Why We Appear To Be On The Down-Hill-Side Of Unemployment

A New Strategic Alliance  
Our Monthly Performance Update
Incomes - A Four-Decade Long Report Card
Will the Real Unemployment Rate Please Stand Up?
It's ROC That Matters
Will They Keep Buying Our Bonds?
Rocket-Riding Stimulus Junkies (Part II)
Paying the Piper
Are You in "Old-Man Shape?"

I often write about the facts in this letter with little or no emotion.  However, peeling back the layers of the onion of economic data over the past 18 months has brought tears to my eyes.  I have close friends that have lost their jobs, houses, and even their families during this great recession.  It is a humbling experience to watch it affect real people trying to live real lives. 

In this week's IQ, we dig into the unemployment numbers and find some encouraging signs that hopefully point to more jobs.  This recession has affected a lot of hard-working people who are desperately looking for a way to put food on their family's dinner table.  I hope the recent slowing of unemployment will soon turn into new jobs and provide them to people who need them most.   

We sat at this very same place back in the mid 1930s when the economy came stumbling back from the first leg of the depression until bad political decisions of higher taxes and restricted trade sent the economy into another deeper decline.  It was this second decline that turned a sever recession into the Great Depression.  We are seeing some recent trade spats with China and the Obama Administration. It is still planning on eliminating Bush's tax cuts.  Despite these warning signs, I am still cautiously optimistic that cooler heads will prevail and we will not make the same poor decisions that will cripple our economy and send us back into a deep recession.

A New Strategic Alliance 

Before jumping into our research, I have some exciting news about an important new strategic alliance.  As you are probably aware, ProfitScore Capital Management is in the business of managing money for individual and institutional investors.  Institutional investors can take many forms such as Registered Investment Advisors, hedge funds, family offices, broker dealers, corporations, pension funds, etc.

Because of overwhelming regulation, one of the most challenging investors to serve are broker dealers.  To better serve this market and to give these important clients the respect and service they deserve, ProfitScore has signed an exclusive distribution relationship with Flexible Plan Investments to serve the broker dealer channel. 

In this relationship, ProfitScore will begin offering its portfolios through Flexible Plan Investments and Flexible Plan will set up and oversee the client account and manage the broker dealer relationship.  In other words, each firm will concentrate on what they do best.  I have known Jerry Wagner, CEO of Flexible Pan Investments, for many years and feel fortunate to partner with Jerry to serve the broker dealer marketplace. 

Flexible Plan has served the broker dealer channel for over 25 years and is currently approved at over 500 broker dealers.  ProfitScore will benefit by being immediately available at hundreds of broker dealers and thousands of their representatives over night.  Flexible Plan and ProfitScore are on track to start offering these portfolios by November 1.  I promise to keep you posted as we get closer to making these portfolios available.

If you are a broker dealer or a representative of a broker dealer and are interested in learning more about how ProfitScore and Flexible Plan Investments can help you manage your clients' assets and to provide you with the tools to grow your assets under management, we would love to hear from you by sending us an email to: advisor @ profitscore.com.

An Update on Our Performance

The main reason for writing hundreds of pages of commentary and sharing our research is to keep our current clients updated on our thoughts and to shamelessly promote our investment portfolios to investors that may need our help managing their assets.  Below is a brief performance update on our investment portfolios.

Fixed income continues to shine as the bright spot in our performance.  I get asked often what this portfolio is comprised of, so I thought I would take this section of the newsletter for the next few monthly letters to describe our portfolios in a little more detail. 

The Income Builder portfolio is a multi-manager portfolio that is 100% invested in interest rate sensitive assets.  Because we strive to produce absolute returns, this is not your traditional fixed income investment.  All of our portfolios are considered absolute return investments because we take both long and short positions in all the assets we trade.  Income builder is comprised of high yield bonds, government bonds, and the U.S. dollar, each traded actively to benefit from changing market conditions.  The portfolio's assets are currently allocated to six investment managers who are trading eight quantitative-based investment strategies. 

The design of this portfolio truly gives an investor an opportunity to earn equity-like returns with fixed income volatility.  To see more performance statistics on the Income Builder portfolio or some of our other investment strategies, please click on the blue-lettered links in the performance table below.

Below are recent performance returns on the four portfolios we currently offer:

Past 12









Income Builder  (IB)





The Guardian  (GRD)





Harmony Plus  (HMY)





The Expedition  (EXP)





S&P 500  (SP500)





Important Performance Disclosure


ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors.  If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

  1. Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
  2. Call us directly at (800) 731-5690.
  3. Simply send us an email to info @ profitscore.com.
Someone will contact you within 24 hours of receiving your information.

Will the Real Unemployment Rate Please Stand Up?

It is clear that employment is increasingly impacting stocks as investors fret over the ability of our fragile economy to generate jobs and boost consumer confidence.

With a release that was worse than expected, the Bureau of Labor Statistics (BLS) reported that there was a monthly loss of 263,000 jobs in September lifting the official U-3 unemployment rate to 9.8%. And, although the number was depressing, it was a mere flesh wound compared to the BLS household survey that showed a September decline of 710,000 jobs.

Some analysts charged that the household survey "vastly" underestimated the loss of jobs (see article September Unemployment... below). How could two estimates from the same government agency be so different? And, did it mean that the chances for a double-dip recession had just increased? Clearly the market was confused. 

The chart below adds more confusion. It shows three different unemployment estimates (not including the household survey). Notice the difference between them. The government uses the most benign unemployment measure (U-3) that removes discouraged workers, or those who have given up looking for work (9.8%). This number also doesn't include those who have been forced to go from full-time to part-time employment as part of job cutbacks. 

Next, is the U-6 unemployment number which was 17% in September that includes these two groups.  Finally, there is the ShadowStats.com estimate that calculates unemployment, including all the groups that have been removed over the years to make the numbers (and the government) look better, was 21.4% in September. That is as bad as it was during the dirty thirties! Which number was most accurate?

Examine Figure 1 and you will notice that although the numbers are different, they are nearly identical in one respect. The three lines move exactly together - they increase and decrease at about the same rate (rate of change). So, no matter which estimate you believe, the rate at which they are getting better or worse is the same.

Geek Note:
Please keep in mind that because the government has changed the way they calculate unemployment, it is mathematically impossible to compare today's official government unemployment numbers to other times in U.S. history.  That is why we use unemployment numbers from Shadowstats.com, who uses the same calculation methodology that was used during the Great Depression. 

Figure 1 - Chart showing three different unemployment rates. First, the official U-3 rate (green), generally discussed, which rose to 9.8% in September. Next, the broader U-6 unemployment rate (yellow), which includes discouraged and part-time workers that came in at 17% in September. And, finally the alternate unemployment or Alt rate published by ShadowStats.com, which was 21.4% (red) in September. Shadowstats.com

It's ROC That Matters

In an effort to show the true picture, we have constructed a rate of change (ROC) chart (using the U-6 unemployment number). We also placed vertical dashed lines at the beginning and end of the last recession and at the beginning of the current one. In both cases, the unemployment rate had begun to increase fairly rapidly before the recession was officially declared by the National Bureau of Economic Research (NBER), the agency entrusted to tell us when recessions begin and end.  It is interesting to note that the 2002 recession officially ended in November 2001 (although we had to wait until July 2002 to be told that fact by the NBER), a full month before that rate at which jobs were being lost peaked. But December 2001 was also sixteen months before the market ultimately bottomed and the rally began (March 2003).

Figure 2 - Rate of change chart showing the speed at which the U-6 unemployment rate changed between 1995 and September 2009.

Two things stand out in the chart. Not only do we see how unemployment peaked well ahead of the recovery and the fact that the rate jobs were being lost soared much higher this time around, but what becomes clear is the that the rate at which jobs are being lost peaked in April 2009. So unless jobs losses accelerate again, this is more proof that even if this rally proves to be a bear rally and retraces, it has strong potential to be a market bottom. Not only that, if things are more or less the same, there is a good chance that the NBER could eventually declare this recession officially over in March (or thereabouts).

Many economists have voiced their opinion of how  unemployment is a lagging indicator. However, take the derivative or rate of change and the rate looks to be a pretty good leading indicator. The important caveat here is something we have all read in investment prospectuses - past performance does not guarantee future results. 

There is always the chance that this is just a temporary improvement before the next employment rate decline and one of the most probable catalysts for this kind of reversal is the risk for rapidly rising interest rates.

Will They Keep Buying Our Bonds?

What happens when the government has a bond auction and nobody comes?

In 2006, the world got its first taste of what could happen to an industrialized nation when investors decided, en masse, that the interest rate the government was offering on its bonds simply wasn't worth the risk. It wasn't pretty. Saddled with a current account deficit north of 15% of GDP and fast rising foreign debt, Iceland, an OECD member and one of thirty most-developed countries in the world, desperately needed to sell its bonds.

But government bond auctions failed to attract investors even though the rate was a healthy 8%. Even an increase to 14% wasn't enough to entice investors.

Fast forward to October 2008 - in an effort to stem rapid declines in the value of the Icelandic krona, which had its value cut in half on October 8 alone - the government was forced to raise the nation's overnight lending rate 600 basis-points to 18% in one day!

And now a similar situation is unfolding in EU-member Latvia. Like Iceland, it has been a crisis-in-the-making for a while.

Flash back to June 3, 2009, the day that the Latvian government managed to sell just 5% of the more than 50 million lati (about $100 million in US) in bonds. Like a number of nations around the globe, Latvia is drowning in debt. With a GDP down 18.6% in the past year, its public debt as a percentage of GDP swelled from 19.5% in 2008 to a projected 34.1% in 2009. But this amount of debt pales in comparison to many of its European neighbors. Public debt in Italy, Greece, Belgium, Hungary and Ireland are projected to swell to 113%, 103.4%, 95.7%, 80.8% and 61.2% in 2009.
The failed bond auction reflects growing tensions in the Eurozone. Two other eastern European nations, Lithuania and Estonia, have seen their GDPs drop 10.9% and 15.6%, respectively,  over the last year prompting a number of analysts to wonder if they are next.

Figure 3 - Monthly chart showing net Treasury international capital flowing into and out of U.S. Treasuries between 2005 and present.

Ballooning debt and falling economies is not a problem unique to the Eurozone. Federal debt in the United States is projected to be in excess of 100% for 2009 and that is a drop in the bucket compared to unfunded liabilities such as Medicare and Social Security. Our point is that governments in the most industrialized nations around the globe are becoming increasingly reliant on investors to finance rising debt levels. 

In our recently updated U.S. Net Treasury International Capital Flows Chart (Figure 3), we see that the net foreign demand for our bonds has been steadily dropping since 2005. From the beginning of this year, there has been only one month in which there was not a net redemption of Treasuries by foreigners and the gap between government budgetary needs every month (red line) and foreign capital has steadily widened. Also notice that the long-term trendline (yellow) fell into negative territory in May.

If you listen to weekly government bond auction results, there continues to be a strong demand for Treasuries even though the rates of interest are near historic lows. This is good news as long as it lasts, but just how long can we expect investors to keep buying bonds and be paid back in dollars that have almost steadily dropped in value over the last year?

Could Iceland and Latvia be early canaries in a global bond contagion? And perhaps even more important, how will it impact us all?

Rocket-Riding Stimulus Junkies (Part II)

"You cannot spend your way out of recession or borrow your way out of debt."
Daniel Hannan, Member of the European Parliament

Back in December we discussed the rate at which the adjusted monetary base or money in circulation in the U.S. had rapidly increased in the past few months. According to the Federal Reserve website, the adjusted monetary base (AMB) is the sum of currency in circulation outside Federal Reserve Banks and the U.S. Treasury, deposits of depository financial institutions at Federal Reserve Banks, and an adjustment for the effects of changes in statutory reserve requirements on the quantity of base money held by depositories.

By November, year-over-year growth in the monetary base was an incredible 97%; a rate of growth unprecedented in our history as the next chart shows. You will be interested to know that the printing presses have remained in overdrive since then, hitting another new level of year-over-year growth of 112% in April. If you are looking for the fuel behind both the economic recovery and the stock market rally, look no further.

I like to think of the recovery this way. You know those ceramic fake logs you see in a gas fireplace that start to glow a few minutes after it has been ignited? Comforting isn't it, especially when it's cold outside. However, it isn't so comforting to know that Washington has created a gas fireplace economy and the fuel they are using is freshly printed cash. What happens when the gas to our ceramic log economy is turned off?

The question is, have the trillions in stimulus money fueled real economic growth, started new businesses and allowed existing businesses to become profitable enough to survive on their own once the stimulus gas is turned off? This is one reason for caution and why we need more confirmation before we'll know if the unemployment rate discussed above is truly subsiding or just taking a break before soaring to new heights.

Figure 4 - Data from the Federal Reserve showing the adjusted monetary base or money in circulation going through the roof over the last year. So what happens when the presses get turned off?

Paying the Piper

But the bigger problem lies ahead. When the presses do eventually get turned off, the money still has to be paid for (that is unless the nation files for Chapter 11 bankruptcy). As it stands, this money is simply being added to the books as debt.

An interesting paper written by Kyle Bass, Managing Partner of Hayman Associates, the man who allegedly made billions shorting the subprime market, sheds some more light on the true unemployment and hyperinflation threats. 

According to Bass, "There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980... all of which were caused by financing huge public deficits through money creation."

Bass discusses the work of Peter Bernholz, Professor Emeritus of Economics in the Center of Economics and Business at the University of Basel, Switzerland, whose 2003 book Monetary Regimes and Inflation: Historic, Economic and Political Relationships, retraces past episodes of hyperinflation and provides an insightful look into the intertwined worlds of politics and economics, with special attention given to money. 

Professor Bernholz studied these failed economies and made a startling conclusion - the hyperinflation tipping point occurred when the government deficit exceeded 40% of its expenditures.

So where does that leave us?

"According to the current Office of Management and Budget (OMB), U.S. federal expenditures are projected to be $3.653 trillion for financial year 2009 and $3.766 trillion for FY 2010 with unified deficits of $1.5802 trillion and $1.5 trillion respectively. These projections imply that the U.S. will run deficits equal to 43.3% and 39.9% of expenditures in 2009 and 2010, respectively. To put it simply, roughly 40% of what our government is spending has to be borrowed," a level of debt that Professor Bernholz's research has shown is unsustainable.

Bass believes that, "global currency printing will inevitably lead to high levels of inflation - outright currency debasement. Historically, it has taken 18 months to two years to take hold, but we believe it could be sooner due to the size of both monetary and fiscal stimulus as well as the coordinated global nature of the actions."

How they are investing in anticipation of such a scenario makes it very interesting reading and is available in the first link below. But it is very fascinating to note that Professor Peter Bernholz's conclusions are frighteningly similar to those of  Ralph Foster is his 2008 book, Fiat Paper Currency: The History and Evolution of our Currency, which I also highly recommend.

In the meantime, it's a trader's market and riding this rally requires keeping one hand firmly on the exit button.

Interesting Reading

Deep Thoughts from Kyle Bass

Review of Monetary Regimes and Inflation: Historic, Economic and Political Relationships

September Unemployment: ACTUAL LOSS 995k

Household Survey vs. Non-Farm Payrolls

BLS News Release Page

A House Regulated Cannot Stand - How regulation helped devastate the housing market

Hotel defaults, foreclosures rise in California - Defaults, foreclosures up five-fold in ‘09

Link to Ralph Foster's Fiat Paper Currency: The History and Evolution of Our Money

Ailing Fast - Latvia on Life Support

Iceland, in Nod to IMF, Boosts Rate to Kick-Start Crown

Portfolio Performance Analysis

Risk & Reward
Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below.  Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength.  Commentary found in this newsletter is for informational purposes only and does not effect how our portfolios are traded.   

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

The S&P 500 continues its momentous climb higher, piling on another 3.73% in September.  The S&P 500 is currently priced for perfection, so a negative earning session would almost certainly cause a sharp drop in current prices.  As we pointed out above, positive signs in the economy are starting to appear.  So, unless something critical happens to the economy, it may start to provide some fundamental justification for stabilizing the market. 

Without question, this rally has gotten ahead of itself and will almost certainly have a meaningful correction to stabilize recent gains.  If the economy continues to improve, then we should see the second leg of this advance take shape.  If not, then there will have been no justification for this advance and equities will get crushed.  In other words, if the economy begins to justify this recovery then there is room for more upside.  If economic and earnings data begins to fall short of expectations, then there is lots of downside risk.     

As I pointed out in last month's letter, our equity trading accuracy fell below 30% in August.  The last four weeks have us battling back over 50% and our charts are up and to the right.  Since March's low, the market has been steadily shifting from a short term mean reverting market to trending for several days to weeks in a row.  It has taken our quantitative models time to adjust to this regime change in the market, but recent improvements in our equity trading accuracy are encouraging.    

Our fixed income traders operate and function in a completely different world than our equity traders, so it is common for one equity curve to go up while the others go down.  In 2008, equity outperformed fixed income, but our fixed income portfolio has quickly made up for lost ground and now leads all portfolios for the year and past 12 months.  Our equity models appear to have stabilized to recent market changes, so I anticipate our equity strategies to take the lead over the next several months.    

Index Advantage:

All of the losses experienced in this important allocation occurred in the first two weeks of September.  Trading accuracy has steadily improved from what we expect was the equity low for this allocation.  October is currently showing small gains and trading accuracy continues to improve.    

For the month, this pillar gained -1.71. 

Strategic Balance:

We again experienced a small loss trading U.S. sectors and international markets for the month.  Our overall investment exposure remains historically low as these traders patiently wait for higher, rewarding, low-risk trades.      

For the month, this pillar earned -0.42.      

Dynamic Income:

This now makes the 6th winning month in a row for our fixed income allocation.  Month-to-date October is also showing green across the board lead by our allocation to government bonds.    

For the month, this pillar earned 4.09.

Our portfolios are built using varying distributions to the strategic allocations discussed above.  To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below: 

If You Are a Client, Don't Be Confused.
Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October).  For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements.  It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis.  To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum. 

Are You in "Old-Man Shape?"

As I have gotten older, I realized how important it is to stay physically fit.  It takes months to get into shape, and only a few weeks to fall off the wagon.  My definition of being in shape has changed over the years.  When I was in my late teens and early 20s, I thought being in shape meant I needed to bench press 300 pounds.  The thought of lifting that kind of weight these days makes every joint in my body ache.

Nowadays being fit means I am in good enough shape to ride my mountain bike in the foothills, hunt for chukkar along the Snake River Canyon, or ski Idaho's many slopes.  After a while, my mind's eye actually starts to make me feel like I am in the kind of shape I was in during my early 20s.  Well, that is until I do something silly like play a game of soccer against my daughter's soccer team.

I didn't grow up playing soccer, but have grown to have a lot of respect for the game.  I am an assistant coach for my oldest daughter's team.  Sarah has a great coach named Corey, who makes practices both fun and challenging.  During our last practice, Corey wanted the two of us to play on one team against Sarah's entire undefeated team so we could spread the field and teach the girls how important it is to stay in their correct position.  In hind sight, let me advise you against doing this when you only have one other person on your team and the field is 100 plus yards long. 

What I didn't know until after practice is that Corey is a marathoner and runs between 5 and 18 miles a day.  He thought this would be a great way to teach the girls some important fundamentals and good exercise for us.      

Corey didn't even have sweat on his brow as he encouraged me to run faster to get open for the pass.  For a brief moment, I thought I might actually pass out from a lack of oxygen to my brain caused by my bleeding lungs.  It was hard to hear the laughing of the girls zooming by me to steal the ball because of the ringing in my ears.  What a wake-up call!  There is a big difference between running on a treadmill and running 100-yard sprints up and down a soccer field.    

This kind of reality check seems to happen to me about every couple of years.  My mind tricks me into thinking that I am in good shape just because I work out on a regular basis.  My daughter has coined the phrase as "old-man shape."  It is a shame that they wasted all of that strength and agility on the youth. 

Halloween is just around the corner and my kids are finalizing what they want their costumes to be.  Annabelle was dressed up as an angel last year, but this year she wants to look like a Hershey Bar.  Her mom is really struggling on figuring out how to make a costume shaped like a candy bar.  Sarah and her buddy have decided to dress up by dressing down to their PJs.  I can't wait to take the pictures. 

Working to grow your wealth,

John M. McClure
President & CEO
ProfitScore Capital Management, Inc.

P.S. ProfitScore provides its separately-managed accounts to individuals, advisors and institutional investors.  If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

  • Complete our Private Client Group request form by clicking here http://profitscore.com/insight.aspx and submitting your contact information. (This is the most preferred method.)
  • Call us directly at (800) 731-5690.
  • Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Posted 10-13-2009 5:08 PM by John M. McClure