"Kee" Points with Jim Kee, Ph.D.

Friday’s jobs report was a little below expectations, with an initial estimate of 173,000 jobs created in the month of August. That was below so-called ‘expectations’ of 220,000, and the market sold off. The BLS (Bureau of Labor Statistics) reported that the shortfall (from expectations) came primarily from two sectors – manufacturing and mining. Those two sectors in-turn correspond to the two big on-going shocks facing the US economy, namely, the rise in the dollar (hurting manufacturing exports) and the decline in energy prices (that’s the ‘mining’ part). The number will be subject to subsequent revisions, and over the past five years the August report has been subsequently revised upwards by an average of 79,000 jobs (WSJ). And to repeat from prior Kee Points, statistically the average of the last three months has the most predictive power as to what the next month’s (i.e. September) number will be. And the average payroll gains over the last three months is 221,000, so pretty solid.


In fact, the jobs report is seen as a problem by many analysts, as it does not provide a clear indication of strength or weakness, and that adds to the uncertainty over the issue of when the Federal Reserve will hike rates. Interestingly, 89 year-old former Fed Chairman Alan Greenspan also weighed in on the topic publically last week, arguing that the real problem in the US has nothing to do really with monetary policy, but rather fiscal policy (entitlement growth, etc.). “I find it baffling,” said Greenspan, “that we’ve fallen into the position where the major issue is whether a few basis points in an overnight rate by one central bank is going to be all determinant” (Greenspan went on to talk about a military expenditures problem, China, etc.). Even the press has latched on to the notion that it is somewhat absurd that the Federal Reserve needs another month’s data point(s) to make a decision on a policy (0% lower range target for the federal funds rate) that has been in place since basically December of 2008. But there’s a little more than that. As India central bank head Raghuram Rajan put it (Financial Times), “my position over time has been don’t raise rates when the world is in turmoil. It’s a long anticipated event, it has to happen sometime, but pick your time.” I think that’s probably driving the Fed’s thoughts, far more than just data points on jobs, growth, and inflation (which aren’t really forcing action).


Also in the news last week was Nobel Laureate Robert Shiller, who was warning of a possible stock market drop based upon his ‘Cyclically Adjusted Price-to-Earnings Ratio.’ I’ve discussed the CAPE ratio before; it is basically the market P/E ratio, where the ‘E’ or earnings part is averaged over the prior 10 years, accounting for a full economic ‘cycle’ (10 years would encompass most business cycles). Hence the name, ‘cyclically adjusted P/E ratio.’ There are problems with the CAPE, most notably the fact that the current measure of the CAPE includes one of the largest earnings collapses (2008) since the Great Depression. That makes the numerator smaller and the current ratio larger (so the market would seem overvalued). Wharton financial economist Jeremy Siegel is one of CAPE’s biggest critics, though a good friend of Shiller’s. Siegel points out that real earnings growth accelerated after 1945, which makes it misleading to compare the current ratio with historical averages (as Shiller does) that go back to the 1800s. Siegel also points to other limitations of the CAPE, like the fact that accounting rules have changed over time. That also makes historical comparisons misleading. I personally have a problem with the fact that Shiller uses the Consumer Price Index (CPI) to adjust for inflation. Almost any economist who has worked with inflation adjusting will tell you that, as important as ‘real’ or ‘inflation-adjusted’ numbers are in theory, in practice the errors in the inflation index itself can distort the information content of the inflation adjusted numbers. To be fair, Shiller knows all of this, which is why in discussing the implications of the CAPE he notes that “it is not reliable” as a forecasting tool. He also stated last week that “the market could go a lot higher,” and that “nobody can really forecast the market accurately.”