I don’t believe it. … You can’t predict a weak number, but August tends to be weak consistently, and it tends to get revised up consistently. I think the trend is still north of 200,000. Every other data point is pointing to stronger growth, not weaker growth.

Mark Zandi, Chief Economist at Moody’s after last week’s employment report

That, my friends, is confirmation bias on display for all the world to see. Confirmation bias is the tendency to interpret information in a way that confirm’s one’s beliefs or hypotheses. Faced with information that didn’t conform to his view of the economy, Mark Zandi just refused to believe it was true. Zandi certainly wasn’t the only one surprised by last week’s report or the only one who refused to believe the numbers. Frankly, I don’t know why anyone pays much attention to the monthly employment data anyway. It is always revised later – this report lopped 28,000 jobs off the June and July totals – and the reports that are revised the most are always the most important ones. Go back and take a look sometime at the revisions that happen to the data around turning points in the economy. It isn’t a pretty picture.

More interesting, I think, is Zandi’s statement that “every other data point is pointing to stronger growth, not weaker growth”. That is probably an even greater display of confirmation bias than his denial of the employment data. Every other data point is not pointing to stronger growth but if you believe or want to believe that the economy is improving, you ignore the data points that don’t confirm your view. The fact is that the economic data recently has not been significantly different than what we’ve seen the last few years. Yes, there are some areas that are doing better but in general they are being offset by areas that are doing worse. And yes, the number of reports that have been better than expected has been rising but that is more a matter of reduced expectations than gangbuster data.

I would also point out that a lot of the recent data that has been good isn’t data at all. The ISM surveys so many concentrate on are exactly that – surveys. There is no hard data input, they are merely a reflection of the mood of the purchasing managers surveyed. Who, like all humans, are subject to the same biases as Mark Zandi. The ISM surveys provide little guidance about the future movements of the economy. There are times when a high number precedes recession – December 1999 – and times when a low number predicts absolutely nothing – April 2003. Personally, I’ve found the ISM surveys to be more predictive when we are coming out of recession than when we are entering one. And there are other hard data points that are much more predictive which deserve more attention than the latest musings of the country’s purchasing managers.

We track economic data for two reasons. First, we are trying to find inflection points. The payoff from seeing an inflection before everyone else is enormous whether you are turning higher or lower. They are well worth looking for even if quite hard to identify due to, as I said earlier, the tendency for the data to be revised. Second, we are looking for trends within the data that may lead us to profitable opportunities within sectors of the economy. That’s it. We aren’t trying to predict the future but merely doing our best to interpret the data as it comes in and later as it gets revised.

More important than the data itself is the market reaction to the data. One thing it is hard to learn in this business is that it really doesn’t matter what you think of the data whether you are Mark Zandi or a money manager or anyone else (except maybe the Chair of the Fed). What matters is what the majority thinks of the data and how they act on it. We are, after all, investors here and being right about the economy certainly doesn’t ensure you’ll be right about the markets. Right now, the main focus of the market is on future Fed policy so the data is interpreted within that context. Good economic news may not be good market news if the majority believes it will lead to tighter monetary policy sooner than they expect.

The market reaction to the employment report is instructive. The initial reaction was a sell off in stocks and a rally in bonds. Bad economic news was initially interpreted exactly as one might expect. But by the end of the day, stocks were higher and bonds were trading at their lows of the day. It seems that on further reflection, the “bad” economic news was interpreted positively by risk takers as it might mean a delay in Fed tightening. Or at least that is one way to interpret the market moves.

My observation above that the economic data hasn’t changed that much recently from what we’ve seen in recent years is based on the market, not some tally or scorecard of the data. If the economy was improving as dramatically as Zandi believes, the 10 year Treasury note would not be trading at a yield of 2.46%. Either inflation expectations or growth expectations would have moved bond yields higher if Zandi was right. And that hasn’t happened. I’m sure Zandi has an alternate explanation but the simple one is that bonds are telling us that accelerating economic growth and Fed tightening are still a ways off. That could change but for now, I see no reason to alter my view that the economic trajectory hasn’t changed much for the better. If anything the market is saying that future growth will be worse.

Confirming the inflation trend is the movement of the US dollar which has moved higher by 6% (as measured by the dollar index) in just the last 2 months. A rising dollar is positive for inflation (meaning that inflation falls) because it generally depresses commodity prices, a trend that has been in place for months. That is certainly good news for bondholders and potentially stock holders as well – at some point. Lower commodity prices may not be good for commodity producing companies but they are good for consumers who will be putting less of their paycheck into the gas tank, the grocery store and the local utility company. That doesn’t mean they’ll necessarily spend those extra dollars immediately though so it might not show up in higher GDP right away. Indeed, we have recently seen a small rise in savings and despite the angst of the Keynesians like Zandi who want us to spend our way to prosperity, that is a good thing.

As for growth, well, I think the bond market is looking at Europe and other parts of the world and wondering if the US can escape unscathed. The verdict so far seems to be no. The ECB provided a bit of a surprise last week by cutting rates and feinting toward QE but the market reaction was muted for stocks and depressing for the Euro. If Draghi’s moves were believed to be effective I would have expected a higher Euro and a big rally in stocks; we got neither. And with a large part of S&P 500 earnings and revenue coming from outside the US, what happens in Europe – and the rest of the world; Brazil appears to be back in recession – matters.

For now, despite the actual economic data and Mark Zandi’s reaction to it, I see no reason to expect anything from the US economy other than what we’ve seen since the beginning of this recovery. Monetary policy has had the intended effect on the stock and bond markets but the economic effect has been lacking. As a confirmed QE skeptic from the beginning, that isn’t surprising to me (that might be my own bias showing). Our problems may have been caused by monetary policy (or more accurately US dollar policy) but they can’t be fixed by it. If the US economy does start to perform better, the bond market will likely be the first place it shows up. Forget the incoming data and concentrate on the market reaction to it. Who you gonna believe? Mark Zandi or the market?

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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.