Sunday, January 9, 2011

Hedgehogs Respond to Jobs Report

   Recently I read the book Expert Political Judgment: How Good Is It? How Can We Know? by Philip E.Tetlock which discusses the ability of experts to accurately predict future outcomes. Tetlock breaks down experts into two distinct groups as characterized by "Isaiah Berlin's prototypical fox--those who 'know many little things,' draw from an eclectic array of traditions, and accept ambiguity and contradiction as inevitable features of life" and "hedgehogs--those who 'know one big thing,' toil devotedly within one tradition, and reach for formulaic solutions to ill-defined problems." Tetlock's work shows that while hedgehogs are less accurate forecasters, bolder predictions make their views more appealing to general media sources. The research goes on to show that hedgehogs tend to "dig themselves into intellectual holes. The deeper they dig,...the more tempting it becomes to keep on doing what they know how to do: continue their metaphorical digging by uncovering new reasons why their initial inclination, usually too optimistic or pessimistic, was right." From my perspective, and likely Tetlock's, the typical cast of experts portrayed on CNBC offers a prime example of hedgehogs willing to make overly bold predictions and scampering to explain how their views were correct, regardless of the true outcome. On Friday, the Bureau of Labor Statistics reported non-farm payrolls data for December and hedgehogs were out in mass with an abundance of explanations for how their incorrect predictions were not technically "wrong."
   Earlier this week, the ADP payroll report showed an unexpected jump in private job growth to 297,000 jobs in the month of December. Following the strong report, most analysts and economists raised expectations for December payroll growth announced by the Labor Department Friday morning. As of Thursday night, depending on the source, expectations were for an increase of approximately 175,000 jobs with predictions ranging from from 100,000 to 300,000. Friday morning, the official number released showed payrolls only increasing 103,000 in December but with revisions to October and November totaling another 70,000 jobs added.
   Given the data above, what would you expect to be the general consensus on the actual results compared to expectations? If you said somewhat disappointed, you would unfortunately be dead wrong. The consensus portrayed on CNBC was nearly unanimous saying that the number was basically in-line with expectations and right on track for increasing growth in the months ahead. Now I'm certainly not an expert on jobs or unemployment, but in my reality, if consensus expectations miss the mark by nearly 40% and almost all the "experts" miss to the wrong side, that shows a real disparity in the numbers between projections and reality. However, as Tetlock describes, hedgehogs employ several different belief system defenses to explain away any inconsistencies between predictions and reality.
   Many experts argued that revisions to previous months data offset the "slight" miss on December's data. Before discrediting this notion, let's take a look at the revisions compared to prior expectations. A month ago, expectations for November payrolls held hopes of continuing growth with average projections for an increase of 150,000 jobs. The preliminary number from the Labor Department came in at only 39,000 jobs and was raised Friday morning to 71,000. Even with the recent revision, the total increase in payrolls remains less than half of initial expectations. Also including revisions, October non-farm payrolls are now believed to have increased by 210,000, beating expectations of 60,000 by a reasonable margin. Although the average increase in payrolls may be closer to average expectations over the previous three months, the ability to accurately predict on a month to month basis appears widely off base.

   One analyst on CNBC Friday morning noted that adding the 70,000 jobs revision to December's total and the previous months would bring total payroll growth more in line with expectations. Another analyst suggested that the trend is still upward based on a rolling 3 month average of payroll growth. No disrespect to either analyst, but double counting numbers or suggesting that jobs are moving in the right direction based on rolling averages (3 month average for March through May was nearly 318,000 compared to 128,000 in October through December) simply misconstrues the data. Throughout the day other analysts offered explanations such as private payrolls being closer to expectations or the data simply being calculated incorrectly. Ignoring parts of the prediction or simply ruling government data as false, adds to the number of defense mechanisms used by experts to ignore the reality of their incorrect predictions.
   Moving beyond basic payroll numbers to the actual U.S. unemployment level provides a different unique perspective. More shocking than the low total in payroll growth was the significant drop in the unemployment rate from 9.8% to 9.4%. Supposedly, "the number of unemployed persons decreased by 556,000 to 14.5 million in December (BLS)." My math may be a bit fuzzy, but if payrolls grew by only 103,000 in December and were revised higher by a total 70,000 in the months prior, it's hard to find total growth of 556,000. Digging deeper into the actual report, the population not included in the labor force actually grew last month by another 434,000, despite more than 130,000 new entrants. As the portion of the population not included in the labor force grows, the employment participation rate (proportion of the population in the labor force) continues to fall. The participation rate in December fell to 64.3%, the lowest reading since April 1984. During the early 1980's double dip recessions, the participation rate reached a low of 63.5% from a peak of 64% in January 1980. Since the second recession ended in November 1981, the participation rate has averaged over 66.1%, topping out at 67.3% in January 2000.

   As for the Federal Reserve, Ben Bernanke spoke this morning before Congress and said that the jobs picture will take several more years to revive. For the participation rate to reach it's average of the past 30 years, the labor force needs to grow by nearly 6 million, excluding any population growth. Considering an unemployment rate near 10% and 8 million jobs during the last recession, the economy needs to create a conservative 13 million jobs to attain anything resembling full employment. Were payroll growth to vastly improve to an average of 250,000 jobs per month, it would still take more than 4 years to achieve that goal. With the Fed's inflation expectations remaining below their stated goal looking several years out, it's hard to envision any rate increases in the near future. As recently as yesterday the market was pricing in about a 50% chance of the first rate hike in November of this year. We should not be surprised if these projections again prove too early or if any rate hikes are delayed potentially beyond 2012.


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