Tax Data Shows That The Latest Market “Narrative” is Really a “Myth”

There’s a special report that I look forward to on the 8th business day of the month. This month, that was the 11th. Only this month, it wasn’t there. It’s the Monthly Treasury Statement for the preceding month from the US Treasury.

We love that data because it’s raw, unadulterated, and unmanipulated. It gives us an inside look at critical sectors of the US economy. It covers the entire month, not just a snapshot on a given day, and it’s only 8 days old when they give it to us.

Even better is the end of month Daily Treasury Statement, which is released the day after the month ends. I’ve been accumulating that data for years. Not only is it pure unmanipulated reality, it’s real time.

I issue a detailed monthly report about key line items, like withholding, non-withheld, corporate and excise taxes. And I’m always happy to pull a juicy tidbit from that report for you every so often.

Then around the middle of the month, I report on the Monthly Treasury Statement. The monthly data provides additional details on Social Security versus income tax withheld, and in the categories of Excise taxes. Those are like Federal sales taxes on numerous items, like guns, alcohol, your phone bill, tobacco,  as well as the better known levies on  aviation, and gas at the pump.

It’s great data and I was looking forward to finding and reporting something interesting for you. But alas, this month it’s nowhere to be found. The government shutdown has delayed it. I guess  we’ll just have to go without for now.

But that’s the nice thing about the Daily Treasury Statement. They’re still publishing it and we need not wait until the end of the month. And boy does it have an interesting story to tell this month.

A chart of the data shows that the current market narrative is really a myth!

Here’s Why Withholding Taxes Are Such A Great Indicator

The withholding tax line item tells us a lot about the state of the economy. It can give us a leg up on what to expect from the monthly jobs report at the beginning of the following month. Most  important, it tells us in advance whether forthcoming economic data will keep the Fed on course, or cause it to have second thoughts.

The jobs report on the first Friday morning of every month is based on a survey of employers that asks them how many employees they had on the 12th of the month before? We already have a pretty good idea of how that number will shape up because we saw the actual tax data 3 weeks before.

With the magic of moving averages and year to year comparisons we can look at this very noisy data as of 2 days ago and know exactly how the US employment trend is going.

For example, there was a huge, out of the ordinary bulge in withholding taxes in early November.  So we had an inkling that something big was coming.

Looking ahead, the BLS jobs report for January will use an as/of date of January 12. And we already have that data! So we have an idea of what to expect in the next report early in February.

I use the daily data to compile a 2 week moving average of total withholding collections. That’s still extremely noisy, so I smooth it further with a 4 week moving average. That shows us the trend. Comparing a 3 day moving average to that monthly moving average shows us the current direction.

Business doesn’t move in a straight line in the short run. Some weeks are busier than others. The bigger trends are smooth, but embedded in those trends are weeks when the economy is growing faster. Then it slows down to catch its breath. Then it speeds up again. There are external stimuli that cause wobbles too, but this pattern of small ups and downs is readily visible in the tax collections. It is not new. I’ve seen it in these charts for years! It’s readily visible in the 4 week moving average (blue line).

Click to enlarge

The Data Foreshadowed that The Jobs Report Would Beat The Consensus

What’s important in the big picture isn’t these fluctuations, but the overall trend. However, if you’re trading, these fluctuations do matter. Sometimes there are abnormal fluctuations, and sometimes they coincide with the date of the jobs survey.

For example, the December jobs number surprised the heck out of the Wall Street crowd. But we saw the giant bulge in the tax data weeks before. The consensus estimates are posted a week or more in advance of the official report, so we knew that the consensus was in line with recent months. But we had an inkling that the number would be much bigger. And so it was.

Revenue Dropped Because of The Tax Cut, But The Economy Hasn’t Changed Course

The tax cut took effect back in February. We can see how that shifted the year to year rate of change from positive to mostly negative. That’s important because the drop in revenue means an increase in the amount of debt the Treasury must issue. And Treasury supply absorbs investment liquidity and shifts it into the economy. Stimulative for the economy, but a drag on the financial markets when liquidity isn’t expanding.

It doesn’t mean that the economy is slowing, but there’s no sign that the growth rate is increasing either.

The gold box shows the range of post tax-cut changes. Except for the bulge late in the year, the fluctuations have stayed in the same range. That range would have been consistently on the plus side of the zero line if not for the tax cut.

Therefore, this chart gives us very useful additional information. It tells us that the US economy isn’t accelerating and isn’t slowing down. It’s fluctuating in the same growth range. We can’t directly adjust for the tax cut impact, but my eyeball guess from comparing it with last year’s range, would be that the adjusted growth rate would be from +1% to +5%. Average that out and it tells us that economic activity probably is increasing at around a 3% rate, on average.

Why any sane person would think that a 3% growth rate would deter the Fed from continuing to tighten, escapes me.  But that’s where the conversation has gone over the past 2 weeks, and that’s the “narrative” associated with the current rally. A better word for “narrative” here would be “myth.”

I have one final observation for you. The normal fluctuation as of January 12, the BLS Employment Survey as/of date, was right at the nadir of its usual range. If anything, we’ll see a negative jobs surprise for January.

That’s likely to give the bond market a temporary liquidity shot as buyers pile in when they see the “bad news.” How the stock boys will react, I wouldn’t hazard a guess. If I did, it would probably be wrong.

We should keep an eye on whether the line has its usual rebound here. If it goes materially lower, that would suggest economic contraction, while a rebound would suggest that nothing has changed. The government shutdown, and it’s conclusion, are wild cards here. For now, let’s just say we live in “interesting” times.

I know that some folks are annoyed with me for recommending that we just keep holding and rolling T-bills. But I’ll stick with that until I see more evidence that not only is the Fed thinking about a return to money printing, but is on the verge of implementing it. Until then, I think the safer, saner thing to do is sit this rally out. There just doesn’t seem to be any basis for the Fed to dramatically ease policy any time soon.

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