lighthouse macro report - 2014 - august

Lighthouse Investment Management

Macro Report - US Economic Indicators - August 2014 Page 1

Macro Report

Economic Indicators - USA

August 2014



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: Establishment versus Household Survey ............................................................................. 14

Employment: Jobs Gained/Lost .................................................................................................................. 15

Employment: Initial and Revised Non-Farm Payrolls .................................................................................. 16

Employment: Full Time ............................................................................................................................... 17

Employment: Population, Labor Force, Employees .................................................................................... 18

Employment: Labor Force Participation Rate ............................................................................................. 19

Employment: Unemployment..................................................................................................................... 20

Recessions: Employment ............................................................................................................................ 21

Recessions: Real Disposable Income .......................................................................................................... 22

Recessions: Consumer Spending ................................................................................................................ 23

Consumer Confidence: University of Michigan Survey ............................................................................... 24

Consumer Confidence: Conference Board Survey ...................................................................................... 25

Credit: Total Outstanding ............................................................................................................................ 26

Credit: Bank Loans and Leases .................................................................................................................... 27

Retail Sales: Nominal .................................................................................................................................. 28

Retail Sales: Real ......................................................................................................................................... 29

Retail Sales: Real per-capita ........................................................................................................................ 30

Retail Sales: Excluding Autos ...................................................................................................................... 31

Retail Sales: Online...................................................................................................................................... 32

Manufacturing: Hours Worked ................................................................................................................... 33

Weekly Earnings .......................................................................................................................................... 34

Manufacturing: Orders ............................................................................................................................... 35

Orders: Capital Goods ................................................................................................................................. 36

Manufacturing: Supplier Deliveries ............................................................................................................ 37

Energy: Consumption .................................................................................................................................. 38

Energy: Production...................................................................................................................................... 39

Transportation: Miles Traveled ................................................................................................................... 40

Transportation: Gasoline Consumption ...................................................................................................... 41

Income: Real Disposable Income per Capita .............................................................................................. 42

Inflation: Consumer & Producer Prices....................................................................................................... 43

Inflation Drivers .......................................................................................................................................... 44

Inflation Drivers - Table ............................................................................................................................... 45

Inflation Expectations ................................................................................................................................. 46



Summary

The "Good":

Further decline in crude oil prices

Further improvement in Consumer Sentiment and Consumer Confidence

Stronger core capital goods orders

Better real disposable income growth

The "Bad":

July employment report (+209k) missed expectations (+233k)

Single-family building permits just 1% above previous year's level

Real retail sales per capita have still not reached the level seen in March 2006

No improvement in Labor Force Participation Rate

CONCLUSION: The US economy is very unlikely to be in a recession. However, economic growth remains

weak. What would the Fed do if the economy re-entered a recession? Its balance sheet already exceeds

$4 trillion, or 25% of GDP. Accelerating inflation could hurt consumers.



Lighthouse Recession Probability Index

The latest recession probability stands at 0%

Probabilities will slightly change as Industrial Electricity Usage data becomes available with a 2-

month time lag



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-rate-

policy).

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).

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 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.



Verification of LRPI:

We set 40% as threshold for the LRPI to indicate a buy (recession probability 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.



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.



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



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 317m in 2014).

Multi-family housing (rentals) permits are cooling off a bit while single-family permits (owners)

recovering. This indicator has a triple weighting in the LRPI. Currently no red flag.



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.



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 accelerated after disappointing in December and

January. Average monthly growth over the past 12 months rose to 214k.

According to the Household Survey, average monthly employment growth over the past 12 months

fell to 172k (from 179k).



Employment: Jobs Gained/Lost

Current monthly payroll growth is improving.

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.



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, positive revisions have become smaller.

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.



Employment: Full Time

The overall employment picture may be misleading. 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).

After a drop in June, recent data show decent growth for the number of full-time employees:



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 decline of number of people not in the labor force:



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.



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 by 13 million to over 90

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 13.7% (instead of 6.2% as

reported).



Recessions: Employment

The recovery of employment after the 2008/9 financial crisis has been the slowest among the

past 6 recessions

In May 2014, employment finally exceeded the level at the onset of the recession (= 100) after a

record-long 77 months

Taking earlier recessions as a template, employment should currently be about 10% (or 14

million jobs) higher



Recessions: Real Disposable Income

Real disposable income has recovered at the slowest pace compared to earlier recessions

Compared to an average of the past 5 recessions, income should be at around 10%, or $1.7

trillion, higher



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 317

million (4.7%) since the beginning of the recession.



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.



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.



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.



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 weeks, mainly due to business loans

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 since the beginning of 2014; June was revised downwards:

This indicator has exited the red warning area but needs to be watched closely.



Retail Sales: Real

No recession signal currently; this indicator has a triple weight in the LRPI

Real retail sales growth weakened in Q4 and Q1, but is recovering since March:

This indicator remains close to warning level and needs to be watched closely.



Retail Sales: Real per-capita

Real per-capita retails sales are still 5% below their pre-recession peak

Growth recovered in Q2, but has been slowing recently:

No recession signal (yet)



Retail Sales: Excluding Autos

Monthly auto sales, at over $80bn (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



Retail Sales: Online

Online retail sales (Amazon, etc) are growing faster than overall retail sales and have reached

almost $40bn a month

This corresponds to around 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)



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 reached a new record high

Currently no recession warning



Weekly Earnings

Average weekly earnings by private employees continue to grow slowly

Growth bounced up a bit in Q2, barely enough to compensate for inflation:



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.

However, the index dropped 13.2 points in January - the second-largest drop in over 40 years

(the chart above uses a 3-months moving average). It bears a watchful eye.



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 picked up in Q2



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.



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 100%

"Electricity usage" carries a single weighting in the LRPI



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



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 (which is theoretically

possible - we might not know it yet). 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, historic data has been revised going

back for years, denting confidence in this indicator further.



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 (recovered since then)

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.



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 huge

warning sign. However, December 2012 was boosted by tax-related dividend payments (hence

December 2013 suffered from base-effect).



Inflation: Consumer & Producer Prices

Core consumer price inflation remained stable

The CRB commodity price index has cooled off from a peak of +12% to +4% in 2014

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



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.



Inflation Drivers - Table

Over the past 3 months, headline inflation amounted to 2.8%, core inflation to 1.9%

Price increases for food accelerated markedly in recent months

Gasoline, despite a drop in crude oil prices, continue to boost headline inflation

Rent and OER remain important drivers

Medical Care costs are rising faster (+2.6%) than at the beginning of the year (+2.1%)



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:



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).



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

taken as investment advice. Nothing posted here shall constitute a solicitation, recommendation or

endorsement to buy or sell any security or other financial instrument. You shouldn't be surprised that

accounts managed by Lighthouse Investment Management or the author may have financial interests in any

instruments mentioned in these posts. We may buy or sell at any time, might not disclose those actions and

we might not necessarily disclose updated information should we discover a fault with our analysis. The

author has no obligation to update any information posted here. We reserve the right to make investment

decisions inconsistent with the views expressed here. We can't make any representations or warranties as to

the accuracy, completeness or timeliness of the information posted. All liability for errors, omissions,

misinterpretation or misuse of any information posted is excluded.

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Management does not take custody of any client assets.

lighthouse macro report - 2014 - august

Documents

consumer confidence

household survey

consumer spending

farm payrolls

labor force participation

university of michigan

conference board survey

fed funds rate