Lighthouse Macro Report - 2015 - October

Lighthouse Investment Management
Macro Report
Economic Indicators - USA
October 2015
Macro Report - US Economic Indicators - October 2015
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Contents
Summary.................................................................................................................... 3
Introduction................................................................................................................ 4
Fed Funds Rate........................................................................................................... 8
Crude Oil.................................................................................................................... 9
Construction: Building Permits................................................................................. 10
Employment: Non-Farm Payrolls............................................................................... 11
Employment: Population Growth.............................................................................. 12
Employment: Establishment versus Household Survey............................................13
Employment: Initial and Revised Non-Farm Payrolls.................................................14
Employment: Full Time............................................................................................. 15
Employment: Population, Labor Force, Employees...................................................16
Employment: Labor Force Participation Rate............................................................17
Employment: Unemployment................................................................................... 18
Recessions: Employment.......................................................................................... 19
Recessions: Real Disposable Income........................................................................20
Recessions: Consumer Spending.............................................................................. 21
Consumer Confidence: University of Michigan Survey.............................................22
Consumer Confidence: Conference Board Survey....................................................23
Credit: Total Outstanding.......................................................................................... 24
Credit: Bank Loans and Leases................................................................................. 25
Retail Sales: Nominal................................................................................................ 26
Retail Sales: Real...................................................................................................... 27
Retail Sales: Real per-capita..................................................................................... 28
Retail Sales: Excluding Autos.................................................................................... 29
Retail Sales: Online................................................................................................... 30
Manufacturing: Hours Worked..................................................................................31
Weekly Earnings....................................................................................................... 32
Orders: Capital Goods............................................................................................... 33
Manufacturing: Orders.............................................................................................. 34
Manufacturing: Supplier Deliveries...........................................................................35
ISM: Manufacturing and Services............................................................................. 36
Energy: Consumption............................................................................................... 37
Energy: Production.................................................................................................... 38
Transportation: Miles Traveled..................................................................................39
Transportation: Gasoline Consumption.....................................................................40
Transportation: Rail Freight Carloads........................................................................41
Transportation: Rail Freight Intermodal.....................................................................42
Transportation: Truck Tonnage.................................................................................. 43
Transportation: Air Freight........................................................................................ 44
Income: Real Disposable Income per Capita.............................................................45
Income: Real Income................................................................................................ 46
Inflation: Consumer & Producer Prices.....................................................................47
Inflation Drivers........................................................................................................ 48
Inflation Expectations............................................................................................... 49
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Summary
The "Good":
Continued growth in non-farm payrolls with upwards revision of earlier
months
Strong growth in multi-family building permits
Accelerating demand for business (+11%) and consumer (+5%) loans
Better growth in average weekly earnings (probably due to minimum-wage
increases)
The "Bad":
Dip in consumer confidence
Real retail sales per capita have still not reached the level seen in March 2006
Retail sales growth excluding (easy-to-finance) autos has slowed to 1.3%
Continued fall in core durable goods orders (now in recessionary territory)
Weaker growth of employment, income and consumption compared to
previous recoveries
CONCLUSION: The US economy is unlikely to be in a recession. However, economic
growth remains timid, and tumbling Emerging Market currencies point towards an
imminent crisis. Combined with low inflation, nominal GDP growth looks
insufficient to service considerable debt levels. The current economic expansion
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(77+ months) already exceeds the average length (65) of recoveries since 1958.
With rates already at 0%, what could the Fed do if the economy re-entered a
recession? Its balance sheet already exceeds $4 trillion, or 25% of GDP. Another
episode of "quantitative" easing looks likely.
Introduction
Recessions are bad for company profits and hence stock prices. Knowing when an
economic slow-down looms can give important clues about asset class selection.
In the US, the beginning and the end points of recessions are declared by the NBER
(National Bureau of Economic Research). The NBER defines recessions as a
"significant decline in economic activity spread across the economy" (not, as often
believed, as two consecutive quarters of negative GDP growth).
The NBER takes it's time to date the beginning and the end of a down-turn; it
announced the beginning of the last recession (December 2007) only on December
1, 2008 - one year later. By that time, the S&P 500 Index had fallen from 1,575
points to 741. Similarly, the end of the recession in June 2009 was announced on
September 20, 2010 - more than one year later. By that time, the S&P 500 had
already soared from 940 points to 1,142.
Waiting for the NBER to declare beginning and end of recessions would have led to
inferior investment results (the NBER is correct in taking it's time, since many
economic indicators are being revised multiple times as preliminary data gets
updated).
Traditional leading indicators include values such as the stock market and the slope
of the yield curve. However, the stock market does not seem very good at
anticipating recessions, as the S&P 500 index marked an all-time high in midOctober 2007, a mere six weeks before the most severe recession of the last 8
decades began.
The yield curve has historically been a very good warning sign of recessions, as the
Federal Reserve Bank was forced to increase short-term rates in order to cool an
overheating economy (thereby triggering a recession). However, with short-term
interest rates near zero for the foreseeable future, the yield curve could only invert
if long-term yields dipped into negative territory. While not entirely impossible
(negative yields for up to 2 year maturities have been observed in German, Swiss,
Danish and other government bond markets) it is very unlikely to happen in US
Treasuries. Therefore, the slope of the US yield curve is unlikely to give any hints
about a recession occurring under ZIRP (zero-interest-rate-policy).
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Indicators published by other institutions, such as ECRI (Economic Cycle Research
Institute), are proprietary and not transparent, giving investors only the choice to
"believe-it-or-leave-it".
The Conference Board Leading Indicator includes questionable values such as the
S&P 500 Index, the slope of the US yield curve and M2 money supply (which we
have found to have little correlation with economic cycles).
As most recessions last rarely longer than a year, the economy usually had already
exited a recession by the time the NBER declared it to be in one.
Revisions to GDP growth render it useless for investment purposes; On August 28,
2008 (already 8 months into the "great recession"), Q2 2008 GDP growth was
revised upwards from an initial +1.9% to +3.3%, triggering a 2% stock market rally.
Later, growth was revised down to 1.3%, with the following quarters delivering
-3.7%, -9.2% and -5.4% (quarter-on-quarter, annualized). The S&P 500 Index didn't
regain the level attained that day for another 2 1/2 years.
Finding a reliable indicator for identifying recessions "real-time" would already be a
great improvement over waiting for the NBER.
Over the past 50 years, every recession was easily explained by two factors: oil and
the Fed.
Unfortunately, this does not have to be the case going forward. Due to impotence of
monetary policy at the lower zero bound and rapidly increasing government debt
the Fed might not be able to raise rates in the foreseeable future. A recession might
hence happen without prior tightening by the Fed.
We looked at many indicators from every angle; most had to be smoothed to cancel
out short-term "noise" in order to prevent false signals (we use 3-months moving
averages).
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Some indicators do not reveal useful signals unless you look at decline from recent
peaks. Other data needs to be trend adjusted (number of miles driven, for example,
benefits from rising number of cars and population).
The table on the following page shows indicators we have tested. Our criteria:
false positives (calling for a recession when there was none)

false negatives (missed a recession)
confidence it will work in the future and
lead / lag time
No two recessions are the same. Trigger levels can be too strict (missing some
recessions) or too lose (giving too many false positives). We therefore created a
range. The lower ("strict") boundary is the level necessary to avoid false positives;
the upper ("lenient") boundary is the level necessary to catch all recessions. A highquality indicator will have a narrow range, and recessions will be called with high
confidence. An indicator at the upper boundary will be awarded a 50% probability,
increasing towards 100% at the lower boundary.
The overall "Lighthouse Recession Probability Indicator" (LRPI) is a weighted mean
of individual indicators. High confidence and timeliness of signal have been awarded
higher weights (maximum: 3) then those with low confidence or tardiness
(minimum: 1). On the following page you see the LRPI since 1971, predicting every
recession (assumed once 40%-50% probability is exceeded).
The Federal Reserve Bank of St. Louis publishes a recession probability indicator by
Chauvet / Piger (black line). It is based on four inputs (non-farm payrolls, industrial
production, real personal income and real manufacturing and trade sales). However,
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the most recent data point for Chauvet/Piger is usually three months old, while LRPI
is constantly updated (1 months old data).
You can see that LRPI shows first warnings signs much earlier than Chauvet/Piger.
In a recent response to a blog post, Chauvet clarified their indicator calls for a
recession only "after exceeding 80% for a couple of months". Additionally, their
indicator is "smoothed" as the raw data can reach 70% (2003/4) without being
followed by a recession. Their indicator initially showed a recession probability of
20% for August 2012, only to be revised down to 1.7% six months later.
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The latest recession probability stands at 6%

Probabilities will slightly change as some data become available with a time lag
Putting all indicators on equal weighting, recession probability would rise to 18%
(blue line below)
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Fed Funds Rate
The US central bank ("Fed") increased interest rates ahead of each of the last 9
recessions. The black line shows the absolute level of the Fed Funds rate; the blue
line the increase from the prior post-recession low. An increase between 2 and 4.5
percentage points from the previous low preceded every recession since 1954.
Recessions are shaded in gray. Yellow dots indicate the beginning of a recession;
green dots the end. The absolute level (black line) is usually on the right-hand scale,
while percentage changes (blue line) are on the left-hand scale. Negative absolute
numbers should be ignored as they are merely needed for better formatting.
This indicator has a double weighting in the Lighthouse Recession Probability
Indicator.
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Crude Oil
An increase in the price of crude oil of 75% to 100% preceded five out of the
last six recessions
Close call in March 2011 and February 2012
Currently not a red flag
Crude oil would have to rise above $113/barrel in order to trigger an early
warning
This indicator has a triple weighting in the LRPI
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Construction: Building Permits
Want to build a house? Need a permit! Any decline in permits of 25%+ from prior
peak and you can bet on a recession. Missed the one in 2001 though. 2011 was a
close call. Absolute level still below 1990/91 recession lows (despite US population
growth from 250m then to 320m in 2015).
Multi-family housing (rentals) are growing at very high pace as fewer people can
afford houses and are forced to rent. This indicator has a triple weighting in the
LRPI. Currently no red flag.
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Employment: Non-Farm Payrolls
The number of people on "payroll", or employed, is a good proxy for the health of
the economy. You can see the long "valleys" of lost payrolls after recent recessions
compared to earlier ones. A decline of more than 1% from previous peak payroll
level indicates a recession. There have been no misses and no false positives; even
the "tricky" back-to-back recessions in 1980 and 1982 have been called correctly by
this indicator. The payroll report, also known as Establishment Survey, is based
on a sample of 145,000 businesses and government agencies. The "Current
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Population Survey" (aka Household Survey, next page) consists of a sample of
60,000 households (leads to similar results over time, but is more volatile).
Does counting jobs reflect the actual picture of the economy? Only 47% of all
working-age Americans have full-time jobs. Since 2007, six million full-time jobs
have been lost, but 2.5 million part-time jobs gained. Part-time jobs often come
without "benefits" such as health insurance. From peak employment (Q1 2008) to
Q1 2010 1.2 million "higher-" wage jobs (median hourly wage $21-54) have been
lost; in the subsequent 2 years only 0.8 million have been recreated. While almost 4
million mid-wage jobs ($14-21) have been lost, only 0.9m have reappeared. Among
lower wage jobs ($7-$14), 1.3 million have been lost, but 2 million gained. This
indicator has a triple weighting in the LRPI.
Employment: Population Growth
US employment grew merely 5% over the past 15 years, comparable to

Greece
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This despite the fact the US has a higher birth ratio (12.5/1,000) than most
European countries plus around 1 million (legal) immigrants per year
(3.3/1,000).
Since mid-2007, population increased by 21m but only 3m additional jobs.
16m left labor force:
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Employment: Establishment versus Household Survey
The National Bureau of Economic Research (NBER) uses the average of the
Establishment and Household Survey in order to determine recessions.
According to the Establishment Survey, job growth continues at a modest pace

(243k per month)
According to the Household Survey, average monthly employment growth over

the past 12 months has been 215k.
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Employment: Initial and Revised Non-Farm Payrolls
This chart shows monthly changes in employment as initially reported (black

dotted line), the revised number (thick black line) and the difference between
the two (green/red chart, right-hand scale)
During the last recession (we didnt know we were in one yet), monthly
employment numbers were revised downwards by up to 273,000
In Q3 2008, revisions were -159k, -190k and -273k (that was before Lehman
happened)
In recent months, revisions have been mixed
The BLS (Bureau of Labor Statistics) approximates the impact of start-ups / dying
businesses on employment by simply ignoring both, assuming they cancel each
other out. This obviously leads to initial underreporting of job losses in a
recession. A benchmark revision occurs once a year (in March).
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Employment: Full Time
During recessions, higher paying full-time jobs are usually being replaced
with part-time jobs.
Part-time jobs come without healthcare benefits, forcing employees to cover

their own medical expenses (leaving less money for consumption).
Growth in the number of full-time employees has picked up in recent months:
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Employment: Population, Labor Force, Employees
5-year growth of population, working age population, labor force and

employment is slowing
The unemployment rate is helped by high number of drop-outs from the labor
force
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Employment: Labor Force Participation Rate
The US unemployment rate has declined thanks to a drop in the Labor Force
Participation Rate (people with jobs relative to people who could potentially
work). Many have exhausted their unemployment benefits and have left the
workforce (not counted as unemployed).
Large numbers have applied for disability insurance, removing those folks
permanently from the labor market (as opposed to unemployment, which
usually is temporary).
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Economic growth depends on decent increases in employment and real

incomes; both measures are showing limited growth.
Employment: Unemployment
Less than half of the US population (49%) is in the labor force, and 46% are
employed
The share of population not in the labor force (children, home makers,
discouraged workers, disability, retired) keeps rising, especially since the
'great recession'
An ageing population explains only part of the observation. The number of

people on disability insurance increased by 2.5 million since 2008. Expiration
of unemployment benefits might have motivated some to apply for disability
insurance. In contrast to unemployment, disability is permanent, meaning
those folks have left the labor force for good.
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Since 2007, the number of people not in the labor force has increased from
77 million to over 93 million, leading to less tax revenues and higher transfer
payments from the government.
Elevated drop-outs from the labor force lead to under-reporting of the

unemployment rate. Without those drop-outs from the labor force, the
unemployment rate would be at a stunning 14.5% (instead of 5.1% as reported).
Recessions: Employment
The recovery of employment after the 2008/9 financial crisis has been the
slowest over the past four decades. Employment finally exceeded the level
from the onset of the recession (= 100) in May 2014, after a record-long 77
months.
Taking earlier recessions as a template, employment should currently be

about 10% (or 14 million jobs) higher
While employment increased only by 3m since mid-2007, the number of

people not in the labor force grew by 16m:
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Recessions: Real Disposable Income
Real disposable income has recovered at the slowest pace compared to

earlier expansions
Compared to the average of the past 5 recessions, income should be at

around 10%, or $1.7 trillion, higher
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Recessions: Consumer Spending
Consumer spending in the current recovery is significantly weaker than in the

past
"Never underestimate the US consumer" was an often-preached slogan

during the 1990's and early 2000's. However, the most recent recovery is
marked by a disappointing development of consumer spending.
If earlier recoveries are a guide, consumer spending should be between 20%

($2.2 trillion) and 33% ($3.6 trillion) higher.
Per-capita consumer spending is even slower, as the population has grown

from 303 to 322 million (6%) since the beginning of the recession.
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Consumer Confidence: University of Michigan Survey
The University of Michigan, together with Thompson-Reuters, conducts more

than 500 telephone interviews twice a month to gauge consumer sentiment,
with a reference point from 1964 set to 100. A preliminary mid-month survey
is followed up by a final one towards the end of the month.
The indicator had one false positive (2005) and one miss (1981; the 19801981 recessions were back-to-back, so let's not be too harsh about that). A
decline of 25%+ from previous peak indicates a recession. 2011 was a close
call. This indicator has a triple weighting in the LRPI and does currently not
deliver a warning.
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Consumer Confidence: Conference Board Survey
The Conference Board, an independent business membership and research

association, conducts a survey of consumer confidence by mailing out
surveys to more than 3,000 randomly selected households. The cut-off date
for a preliminary number is the 18th of the months. The final number includes
all surveys returned after that date.
The indicator had two false positives (1992, 2003), but it did catch all
recessions including the ones in 1981/2 and 2001 (difficult for a lot of other
indicators). 2011 was a "close call". This indicator has a double weighting in
the LRPI and currently does not raise any red flags.
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Credit: Total Outstanding
Most recessions have been accompanied by a reduction in the growth of debt. But
debt never shrunk, Until, for the first time in 60 years, debt actually shrunk in 2009.
A reduction of only 2% caused a massive recession. I have included the 1987 stock
market crash (red triangle). Economic growth is dependent on credit growth.
Unfortunately, data becomes available only once every quarter, with the latest data
often many months old. We had to exclude this measure from LRPI to ensure
timeliness, however present it here for informational purposes:
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Q2'09 saw the peak of TCMDO relative to GDP (374%). Year-over-year growth
peaked in Q3'07 at 10.6%, just as the S&P 500 hit its previous all-time-high of 1,575
points.
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Credit: Bank Loans and Leases
Since 1971, growth of loans and leases below 2% has been associated with
recessions
Securitization and shadow banking might be able to mitigate the effects of

slowing bank lending
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Commercial lending has picked up further in recent months
We have not yet incorporated this data into our recession indicator
Retail Sales: Nominal
For the LRPI, we have replaced this indicator with "real retail sales" (see next
page). Nominal retail sales include inflation, and hence say little about
volume growth.
Retail sales growth has recovered after a weak Q1:
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This indicator remains in the red warning area and needs to be watched
closely.
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Retail Sales: Real
No recession signal currently; this indicator has a triple weight in the LRPI
Real retail sales growth was very weak in Q4'13-Q1'14 and Q4'14-Q1'15, but
recovered slightly
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This indicator is currently not in the 'red zone' usually associated with
recessions
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Retail Sales: Real per-capita
Real per-capita retail sales are still below their pre-recession peak
Growth recovered since a dismal winter 2013/14
No recession signal currently
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Retail Sales: Excluding Autos
Monthly auto sales, at around $90bn (20% of total retail sales), continue to
benefit from very low interest rates, abundant credit and deep-subprime
used-car loans. Excluding auto sales, retail sales growth looks 'recessionary'
(see above).
Excluding autos, retail sales growth has slowed down significantly. Gasoline
sales are down $7bn due to lower oil prices (allowing consumers to spend
otherwise)
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Retail Sales: Online
Non-store (online and mail order, Amazon / Land's End etc) retail sales are
growing faster than overall retail sales, exceeding $40bn a month
This corresponds to more than 15% of retail sales excluding autos and foods
(things that you probably wouldn't buy online)
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Online retail sales suffer large setbacks in recessions. This is probably due to
the discretionary nature of products sold (mostly consumer electronics etc)
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Manufacturing: Hours Worked
Companies prefer to reduce employee's working hours rather than firing

them straight away
A drop in average weekly working hours in the manufacturing sector of 2% or

more indicates a recession (except for 1996); the indicator carries a double
weight in the LRPI
Weekly hours have come off a bit from their recent high
Currently no recession warning
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Weekly Earnings
Average weekly earnings by private employees continue to grow at a

moderate paste
Growth accelerated a bit
Recent increases in minimum wages as well as pay raises at Wal-Mart (1.4
million US employees) might accelerate wage growth further. This opens up
the possibility of better growth in real wages, which has been lacking for a
long time
Page 40

Orders: Capital Goods
Defense and aircraft orders are lumpy and distort trends (twice as much as
core), so we exclude them here. We have "medium" confidence in this
indicator due to limited historic data. The "red zone" has been set at -5% to
0%. The indicator carries a single weight in LRPI.
Core capital goods orders are currently sounding a bright right red warning:
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Manufacturing: Orders
The Institute for Supply Management (ISM) regularly asks company

executives about orders, sales, inventories etc. A level of 50 indicates
"unchanged" (economy stagnates).
This indicator delivered one false positive (1989) and carries a double
weighting in the LRPI.
The ISM Survey currently does not yield a warning sign.
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Manufacturing: Supplier Deliveries
Multiple false positives (1985, 1989, 1995, 1998, 2005) muddy the water.
Therefore, this indicator has been slapped with "low" confidence and a
corresponding single weighting.
The current reading suggests modest growth in manufacturing supplier

deliveries.
Page 43

ISM: Manufacturing and Services
Pricing is very weak

Orders look good in service sectors, but are weakening in manufacturing
Overall, most indices are down compared to 12 months ago
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Energy: Consumption
If you run a business you need electricity. Weather can have an impact as
electricity use in the US peaks in summer due to air conditioning. If electricity
usage drops by 1% or more, it's a recession
Limited historic data, but no misses and no false positives (maybe 2014)
Current data puts the likelihood of recession at 0%
"Electricity usage" carries a single weighting in the LRPI
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Energy: Production
Electricity production should be linked to economic growth. This indicator,

unfortunately, had many false positives (1983, 1992, 1997, 2006), so
confidence is "medium"; recent data revisions of up to 2.5% magnitude dent
confidence further. Setting the trigger lower than -0.5% would eliminate false
positives, but make you also miss some recessions.
Electricity production has recovered from a steep drop in 2012
This indicator carries a single weighting in the LRPI
The current level does not indicate a recession
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Transportation: Miles Traveled
The US population grows by 2.25m people (0.7%) per annum, so traffic increases
constantly. If total miles driven grow less than 0.1% versus its own trend, you are
likely to be in a recession (the unemployed drive less).
The 2001 recession was missed. This indicator says we had a recession in 2011. The
prolonged decline in miles traveled since 2007 is puzzling; the decline being deeper
than the back-to-back recession 1980/81. Online shopping, car pooling and workfrom-home jobs might have contributed to this trend. A recent poll indicated young
Americans are less keen on acquiring a driver's license than one or two decades
ago.
Unfortunately, data is made available only with a time lag of three months. This,
combined with lower confidence, made us exclude this indicator from the LRPI. In
March 2014, historic data has been revised going back for years, denting confidence
in this indicator further.
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Transportation: Gasoline Consumption
Cars need gas, and gas needs to be delivered to gas stations; inventory
effects are unlikely because of high turnover
"Low" confidence because of false positive (1996) and limited historic data
The harsh decline in 2012 is puzzling - same signal as "miles traveled"

(previous page)
Some US cities are upgrading their public bus fleet onto natural gas,
potentially contributing to the decline in gasoline consumption
This indicator is currently giving 0% likelihood of recession
This indicator is related to "miles driven", confirming trends on one hand, but being
redundant on the other. It has therefore been excluded from LRPI.
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Transportation: Rail Freight Carloads
Thanks to input from readers four charts on freight transportation will be included
going forward. Unfortunately the data are available with considerable time lag only.
Bulk freight includes coal, ore, grain, liquids (chemicals), sugar and fertilizer.
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Transportation: Rail Freight Intermodal
Intermodal freight is being transported in containers, often using multiple modes of

transportation (ship, rail, truck). Containers make changing modes easier without
handling the freight itself.
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Transportation: Truck Tonnage
The ATA (American Trucking Association) Truck Tonnage Index measures the total
amount of tonnage hired for transport from American freight trucking services. It is
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often used as a barometer of commerce and trade in general across the US, as 68%
of freight by (81% by value) is transported by trucks.
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Transportation: Air Freight
Air freight by volume is negligible (0.1% of total), but not by value ($28bn, or 4%).
Items transported include mail and urgent documents (FedEx, DHL, UPS, TNT etc),
flowers, spare parts etc.
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Income: Real Disposable Income per Capita
Income growth recovered after a drop at the end of 2013
Given low growth of real incomes, consumption can grow only if consumers
dip into savings (difficult if no savings present) or take on additional debt
The stagnation of real incomes is the main reason for slow economic growth
in the US
Page 55

Income: Real Income
Total real income more than doubled since 1984 (or 2.8% per annum)
Per capita, real income still grew more than 67% (1.7% p.a.)
However, median real income increased only 25% (0.8% p.a.)
Median real income per household barely grew (9%, or 0.3% p.a.)
Most real income gains are captured by better-earning workers. However, the
highest marginal spending occurs with lower-income consumers.
This contradicts the Fed's storyline about a wealth effect from higher stock
prices as equities are not owned by lower-income households.
Increasing inequality of income and wealth are the main reasons for timid US
consumer demand.
Page 56

Inflation: Consumer & Producer Prices
Core consumer price inflation remained stable, slightly below the Fed's target
of 2%
Over the past 12 months the CRB commodity price index has declined 30%
The Fed is trying, so far unsuccessfully, to generate inflation (to boost

nominal GDP). Due to low wage growth one option could be to devalue the
dollar (in order to import inflation via rising import prices)
Page 57
If oil prices soared and the dollar tanked, inflation could quickly get out of
hand
Page 58

Inflation Drivers
In order to understand inflation we have to look at the most important drivers of

CPI:
41% housing (shelter, heating, electricity, furnishing)

16% transportation (cars, gasoline, maintenance)
15% food and beverage (eat at home, restaurants)
"OER", or owner-occupied rent, is the dominant part of housing. The data is sampled
by asking home owners what they think their house would fetch if someone wanted
to rent it. So it is complete guess-work by mostly non-economists. However, it is
probably fair to assume that rising house prices and property taxes will lead to
increased estimates of OER.
Over the last three months (annualized), headline inflation is 1.5%

Core inflation (excluding food & energy) is equally 1.5%
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Inflation Expectations
Real yield = nominal yield minus inflation. Resolving the equation for inflation
you get:
inflation = nominal yield minus real yield
The break-even rate of inflation is the rate at which it does not matter if you
bought Treasury bonds or TIPS. The chart shows implied inflation rates for the
next 5 (red), 10 (blue) and 30 (black) years. The "expected" rate of inflation is
not a forecast; it may or may not come true (market expectations change).
The stock market is, at times, highly correlated to changes in the expected
rate of inflation. Inflation expectations have decreased:
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Reasons why US inflation might be over-estimated:
Owner-occupied rent is a non-cash item that home owners do not spend. A

strong increase in home prices might therefore lead to increased CPI numbers
due to increased rent estimates by owners.
On the other hand, property and school taxes (which have been going up
significantly) as well as mortgage costs are not included in CPI calculation (they
are not assumed to be 'consumption'.
Reasons why US inflation might be under-estimated:
The US Bureau of Labor Statistics (BLS) uses "hedonic quality adjustments" in

calculating inflation, mainly in apparel and electronics. If the price of an item
remains the same, but the quality / features improve, the BLS takes that as a
price decline. The sub-index for information technology, for example, fell from
100 (1982-84) to 8.4, indicating a 92% price decline (which, of course, did not
happen).
Shadow Stats (www.shadowstats.com by John Williams) publishes an 'alternate'
measure of inflation, based on unchanged BLS methodology used prior to 1980.
He arrives at a current inflation rate of around 10%:
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While certain skepticism with BLS methodology is warranted, I doubt inflation since
2000 has been hovering around 8-10%. Over the past 14 years, nominal US GDP
has increased roughly 60% (from $10trn to $17trn), or less than 4% per annum.
Therefore, real GDP would have had to decline by 4% every year over the past 14
years, or around 40%. It is highly unlikely such a development would not severely
impact employment (or the entire financial system).
Page 63

Any questions or feedback welcome.
Alex dot Gloy at LighthouseInvestmentManagement dot com
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Management or the author may have financial interests in any instruments mentioned in
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Macro Report - US Economic Indicators - October 2015

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Macro Report - US Economic Indicators - October 2015

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Macro Report - US Economic Indicators - October 2015

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false positives (calling for a recession when there was none)

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

The latest recession probability stands at 6%

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Close call in March 2011 and February 2012

Currently not a red flag

This indicator has a triple weighting in the LRPI

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

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Employment: Non-Farm Payrolls

Lighthouse Investment Management

Employment: Population Growth

US employment grew merely 5% over the past 15 years, comparable to

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

According to the Establishment Survey, job growth continues at a modest pace

According to the Household Survey, average monthly employment growth over

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

This chart shows monthly changes in employment as initially reported (black

In recent months, revisions have been mixed

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Part-time jobs come without healthcare benefits, forcing employees to cover

Growth in the number of full-time employees has picked up in recent months:

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

5-year growth of population, working age population, labor force and

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Economic growth depends on decent increases in employment and real

An ageing population explains only part of the observation. The number of

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Elevated drop-outs from the labor force lead to under-reporting of the

Taking earlier recessions as a template, employment should currently be

While employment increased only by 3m since mid-2007, the number of

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - October 2015

Lighthouse Investment Management

Real disposable income has recovered at the slowest pace compared to

Compared to the average of the past 5 recessions, income should be at