tack on a 4% decline in G&A due to corporate workforce cuts (400 positions at about $40mm) and write downs at Geoffrey Beane, and PVH realized 7% EBIT growth last year on a 4% sales decline.


Now, the company begins to go up against extremely tough compares on the gross margin and SG&A lines, and must rely on sales. But without the consumer showing up en masse, the company needs a PVH-specific product driver for the core business – and it would have needed to have been investing in that for the past 2-years. Either that, or it could have simply gone out and bought growth – a la Tommy.


The icing on the cake is a complete reclassification of the reporting segments. In all fairness, this is likely the proper thing to do as GAAP accounting states the company must report in a way that it runs its business – and the business structure has changed. But the reality is that the reclassification clouds the water as it relates to understanding the real trajectory of each of PVH’s units.


This note sounds like sour grapes. That’s not intended. I call the narrative for what it is, and will model it accordingly. Keith will guide with timing and sizing on either side. For now, this is a ‘Do Nothing’ stock -- though I have a fundamental bias to the downside 2-3 quarters out.



FYI: An interesting comment from management on the call about inventories. Good perspective. Sounds like the lynchpin is whether the department stores are correct in modeling 2-4% comp store sales.


I guess I'll speak on inventory levels at retail. I think the retailers -- we went through nine months starting in the third quarter of last year where retailers were chasing inventory consistently from suppliers and because of the availability of production piece goods, in that time frame you were able to react quicker. There was production availability. You were able to get it in. You were able to do what was necessary, fly goods, do whatever. There was transportation available. As demand really started to dramatically improve in the fourth quarter of last year, coming into 2010, clearly production started to fill up. You know all the stories about all the transportation issues. We were very clear with our retail partners. If you want goods, it's going to be very difficult to chase in the second half of 2010. You're going to have to get the orders. So the retailers were forced to really get ahead of the sales trend and they're buying into whatever their planned comps are. We're seeing that in our business and right now I would say to you inventories are in good position. We're in excellent shape at retail. The sales plans with our key customers seem to be running ahead. Clearly inventory's in good shape and they've bought into their 2% or 4% comp store increase depending whatever it is, the retailers have basically bought into that.


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