GDP & Unemployment: The Morning After

We are coming up on another unemployment report. Preliminary indications are not good. So far we seem to be in another jobless recovery. A deeper look at the recent GDP Report plus the upcoming unemployment report supports my view that this will be a V-Shaped recovery, albeit a jobless one, and not much of a V, with a high risk of a double-dip W to come.

The Q4 GDP report was driven by inventory rebalancing, a transitory factor. David Rosenberg's morning-after comments start with "expect big-time revisions", meaning downward. A key insight is that real domestic demand slowed from 2.3% in Q3 to 1.7% in Q4, as shown in this chart from Prieur du Plessis, where inventory is removed and the underlying final demand trend is bared:

 

This chart is bad news, as it says there really isn't any recovery. One would expect a sharp V after the fall we had in 2008, and we do not appear to be getting it. Pierre comments that this pattern "doesn't live up to past recoveries at all. ... Without stronger demand growth, a V-shaped recovery is not on the cards and the unemployment rate will not start heading south."

The Pragmatic Capitalist has a series of comparison charts of production, retail, employment and income, and all of them show more an L than a V so far. Here is the production chart:

 

An even bigger problem comes from unemployment: 

We saw history in the making — an eye-popping 5.7% GDP growth rate the exact same quarter that the unemployment rate rose 40 basis points, to 10%. It is like Houdini’s rabbit! This has never happened before. Normally, when we see a GDP number like this the unemployment rate declines 20 basis points during the quarter in question. The flip side is that in the past, when the unemployment rate rose as much as it did in the fourth quarter, believe it or not, in those quarters real GDP actually contracted fractionally (at a 0.5% annual rate).

A huge red flag was just raised about unemployment, which makes you wonder how far off the official stats have become from reality. The BLS is going to revise down its job estimates from April 2008-March 2009 by a whopping 824,000 jobs. This chart from Bloomberg shows how the prior reports change:

The whole Bloomberg article is worth reading, as it has other charts on point that make this issue vivid. The recount is due to how the BLS counts birth/death of job positions/companies, which they admit is flawed, but have no plans to fix. Instead, the next revision comes out in 2011, and will affect the whole Hope Rally period from April 2009 to March 2010. Over 990,000 jobs were added based on their flawed model.

The total over-count is 1.8M jobs. Wow. This means rather than the initial 4.8M jobs lost, it actually was 5.6M, and with the added miscount since, 6.6M. Oops, only off by 45%. I wonder what that would have done to the 10% unemployment rate?  Up 6% fromthe prior low rate to up 9%, or 13% overall? 

Obama claimed in the SOTU that he had saved or created 2M jobs. Only 600K or so could actually be counted from his own people, so that was a bit (!!) of an exaggeration. The BLS actually "created" more jobs than the Stimulus. 

A third shoe to drop is the Stimulus itself. I have written how once it passes its peak level per quarter, it will act as a drag on GDP. GDP is calculated using the change quarter to quarter, which is why less of a decline in inventories in Q4 ADDED to the GDP number. In Q4 government spending contributed a negative 0.2% to GDP, even though stimulus outlays remain high. From now on Stimulus outlays will decrease, even though a lot remains unspent. It will drag down future GDP even more. 

Now, all of this stresses my point of view that every W starts as a V. What if we get no V? So I dug deeper to find indications of a V: 

First, the trend seems to be turning to positive. The BLS birth/death model added fewer artificial jobs in Nov and Dec than earlier in 2009 and back in 2008. Maybe the revisions next year will lower jobs early in 2009 and increase them later in 2009, potentially answering the problem Rosenberg flags of how can GDP rise when jobs are falling?Regardless of that, the worst fall is behind us, leaving room for the V-shaped recovery despite Rosenberg's misgivings. 

Second, we are in another jobless recovery, as we had in 1991 and 2001. Many economists follow the Okun Rule, that a 2% drop in GDP causes a 1% rise in unemployment. This rule no longer works, probably because it was constructed in a time of cyclical unemployment: the job is lost but the position remains so the person gets hired back. Instead we have entered a period of structural unemployment where the job is lost and the position goes away. After 1991, it was defenses jobs - the so-called peace dividend. Movies were made of disgruntled middle-aged defense workers. After 2001, it was dot-com workers. Commercials were made of lonely sock puppets. After 2007, it is construction jobs. Not much work pounding nails in Nevada these days. 

Third, we are really in a 100-year-flood type of event. Looking at what is usual or unusual since 1946 misses that this Great Recession is not like any other since the Great Depression: it is the morning after of a huge credit bubble. In a normal recession, Fed tightening strangles a boomlet that usually comes with excess inventory. As we go through inventory rebalancing, things slow sharply but not for long, and away we go with growth again. Unemployment rise quickly, then shrinks quickly as workers are brought back to factories and retail. In contrast, we just came through a different dynamic, where people were using their homes as ATM machines, and when the real estate party ended, they began cutting back, well before unemployment rose. To the extent they retained savings, they can start spending again before employment begins to go back up - explaining what Rosenberg found unusual.

Supporting that perspective is this chart, which shows PCE (personal consumption) rising in a V-shaped recovery off the bottom. If PCE is increasing, employment should follow. 

 

How to square this chart with the chart above, where "final demand" dropped in Q4 over Q3? Well, this chart is a year-over-year comparison and we were in serious freefall in late 2008. The quarter-over-quarter comparison has a downtrend, but Q4 was up over 2008. More to the point is an informative look at PCE by Ed Harrison at Credit Writedowns:

• personal income has fallen off a cliff, and we are in the worst patch in 50 years, but we have begun digging out of that hole since Aug 2009
• disposable personal income fell as well, but not as much, meaning the tax rebates and transfer payments have softened the fall, which is good - my position has been we should bailout people and not banks - but is still the worst performance since DPI records were first kept
• consumer spending also fell off a cliff, but dropped BEFORE income, which while unusual fits my scenario (above) that we used housing as a big ATM machine, and pulled back once the machine went dry, before jobs were lost
• savings spiked up, then went down, then up, and are now trending down - meaning we are reactive, tending to spend as the bad news abates and save as it returns

He concludes that PCE has been on a 4-5 month increase. Let me add that we had spikes up in PCE in July/Aug and then again in Oct due to one-time government gimmicks (cash4clunkers, first-time homebuyer credit), followed by deep drops. These gimmicks perversely disguised the trend up in PCE by pulling demand forward a few months, followed by a "morning after" air-pocket down. The retail and housing drops in Dec and now Jan are a result of the last of those gimmicks, which ended in Nov, but the trend may reverse back up presently. 

A further data point is retail sales. It came in good in Nov, softer in Dec, and now ominously softer again in Jan. But not by much. Yet.

Business loans are weakening, yet the ISM index shows manufacturing is strengthening (more inventory!). Also, while net exports have been a problem, there has been some improvement. With cheaper oil (lower imports measured in $ not #) and a continued increase in exports, net exports could surprise in Q1. 

So it appears that Q1 should also come in up. If Q4 gets revised down, even a modest Q1 increase could be up QoQ. 

This bodes well for a V-shaped recovery, albeit a shallower V than typical. My primary caution is that PCE is doing better than income tax collections, which indicates a lot of it comes from tax-free contributions, such as Stimulus transfer payments (tax rebates, unemployment extensions, etc.). As with inventory rebalancing, this is not sustainable. 

It looks like Q1 (and maybe Q2) will be driven by continued transient inventory rebalancing plus government temporary transfer payments, but not by increases in income nor business investment. 

I stand by the double-dip. Every W starts like a V.

Comments

[michael eckert]

Really nice write-up :)

[Michael]

Duncan, I don't know where you find the time to do all of this, but it is a job well done, for sure!

[Eventhorizon]

Michael, do you blog anywhere? Do you opinion on the various broad markets going forward? You have teased us before with your experiece level, are you willing to share a little about your general approach to trading?

Y-Man - another outstanding post. You have been on a roll lately, I can barely keep up!

[DG]

Yeah, Yelnick, great job pulling all of these different strands together on the fundamentals. I read a lot of the same source material and it all tells the same downbeat story, despite the continued push to make people believe the worst is over. Perhaps the worst in terms of the pace of decline, but certainly not the worst in terms of actual economic conditions.

[betterdays]

THIS RECOVERY IS BALONEY ..TAKE AWAY THE TRILLIONS OF NO INTEREST MONEY FLOATED BY THE fED ... YOU GOTS NOTHING
Nice to see the CNBC Fast Money crowd today, not shilling for their's or friends trading book.
Buy a big dip Friday ? although still going lower

[Webber]

Right, Terranewone was selling out and Finerwoman didn't know what to do. She was even getting tips from Getlongagain on how to protect her positions.

[Taz]

DG

have you been having probelms with your website? Perhaps webnanny may have had the last say here on my end.

[Anon]

Interesting action in the grains today.

[DG]

Taz,

No, not that I know of. There were a stream of posts today.

[Taz]

Thx DG

Alas I can no longer access ur website from work (it is strange because the website is not blocked it just says, address wrong or not connected to net - everything else works fine)

And my missus does not like me doing work at home :(

[Michael]

Eventhorizon,

I am a very active daytrader that will also position trade on occasion; specializing in only one or two stock sectors. Thus, I do not have time to blog about my trading methodology.

I really try to keep things as simple as possible, so as to NOT distract myself from all sorts of technical indicators that rarely offer much in the way of predictive value, and yet hinder my ability to pull the trading trigger. It's one thing to blog, but its entirely another to actually have some skin in the game. I have a lot of respect for Carl Futia for his ability to pull the trigger and post his trades, without getting overly complicated on his blog. Unlike most of the Elliott Wavers who more often than not seek to anticipate a potential trend change, I on the otherhand am a big believer in simply IDENTIFYING and CONFIRMING the trend in the stocks (and market) that I am trading. Price means everything to me.

That having been said, I did offer some thoughts on what I believed to be a tremendous growth opportunity in a very small micro-cap company called EXAS around the Holidays. EXAS is currently developing a 3-DNA marker stool test for colorectal cancer, which is the #2 killer in the US of people over the age of 50, and a $1.2 billion dollar market place. Unlike a colonoscopy, this DNA marker screening test is totally non-invasive.

I am not recommending this company as an investment or trade to anyone. You can listen to their upcoming conference call on Feb. 16th from a proven management team that has a track record of having obtained FDA approval for a cervical cancer PV screening test. I believe that Managment is always key to the success of a micro-cap becoming a much larger cap. The current management team at EXAS ( as of March 2008 ) is exceptional, in my opinion.

As always, do your own due-diligence.

[Alex]

guys guys guys, check out this incredible chart by Neely....waves B+C+D = E

http://www.traders-talk.com/mb2/index.php?act=attach&type=post&id=14663

[KRG]

Y:

Great post once again.. I find it tough to keep track of your posts and I wonder how you manage to post them and in quick succession too!!

Have a good one. Cheers

[trendlines]

Folks, the big question: Are we at the start of wave 3? And here's a very different answer based on my study of US and Shanghai charts:

http://trendlines618.blogspot.com/2010/02/us-vs-china-is-there-leader.html

[DG]

guys guys guys, check out this incredible chart by Neely....waves B+C+D = E

Alex,
In fairness to those who criticize Neely, it took him a long time to reach that perspective and many failed attempts to catch the reversal.

He also had a trade management mistake that cost short-term traders some profits on the decline this week.

But, yes, that was a nice chart.

[DG]

I wouldn't chase it, but cash SPY above 107 is a buy.

[DG]

Given the price behavior so far, a buy at the market is fine now.

[Steven_737]

It appears that both ES and NQ are in the process of finishing the final set of nested w4 - w5.

This price action completes wave 1 from the January top.

A nice divergence is also shaping up on the hourly chart. Similarly a divergence setup is being formed on the daily.

Of course confirmation in needed to call that wave 2 is under way.

[DG]

I closed the shorts on the SPY a little earlier. I doubt we'll go back above 109, however.

[Michael]

Looks like the fib-ratio retracement target of 1056 SPX is holding up pretty well.

[Michael]

Am buying ACI, ANR, BTU, CNX, CLF, and FCX.

[Eventhorizon]

Michael,

Thanks for the response - re-reading my post it came off as an interrogation which was not my intent; I am genuinely interested.

It is interesting to have confirmed that the KISS principle is alive, well and successful!

Do you trade your own account, or are you on a prop desk or maybe with a hedge fund? I understand you cannot divulge the specifics. You mentioned that you specialize in one or two sectors. Do these change depending upon opportunity or have you chosen to focus on those specific sectors for the foreseeable future? One last question ... what is the balance between systematic and discretionary in your trading?

I understand if you don't feel like answering the above!

[Michael]

Evenhorizon,

Don't have much time to answer right now, but briefly...I am trading my own account.

I have chosen to concentrate my trading on the oil drilling and coal sector and due to global macro trends, I do not see that changing anytime soon. These sectors are also high beta one's that provide tremendous volatility for trading and set-up nicely via technical analysis and some rather simple trend following indicators like moving averages.

I also have pretty good depth of knowledge when it comes to the electronics defense sector and the DoD budget due to a core investment holding in a Trust account, but that's another story.

I would say that my intra-day "scalping" is all discretionary, while my position trades are systematic.

And yes, the KISS method is alive and well. The human being simply cannot process all the data that is thrown at him in this electronic day and age. It becomes a distraction, and not conducive to pulling the "trigger" and trading, in my opinion.

Hope this helps.

[DG]

Another short trade triggered here. Doesn't mean the high is in. Due to volatility, the stop on the original long trade was below 103, so no need to jump out of that one as of yet.

[Michael]

DG,

I'm confused.
You have recommended a LONG position with a stop loss at 103, but you just got a SHORT trade triggered here at 105.81 at 8:52am Pacific Time?

[Michael]

By the way, Crude just got hammered as sell-stops got triggered under today's early morning lows... Down nearly $3.00 at $70.30, and pressuring the equity market here.

Tremendous volatility.
Must be very nimble!

[DG]

Michael,

Yes. It will all work out in the end, in all likelihood.

[DG]

Also, you should be confused. If the methodology were obvious, the ability to profit from it would be minimal, no?

What's the quote from Granville, "If it's obvious, it's obviously wrong", right?

[Michael]

"Also, you should be confused. If the methodology were obvious, the ability to profit from it would be minimal, no?" --- DG

So why even bother posting your recommendations here?

[DG]

So why even bother posting your recommendations here?

To show what the final outcomes are. If the final outcomes are good, that's all that matters, right? Isn't that the ultimate validation of any trading method?

You and others are always saying E-wave can't be used for consistent trading and I'm out to show you that the opposite is true. Once I've shown it sufficiently, I'll stop posting them. I grew tired of all the "debates" centered on theory, so I'm going to generate some data to complement the theories.

[Michael]

"You and others are always saying E-wave can't be used for consistent trading and I'm out to show you that the opposite is true. Once I've shown it sufficiently, I'll stop posting them." --- DG

I'm sorry, but posting that your system is BOTH long and short at the same time is not helping your argument.

I'm amazed that you are not able to see that.

[JT]

Michael,

You must forgive our beloved "DG" for speaking out of both sides of his mouth... He does that quite frequently. In fact, we have all grown quite used to it by now.

[DG]

I'm sorry, but posting that your system is BOTH long and short at the same time is not helping your argument.

Uh, last time I checked, the quality of a trade is judged by the difference between its entry and exit prices, not what other trades were also open at the time. If I close both trades at a profit, does it really matter that I was long and short at the same time? Is there some kind of penalty for that, of which I am not aware?

I'm amazed that you are not able to see that.

[DG]

You must forgive our beloved "DG" for speaking out of both sides of his mouth... He does that quite frequently.

That's because I can think with both sides of my brain.

As I said, let's wait for the final result before making judgments, eh?

[JT]

Wow DG.

You are actually admitting to having a system that is BOTH LONG & SHORT at the same time, and believe that such a position is meaningful to making your point that E-Wave can be consistently profitable when trading?

You really need to adjust those meds that you are on, because you are making yourself look like a total fool here.

I wish that Yelnick had an IGNORE button, because the only case that you have made is that there should be one on this website.

[DG]

I wish that Yelnick had an IGNORE button, because the only case that you have made is that there should be one on this website.

Don't wish it, just ignore me. It's pretty clear which posts are mine. They are the ones that say "Posted by DG".

You are actually admitting to having a system that is BOTH LONG & SHORT at the same time, and believe that such a position is meaningful to making your point that E-Wave can be consistently profitable when trading?

Yes, because what I'm doing is a variation of NeoWave, especially the logic. If it works, there is something descriptive of the market in it.

Again, the proof is in where I close out my trades, not whether you agree with them or not while they are open. I find it hilarious that guys who claim to be TRADERS have such narrow ideas of what might work in TRADING. Again, are dollars deducted off my final profit if I had both a long and a short trade open at the same time? If not, please, describe to me the exact reason why it matters? Because it "simply isn't done"? What is this, Victorian England where we have to do things the way they've been done "just because"?

We'll see how the trades net out. That's all that matters to me. You can concern yourself with the "propriety" of having a long and short trade on at the same time all you want.

Anyway, break of the intraday low allows me to lower the stop on the short trade. Risk on the trade is now reduced by 2/3.

[DG]

A few pennies profit now locked in on short trade.

I'd actually prefer it if we went down to the area right near the stop on my long trade and then reversed, but that's in an ideal scenario.

[JT]

No one cares.
You've been exposed, DG.
Take it somewhere else.

[DG]

You've been exposed, DG.

Stop telling about about your favored grade-school playground activities. Exposed as what? A guy who knows when to take a short trade? Gee, I guess I'll have to plead guilty to that one, officer.

Anyway, back to trading. Stop for the short trade is in place and over half an SPY point locked in, no matter what happens from here. See, I told you the market was weak. I actually would prefer that we just go up from here, anyway. The short trade was always a bit riskier because of the current wave structure and the stop it allowed me to set, so I'll be glad to have that one off the table and just focus on the long side trade.

[Mamma Boom Boom]

A tiny little bird (I think it was a peckerwood) told me to move stops in and prepare to cover shorts. What a nice little bird. I think I'll throw him some crumbs.

[Dave B.]

FCX does not want to go down. double bottomed at $66.00 and just rallied $2.00

[Michael]

Yep, FCX is one of my favorites to trade!

By the way, the coal stocks are all GREEN on a day when the Euro has gotten pounded.

[DG]

A tiny little bird (I think it was a peckerwood) told me to move stops in and prepare to cover shorts. What a nice little bird. I think I'll throw him some crumbs.
--------------------------------------------------------
That's one smart bird.

[Mamma Boom Boom]

>That's one smart bird.<

Thanks. You might have noticed that was right at the bottom, too.

(I'm not certain what the clock showing refers too. Is it Pacific time?)

[DG]

Yes, that's Pacific Time.

Yep, I was stopped out of my short right around that same time, so the market was all ready to head up. Nice short squeeze at the end. Very big volume on the index ETFs.

All in all, though, what I'm really looking for is for this rally to fail at some point next week, for what could turn out to be a very nice shorting opportunity.

[Mamma Boom Boom]

>for this rally to fail at some point next week<

Sorting thru the chicken entrails, it does look like some heroes stepped in this afternoon. But I don't think it was much (maybe a token jester from the PPT). It will take more power than that to get more than about two days of rally. But, who knows?

[DG]

But, who knows?
---------------
The only two things that would really surprise me are an immediate return to the downside or a new high. Other than that, the bulls have the ball now and will do with it what they can.

[Steven_737]

"the bulls have the ball now and will do with it what they can"

A nice Fibonacci retracement wave 2 to levels 1080 (50%) to 1106 (61.8%), with 1123 extreme (78.2%).

Wave 1 according to my count is complete:
http://farm5.static.flickr.com/4061/4332848325_b32aee70c4_b.jpg

[Taz]

Keep up your posts DG.

I for one appreciate them.

Very few here have the balls to put it on the line as you do, day in and day out.

As to having longs and shorts on the market at the same time, I am amazed how so few can comprehend this concept. In a two horse race, the first has a 75% chance of winning, the second a 25% chance of winning. If you are able to back both horses and ensure a guranteed profit regardless of who wins, why is this less inferior to backing only one horses and losing some of the time. I think it is a simple recognition of the fact that the market does not always accomodate our view. Obviosuly your positions are not guranteed from the onset but as you illustrated it does not take much for you to lock in a profitable stop loss.

[Webber]

With the Winter Olympics starting next weekend there is a lack of snow on the ski jump but the market will oblige as the next 2 weeks will be wave (iii) of iii(circle) of 1. The higher close today was smart money getting out of shorts for the weekend with all the debt turmoil going on. They will jump back in Monday. Wave (i) dropped 60 and wave (a) of (ii) bounced 22 to 1066.80, the 4th(circle) of iii(1065.99 ), a 36% retracement. This same fractal appeared in wave ii(circle) which ended Tuesday. Wave (b) and (c) will likely complete wave (ii) by next Tuesday around today's closing and then drop well through SP1000 to expiration. Downhill skiing ahead!