How to Interpret This Week’s Economic News

A street sign for Wall Street outside the New York Stock Exchange on March 9, 2020. Carlo Allegri/Reuters

Commentary

There are many recent anecdotes about new stock market participants having fun, playing with their money, while sitting at home during the lockdown, thinking they somehow have better insight than the scores of people who are paid hundreds of thousands of dollars a year to publish their very best thinking for thousands of clients.

Bloomberg Intelligence reports that 19.5 percent of stock market activity during the first half of 2020 has been by individual investors—double the levels in 2010 and about one-third higher than in 2019.

Just to illustrate the point with one current darling of individual investors and Wall Street: Yahoo Finance tracks 22 Wall Street analysts who have each already published their estimate for Tesla’s 2021 profits. Yahoo Finance uses these analyses to determine its “Forward P/E ratio” and other information. And, yet, some folks seem to believe they’ll attain some insight that’s superior to that of all those professional Wall Street analysts, the ones working for all those professional investors, who, by the way, have way more money to buy cheap stocks and analyze which expensive stocks to sell.

This anecdote about one company can be generalized to the entire U.S. stock market, the entire U.S. bond market (which is generally usually about three times the size of the U.S. stock market), the entire global market for gold, financial instruments tied to wheat or soybeans, and every other financial instrument you can think of.

Current financial market prices for all financial products and securities and currencies are a reflection of just two things: 1) the future, and 2) how much an investor needs to get paid. All investment decisions can be distilled to 1) trying to predict the future, and 2) figuring out how much investors will want to earn from this particular investment.

With that distillation, we can quickly see that the most important “factors” determining asset and securities prices are those that most affect supply and demand, and profits. So, currently, almost every professional investor understands that the timing of the end of the global pandemic and the outcome of the U.S. presidential election are, by far, the most important things to try to understand before they happen.

With that insight, investors can allocate investments along all the continua they measure: risk and higher return versus safety and likelihood for return of capital, domestic investments versus non-domestic investments, investments expected to perform well if the global pandemic ends soon (think airlines and hotels and entertainment venues) versus those that may do well if the global pandemic lasts longer than expected (think companies tied to home computing and home entertainment).

With that as justification, we wanted to share how we’ll be thinking about the important economic data being released this week. These data will be discussed in the mainstream media for what they said about the economy during time periods already elapsed. But, for savvy investors, that’s not very interesting or very helpful in making decisions about what to buy or sell to maximize expected risk-adjusted returns.

Sept. 1: ISM Report

On Sept. 1, the monthly ISM Manufacturing Index report was published. The Institute of Supply Management takes a survey among its members who buy everything for many of the manufacturing companies in America. The basic form of the ISM’s questions to its members is, “Do you expect X to be higher or lower in the next few months?” From that, the institute creates a “diffusion index” by adding up all the “highers” and subtracting all the “lowers.”

I really like the ISM reports—they provide lots of details from experts who know and whose insights have actually proven to be one of the best crystal balls in the economist’s tool kit.

On Sept. 1, there were three key data made available from the ISM report on manufacturing businesses in the United States: 1) productivity is going way up, very quickly; 2) inventories are shrinking because businesses are selling but supply chains remain clogged due to the pandemic; and 3) prices are expected to be higher in the next few months than they have been in the recent past—i.e., America’s purchasing agents are expecting at least a short blip in higher inflation.

Productivity is the No. 1 driver of increased worker income, profits, wealth, and national income. For example, if productivity is up 7.5 percent from one year to the next, that means that for the same number of worker hours, workers can produce 7.5 percent more product. For now, we’ll ignore that purchasing managers actually believe prices are going to increase, and we’ll just assume no change in the price of products.

If workers can produce 7.5 percent more goods with the same number of hours, they can be given a 5 percent raise and the company will be at least 2.5 percent more profitable (and if the company uses 50 percent debt to finance its operation, return on equity might actually increase some 5 percent—which would lead to an increase in the stock price of, let’s say, 5 percent, all else equal, even after the workers got their 5 percent raise.

This leads us directly into the next major pieces of economic news, due Sept. 3 and 4.

Sept. 3: Productivity Expected to Show 7.5 Percent Increase

On Sept. 3, the Bureau of Labor Statistics (BLS) is expected by Wall Street analysts and other economists to report that productivity increased 7.5 percent during the period measured (according to the Bloomberg survey).

Sept. 4: Monthly Employment Report

On Sept. 4, the BLS will report its most recent findings about the employment situation in the United States for the month of August. The official, headline unemployment rate is expected to fall to 9.8 percent from 10.2 percent (according to Bloomberg).

Markets will be paying close attention because traders know that investors will care about this number. If the rate falls substantially below 9.8 percent, traders will push up stock prices and push down prices on U.S. Treasury bonds (causing interest rates to rise).

Meanwhile, if the unemployment report shows unemployment didn’t go down or, even worse, actually went up from the previous reading, stocks will be sold–equity prices will fall–and bonds will be purchased, causing bond prices to rise and rates to fall.

The details within the report to focus on include average hourly income, average hours worked, and labor force participation rate.

Beyond This Week

Of course, the prospects of a vaccine to prevent COVID-19 or the development of a treatment preventing severe illness and reducing the likelihood of death are, by far, the most important possible unknown change that might affect investment prices in the near term.

There’s also the U.S. general election on Nov. 3, with all its implications for the U.S. regulatory regime, trade policy, and tax policy. Thus, state-by-state polling data and its implication for the Electoral College outcome are important to watch right now.

In the more immediate term, we will be looking very closely at what the Federal Reserve has to say on Sept. 16. We will provide analysis about that meeting in the next two weeks. However, as a preview of some of what will be important that day, readers are encouraged to go to the Fed’s website and review the projections released after the Fed’s June 9–10 meeting.

On Sept. 16, we’ll be looking for key differences from the June 10 data.

Tim Shaler is a professional investor and economist based in Southern California. He is a regular columnist for The Epoch Times, where he exclusively provides some of his original economic analysis.