No Respect

When people use the phrase “no respect” in a Wall Street context, it typically refers to a rising equity market that catches investors off guard. A no respect market is essentially one where investors have focused on the wrong narrative and failed to update views based on new information. In behavioral finance terms, this failure is known as a conservatism bias. A conservatism bias is also a form of cognitive dissonance, which is the mental discomfort a person may feel when faced with data that conflicts with ones views. It is this dissonance that causes a person to ignore or discount new data.

Understanding and addressing a conservatism bias is one of the most important abilities an investor can have and it’s not just applicable to investing either. Dealing with and adapting to new information in ones life is also critical for a healthy existence…Now before your eyes start to glaze over, lets switch from the academics and philosophy of behavioral finance to what is currently happening that makes this so important.

Right now, we have not just a no respect equity market, but a no respect economy to go with it. When I say no respect economy, I am referring to the significant services section of the economy which is being discounted and sometimes completely ignored by financial media. A topic I have touched on many times in my writings has been the transformation of the U.S. economy to a services / consumption based economy versus the old manufacturing / export driven one. This is most easily demonstrated in the below tables with selected items from the most recent GDP and nonfarm payrolls reports:

GDP 11.29.15

Jobs 11.29.15


As you can see in the tables, exports and manufacturing play reduced roles in terms of GDP and employment. Going forward, manufacturing employment continues to decline while Professional & Business Services is on the rise.

PBS 11.30.15

It seems however, that no matter how much the data shows we are a services based economy, many economists, journalists and others in financial media refuse to adapt to this change…Cognitive dissonance

Services Ignored

So lets take a look at conservatism bias in action. Here is an article just published by the WSJ on Saturday… 5 Things To Watch On The Economic Calendar..The good news is that the article cites this Fridays payroll number as being the most important item to watch this week. The very bad news is that they fail to mention we are getting the best indicator we have on the services side of the economy on Thursday, the ISM Non Manufacturing Index (NMI). Given the relative importance of services data, you would think that NMI would have made it into this list or have at least been included with the mention of the ISM Manufacturing report.

For some background on ISM data, it actually goes back to 1915 and covers all these industries:

Non-Manufacturing ISM® Report On Business® is based on data compiled from purchasing and supply executives nationwide. Membership of the Non-Manufacturing Business Survey Committee is diversified by NAICS, based on each industry’s contribution to gross domestic product (GDP). The Non-Manufacturing Business Survey Committee responses are divided into the following NAICS code categories: Agriculture, Forestry, Fishing & Hunting; Mining; Utilities; Construction; Wholesale Trade; Retail Trade; Transportation & Warehousing; Information; Finance & Insurance; Real Estate, Rental & Leasing; Professional, Scientific & Technical Services; Management of Companies & Support Services; Educational Services; Health Care & Social Assistance; Arts, Entertainment & Recreation; Accommodation & Food Services; Public Administration; and Other Services (services such as Equipment & Machinery Repairing; Promoting or Administering Religious Activities; Grantmaking; Advocacy; and Providing Dry-Cleaning & Laundry Services, Personal Care Services, Death Care Services, Pet Care Services, Photofinishing Services, Temporary Parking Services, and Dating Services).” **Taken from the October ISM NMI report.

Now we need to take a look inside the October NMI report which came in at a very strong 59.1. The NMI employment sub-index came in at 59.2 up from the prior months 58.3. So why is this significant? Because in the October payroll report, Professional and Business Services posted the largest gain of all industry sectors, helping push Octobers job gains to 271K. However, given the volatile history of payroll data, this could be a complete coincidence…But it still can’t be ignored.

Services Mistreated

I have taken a couple screenshots provided by the Econoday news service which provides the raw economic data reporting for Bloomberg, Barron’s, Nasdaq and other online sources.

ISM weak star 11.26.15

Above, I have circled the two ISM reports we have coming up. As you can see, the manufacturing report has been ranked higher in importance over the NMI report. Based on the significantly greater role that services play in our economy, one would think that NMI would be given the higher rank or perhaps both be of high priority. The fact that Econoday equates the NMI report with that of a Fed regional report just shows how misunderstood services data is.

Below, we have a case where the Markit Services Flash report is relegated to near complete insignificance while its manufacturing counterpart receives a mid level priority ranking.

PMI No star 11.26.15

Granted, the Markit PMI Manufacturing and Services Reports are new compared to ISM, they still present relevant data on a timely basis. All this said, the PMI Services Flash report for November came in at 56.5, its highest level since April. The employment sub-index also increased from last month which could bode well for the November payroll print. In one way, the misreporting of services data provides an opportunity for those that follow it. If services data keeps just where it is, we are looking at a strong economy. ISM equates the current NMI reading of 59.1 with a 4.5% GDP. A 4+% GDP would have the Fed raising rates much more quickly than the bond market is even close to anticipating.The bottom line here is that investors are being disadvantaged by the underreporting and sometimes outright omission of a significant and healthy part of the economy.

Upcoming Week

We have an action packed week leading up to yet another “most important ever” payroll number on Friday. The items I’ll be looking for most this week will be both ISM reports, construction spending, and weekly claims data. Weekly unemployment claims have been historically low for the last six months and are really pointing towards a full employment labor market. As long as the employment data keeps they way it has been, the economy will keep chugging along… So lets see what this week brings!

Critical Mass

It’s been a while since I’ve been able to get something posted as I was traveling for a bit, so It’s really nice to jump back in with several items that are feeding my confirmation bias…So another first Friday of the month has come and that means our favorite labor indicator, Non Farm Payrolls, came out and oh what a doozie it was. NFP came in at 271K for October, well ahead of expectations. To give some context on how strong the number was, the average monthly gain since the recovery really started in January 2010 has been 185K. This is important because the recession officially ended in June 2009 as per the NBER, but we were still shedding jobs at that point. If we were to go back those six months, the average would drop to just 146K making October’s 271K that much more of a strong print.

NFP Escape Velocity 11.7.15

The long term picture of payrolls…If not full employment, it’s darn close.

NFP LT 11.8.15

This strength in payrolls brings me to the idea of the economy having finally reached its critical mass versus still needing to hit “escape velocity.”In physics, a critical mass is the minimum amount of matter needed to sustain a chain reaction. In economic terms, critical mass would be the point where an economy has built up enough of its primary driver to sustain itself until the next downturn. In the U.S., that primary driver is consumption. We know consumption can only be fueled by jobs and income. That said, when we look at the gains in payrolls, the low levels of unemployment claims and the high level of services consumption in the economy, we have indeed attained our critical mass.

Services Labor

A topic that I’ve been discussing here and on Twitter since June is the importance of  service components in labor and inflation data. In labor data, the service category covers occupations that range from lawyers, accountants, architects, engineers, computer programmers, medical and education professionals, waiters and bartenders…even to CEO’s. Now, to put services labor in perspective versus its “hard” labor peers, lets look at the total persons employed in various industries and their earnings generated as of October payrolls. Industries are ranked by total earnings.

NFP TE 11.8.15

Items to note:

  • Four of the top five earning industries fall into the services category.
  • Mining and logging contribute the least to total earnings while the overall economy is still having healthy growth.
  • Increases in food services and administrative support services are a knock on effect of increased consumption and business’ needing to support increased demand.

People always bemoan the loss of manufacturing jobs and their associated wealth, but the data does not support it. Professional and Technical Services (PTS) average earnings are 38% greater than manufacturing wages and will overtake manufacturing in terms of headcount in the near future. Also, the broader services category, Professional and Business Services, already generates nearly 22 billion dollars in weekly earnings.

X Marks The Spot

X Marks the spot 11.8.15

The chart above shows us the long term employment change in manufacturing versus PTS. This trend along with the higher wages associated with PTS demonstrates a healthy transition to a services-based economy. The bottom line here is that wages and jobs are growing in the right places.

Services In Action

ISM 11.8.15

When we consider how much more of a services based economy we are today compared to 1997 and 2005, this chart is showing a strong economy.

This past week we got the two major data points for gauging the services economy. The ISM Non Manufacturing Survey and the Markit Services PMI. The ISM report came in at a very strong 59.1 with employment and new orders components pushing highs, while the Markit survey came in at 54.8. In these surveys, anything over 50 represents overall expanding activity which is something many people seem to forget. So when financial media sites say “a plunge in activity from 55 to 53,” it’s simply a case of negative framing at its best. That said, the  reading of 54.8 in the Markit survey is still a healthy reading, but you wouldn’t think so after reading the report. Looking at the data in ISM NMI, we clearly have strong services consumption going on. This month, the ISM Employment index gave us a great preview of the NFP report. It’ll be interesting to see if that holds up next month. The point here is that we are a services-based economy, and I can’t stress enough the importance of looking at these services indicators.

So Now What ?

Given the data we’ve gotten recently and the October FOMC statement, a December rate hike is definite. The only way that a hike does not happen is if we get some type of macro event that causes real global turmoil. Since the Fed backed off its global macro fund stance that it had in the September statement, it will take more than a Chinese stock market sell off to sway them now. Coming up this week, we get one of my favorite indicators, the NFIB Small Business index along with JOLTS, weekly claims, retail sales and PPI. There are a couple other data points, but these are the ones I’m focused on. NFIB is a great check on small business which helps fuel consumption on a regional level across the country so we need to pay attention to that. The moral of the story here is to buy the dips in equities and sell the rips in bonds. It’s good to be back in the swing of things…