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Scary Economic News

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The information which I’m passing along to you today might come as a shock to those listening to the usual stock market cheerleaders, who predict good times ahead.  Let’s start with economist John Hussman of the Hussman Funds.  For quite a while, Dr. Hussman has been warning us to avoid drinking the Kool-Aid served by the perma-bulls.  In his latest Weekly Market Comment, Hussman offers yet more sound advice to those under the spell of brokerage propagandists:

I want to emphasize again that I am neither a cheerleader for recession, nor a table-pounder for recession.  It’s just that given the data that we presently observe, an oncoming recession remains the most probable outcome.  When unseen states of the world have to be inferred from imperfect and noisy observable data, there are a few choices when the evidence isn’t 100%.  You can either choose a side and pound the table, or you can become comfortable dwelling in uncertainty, and take a position in proportion to the evidence, and the extent to which each possible outcome would affect you.

With most analysts dismissing the likelihood of recession, I have been vocal about ongoing recession concerns not because I want to align myself with one side, but because the investment implications are very asymmetric.  A slow but steady stream of modestly good economic news is largely priced in by investors, but a recession and the accompanying earnings disappointments would destroy some critical pillars of hope that investors are relying on to support already rich valuations.

Yale Professor Robert Shiller is the guy who invented the term “irrational exuberance”, which was title of his bestselling book – published in May of 1996.  Although the widely-despised, former Federal Reserve Chairman, Alan Greenspan is often credited with creating the term, Greenspan didn’t use it until December of that year, in a speech before the American Enterprise Institute.  Shiller is most famous for his role as co-creator of the Case-Shiller Home Price Indices, which he developed with his fellow economists Karl Case and Allan Weiss.  While many commentators decried the idiotic economic austerity programs which have been inflicted across Europe, Professor Shiller investigated whether austerity is at all effective in spurring economic growth, seeking a better understanding of austerity’s consequences.  In a recent essay on the subject, Dr. Shiller cited the work by Jaime Guajardo, Daniel Leigh, and Andrea Pescatori of the International Monetary Fund, who recently studied austerity plans implemented by governments in 17 countries in the last 30 years.  The conclusion reached by Professor Shiller should sober-up the “rose-colored glasses” crowd, as well as those aspiring to implement similar measures in the United States:

The austerity plans being adopted by governments in much of Europe and elsewhere around the world, and the curtailment of consumption expenditure by individuals as well, threaten to produce a global recession.

*   *   *

There is no abstract theory that can predict how people will react to an austerity program.  We have no alternative but to look at the historical evidence.  And the evidence of Guajardo and his co-authors does show that deliberate government decisions to adopt austerity programs have tended to be followed by hard times.

Policymakers cannot afford to wait decades for economists to figure out a definitive answer, which may never be found at all.  But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.

The really scary news concerning the state of the global economy came in the form of a report published by the World Bank, entitled Global Economic Prospects (Uncertainties and vulnerabilities).  The 157-page treatise was written by Andrew Burns and Theo Janse van Rensburg.  It contains more than enough information to induce a serious case of insomnia.  Here are some examples:

The world economy has entered a very difficult phase characterized by significant downside risks and fragility.

*   *   *

The downturn in Europe and weaker growth in developing countries raises the risk that the two developments reinforce one another, resulting in an even weaker outcome.  At the same time, the slow growth in Europe complicates efforts to restore market confidence in the sustainability of the region’s finances, and could exacerbate tensions.

*   *   *

While contained for the moment, the risk of a much broader freezing up of capital markets and a global crisis similar in magnitude to the Lehman crisis remains.  In particular, the willingness of markets to finance the deficits and maturing debt of high-income countries cannot be assured.  Should more countries find themselves denied such financing, a much wider financial crisis that could engulf private banks and other financial institutions on both sides of the Atlantic cannot be ruled out.  The world could be thrown into a recession as large or even larger than that of 2008/09.

*   *   *

In the event of a major crisis, activity is unlikely to bounce back as quickly as it did in 2008/09, in part because high-income countries will not have the fiscal resources to launch as strong a countercyclical policy response as in 2008/09 or to offer the same level of support to troubled financial institutions.

*   *   *

Developing countries need to prepare for the worst

In this highly uncertain environment, developing countries should evaluate their vulnerabilities and prepare contingencies to deal with both the immediate and longer-term effects of a downturn.

If global financial markets freeze up, governments and firms may not be able to finance growing deficits.

*   *   *

One major uncertainty concerns the interaction of the policy-driven slowing of growth in middle-income countries, and the financial turmoil driven slowing in Europe.  While desirable from a domestic policy point of view, this slower growth could interact with the slowing in Europe resulting in a downward overshooting of activity and a more serious global slowdown than otherwise would have been the case.

In other words, Europe’s economic austerity programs could turn another round of economic contraction into a global catastrophe (as if we needed another).

This is what happens when economic policymaking is left to the plutocrats and their tools.  “Those who fail to learn from the past are doomed to repeat it.”  It appears as though we are well on our way to a second financial crisis – with more severe consequences than those experienced as a result of the 2008 episode.


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Seeing Reality With Gold Glasses

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March 8, 2010

The most recent report from the Bureau of Labor Statistics concerning non-farm payrolls for the month of February has surprised most people and it has left a number of commentators feeling upbeat.  Reuters had reported that “The median forecast from the ten most accurate forecasters is for payrolls to fall by 70,000.”  Nevertheless, the BLS report disclosed a figure of approximately half that much.  Only 36,000 jobs had been lost and unemployment was holding at 9.7%.   One enthusiastic reaction to that news came from the Mad Hedge Fund Trader:

While the employment rate for those with no high school diploma is 16%, the kind of worker who lost their manufacturing jobs to China, the jobless rate for those with college degrees is only 4.5%.  This is proof that the dying sectors of the US economy are delivering the highest unemployment rates, and that America is clawing its way up the value chain in the global race for economic supremacy.  It is what America does best, creative destruction with a turbocharger.  There is a third influence here, which could be huge.  The BLS only contacts existing businesses for its survey.

*   *   *

The bottom line is that payroll figures are much better than they appear at first glance.

Prior to the release of that report, many commentators had been expressing their disappointment concerning the most recent economic indicators.  I discussed that subject on March 1.  On the following day, John Crudele of The New York Post focused on the dramatic drop in the Consumer Confidence Index, released by The Conference Board — a drop to 46 in February from January’s 56.5.  Here is the conclusion Mr. Crudele reached in assessing what most middle-class Americans understand about our current economic state:

Even with the stock market still bubbling and media trying its damnedest to convince us at least a million times a day that there’s an economic recovery, the American public isn’t buying it.

*   *   *

The economy has stabilized since then, helped greatly by the fact that some wealthy people feel wealthier because of an unbelievable snap back by the stock market during 2009.  (And by unbelievable in this context I mean that what happened shouldn’t be believed as either legitimate or sustainable.)

Don Luskin of The Wall Street Journal’s Smart Money blog articulated his dissatisfaction with the most recent economic indicators on February 26.  One week later, Luskin presented us with a very informative analysis for understanding the true value of one’s investments.  Luskin spelled it out this way:

Consider stocks priced not in money, but in gold.  In other words, instead of thinking of stocks as investments you make in order to increase your wealth in dollars, think of them as something to increase your wealth in gold.  After all, you don’t want to make money for its own sake — you want the money for what you can buy with it.  Gold is a symbol for all the things you might want to buy.

*   *   *

It’s easy to track stocks priced in gold because the price of the S&P 500 and the price of an ounce of gold vary closely with one another.  As of Thursday’s close, they were only about $10 apart, with the S&P 500 at 1123, and gold at about 1133.

How about a year ago, on the day of the bottom for stocks on March 9?  That day the S&P 500 closed at 676.53.  Gold closed at 920.85.  That means that one “unit” of the S&P could have bought 73% of an ounce of gold.

Today, with stocks and gold each having risen over the last year — but with stocks rising more — one “unit” of the S&P can buy 99% of an ounce of gold.  All we have to do is compare 73% a year ago to 99% now, and we can see that stocks, priced in gold, have risen 34.9%.

A 34.9% gain for stocks priced in gold is pretty good for a year’s work.  But it’s a far cry from the 69.1% that stocks have gained when they are priced in dollars.  Do you see what has happened here?  Stocks have made you lots of dollars.  But the dollar itself has fallen in value compared to the real and eternal value represented by gold.

Here’s the most troubling part.  The entire 34.9% gain made by stocks — priced in gold, that is — was achieved in just the first five weeks of rallying from the March 2009 bottom.  That means for most of the last year, since mid-April, while it has appeared that stocks have been furiously rallying, in reality they’ve just been sitting there.  All risk, no reward.

*   *   *

So why, then, did stocks — priced in dollars, not gold — continue so much higher?  Simple:  We experienced inflation-induced growth.  Throw enough stimulus money, an “extended period” of zero interest rates from the Fed, and a big dose of government debt at the economy, and you will get some growth — and, eventually, lots of inflation.

Luskin concluded the piece by explaining that if stocks move higher while gold moves lower, we will be seeing evidence of real growth.  On the other hand, if gold increases in value while stocks go down or simply get stuck where they are, there is no economic growth.

Luskin’s approach allows us to see through all that money-printing and excess liquidity Ben Bernanke has brought to the stock market, creating an illusion of increased value.

Everyone is hoping to see evidence of economic recovery as soon as possible.  Don Luskin has provided us with the “x-ray specs” for seeing through the hype to determine whether some of that evidence is real.



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A Wary Eye On The Indicators

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March 1, 2010

The past few days brought us some observations by a number of financial commentators, who expressed concern about how our economic recovery is coming along.  Although none of the following three are ready to start sounding alarms, they all seem to share a similar tone of discouragement.

Don Luskin of The Wall Street Journal ’s Smart Money blog began his February 26 piece with an explanation of how proud he used to be about the accuracy of his May, 2009 declaration that the recession had ended.  Although he still believes that he made the right call back then, the most recent economic indicators have muddied the picture:

I made my recession end call in May because of an entirely different set of statistics, designed to be predictive rather than merely to recognize what has already happened.  What worries me is that these statistics have all started to get a little worse recently.

Luskin explained that although initial unemployment claims reached their peak in early April, the four-week moving average has risen 7 percent from where it was a few weeks ago.

Over history, upticks like that have no predictive value.  There have been many of them, and very few have led to recessions.  Still, 7% is a big reversal.  In May when I got excited about the drop in claims, that drop was only about 4%!

Luskin found another disappointing trend in the fact that earnings expectations for the S&P 500 are now growing at a much slower pace than they were in April.  Two other trends concerned him as well.  The fact that the dollar has rallied ten percent in the last couple of months raises the question whether “the fear that gripped world markets in 2008 and 2009” could be returning.  Finally, the fact that the credit spread between Treasuries and “junk bonds” is now at six percent after having been below 5%, brings a little discomfort simply because of a move in the wrong direction.  Nevertheless, Luskin is still optimistic, although his perspective is tempered with realism:

So is the economic recovery over?  I don’t think so.  I think it’s just being tested.  None of the indicators I use to detect the onset of recession are giving signals.  But it’s haunting, nevertheless.  After the horrific global recession we went through, you’d think we ought to come roaring back. We’re back, but we’re not exactly roaring.

In Sunday’s Washington Post, Frank Ahrens wrote an article discussing three indicators that “spell trouble for the recovery”.  Here’s how he explained them:

— On Wednesday, the Commerce Department reported that January new-home sales dropped 11.2 percent from December, plunging to their lowest level in nearly 50 years.

— On Tuesday, the Conference Board reported that February consumer confidence fell sharply from January, driven down by the survey’s “present situation index” — how confident consumers feel right now — which hit its lowest mark since the 1983 recession.  On Friday, the Reuters/University of Michigan consumer sentiment survey also showed a falloff from January to February.

— On Thursday, the government’s report on new jobless claims filed during the previous week shot up 22,000, which was exactly opposite of what economists predicted.  Forecasters expected new jobless claims to drop by about 20,000.

Taken together, what do these reports tell us?

We’ve got a long way to go to get out of this economic mess, and we may be actually losing a little ground.

At the conclusion of that piece, Mr. Ahrens added that another factor holding back recovery is the current state of activity in the stock market.  Investors seem to be exhibiting caution, uncertainty and “a hard-to-shake sense that we haven’t hit bottom yet”.

As I frequently point out, one of my favorite financial gurus is Jeremy Grantham of GMO.  The February 26 issue of Bloomberg Business Week featured an article by Charles Stein concerning Grantham’s career.  In the section of the piece discussing Grantham’s current outlook, we see yet another view toward a very lean, slow recovery process:

Grantham’s favorite asset class today is high-quality U.S.stocks, companies defined by high, stable returns and low debt.  The allocation fund had 31 percent of its money in that category at year-end, sometimes called blue chips, according to the GMO Web site.  In the interview, he said he expects such stocks to return an average of 6.8 percent a year over the next seven years, compared with 1.3 percent for all large-cap U.S. stocks.

Emerging-market stocks may rise about 4 percent annually in the next seven years, as investor enthusiasm for economic growth in developing countries carries the stocks to unsustainable levels, Grantham said.

“Why not go along for the ride?” he said.  The MSCI Emerging Markets Index returned an average of 22 percent in the past seven years, compared with a gain of 5.5 percent by the S&P 500 index.

U.S.government bonds will return 1.1 percent a year over the seven-year period, according to the latest GMO forecast.  The Bank of America Merrill Lynch U.S. Treasury Master Index rose 4.3 percent from 2003 through 2009.

Grantham said he expects a difficult, not disastrous, period for the economy and investments.

“It will feel like the 1970s,” he said. “One step forward, one step back.”

None of the three gentlemen whom I have quoted here are seeing visions of rainbows and unicorns in our economic future — at least not for the next few years.  Be sure to keep the opinions of these experts in mind if the cheerleading by some perma-bull, TV pundit motivates you to “get in on the ground floor of the next stock market rally”.  You could save yourself a lot of money and even more pain.



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The News Nobody Wants To Hear

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December 11, 2008

You can’t watch a news program these days without hearing some “happy talk” about how our dismal economy is “on the verge of recovery”.  You have to remember that many of these shows are sponsored by brokerage firms.  That fact must be taken into consideration when you decide how much weight you will give the opinions of the so-called “experts” appearing on those programs to tell you that the stock market has reached “the bottom” and that it is now time to jump back in and start buying stocks.  Similarly, those people interested in making a home purchase (i.e. millionaires, who don’t have to worry about getting a mortgage) want to know when the residential real estate market will hit “bottom” so they can get the best value.  If I had a thousand dollars for every time during the past six months that some prognosticator has appeared on television to tell us that the stock market has “hit bottom”, I would have enough money to start my own geothermal power utility.

People interested in making investments have been scared away from stocks due to the pummeling that the markets have taken since the “mortgage crisis” raised its ugly head and devastated the world economy.  If those folks believe the hype and start buying stocks now, they are taking a greater risk than the enthusiastic promoters on TV might be willing to disclose.

People just don’t like bad news, especially when it is about the future and worse yet, if it’s about the economy.  On Friday, December 5, the stock market rallied, despite the dismal news that November’s non-farm employment loss was the greatest monthly employment decline in 34 years.  More than half a million people lost their jobs in November.  Despite this news, all of the major stock indices were up at least 3 percent for that day alone.  Have all these people bought into the magical thinking described in The Secret?  Do that many people believe that wishing hard enough can cause a dream to become reality?

There is one authority on the subject of economics, who earned quite a bit of “street cred” when our current economic crisis hit the fan. He is Nouriel Roubini, a professor of economics at New York University’s Stern School of Business. He earned the nickname “Doctor Doom” when he spoke before the International Monetary Fund (IMF) on September 7, 2006 and described, in precise detail, exactly what would bring the financial world to its knees, two years later.  In this time of uncertainty, many people (myself included) pay close attention to what Dr. Roubini has to say by regularly checking in on his website.  On December 5, we were surprised to hear Doctor Doom’s admission to Aaron Task (on the web TV show, Tech Ticker) that his own 401(k) plan is comprised entirely of stocks.  Dr. Roubini explained that he is not in the “Armageddon camp” and that for the long haul, stocks are still a good investment (although currently not a good idea for investors with more short-term goals).  Upon learning of this, I began to wonder if the revelation about Doctor Doom’s stock holdings could have been the reason for the stock market rally that day.

Yesterday, I had the pleasure of meeting Dr. Roubini at a lecture he gave within staggering distance of my home.  I was able to talk to him about my concern over Federal Reserve Chairman, Ben Bernanke’s idea of having the federal government purchase stocks in order to pep-up a depressed stock market.  How could this possibly be accomplished?  How could the Fed decide which stocks to buy to the exclusion of others?  Dr. Roubini told me that the government has already done this by purchasing preferred shares of stock issued by the banks participating in the TARP program.  He explained that rather than purchasing selected stocks of particular companies, the government would, more likely, invest in stock indices.  Before I get to Doctor Doom’s other points from his lecture, I will share this photo taken of yours truly and Doctor Roubini (who appears on your left):

Doctor Doom with Me

Dr. Roubini told the audience that he believes this recession will be worse than everyone expects. During the next few months, “the flow of macroeconomic news will be awful and worse than expected”. He opined that people are going to be surprised if they think that the stock market “bottom” will come in mid-2009. He expects that by the end of 2009 “things will still be bad” and unemployment will peak at 9% in early 2010. He thinks that the consensus on earnings-per-share estimates for stocks during the next year is “delusional”. He anticipates risk aversion among investors to be severe next year. We are now in a global recession and this has caused commodity prices to fall 30%. He pointed out that commodity prices could still fall another 20%. He considers it “very likely” that between 500 to 600 hedge funds will go out of business within the next six months. As this happens, the stocks held by these funds must be dumped onto the market. With respect to the beleaguered residential real estate market, he pointed out that home prices could fall another 15-20% by early 2010.

The good news provided by Dr. Roubini is that the global recession should end by the close of 2009. However, he expects recovery to be “weak” in 2010. He surmised that the possibility of a systemic meltdown has been minimized by the actions taken at the recent G7 meeting and most particularly with the G7 resolution to prevent further “Lehman Brothers-type” bankruptcies from taking place. He concluded that this recession should be nothing like the Japanese recession of the 1990s, which lasted nearly a decade.

So there you have it:  The news (almost) nobody wants to hear.  You can say these are the predictions voiced by one man who could be wrong.  Nevertheless, given Dr. Roubini’s track record, I and many others hold his opinions in high regard.  Now, let’s see how this all plays out.