Lighthouse Macro Report - 2015 - March

Lighthouse Investment Management
Macro Report
Economic Indicators - USA
March 2015
Macro Report - US Economic Indicators - March 2015
Page 1

Contents
Summary ....................................................................................................................................................... 3
Lighthouse Recession Probability Index........................................................................................................ 4
Introduction .................................................................................................................................................. 5
Fed Funds Rate............................................................................................................................................ 10
Crude Oil ..................................................................................................................................................... 11
Construction: Building Permits ................................................................................................................... 12
Employment: Non-Farm Payrolls ................................................................................................................ 13
Employment: Population Growth ............................................................................................................... 14
Employment: Establishment versus Household Survey ............................................................................. 15
Employment: Jobs Gained/Lost .................................................................................................................. 16
Employment: Initial and Revised Non-Farm Payrolls.................................................................................. 17
Employment: Full Time ............................................................................................................................... 18
Employment: Population, Labor Force, Employees .................................................................................... 19
Employment: Labor Force Participation Rate ............................................................................................. 20
Employment: Unemployment..................................................................................................................... 21
Recessions: Employment ............................................................................................................................ 22
Recessions: Real Disposable Income .......................................................................................................... 23
Recessions: Consumer Spending ................................................................................................................ 24
Consumer Confidence: University of Michigan Survey............................................................................... 25
Consumer Confidence: Conference Board Survey ...................................................................................... 26
Credit: Total Outstanding............................................................................................................................ 27
Credit: Bank Loans and Leases .................................................................................................................... 28
Retail Sales: Nominal .................................................................................................................................. 29
Retail Sales: Real ......................................................................................................................................... 30
Retail Sales: Real per-capita ........................................................................................................................ 31
Retail Sales: Excluding Autos ...................................................................................................................... 32
Retail Sales: Online...................................................................................................................................... 33
Manufacturing: Hours Worked ................................................................................................................... 34
Weekly Earnings .......................................................................................................................................... 35
Manufacturing: Orders ............................................................................................................................... 36
Orders: Capital Goods ................................................................................................................................. 37
Manufacturing: Supplier Deliveries ............................................................................................................ 38
Energy: Consumption.................................................................................................................................. 39
Energy: Production...................................................................................................................................... 40
Transportation: Miles Traveled................................................................................................................... 41
Transportation: Gasoline Consumption...................................................................................................... 42
Income: Real Disposable Income per Capita .............................................................................................. 43
Inflation: Consumer & Producer Prices....................................................................................................... 44
Inflation Drivers .......................................................................................................................................... 45
Inflation Expectations ................................................................................................................................. 46
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Summary
The "Good":
Continued growth in non-farm payrolls with noticeable upwards revision of earlier months
Best year-over-year increase in men's labor force participation since July 2008
Consumer Confidence (3m average) highest since February 2005
Accelerating demand for business (+13%) and consumer (+5%) loans
Better growth in average weekly earnings
The "Bad":
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 1.7%
Lower growth in core durable goods orders
Weaker growth of employment, income and consumption than during earlier recoveries
CONCLUSION: The US economy is very unlikely to be in a recession. However, economic growth remains
timid. Combined with low inflation, nominal GDP growth seems insufficient to service considerable debt
levels in the long term. The current economic expansion (70+ months) already exceeds the average (65
months) and median (59 months) length of economic recoveries since 1958. What would the Fed do if
the economy re-entered a recession? Its balance sheet already exceeds $4 trillion, or 25% of GDP. A
strong dollar and slowing inflation might force the Fed to launch another episode of quantitative easing.
Page 3

Lighthouse Recession Probability Index
The latest recession probability stands at 0%
Probabilities will slightly change as Industrial Electricity Usage data becomes available with a 2month time lag
Page 4

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 mid-October 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-ratepolicy).
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.
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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).
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
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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 high-quality 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, 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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Verification of LRPI:
We set 40% as threshold for the LRPI to indicate a buy (recession probability <40%) or sell (>40%) signal.
Transactions have been done at the monthly closing price of the S&P 500 following the month for which
the signal occurred (in order to accommodate time lag):
An investor using the LRPI as a trading tool would have suffered only one loss of 7% (August 1980) while
avoiding the dot-com crash (2001) and the 'great recession' (2008-2009). The system creates no
unnecessary churn. While the control group ('buy-and-hold') would have created a higher return (with
higher volatility) this might be due to the test period coinciding with one of the longest bull markets in
history (1982-2000).
Annex: LRPI Components

Please find charts for all contributors to the LRPI on the following pages.
Page 9

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.
Page 10

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
Page 11

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) and single-family permits (owners) are growing at a modest pace. This
indicator has a triple weighting in the LRPI. Currently no red flag.
Page 12

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 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.
Page 13

Employment: Population Growth
Employment in the US has only grown 5% over the past 15 years, comparable to Greece
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, a 18.5 million growth in population translated into only 2m additional jobs,
while 16m left the labor force:
Page 14

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. Average monthly
growth over the past 12 months rose to 267k.
According to the Household Survey, average monthly employment growth over the past 12 months
has been 250k.
Page 15

Employment: Jobs Gained/Lost
Current monthly payroll growth is accelerating
The margin of error for monthly payroll data from the Establishment Survey is around 100,000,
and revisions can be up to 300,000
The current trend is not pointing towards a recession
Page 16

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 overwhelmingly positive
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) to update the data.
Page 17

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:
Page 18

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
Last month saw a decent increase in labor force as well as employment:
Page 19

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, have left the workforce and are 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).
Economic growth depends on decent increases in employment and real incomes; both measures
are showing moderate growth only.
Page 20

Employment: Unemployment
Less than half of the US population (49%) is in the labor force, and 45.5% 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.
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 15.2% (instead of
5.7% as reported).
Page 21

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 2m since mid-2007, the number of people not in the labor
force grew by 16m:
Page 22

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
Page 23

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 320
million (5%) since the beginning of the recession.
Page 24

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 1980-1981 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.
Page 25

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.
Page 26

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:
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.
Page 27

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
Commercial lending has picked up further in recent months
We have not yet incorporated this data into our recession indicator
Page 28

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 since the beginning of 2014; January was disappointing:
This indicator has exited the red warning area but needs to be watched closely.
Page 29

Retail Sales: Real
No recession signal currently; this indicator has a triple weight in the LRPI
Real retail sales was very weak in Q4 2013 and Q1 2014, but has recovered since
This indicator managed to avoid the 'red zone' usually associated with recessions
Page 30

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.
Page 31

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).
In Q4 2012, 45% of all car financings were subprime (FICO score <660)
Excluding autos, retail sales growth has slowed down significantly:
Page 32

Retail Sales: Online
Non-store (online and mail order) retail sales (Amazon, Lands' End etc) 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)
Online retail sales suffer large setbacks in recessions. This is probably due to the discretionary
nature of products sold (mostly consumer electronics etc)
Page 33

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 recently reached a new record high
Currently no recession warning
Page 34

Weekly Earnings
Average weekly earnings by private employees continue to grow at a moderate paste
Growth accelerated a bit towards the end of Q2
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 35

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.
Page 36

Orders: Capital Goods
Defense and aircraft orders are lumpy and distort trends, 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. Currently no warning sign.
Defense and aircraft orders are more than twice as much as the core
Growth in core capital goods orders slowed down at the end of 2014
Page 37

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 38

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
Current data puts the likelihood of recession at 0%
"Electricity usage" carries a single weighting in the LRPI
Page 39

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 indicates a recession probability of 87%
Page 40

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 work-from-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.
Page 41

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
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.
Page 42

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
In December 2013, real disposable income and real disposable income per capita fell below their
level seen twelve months earlier. This has usually occurred only in recession, and is a warning
sign. However, December 2012 was boosted by tax-related dividend payments (hence
December 2013 suffered from base-effect).
Page 43

Inflation: Consumer & Producer Prices
Core consumer price inflation remained stable. However, over the past three months annualized
core inflation fell to 1.3%
The CRB commodity price index has cooled off from a peak of +12% in June 2014 to -20%
The Fed is trying to generate inflation (to boost nominal GDP) by devaluating the dollar (in
order to import inflation via rising import prices) - so far unsuccessfully
If oil prices soared and the dollar tanked, inflation could quickly get out of hand
Page 44

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 guesswork 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 -5.2% ("B").
Core inflation (excluding food & energy), inflation is 1.3% ("A").
Page 45

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 over the past month:
Page 46

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%:
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 47

Any questions or feedback welcome.
Alex dot Gloy at LighthouseInvestmentManagement dot com
Disclaimer: It should be self-evident this is for informational and educational purposes only and shall not be
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+++++++++++++++++++++++++++++++++++++++
All clients have their own individual accounts held at an independent, well-known brokerage company (US)
or bank (Europe). This institution executes trades, sends confirms and statements. Lighthouse Investment
Management does not take custody of any client assets.
Page 48

Lighthouse Macro Report - 2015 - March

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Lighthouse Macro Report - 2015 - March

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Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Lighthouse Investment Management

The latest recession probability stands at 0%

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Lighthouse Investment Management

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

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Annex: LRPI Components

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 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 - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Current monthly payroll growth is accelerating

The current trend is not pointing towards a recession

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

In recent months, revisions have been overwhelmingly positive

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

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

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Last month saw a decent increase in labor force as well as employment:

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

The Conference Board, an independent business membership and research association,

Macro Report - US Economic Indicators - March 2015

Lighthouse Investment Management

Lighthouse Investment Management

Commercial lending has picked up further in recent months

Macro Report - US Economic Indicators - March 2015