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:
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.
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
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.
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.
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.
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.
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!