Headlines versus Underlying Data, part II: Rare Rational Realists?

I am somewhat fascinated by the current debate between those who consider themselves "Realists" (including me) and the people who call us "Pessimists." It all stems from looking at the economic data and drawing the approriate conclusions.

Optimists versus Pessimists?  Realists versus Fantasists? Jeerleaders versus Cheerleaders?

As I have stated in the past, a good strategist/trader/analyst/investor should be neither a Bull or a Bear. That means interpreting the data before you, without a bias. When I do that, the data clearly reveals signs of weakness below the surface. I don’t expect the economy to be perfect — but for me to believe that we are in a robust expansionary phase, I would expect to see more indicia of sustainable growth — broad signs across many sectors.

Instead, I find that most data showing sectors of supposed strength do not stand up to close scrutiny.

To grossly oversimplify: A healthy economy comes out of recession as Government (deficit) spending leads the way (Keynes
and all that). Then, pent up consumer demand takes over, as individuals
begin spending in earnest. Finally, to ramp up to meet all this new demand,
businesses begin (CapEx) spending and hiring. This begets a virtuous cycle that runs on until it eventually shows signs of inflation, which begets rate
hikes, which (of course) go too far and cause the next recession. Then it all starts
over again.

Withthat scenario in mind,lets pull a few graphs from the pages of the Cleveland Fed’s Economic Trends:  This time, we’ll review the Sectors Contributing to GDP (percent changes) and the always scintillating Labor Participation Rates (employment to population ratio).


Have a look at this chart — and before I write anything "negative" about — see what you think about it. What sectors are contributing to growth?

% change real GDP

Data are seasonally adjusted and annualized

Source:  Economic Trends November 2005 (Federal Reserve Bank of Cleveland)


Ok, have you reached any conclusions yet?

Here’s mine:

First, we see that personal consumption has increased. You may be wondering what consumption has to do with producing goods or services, but we will save that discussion for another time.   

Second, despite my co-guest from Thompson Financial claiming their
proprietary model showed enormous gains in Corporate CapEx Spending (on
Kudlow & Co. last week), we clearly see that Business Fixed
Investment decreased last quarter. (Funny how those proprietary models
do that).

Third, we see that government spending has gone up (and up and up). 4 years into the recovery,  government spending is still accellerating. Hmmmmmm.

After a torrid run, Residential investment cooled in Q3. The drop in Q3 exports was likely
hurricane related, as the Mississippi was mostly closed for a while there; it does not signify much either way. I’m not sure
what to make of the big move in inventory draw down. Perhaps this is
somehow reflecting the build up of GM/Ford cars and
their subsequent big selling during the employee-priced giveaway.

Conclusion:  I see GDP strength coming largely from consumer
spending, as well as from Government spending. Surprisingly, at this phase of the recovery, it is not a function of
increasing corporate CapEx.  Private inventory investment was
also negative.



Here’s another example where I find the non-pessimist argument wanting: Some very Bullish commentators have used the low 5.0% unemployment rate as proof of the economy’s strength.

When I look at the unemployment rate, I see something very different:

Labor Participation Rate

click for larger graphic


Source:  Economic Trends November 2005 (Federal Reserve Bank of Cleveland)

This chart, from the Federal Reserve Bank of Cleveland most recent "Economic Trends,"
shows that over the past 5 years, the Employment-to-Population ratio
has dropped precipitously, falling from about 64.7% (2000) to 62.2%
(mid-2003). Two and half percent may not sound  like alot, but when
applied to *143 million Americans, its quite huge — over three and
half million (-3.6M) people who dropped out of the Labor force.

The good news is that over the past 2 years, this has crept back up
to  62.9% (+0.9M). The bad news is that nearly 3/4 of those "dropped
out" of the labor force (2.6m) have yet to return.

This is quite apparent to anyone who bothers to look at the data. Because of this, whenever someone trots out "5% Unemployment rate" as
proof of the strength in the economy, I just shake my head. The data is
what it is, and to spin it otherwise is proof hackdom or incompetence.
(Sorry for the unvarnished truth, but that’s how I see it).


How’d you do? Looking at these two charts of data from the Cleveland Fed, what conclusion’s did you draw?

Are you a Pouting Pundit of Pessimism? Or, are you a Rare Rational Realist?

Your portfolio awaits your answer. So do your returns . . .


* BLS reports a baseline number of 142.6 million employed and a civilian labor force of 150.2 million.

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What's been said:

Discussions found on the web:
  1. Dave Evans commented on Dec 5

    Great article, though I wonder if it’s a case of the headline writers consciously providing headlines that the editors want to project or if it’s a case of the writers unconsiously adapting the data with the schema of the world?


  2. Trent commented on Dec 5

    Nice article. My only rebuttal is that without knowing the reasons behind workforce dropouts we can’t really assess whether the 5% is meaningful. A voluntary exit from the workforce has very different implications than an involuntary one.

    Even if the catalyst for an early retirement was being laid off, nonetheless the worker was in a position to decide not to reenter the workforce.

  3. wcw commented on Dec 5

    There is no way to spin those 2% as ‘voluntary’ dropouts. Four years is a very short time, so it is a safe assumption that virtually everyone who wanted to work in 2000 wanted to work in 2004. If not, whether they call themselves homemakers or consultants today, they’d take that old-fashioned job if there were one to be had.

    To believe otherwise is to have a falsifiable hypothesis. What’s yours?

  4. Barry Ritholtz commented on Dec 5


    The simultaneous increase in the numbers of people unemployed for 6, 12, and 18 months implies this was hardly voluntary . . .

  5. Chad K commented on Dec 5

    On the second chart… a small note.. as I seem to be the “have you considered” person lately..

    The birth rate in the US rose a bit (as far as birth rates go) in the aftermath of 9/11. How many women left their jobs (or careers) to stay at home and raise their children? And… how many of them came back in recent months and years?

    I propose that the small shelf seen between early and late 2002 (62.5%) is a possible true floor, while the additional drop (0.5%) can be corellated to births… just my theory. I think 62.5% was probably the real bottom and that as the years move on, that 0.5-1% who were gone, will return (as it likely has not yet).

    Anecdotally… my wife and many of my co-workers wifes are currently stay-at-home (35% of the office has kids under 2yrs right now). All previously had jobs, and some even had careers. I know that many plan to return when the kids are in kindergarten or first grade. Should we then see an increase in that range (.5-1%) starting in the next two years?

  6. B commented on Dec 5

    Workforce participation rates are down because people have given up or have become frustrated as underemployed. I see it daily because I come from a working family. ie, Blue collar. That is why I never listen to statistics. The reality is our economic miracle is more along the lines of European employment rates than the Federales would like you to believe. It’s measured differently. Now are not good times for the lower middle class regardless of what ivory tower leaders want us to believe.

    I look at it as a simple question. Historically, economic cycles last a pretty regular period of time. 2.5-4 yearsISH. We are there. The question is whether we will see a containable slow down before the next run or whether we will see the economy crater. Both have happened historically but a more likely historical outcome is a slow down. Globalization makes that much more difficult to predict in my estimation. A slow down in the US consumer does not necessarily mean a recession or a significant market correction. It plays a key role but it may not be as important as it was historically. ie, Is it different this time? :) The only constant in economics are that the models always change. That’s why economics is more voodoo than science. That is also why economists as market forecasters are no better than the neighborhood burger flipper. If Newton & Einstein needed to amend their theorems constantly as economists do, we’d still be riding in wagons. There are 6 billion consumers in the world and they are all gathering wealth at a rate that has never been seen in history. So, the question is if US fundamental/economic analysis is complete and accurate given this new paradigm? I do know as Asia, South America and Eastern Europe develop into more consumer driven economies, it will surely blow current economic thinking out of the water. Comments?

  7. Brian commented on Dec 5

    I’ve read that the difference in unemployment rates between Europe (Germany, France) and the US can be explained by differences in how unemployment is counted (we don’t count underemployment or people who quit looking for example). True? The difference is often offered as “evidence” of the superiority of the US. I tend to think that we’re a lot more alike – stagnant, mature economies. A lot more social darwinsim here though.

  8. B commented on Dec 5

    I just saw this Thomson guy from Thomson Financial on CNBC. His rational for being a bull makes me think he’s a toad. lol. I sure as heck don’t buy his caca. I think there is a reason to ponder why we may skip the normal down trend but he’s a clueless perma bull.

    Indeed that is true as to how many European countries report unemployment. It’s partially as a result of their massive social safety nets which allows a cleaner representation of employment.

    That said, I see two major differences between our economies. And it surely isn’t tax rates because American corporations literally have the highest tax rates in the world. #1. The major differences in my mind are availability of VC funds/entrepreneurial opportunities and our immigration policy which continues to fuel growth. While Europe has “reasonably” lenient immigration, America has significantly outgrown Europe in immigration. Take that away and our GDP growth and jobs creation is just like Mother Russia. (Soviet Union as clarification) Especially with our declining birth rate. That’s why these cockamamie thoughts of shutting off our borders because immigrants are taking our jobs is foolish. It would literally kill a major part of what made America great. We are all immigrants or children of children….Immigrants pay my Social Security, they bring an drive and spirit to live the American dream, they go to our universities, become rocket scientists, add to our basic research knowledge and add fuel to our economy, etc, etc. Frankly, I’d vote we annex Mexico and Canada. Oh, and Cuba for the music, cigars and an eastern Hawaii so we don’t have to fly 12 hours to Hawaii. More like 15 with stops.

  9. Wolfe commented on Dec 5

    You know there are statistics that detail the labor force participation rate? The decling labor force participation rate has primarily come from Teenagers. More teenagers have been choosing to go to college and more students are staying in school longer (either on the 7 year Bachleors plan or for graduate school). Both Scrivner and the Chief Brief blogged on this very subject after a Paul Krugman editorial in the New York Times



  10. Lord commented on Dec 5

    I am not sure whether voluntary or involuntary makes any difference. In a sense, it is all voluntary as just about anyone can find a low wage service job if they have to, just as in another sense it is all involuntary as just about anyone able to will work if the opportunity matches their interests, skills, location, and pay. Is the fact that they don’t have to take a substandard job a positive? Is the fact that some might not find work sufficiently rewarding a positive? Now if the unemployment rate could be lowered to 4% we would likely see some real improvement in participation.

  11. wcw commented on Dec 5

    Look, real numbers, if only by reference.

    However, the BLS says teenagers are not the explanation. Go to http://www.stats.bls.gov/webapps/legacy/cpsatab1.htm and select the various employment-population ratios. While the ratio for teenagers is way down, it doesn’t account for the effect — not shockingly, since teenagers just aren’t that big a chunk of the demographic in the US. For men 20+, we’re at 72.6% E/P now, down 2% since summer 2000. For women 20+, we’re 58.1% now (parenthetically — jeepers), down 1% from spring 2000.

    This is what I love about a real hypothesis — it is falsifiable. Consider yours falsified, and get back to us with a good idea of why 2% of men over twenty and 1% of women over twenty who were working in 2000 aren’t any more.

    They’re not in school, I think we can agree.

  12. Jack K. Miller commented on Dec 5

    Great chart!

    Look at it in the context of where we were in 1995, a very similar point in the business cycle. The expansion was just getting ready to rock and roll then as it is now. Short rates are going up around the globe in anticipation of higher capital spending and higher utilization of resources, including labor. Labor will be in the cat bird seat for the next 4 years; not the overpaid union jobs but the average job is going to be bid up.

  13. cm commented on Dec 5

    B: VC funds and entrepreneurial opportunity being more readily available in the US is not unsubstantially related to the fact that the US prints the world reserve currency, has its note paper bought by its trade partners, and thus has the luxury of being able to issue and easily write off a lot of debt. The latter incidentally is also the reason for a large US internal demand, which provides a large part of the consumer market into which entrepreneurs and their financiers are selling.

    In Germany, for example, obtaining any type of credit is so much harder, for the opposite reason.

  14. Bry commented on Dec 5

    I agree with a certain analyst who says we are in a long-term bear market, currently experiencing a short-term bull. As an economist, the key is, as always, forcasting(the good ones get rich, the bad ones flip burgers as one econ teacher taught me) when it switches back to a bear.

  15. d. commented on Dec 6


    The 2% drop in men:

    I’m willing to bet that there’s a whack of 50+ out there who decided to take it easy. Can’t find a job but aren’t too sure whether they can retire or not.

    As for women:

    My guess is that daycare being too expensive or hard to find, it does not make sense to take a minimum wage job.

  16. bhaim commented on Dec 6

    It’s not just employment-to-population ratios. It’s real wage growth. It’s the relative amount of long-term unemployment. It’s payroll employment. We have four of five indicators telling us that the state of the job market is not that good and only one–the unemployment rate–reading green.

    Brad DeLong’s website
    July 12, 2005


  17. BOPnews commented on Dec 6

    No Holds Barred

    high impact post from Barry Ritholtz….

  18. d. commented on Dec 6


    I’ll be darned! In my entourage the only ones who can’t seem to find work are 50+!!!

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