Torture the Data long enough and it will confess to anything...

The core motivation for this Blog was to promote some rigor in business and economic analysis and research. In our posts we had talked about how research is becoming less and less exploratory and more and more confirmatory.

I was just reading an article on Yahoo! Real Estate from CNNMoney.com titled "Americans Tame Their Wanderlust". The article is pretty cool as it focuses on domestic migration patterns, which obviously has a strong bearing on regional shifts in Real Estate demand and pricing. What was not so cool was the lack of connectivity between the data presented and the corresponding insights developed. For instance the article's title is based on the following statement "Only about 2.4% of Americans moved from state to state in 2008, down from 2.5% the previous year". The author relies on U.S. Census Bureau population data, which is publicly available at the Census Bureau website. Now this is a 0.1% change- 307,000 absolute decline assuming a total U.S. population of 307 Million. This seems like a large number if the numbers aren't estimates but actuals, but it is impossible to measure this data with 100% accuracy, so the Census Bureau like most other folks in Business and Social research settles for 90% confidence (with a 10% probability that the estimates are wrong). A key metric in gauging how much importance to put into this change is the "standard deviation" of how this percentage varies year over year. So if this percentage varies +/-0.05% every year, there is only a weak possibility that there was actually a decline and for all purposes the change would be statistically "insignificant".

I am not saying that the article is inaccurate, all I am saying is that in my opinion enough data may not have been presented to justify the title. It is especially risky to base real estate investment decisions using just two data points as typically the gestation period for these investments to bear fruit is significantly longer than 2 years (if more folks had been mindful of this we probably wouldn't have had a real estate bubble).
A little rigor around analysis of Census Bureau would have yielded the author a few interesting nuggets around domestic migration trends in place. For example the chart below shows net migration trends by 4 U.S. regions.
 

The chart indicates that with the exception of 2002-2003, the South seems to significantly lead all other regions in migration. The West seems to have some cyclical pattern going on but seems to generally mean-reverting around an equilibrium balance. Over the past 10 years the exodus out of the Midwest has progressively abated. The exodus out of the Northeast seems to have peaked out in 2004-2005 and is progressively becoming less negative in net domestic migration.

Looking at this from a State level may have generated too much noise as there are several factors to be considered like the fact that Washington D.C. is at the confluence of three states and has a significant number of people that at one point in time or another lived in both D.C. and one of the neighboring states. So either analysis and insights should be limited to the granularity permitted by raw data or an appropriate statistical model should be leveraged that controls the influence of potentially confounding factors.

Eye on The U.S. Economy: September 2009 Employment Report

The Employment Situation Report comes out on Friday September 4th, 2009 at 8:30 A.M. Based on other reports that came out earlier this week, it may go either way vs. expectations. Consensus estimates an average decline of 200,000 in Nonfarm Payrolls.


Although the ISM Manufacturing Index came out on September 1st at a very strong at 52.9 vs. a Consensus of 50.5, the Inventories Index was weak, suggesting Manufacturers are drawing down existing Inventories, which doesn't help Employment. but production was up.
From a historical perspective, last month ISM Manufacturing Index had an upside surprise, ADP came in at -371K, Consensus estimates on Nonfarm Payroll were -300K and Actual came in at -247K. So if we see a repeat trend this month, we could actually come better than -200K.

So far I see a couple of positive factors supporting better than expected Employment and one negative factor (ADP).

Here's the reason I am honing into Employment this month- Personal Income usually lags Employment and leads Consumption, therefore it is logical that Employment trends in September and October could be a major influence on Holiday sales. If you look at the last ten years Retail Sales estimates from the Census Bureau (excluding Auto), the monthly SAAR (Seasonally Adjusted Annual Rate) correlation vs. the Month-over-Month Employment percent change peaks out at a 3-month lag. The correlation with monthly change in Seasonally Adjusted Retail Sales (ex-Auto) peaked at a 2-month lag. Unless we have significant improvement in Employment and Personal Income over the next two months, we are looking at another year of bleak Holiday sales.

Wading Through A Deluge of Recession Pricing Advice

Over the past year or so a lot of advice has come out from business thought leaders about recessionary pricing strategies. Below are three articles from what are considered to be well-regarded sources:
INSEAD: When to push the panic button?
Harvard Business School: Marketing Your Way Through a Recession
McKinsey: Pricing in an inflationary downturn
Although there's a lot of valuable advice in these perspectives, it is surprising that some of these studies propose a one-size-fits-all approach to recessionary pricing.
Sorry to burst the bubble, but the consumer decision process is not that simple. For instance the INSEAD article proposes that consumers are not more price sensitive during a recession, the extra sensitiveness shown during recessionary times is attributed to income smoothing and advices firms to focus on share of customer wallet rather than share of market. Good advice, but while it is great to focus on share of wallet, share of market ultimately determines the financial performance corporate stakeholders will be evaluated on. Share of wallet as a metric is focused on retention(up-selling and cross-selling). While retention is critical, acquisition is important too in driving growth. Market-share is a more wholesome metric that takes into account performance of both retention and acquisition activities, especially if the firm is in a growing category, where acquisition could be a greater determinant of performance than retention. On the other hand for mature industries, retention would certainly be more important. This highlights the perils of subscribing to generic strategies.
Another frequent advice I have come across is to not take a perceived increase in price sensitiveness during economic downturns as a signal to aggressive pricing strategies that may lead to unprofitable price wars. That is all good, but game theory suggests that in multi-competitor industries, you will always have a player that will try to increase their payoff by defecting and using aggressive pricing strategies to garner market shares. In this case should you take the higher road and trust in your customer loyalty or protect your market-share?
The Harvard article scores on a few points, for instance Advice #6 is to "Adjust Pricing Tactics"- some good nuggets of wisdom here, but #3 "Maintain Marketing Spending" is no all that realistic. Margin pressures inevitably result in budget cuts.
The McKinsey article actually has some pretty good advice on how research steps that can help fine tune pricing strategy, without actually trying to generalize findings. I especially liked these:
Monitor customer-level profitability
Update price sensitivity research
Monitor your industry’s microeconomics
Consumers reaction to pricing in recessions is not generic across all of their purchases. For instance, if a Brand is in a category with relatively low product differentiation, price discounting could forever forfeit brand premium, while Brands in categories with higher product differentiation can actually leverage pricing without damaging longer term equity. Also for service-based industries, brands can drive longer-term market-share by lowering price and locking in customers over a longer-period. Ultimately the key thing to remember is that when it comes to pricing strategy- one size certainly doesn't fit all.

U.S. Economic Outlook: Bottom In Sight or Double-Dip Recession?

A quick survey of key economic indicators for the U.S. Economy may indicate that some of the downward drivers may be paring back more than expected, which could either indicate a reversal may be in the offing or we are on the brink of a double dip recession.

Durable Goods Orders: Durable Goods orders are to be released on June 24th and the consensus average is a -0.5% change. Durable Goods orders for April released on 5/28 was an upside surprise (new Orders expected 0.0% change vs. Actual 1.9%), and in April released for March were an upside surprise too (declined less than expected). If the underlying trend in Durable Goods is less negative than what economists are expecting, it may suggest that industrial production and capital spending situation may be a little bit better than expected coming up into the close of the second quarter of 2009.

Consumer Confidence & Consumer Sentiment: Both Consumer Confidence (Conference Board) and Consumer Sentiment (University of Michigan) where upside surprises (upside surprise in April too). Consumer spending is the heart of the U.S. Economy, representing 2/3rd of the economy.

Retail Sales: Although overall Retail sales were slightly below consensus, Retail Sales ex-Auto was slightly better than expected.

Inflation: May Headline Inflation rate was lower than expected, while Core Inflation came in right on the mark.

Employment: May Non Farm Employment was less negative than expected, while the Unemployment rate was slightly higher than expected. Numbers released in May for April also showed a better than expected Non-Farm Payroll situation.

Given the fact that First Quarter GDP was a little worse than Consensus expectation, the overall economic scenario painted by these indicators may suggest that a bottom could be in sight. It is too early to call a turnaround since GDP still has a negative trend, although the trend seems to be decelerating. At the very least we can expect overall 2Q to perform better than 1Q. This seems to align with Prof. Nouriel Roubini’s January prediction (first quarter 2009: -5%; second quarter 2009: -4%; third quarter 2009: -2.5%; fourth quarter 2009: -1%--adding up to a yearly real GDP growth of -3.4% for the U.S. in 2009). Although now "Dr. Doom" Roubini is raising the prospect of a Double-Dip recession, as he thinks that not everything is in alignment for a significant reversal of the recovery trend. Hopefully he is underestimating the impact of all that stimulus money or overestimating the fallout of the public debt burden, because if we are indeed looking at a Double-Dip recession, it will get a lot worse before it gets better.

Global Warming, U.S. Economy and the GM Bailout

Why do I have these three themes in one sentence? That is because I think these could shape each other’s future with a little foresight.

Transportation is the second largest source of greenhouse gas emissions and accounts for a third of all carbon dioxide emission in the U.S. and Canada. Governments the world over are awakening to the fact that irreversible damage is being done to the environment on a global scale, with fossil fuels one of the key culprits. If there is one line item that you are going to find in the budgets of most rational governments the world over, it is investments in clean energy including reducing auto emissions.

President Obama has already made his stance on this clear by saying he hopes to see 1 million plug-in hybrid and electric vehicles on the road by 2015. Many have called this optimistic, but I don’t think so, only that I think President Obama is being myopic in his definition of “road”. I think the U.S. can take a leadership position in the global Hybrid car industry, not just the U.S., by bringing together likeminded Governments that would like to see a reduced consumption of fossil fuels. He said “"The nation that invented the automobile cannot walk away from it." And I agree, but I think “$4 billion in guaranteed loans and tax credits to help U.S. automakers retool for more fuel-efficient cars and to develop batteries for plug-in hybrids that get up to 150 mpg”, is taking a passive stance on the subject. If one American revolutionized the Global Auto Industry with the Model T, no reason why another cannot shape it’s future with making Hybrid technology affordable.

The combination of increased global concern on climate change, public opinion focused on a faltering economy and the current turmoil in the U.S. auto industry provides an alignment that the President should leverage. Especially opportune is the U.S. Government’s investment resulting in controlling interest in General Motors. I have not been fond of bailouts in general, as I favor natural evolution and survival of the fittest, but in this case it could be a good thing. GM is a company that has already made significant investments in hybrid technology (although cars like the 2010 Chevrolet Camaro SS with a V-8 engine bring into question the GM's product development strategy and Bob Lutz's commitment to the longer term). With the might of U.S. Tax payer dollars behind it and a more active rather than a passive Taxpayer role in the Board, this company can take a global leadership role in making U.S. hybrid technology the prevailing currency across the world over the next 5-10 years. This will require the U.S. Government to evolve GM into a largely hybrid car manufacturer. From a macro perspective, this could provide a significant boost to exports in the longer term, balancing the worsening Trade Gap (sales recorded by the global hybrid vehicles market are expected to surge at a CAGR of around 12% during 2008-2015 and focusing on this growth should only enhance Taxpayers’ Return on Investment on GM).

I know from an economic perspective, to make this a profitable venture will require a lot of work. Currently hybrid technology is far from affordable- the GM Volt, which plugs into a household electric socket to charge, is slated to retail for $40,000, nearly the same price as a conventionally fueled Mercedes C Class. As technology improves, this dynamic should change significantly- just look at the Notebook computer industry. And then again this is not just about profits- developing a potentially successful U.S. Hybrid Car Industry has ramifications that will reverberate for more than a hundred years to come, in a global climate that will finally begin the healing process from generations of big-cylinder, gas-guzzling monster cars spewing CO2 into the air.

So is the Government bailout of GM a smart move? Yes- only if President Obama was serious when he was talking about “Change”. If he really is as imaginative a leader as I think he is, he will take this opportunity and score a big touchdown on all three fronts: Global Warming, U.S. Economy and the General Motors.

McKinsey on Economic Regulation: Calling a Spade a Spade...

...or stating the Obvious?


Mckinsey Quarterly just put out an article highlighting the need in the current economic scenario for an increased cooperation between business leaders and regulators. The article states that "As concern over global problems mounts, executives and regulators have everything to gain from building relationships based on trust, and developing solutions that benefit a wide range of stakeholders". First of all I think this is a key area to address as the average Joe asks how come their elected leaders stood by while the business machinery took the free markets doctrine to illogical extremes. If people were rational and self-regulating we wouldn't have the need for the police and the judicial system, and if businesses were rational we wouldn't need the FTC and the SEC. At the same time 2008 was not just about the failure of the free markets system and the article doesn't address some regulatory limitations on dealing with the special circumstances surrounding 2008. In spite of the breadth of the current economic problems, truth of the matter is that trouble began with capital markets and the blatant securitization of all kinds of assets, the true economic risks of which regulators weren't really equipped to assess. Secondly, to some extent the economy validated at least one aspect of the free markets philosophy- survival of the fittest. Take the US domestic automotive sector for instance- these guys were in trouble long before the housing bubble and sub-prime crisis began. The credit crisis and their stocks tanking is forcing them into extinction as their ratings get slashed and they struggle to meet their debt obligations, but the it all boils down to their inability to compete with foreign automakers- evolution principles in action.

So the Recession is finally official- Now What?

On Friday, November 28, 2008 the Business Cycle Dating Committee of the National Bureau of Economic Research announced a peak in economic activity in December 2007. Since it is the NBER's sacred and ordained task to announce recession beginings and end, finally everyone including the government can admit that we are in an official recession until the NBER announces a 'trough', signalling the end of the recession. Interestingly, neither the GDP or the GDI (Gross Domestic Income) showed an extremely clear pattern in the two consecutive quarters of decline rule to identify a peak, only the payroll employment seems to have declined every month since December '07 and the NBER seems to have weighed heavily on this metric to dtermine that we reached a peak in economic activity in December '07. Interestingly, I had posted previously in Is GDP a Consistent Measure? No, GDP is actually a Deceptive Measure... that relying purely on the GDP to determine the state of the economy is not a good idea since this measure may no longer be as reliable as it used to be in the past. Even if the financial markets and the economic production begins to stabilize, employment may continue to decline (economists are expecting Friday's employment report to be abysmal at a 325,000 decline- ADP has reported a 250,000 decline in the private sector). What probably is also driving private sector declines is the fact that stock prices are down in the dumps and management will continue to leverage every opportunity to be efficient by cutting costs to appease shareholders, until revenue growth returns to a point where it offsets the need to improve profit margins through cost-cutting. After the 2001 recession, jobs took 4 years to return to peak levels according to the Economic Policy Institute and if that is any indicator, we are looking at late 2011 early 2012 for a full recovery. With the dramatic decline in House Prices and the bleak performance of retirement accounts, households are increasing their savings rate in "safer" securities (typically bonds), as they can no longer rely on their real estate equity as a retirement cushion. In any case we are a long way from getting out of the woods.

Ghilarducci's Guaranteed Retirement Account Plan & The Macroeconomy

The last couple of weeks there's this rumor that's been floating around that the Government plans to do away with 401K and replace them with what is being called Guaranteed Retirement Account. The idea apparently originates from an economist, Teresa Ghilarducci, who put forward a paper "Guaranteed Retirement Accounts Toward retirement income security" in November 2007. A year after the paper was published, in the wake of one of the worst financial crises in the history of the US, the author was apparently called to testify before Congress as the paper caught the government's eye. The paper proposes that workers "not enrolled in an equivalent or better defined-benefit pension" be enrolled in a "GRA" plan that combines the best features of defined-benefit and defined-contribution plans, offering workers guaranteed (?) retirement benefits- contributions will earn a rate of return guaranteed by the federal government. Upon retirement these funds will convert into annuities. Ghilarducci claims that combined with Social Security, these annuities will replace 70% of pre-retirement earnings (I thought most of the folks who entered the workforce within the past decade had given up ever seeing their Social Security benefits?). Participants would be guaranteed a fixed rate of return that exceeds inflation by 3 percent (but remember you are foregoing the opportunity to generate market returns on your investment- not amounting much today, which is why we are even entertaining this discussion I guess). Assuming this thing works and the Feds will be able to deliver on their promise, what will be the fallout from pulling that kind of capital out of the investment markets? Of the total $17.1 Trillion in U.S. retirement assets, mutual funds managed $2.2 Trillion, while IRAs accounted for $4.5 Trillion (data as of March 31, 2008 from Investment Company Institute). If a $0.75 Trillion bailout was going to pull us out of the financial crisis, what will be the outcome of withdrawing $6.9 Trillion out of capital markets? Or am I missing the math completely?

October Retail Sales

Macy's reported a disappointing sales for the third quarter losing $44 million. Other retailers are expected to report quarterly results later this week including JC Penney, Kohl's and Nordstrom. Few retailers are already reporting poor sales number for the month of October, which is going to put added pressure on the market and the economy. This is going to be a roller coaster fourth quarter.

Enjoy....

The U.S. GDP & The Non-farm Payroll

On the heels of one of the worst ISM Manufacturing Index numbers in over two decades, the Employment numbers that come out on Friday were expected to be bleak- and it exceeded this expectation as the decline was 40K worse than the consensus average of -200K. The report released by the Bureau of Labor Statistics is based on two different surveys with different sample sizes and the bigger focus is on the Non Farm Payroll number that comes out of the establishment survey because this survey is more comprehensive with a much larger sample size than the household survey (375,000 businesses vs. 60,000 Households). The number of total employed persons in the U.S. population has been falling for 10 consecutive months and in October '08 there are 1,138,000 fewer employed persons in the U.S. compared to the November '07 peak of 138,037,000. And all this time economists have been debating whether it's really a recession or not- fact of the matter is the relationship between Employment and GDP may not be what it was in the past- correlating Quarterly change trends in GDP vs Employment (15-year moving window) indicates that this relationship may be only half of what it was 4 decades back.

The Economy has become much more complex than what it was back then and we may need to be redefining how we look at these economic indicators.

ISM Manufacturing Index says the worst is not over yet in the U.S. Economy

So we were just talking about how the GDP is not a very consistent measure of the economy.
The Institute for Supply Managements Manufacturing index (formerly known as the NAPM Survey) just came out today and this little guy's been historically good at measuring contractions. The Index is constructed such that levels at 50 or above signal growth in the manufacturing sector, which is a good measure of actual demand. Levels between 43 and 50 indicate the economy is still growing but the manufacturing sector is slowing down it's activities in anticipation of lowering demand. Levels below 43 indicate that the manufacturing sector is taking drastic measures to counter a significant and extended slowdown in demand- basically the manufacturing sector considers the economy in deep recession. Guess what the Index number that came out today read? 38.9- a 26 year low, just 1 basis point above the September 1982 low of 38.8! This underscores the importance of credit in today's economy in a way, the bank's tightening of the credit faucet, and the events in the Financial markets and broader economy, consumer spending has taken a beating. Another point no one is factoring is the impact of people becoming austere in their spending to shore up their battered retirement accounts. With over a Trillion dollars lost in the country's retirement funds, people who were planning to retire within the next 1 to 2 decades are going to need to increase their savings rate to offset the loss of this year. Guess what that means for spending?

The Employment Situation report is coming out later this week, with such a drastic drop in manufacturing, I am expecting a pretty gloomy picture with the Non Farm Payroll number.

Is GDP a Consistent Measure? No, GDP is actually a Deceptive Measure...

In economics, expert and layman alike keep looking at the GDP quarter over quarter for some direction as to the true health of the economy. Talk about the blind leading the lame! If bubbles are reflective of an inflation of values of goods and assets, be it stocks, real estate or currencies, then an inconsistent metric is one that lacks robustness not to be influenced by bubbles. Look at the GDP- it is easily swayed by pretty much any bubble there is out there. The GDP may have been a good measure when the world was simpler, and production and consumption were driven by real growth in wealth, not by credit cards and home equity loans. According to Federal reserve statistics, Revolving Home Equity $100 Billion to $200 Billion from 1997 to 2002, but from 2002 to 2006 reached $500 Billion. It is difficult to believe that people's equity in their homes more than doubled in 4 years, so basically they were riding the wave of the real estate bubble and an artificial inflation in the value of their homes (old news now since even your neighborhood grocer by now knows about the sub-prime crisis). What's bad for the GDP (even Real GDP) as a metric is how much it is influenced by consumption (more than 2/3rd). With such a spike in Home Equity withdrawal, consumption is bound to spike as well, but this growth in consumtpion can hardly be said to be driven by a real increase in wealth and well-being- it is all driven by money advanced through Home Equity withdrawal, on the assumption of sustained growth in Home prices and not as much due to a genuine increase in actual Home Equity. When that market corrected it was payback time for all the uncontrolled spending driven by Home Equity- and GDP as a metric, was not able to see through that scam.