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Is the So-Called Recovery a Hoax?

Todd Stein & Steven McIntyre
The Texas Hedge Report
August 26, 2004
Courtesy of

During recessions (commonly defined as two consecutive quarters of decline in real GDP), employment, industrial production, trade sales, and personal income have all historically tended to slow down considerably. Businesses and consumers would be forced to clean up their balance sheets by becoming "leaner and meaner," which would of course set the stage for the next expansion.

The US economy has suffered ten recessions since the end of World War II, the last of which officially began and ended during 2001. It was over three years ago when the dotcom burst and NASDAQ decline made headlines on a daily basis. Layoffs began to hit internet startups (remember the pink slip parties), followed by telecom companies' cutbacks, and then finally job losses spread to the rest of the economy. For the first time in a decade, increasing amounts of college students were graduating without a job, thereby spurring record amounts of applications to law and business schools.

While the stock market continued to decline, a so-called economic "bottom" was reached shortly after the 9-11 tragedy struck. At that time, the Federal Reserve began to print money like mad, flooding the system with liquidity through a series of dramatic interest rate cuts and money supply growth. Ignoring the need for households, governments and businesses to clean up their balance sheets, Greenspan lowered interest rates immediately in order to stimulate the economy. Lower short-term rates brought down mortgage rates, increasing home sales to record levels. That not only stimulated more home building but also increased sales of furniture, appliances, and other consumer durables. Lower monthly payments on mortgages and credit cards gave people the ability to spend money they didn't have on things they didn't need such as new cars, luxurious vacations, designer clothing, and fancy meals. Dallas Fed President, Robert McTeer shockingly urged an already over-levered American consumer to spend, saying "Go out and buy something" and ''if we all join hands together and buy a new SUV, everything will be okay."

In addition to monetary stimulus, Congress passed a series of tax cuts in order to keep consumer spending on the rise. This extra spending money went directly into the cash registers of stores such as Home Depot, JC Penny and Sears. Retailers started to give discounts to consumers who would spend their tax refunds in their store and gave special discounts to those who would open up a store credit card account. Consumers began to spend at an extraordinary rate that exceeded their income - and the attack on saving continues today.

This orgy of spending finally began to show up in the bottom lines of American companies starting in late 2002. As the stock market ended its decline, cheerleader media pundits began to talk about a "jobless" recovery. Normally, such silly talk would end quickly as an increasing amount of unemployed consumers would not be able to spend money they didn't have, slowing the recovery. But as a result of this new "easy credit" environment, people kept on spending regardless of their resources. Instead of perusing the help wanted ads, unemployed homeowners refinanced, cashed out, and took trips to Las Vegas in their newly purchased gas guzzling SUVs.

Employment statistics started to improve by the end of 2003, but something was wrong. A look behind the numbers shows that most of the newly created jobs and rising employment rate came from a combination of government hiring, temporary work, a drop in the employable base, and other questionable sources. A second statistic shows that wage growth has been nonexistent while, as you know, the cost of living has increased dramatically. 

We suspect that the job statistics trumpeted on CNBC by people such as Treasury Secretary John Snow or CEA Chairman Greg Mankiw are possibly being manipulated for political reasons. While the level of manipulation may not mirror that of the old Soviet Union, we have a few questions to ask the folks over at the Bureau of Labor Statistics. According to Comstock Partners: "A large majority of the employment growth that was reported and so widely hailed in the last three months is based on a guess attributable to an arcane formula used by the BLS to estimate employment changes resulting from the birth and death of business establishments."  Below is data on the Birth/Death Model adjustment from the Bureau of Labor Statistics. To quote from the BLS: "Earlier research indicated that while both the business birth and death portions of total employment are generally significant, the net contribution is relatively small and stable."  We guess it depends on one's opinion of "stable."  From April 2003 through January of 2004, the net job creation from the Birth/Death Model estimation was just 374,000 jobs in a span of 10 months or about 37,400 jobs a month. Yet, between February and June of 2004, the Birth/Death Model estimation has magically created 915,000 jobs - goosing job creation from the model to 183,000 jobs a month. What is scary is that last month's total job creation was only 112,000 - meaning that if not for the Birth/Death adjustments, we would've LOST 80,000 jobs in June!

In other words, about 80% of the employment growth in the last 5 months (915,000/1,107,000) is derived from a soft government estimate instead of from the actual survey.

To be fair to the BLS, we have no proof that manipulation is taking place and it is possible that their models could be accurate. The skeptics in us just find it odd that the sudden jump in 2004 job creation corresponds with the estimate jumps in the Birth/Death model. Given what we hear and see on the street, it seems that the job market remains pretty weak and the real unemployment rate is something closer to 7% or higher if calculated properly.

So what does this all mean for your investments?  Be wary of investing in stocks sensitive to the overall economy and with historically high P/Es. Anecdotal indicators such as the number of 'get out of debt' commercials you see on television or the ability of college students to get a full-time job right out of school can help individuals put the smell test on government statistics. 

Be suspicious of government officials telling you how great the economy is and how it is looking ever better - you get elected by being an optimist, not necessarily a realist. Finally, in your own personal life, start getting in the habit of saving more by decreasing your consumption of luxury goods. If we do enter recession once again, you will see that the winners will not be those who made money, but those who kept what they had.

August 26, 2004
Todd Stein & Steven McIntyre
The Texas Hedge Report

Todd Stein & Steven McIntyre are internationally known analysts and editors of The Texas Hedge Report, a market newsletter that highlights under and overvalued securities in the equity, bond, currency, and commodity markets.
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