July 16, 2010
The market continues to oscillate, vacillate, and meditate as we warned in our previous newsletter (see Vega Capital Group Quarter I, 2010 newsletter).
In order to get a better understanding of what is happening, let's take a look at one of our favorite economic data — both from political and macroeconomic points of view — the unemployment rate. It is this number which determines the well being of the nation, after all, dictates many economic and political decisions, influences the consumer confidence index, and defines the behavior of our politicians.
Recently, the Bureau of Labor Statistics published its June report. Let's begin with it and analyze it slightly deeper than the headlines.
Let's recall, first of all, that those who were advocating the green shoots have received a serious blow in May of this year. They learned a lesson, and this time around, the approach to the forecast has been much more careful — and probably somewhat subdued. "Yes, we are expecting worse numbers — but only because the temporary census workers are being laid off" — was the favorite explanation of one of the CNBC hosts — the one who thinks he is smarter than every single person he interviews.
After the report came out, the talking heads of CNBC started to tell us that the private sector has added 83,000 jobs. Hallelujah! As a matter of fact, the number of jobs has decreased by 125,000 since the number of temporary workers went down by 215,000. This just tells you to take everything TV economic commentators say with a huge grain of salt. When the number of temporary census workers hired reached 400,000, nobody even mentioned that! In addition, another 200,000 census workers will be laid off in July!
Now let's look more carefully at the growth of jobs in the private sector. After all, it is this growth (while we still have capitalism) that defines the state of the economy. What is surprising is that for many months, the forecasts of government statisticians did not coincide with the predictions of independent statistical and very respectable agencies (such reports are compiled not by polling but consolidating payrolls). Using a very large sample of objective data, the private reports estimated the number of jobs being created in the private sector at about 13,000 (the government agency puts the same number at 83,000). If you followed the above arguments carefully, the answer is obvious — the government statisticians added the "estimated" number of jobs created by small businesses and have come up with 145,000 phantom positions. Therefore, again — the conclusion is obvious — THERE ARE NO NEW JOBS being created in the private sector.
However, to our complete surprise the statisticians reported a decrease in unemployment. How did they accomplish this mathematical miracle? Exactly the same way they did it several reports ago — they just removed about 1,000,000 people from the labor force, and reclassified some unemployed as "temporary not looking for employment." This is completely Kafkaesque: the economy supposedly has been growing from the second half of the last year, and the labor market is shrinking! Of course, you remember that for the current administration, 10% is a psychological barrier of unemployment you cannot overstep…hmm…
OK, enough digging into numbers; the readers might be tired by now. Let us look at the big picture — it is much more difficult to misinterpret it. Let's, for example, look at the weekly unemployment claims — without NORMALIZING or AVERAGING the data (a favorite device of the abovementioned statisticians). To see long term trends, it is better not to average the data.
First, a few empirical but very important facts:
- The level of new unemployment claims has to be below 300,000 to see real job growth.
- If the number of new unemployment claims is about 400,000, we are not creating any new jobs (these are back of the napkin calculations, but they are surprisingly precise).
- If the number of new unemployment claims is about 500,000, we continue to lose jobs.
- In order for us to come back to the pre-crisis employment level, we need the number of unemployment claims not to exceed 200,000 to 250,000 for about 2-3 years!
Analyzing these data, we come to the conclusion that the economy is in absolutely static mode since approximately November of last year. We are sitting in the range of about 400K-500K new unemployment claims for about 8 months, and cannot get out of this range. In other words, One Hundred Billions Dollars of monthly budget deficit keeps the economy on life support machines — but cannot give it a necessary pulse.
On the other hand, the patient's condition is not critical enough to give him Stimulus 2.0 medicine (especially, taking into account the fact that the voices of budget restraint advocates are sounding louder and louder)!
That is exactly why the markets behave so irrationally — nobody can determine the exact course of treatment. Even the most insignificant news might cause wild market oscillation and gyration. Please, pay attention to the fact that though the first quarterly reports were not bad at all — they still caused a very constrained optimism. This is because everybody understands that these results (great earning of those companies) on the macro level are sponsored by the government budget.
The most important statistic — the graph of employment — does not imply the Double Dip, nor tells us that we are out of the recessions either. So what should we expect in the nearest future? The next important data point will come soon — a preliminary number for GDP for the second quarter will be published at the end of July.
A few other important economic headlines are on the horizon:
We are all getting stressed about European banks stress tests — and we will be analyzing the results of stress tests for clues to the health of European banks. Greece is not out of the woods, the oil spill in the Gulf of Mexico has unclear implications, and many other small and not so small events are happening. But the crown of it all is the financial reform. Markets hate uncertainty — and there is no bigger uncertainty than the financial reform with its unclear repercussions.
It seems that the panic about the euro zone has receded — for now. The data seems to support that point of view — the beleaguered country manages to raise Euro 1.6 billion ($2 billion) at a yield of 4.65% in its first venture into the markets since a Euro 110 billion rescue package from the European Union and the IMF was secured in May. That is hardly dazzling.
The index that measures bulk-shipping rates has fallen off a cliff: for most of the past two decades, the main measure of shipping costs has been used as a guide to what is happening to world trade. So the fact that the Baltic Dry Index — which measures the rates charged for chartering the giant ships that carry coal, iron, or grain — has fallen by almost 60% in its longest streak of consecutive declines for nine years (34 days running as of July 14th) has won the attention.
Therefore, if you had a chance to review your June statements, you have noticed a very conservative positioning of the accounts in Vega Equity* Program — a lot of covered calls, increased amount of cash, increased position in the volatility indices — a contrarian position to the market. We continuously observe the markets and take all necessary measures to protect the accounts as new economic data becomes available.
Sectors that continue to attract our attention are still concentrated in oil and oil exploration and technology. Many analysts are of the opinion that computer and software stocks have slumped to their lowest valuations in two decades, a sign to some analysts that they are poised to rebound. We do not totally disagree with these valuations, and have created a wish list, but would like to see other macroeconomic events unfold before building these positions. Of course, the caveat here is that as a group, tech stocks trailed the S&P 500 for seven of nine years through 2008. This year, they are down 4.6 percent vs. the S&P 500's 1.8 percent drop. Attractive valuations and renewed tech spending by U.S. companies that are sitting on a record amount of cash may lift shares even if growth slows.
Feel free to call and discuss your accounts and their positioning. We would strongly encourage you to consider your risk tolerance during these volatile times. It is as important as ever to do it now.
As always, we appreciate your business. Do not hesitate to call us with any questions you might have, and refer us to your friends.
Vega Capital Group Team.