Thursday, March 8, 2012

The NFP coin toss

My inner investor tells me that what matters in the medium term is the American consumer behavior and much of that depends on the employment picture and how good they are feeling about themselves and the economy.

My inner trader tells me that, given the corrective market action we saw on Tuesday, Friday's NFP release is going to be a huge bellwether in determining short-term market direction.

Duelling models
Ahead of the NFP release, we have seen hugely disparate in either direction. TrimTabs is forecasting a subpar 149K new jobs, "based on an analysis of daily income tax deposits to the U.S. Treasury from all salaried U.S. employees". Gallup, which does a telephone poll of 18K respondents by telephone, put out a press release indicating that they expect the March unemployment rate to tick up significantly.

On the other hand, other forecasters like Deutsche Bank is looking for a big upside surprise to the NFP number. Ed Yardeni says the same thing by pointing to the the buoyant ISM surveys and the aggregated results of Regional Fed surveys of manufacturing activity.

On the negative side, the NFIB, which represents small business, said that they were not seeing a particularly upbeat employment outlook from their membership.

...but the ADP report said that a lot of job growth they saw came from smaller businesses.

Analyzing the data
What do you do? Who do you believe?

Here is how I have analyzed the data. First, the Gallup data is not seasonally adjusted. A comparison of this February vs. February last year shows an improvement. As a quick and dirty on a seasonal adjustment, if you compare the sequential change last Jan to Feb was 0.4% and so was this year. So maybe even if Gallup is right, NFP doesn't come in that badly?

On the other hand, the Gallup poll sample is 18K respondents. The sample size of the Regional Fed survey that Yardeni depends on is probably lower, though they are businesses and not individuals.
The Gallup survey is a rolling survey, which tends to be a bit more accurate. However, Gallup forecasts the unemployment rate, which is a function of employment and labor force size (and labor participation rate). However, the market focuses on employment, not unemployment. So given all the seasonal adjustments (a wildcard), even if Gallup is right the number may not come out that badly.
Even though I am leaning slightly bullishly on the NFP release. Trying to guess the NFP headline number and the subsequent market reaction is like betting on the flip of a coin. At best, the NFP figure is extremely noisy. Even if you had an edge, which would be slight given the enormous error term, it would be like being the house at a casino where a high roller ambled up to a roulette table and put several billions dollars on red. Despite having a slight edge, you would be feeling extremely nervous.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.
None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

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