The only value in making the inevitable blunders and errors in this business lies in not making the same mistake twice, a feat roughly on par with quitting smoking in the easier-said-than-done department. Consider the chart below for the January 1989 platinum contract as an introduction to what appears to be dangerous ignorance of past blunders.
Logic Can Be Expensive
Source: CRB-Infotech CD-ROM
The three points marked on the chart represent the day I bought at $508, the day I sold at $517 and the day Ford Motor (F) - Get Ford Motor Company Report announced, just after the market opening, that it was going to start testing a nonplatinum catalytic converter. My reaction: So what? It would take years to develop such a converter, and there was no way this announcement affected the fundamentals of January delivery. Besides, I was trading from an intermarket econometric model of my own design that had kept me long for the previous two months, and you are either going to be disciplined or you are going to be out of this business.
My logic was correct, but did not prevent the near-total evaporation of my profit. I learned, as others had before me and would after me, that the unsubstantiated panics of the ill-informed can trump any level of cool detachment. I still regard this as the worst single trade I ever made, or more correctly, did not make.
Live in a Household, Patronize an Establishment
That lesson brings me to the market's current obsession with the monthly jobs number. Nearly as much ink has been spilled in 2004 over the veracity of the monthly employment report as on the veracity of the various price indices, a topic visited
here last week. The effects of birth and death estimates have been seized upon as a source of manipulation, as have the divergences between the household and establishment surveys.
While these are fair criticisms, it is important to remember the actual numbers reported by these surveys are just that, survey estimates with quantifiable statistical confidence intervals around them. The revisions of the July data we will see reported next month also will have an error band. Statisticians are comfortable with fuzzy data and often find the residuals, or unexplained portion of any model, to be of the greatest interest. Traders, however, have a more instantaneous and deterministic view of the world, and as my platinum trade illustrates, woe to those who take their time crossing the street.
Let's put last Friday's nonfarm payroll estimate into some perspective. The median estimate for the number was a gain of 240,000 as opposed to the actual jaw-dropping number of 32,000 reported. That difference of 208,000 represents a deviation of 0.157% of the 132.325 million workers on nonfarm payrolls at the end of June. That is one-sixth of 1%. Anyone who does political polling, market research or electricity demand forecasting would be thrilled beyond words to have an error margin this low and would be flabbergasted if the results of their work were treated as wildly off the mark.
Moreover, you do not need a conspiracy to explain the differences between the household and establishment data. The labor market is highly dynamic and despite its cold cruelties, we are better off for its capacity to let the American economy shift, as discussed here in July 2003 in the context of the service sector. A long-term comparison of the two numbers shows how the establishment survey results grew at a much faster rate from the end of World War II all the way until the turn of the century.
Household Data NonParallel to Nonfarm Data
The Gap and Its Implications
As noted above, economic modeling is less about fitting the data to a structure than analyzing the unexplained. The gap between the household and establishment surveys appears to narrow most quickly during strong economic times and to widen otherwise. The rational explanation for this behavior is, employers (the source of the establishment data) are more willing and able to hire additional labor when the marginal output of that labor exceeds its marginal cost. In slack times, individuals are more likely to choose self-employment, either actively or out of lack of employment opportunities elsewhere.
If we express the gap in the difference between the two surveys as a percentage of the establishment survey, we can see what a profound effect a prolonged economic boom has on this decision. The 1960s and the 1990s both witnessed far more rapid increases in the establishment survey than in the household survey. The long stagnation of the post-Vietnam era saw a cessation of this shift from the household pool to the establishment pool. Interestingly, and not at all coincidentally, the gap measure corresponds to the fortunes of the stock market as well.
Productivity and Survey Differentials
Labor and Capital
The last decade has seen one of the most rapid increases of productivity on record. Businesses have harnessed technology more efficiently, replacing labor with capital, with high-labor-content goods from exporters such as China, and with global outsourcing. If this dynamic is allowed to proceed, the result will be greater incentives for entrepreneurs, which is something that has never hurt the American economy. Not only will new businesses and industries be created, as we all remember fondly from the 1990s, but the resulting efficiencies and growth in productivity will keep inflation under control.
However, productivity growth will slow if a political decision is made to restrict the dynamism of the labor market via protectionism, restrictions on international investment and outsourcing, higher minimum wages and other legal and regulatory impediments. That development would have the worst of all possible world implications for the American and indeed for the global economy.
The slow, and in some cases negative, productivity growth of the late 1970s corresponded to a period of high marginal tax rates, high inflation and interest rates, an increasing regulatory burden and high energy prices. We are not plagued by high interest rates today, and I am of the opinion that inflationary pressures are in fact receding. Higher energy prices are going to be with us for a while, and perversely we should hope they are: Only a collapse in demand from reduced economic activity will lower them in the short term.
We have a choice on the tax and regulatory side. I as an individual trader have avoided a repeat of that platinum trade. Let's collectively avoid a repeat of the stagflation trade.
As originally published, this story contained an error. Please see
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Howard L. Simons is a trading consultant and the author of
The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to
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