Weekly Economic Update 06-15-2018

The Fake Monthly Jobs Report

On the first Friday of every month, the Bureau of Labor Statistics (BLS) publishes the number of jobs that were created or lost during the prior month and then revises the number of jobs created or lost during the two months prior. Recently the BLS reported a staggering 223,000 jobs were created in May which is an unusually high number considering the late stages of the current economic expansion. However, based on this number as reported by the media, the stock market rallied and interest rates rose as investors worldwide celebrated the unwavering strength of the Trump economy. But what the media didn’t report is the number of jobs created under the BLS’s Birth-Death model which was 215,000.

The Current Employment Statistics (CES) Birth-Death model estimates the net number of jobs created by new businesses each month. Since most new businesses initially have only one employee, the Birth-Death model is largely associated with the number of workers joining the ranks of the self-employed. The BLS estimates these jobs because it can take a long time for a self-employed worker to be counted as employed, so the BLS decided many years ago it would be appropriate to estimate them.

The truth is the BLS does not know if any or all these jobs are created because the number is entirely fictional. In fact, it is someone’s job at the BLS to create this number each month. For May, the headline number of jobs created was 230,000, but 215,000 of them were estimates under the Birth-Death model, meaning only 8,000 jobs were actually created.

The fudging of the monthly Nonfarm Payrolls report is nothing new. It started when Ronald Reagan was President, who in the early years of his Presidency experienced a nasty recession. Our government has figured out that if the public believes the economy is better than it actually is, they will spend more money. When the public spends more money, the economy generally improves. The BLS began estimating the number of jobs created by new businesses to pump up the monthly payrolls report and it worked.

Imagine if the BLS reported only 8,000 jobs were created in May. President Trump, who previews this number the night before, would not have Tweeted before the release about how great the May jobs number was going to be. It is also unlikely the stock market would have rallied and equally unlikely, interest rates would have risen.

When I first learned about the Birth-Death model I was surprised. The mainstream media and the financial media only report the headline number. Occasionally I will run across an expert who knows what this number is. Due to the scarcity of this information, I assumed it was a complex calculation that only an insider might have access to. Last week I decided to make an attempt to become one of these insiders by learning how to calculate the Birth-Death model. Little did I know, the BLS publicly publishes the current and historic monthly Birth-Death model numbers.

With access to the headline monthly Nonfarm Payrolls number and the Birth-Death model numbers, I decided to find out just how many jobs were really created since the last recession. According to the National Bureau of Economic Research, the last recession ended in June 2009.

Since June 2009, the headline monthly Nonfarm Payrolls report shows 17,640,000 jobs created. The Birth-Death model, since June 2009, shows 6,507,000 jobs were estimated to be created, which is 37% of the headline number. The known number of jobs created since June 2009 has been 11,133,000 or 63% of the headline number.

The reason this matters, other than the fact we are being lied to and manipulated, is the Federal Reserve bases their monetary policy decisions partially on the monthly Nonfarm Payrolls report. We have one part of the government creating fictional jobs to make the public think the economy is growing faster than it is, and another part of the government (even though the Federal Reserve is allegedly independent, I will consider them part of the government for the purpose of this essay) is making monetary policy decisions based on those fictional numbers.

To make matters worse, investors are making decisions on how to invest their money based on these fudged monthly job reports. In the past three months, the BLS reported 537,000 jobs created, but 540,000 of them were from the Birth-Death model, meaning over the past three months the economy actually lost 3,000 jobs! For those who continue to chase the stock prices higher, this revelation certainly puts the overvalued state of the stock market into perspective.

The High Cost of Shorting Treasuries

Earlier this year, based on fear of rising inflation, investors began dumping their bonds for stocks and speculators began shorting U.S. Treasury bonds. As Treasury yields rose, investors continued selling bonds and speculators continued to add to their short positions. As of last week, there is now a record amount of money shorting U.S. Treasury bonds. Despite the record short interest, Treasury yields have been flat for the past four months.

Few understand there is a high cost of shorting a bond (or stock), which is why short positions cannot be held indefinitely unless yields continue to rise.

When an investor buys a bond they are taking a “long” position, which means in addition to receiving the regular dividend payment, the investor is hoping the bond will either hold its value or appreciate in price. When an investor shorts a bond, they take a “short” position, which means the investor is borrowing the bond from an investor who is holding a long position.

The investor who has borrowed the bond to take a short position is required to make the dividend payment to the person who owns the bond. U.S. Treasuries pay a monthly dividend, which means the borrower, or investor who is short, has to pay the monthly dividend. Paying a monthly dividend eats into the profit gained from shorting.

With yields flat for the past four months, those holding short positions have been watching their profit slowly erode. If yields continue to hold their current level, or even worse for those shorting, fall, the short holders will start to exit their positions. When a large number of short holders start to exit a position, a short squeeze occurs.

A short squeeze is when a large number of short holders try to exit a position at the same time. Often this forces those who are short to take a long position to cover their short. The reason short holders can be forced into buying a bond or taking a long position is because they may have locked themselves into a short position for several months into the future. With the inability to exit a locked-in short position, the only alternative to mitigate losses is to buy a bond or take a long position.

Often times when cash levels in brokerage accounts are at a low level, such as today, it forces investors holding a locked-in short bond position to sell equities to buy bonds. This is one reason why stock prices can fall when bond prices rise; it’s a function of a short squeeze.

For those worried yields are going to continue spiraling higher, it is unlikely. Professor Milton Friedman, who created the best model for interest rates, shows that yields fall during periods of monetary tightening. With the Fed continuing to reduce the Monetary Base by raising the Federal Funds rate and reducing the size of their balance sheet, it’s only a matter of time before the largest short squeeze in U.S. Treasury history sends yields spiraling down.

Q&A with Steve – Your Questions Answered

  1. What happened to the stock market on Monday?

After further threats of an escalating trade war from the G-7 meeting this weekend, global markets ignored the warns and continued to rise. The U.S. equity rally is largely down to corporate buybacks, which depending on the size of the company who is buying their stock back, can only buy up until the last 10 to 30 minutes of the trading day. This is why in the last half hour of trading, stock prices fell. Trading volumes remain low which is further indication the only buyers remaining are corporations buying their stocks back.

The scheduled 10-year Treasury auction was strongly received, yet those short Treasuries didn’t budge today. Yields were largely flat for the day but continued strong auction results are a major warning sign for all those holding short positions. The securities dealers showed up at the auction, which is interesting since they are also the ones telling the public interest rates are going higher. If they truly believed rates were going higher, they wouldn’t be showing up at the Treasury auction to buy.

Agricultural commodities slid today even though President Trump is working hard to increase prices for our farmers. With the Fed set to meet tomorrow and raise interest rates, this is going to further hurt America’s farmers. The USDA has been under-estimating crop results for the past few years, and insiders say this year, they are over-estimating. Regardless, there’s a heatwave headed towards the growing regions this summer and that will likely be bad news for crop conditions.

The gold miners finally crossed over their 50- and 100-day moving averages but aren’t trading in a price range that signals a buy.

Tomorrow kicks off the two-day Fed meeting where it is expected they will raise the Federal Funds rate on Wednesday. Further tightening will increase the deceleration in the money supply.

  1. What happened to the stock market on Tuesday?

The Consumer Price Index for May came out showing prices (not inflation) are rising 2.8% per year. In the same report, wage growth has been flat, which means consumers are facing increasing prices with less money. When there is a deceleration in the growth rate of the money supply, you can’t have higher prices and higher wages. I fully expect the Fed to raise the Federal Funds rate tomorrow to “combat inflation,” even though rising prices is not the proper definition of inflation.

Tech stocks continue to grind higher as the word on the street is that the public now believes tech stocks are safe an immune from market downturns. Meanwhile, tech executives are dumping their stock into the hands of willing buyers as fast as they can. Remember, when executives are selling their stock and the public is buying, it’s an indication the executives don’t see their stock price going too much higher. If the executives thought their stock price was going higher, they’d hold. This continues to be a warning sign.

The 30-year Treasury auction was well received with strong demand, which is somewhat surprising it was held one day before Fed Chairman Powell is expected to announce a rate hike and provide direction on the Federal Funds rate. The same people who are telling the public to sell their bonds and short bonds are buying bonds.

  1. What happened to the stock market on Wednesday?

As expected the Fed raised the Federal Funds rate by 0.25% today, which will drain $60-70 billion from the monetary base. Chairman Powell stated the Fed will continue a gradual path to normalize the Federal Funds rate to avoid a recession. The Fed is projecting two more rate hikes by year-end.

When asked if the economy was in the midst of the massive credit bubble, Powell said no. When asked about wage growth, Powell said the Fed remains “puzzled” as to why wage growth isn’t happening faster. Powell did state repeatedly that the economy is strong, the banking sector is strong, and higher interest rates were needed to combat inflation. The Fed doesn’t see inflation going much higher, but they still plan to hike rates to return to “normalization.” As if anything the Fed has done in the past 10 years can be considered “normal.”

Usually, a rate hike is bearish for equities, and as expected, stocks sold off a little with the announcement of another rate hike. The sell-off didn’t last long because corporate share buybacks continued up until the last thirty minutes of trading. As the last 30 minutes happened, stocks started to fall as sellers entered the market. Corporate buybacks don’t have any criteria other than to buy, whereas investors see tighter monetary policy being bad for stock prices.

Treasury yields jumped on the announcement, which is usually a good sign because yields tend to move in the opposite direction of whatever the initial reaction is. Sure enough, buyers came and bought bonds. Momentum on Treasuries is in a bottoming pattern with the shorter-term momentum scales turning upwards. This is a good sign for us to bring cash in soon.

I watched the gold miners carefully and actually set the portfolios up in case there was a big move. Prior rate hike announcements have caused large moves in the miners, but not today. Still looks like gold is headed lower before it goes higher.

Agricultural commodities are floating around on news of early crop plantings and the Trump administration enacting tariffs on China. Even if China starts buying soybeans elsewhere, it will cause domestic prices to rise. The bigger issues are the warmer temperatures that are headed to the farming region this summer and that higher interest rates are going to further hurt farmers who recently lobbied the Fed to stop raising rates. If farmers go broke before bringing their crops to market, prices will rise.

  1. What happened to the stock market on Thursday?

Retail sales came in stronger than expected after consumers spent the first four months of the year paying down on their credit cards. Consumers weren’t shopping for cars this time around, so it’s likely pent-up demand from budgeting for four months. Given the drain on the money supply, I expected retail sales to fall, but credit card balances are still growing at an 8% annualized rate despite consumers paying balances down a bit.

Equity markets shrugged off further monetary tightening and seemingly ignored tomorrow’s news of new tariffs on China. Tech stocks continue to rally as investors pile into tech stocks and tech companies continue to buy their shares back. It reminds me of how the markets behaved going into the dot-com bust. Trading volumes are still light.

Bonds, which are a better proxy of the economy, ignored the retail sales report as yields fell. The Bank of Japan announced a further tapering of their bond purchase program and the European Central Bank signaled the possibility of ending their bond purchase program by year-end. Momentum on bonds should start turning upwards next week, which is something the short-sellers don’t want to see. This will be our opportunity to bring cash in and get all the portfolios unified. If there is a short squeeze, yields could fall back to levels not seen since the Presidential election. Even Bank of America Merrill Lynch agrees that yields could fall under 2% in the near term.

The large gold miners are starting to track their 50-day moving average as physical gold remains flat. I’m not convinced the miners have the right call yet, but they tend to rise as bond yields fall. We’ll see how this shakes out. I’ve got the allocation set to move into those positions if opportunity knocks. Momentum is still heading down for now.

Agricultural commodities are back near their 15-year low on the news the US will be handing out more tariffs to China. Usually, tariffs lead to higher prices, so we’ll see. I’m hearing from various traders that this is the cheapest asset class on the planet right now, which is garnering interest from money managers who want to buy low and wait. Momentum is still trending upwards.

  1. What happened to the stock market on Friday?

Stocks fell on news President Trump was planning to announce $50 billion in tariffs against China. Stocks would later rally back on news that China was responding with $50 billion in tariffs of their own. Why that is a reason to buy stocks is beyond me, but it is an indicator of corporate share buybacks dominating the market. It’s always good to have a buyer who doesn’t care about the price or news before they buy.

Treasury yields fell on the news of a budding trade war, but Treasury short-sellers came in to defend their position. There is a clearly defined line of where the buyers and sellers are at, with the sellers fighting from a weakening hand. Should the balance tip in favor of the buyers, we’ll see the beginning of the largest short squeeze in U.S. Treasury history.

Physical gold dumped on the news, which I have been expecting. This suggests gold is likely to head down to the $1,250-65 level that I have previously identified as the last target “Buy Zone” before gold takes off. This is the matching price-level of where I plan to begin buying the gold and silver mining shares. Seasonally, gold tends to begin rallies towards the end of June, so the timing here is favorable.

Soybeans have sold off on news of tariffs, but when you have record demand for food and record supply of food stocks, any disruption leads to higher prices. Even if China buys all their soybeans from other sources, there isn’t enough supply to meet demand, meaning someone will have to buy from us at some point. Likely with prices much higher than today. Large buyers started buying today, as they know either tariffs will drive prices higher or the trade disputes will be settled, which will also lead to higher prices.

With bonds showing signs of their rally beginning and gold falling towards my “Buy Zone,” this should start to open opportunities to get the cash on the sidelines in, and the portfolios rebalance to take advantage of the rising U.S. dollar and the long-anticipated opportunity in the mining sector.

Thoughts on the Momentum Strategy –

My original thought was a momentum strategy would identify which sectors or asset classes have a high probability of rising, which should lead to above average returns with less risk. Last week when I shared with you the return and risk results from a “multi-asset” momentum strategy, and while the returns were good, they weren’t as good as I thought they might be.

The reason the returns weren’t as good wasn’t because the strategy didn’t work – it did. When you invest in low return asset classes, even when momentum is positive, the returns will be lower than a higher performing asset class.

Since momentum has a built-in risk control mechanism to signal when to exit a position, the proper way to implement the strategy is to find the highest performing, most liquid sectors and build them into a strategy. There are only two domestic indices and one international index that meet that requirement.

The other factor is the returns for nearly every asset class are correlated with the return of the S&P 500. If more asset classes had a negative correlation with the broad market, such a strategy would work better.

Rather than invest in bonds on the way up, as an asset allocation strategy would recommend, the best use of bonds is when annual momentum turns negative. The other option, which we are approved to use, is inverse funds, which can profit in a falling market.

Given momentum is decelerating across the major indices, I can’t implement this strategy today without expecting to take a loss before the risk-control mechanism kicks in. However, we can and will implement momentum recommendations as the Fed continues to tighten the money supply until the economy recesses. This will not override my opinion that precious metals, specifically the gold and silver miners, will be one of the highest performing sectors when physical gold breaks out of its 4.5-year trading range.

Video Topic of the Week – Tariffs and the Fed

President Trump plans just announced $50 billion in tariffs against China with another $100 billion ready to go. I will share with you how he plans to win the trade war, but if it goes wrong, it won’t be good for the global economy.

The Fed is worried about “inflation,” but even they have admitted they can’t print money. This week I cover what they are chasing and how it will be a huge policy mistake.