"Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."
— John Maynard Keynes, Tract on Monetary Reform
– Economists and fundamental analysts often miss cycle turns.
– There’s always another recession — and expansion — coming (eventually).
– Learn to separate hand-wringing permabears from credible commentators.
If you have been listening to the financial press recently, you might be shocked (shocked!) to learn that inflation has been increasing and the economy is slowing.
You don’t say?
Of course, readers aren’t just now discovering that this economy has been suffering from inflationary pressures for more than two years, as a chart of the CRB shows.
It’s the same with GDP. Follow the numbers: The third-quarter 2003 number was 7.8% (originally reported as almost 9%), the next quarter’s was 4.2% (originally 6%+) and 2004’s quarterly data came in at 4.5%, 3.3%, 4.0% and 3.8%.
This week, we learned the first quarter of 2005’s number of 3.1% was way below consensus expectations. While some will tell you that 3%+ GDP growth is pretty decent, it’s the trend of waning momentum that is the issue. An early mentor of mine used to admonish traders to not look at the photo, but to watch the full movie instead.
So much for the idea of kinda-sorta-eventually-efficient markets hypothesis.
Slowing GDP and rising inflation have been discussed on this site for over a year now. The investing issue with macroeconomic concerns is not the actual data, but how — and when — that data affects psychology. It’s a question of timing. The commentators who are first now discovering weak GDP and inflationary pressures are not much help to you once the ocean is flat again.
That’s why I use macroeconomics to frame my longer term perspective,
and then mate that with trend analysis and technical analysis. This
allows me to see both long- and short-term actionable possibilities,
and even hold contradictory perspectives (in different time frames).
That’s how I can get long when I’m bearish or short when I am
bullish. It depends upon the market conditions. It’s also why I
frequently mention Ned Davis’ book, Being Right or Making Money.
How We Got Here
We are at a peculiar point in the business cycle where prior
assessments are increasingly coming under scrutiny, expectations are
getting dashed and estimates are being revised. Yet at the same time,
corporate profits are strong, balance sheets are in terrific shape and
future earnings estimates remain robust.
All the while, Mr. Market is suffering from a malaise.
How did we arrive at this juncture at which economists are not only
late in recognizing shifts but have been quite frequently wrong (and
often wildly so)?
To figure out where you are going, it helps to know where you have been, and this is definitely one of those times.
The last bull market began in 1982 and ran almost uninterrupted for
18 years. During the last three of those years, an enormous bubble
inflated. While it was concentrated in the dot-com/tech/telecom arena,
the zest for stocks spilled over into other names. We saw more than
enough enthusiasm to go around.
Alas, like all manias, this one had to unwind. That began in March
2000, as the preannouncement season revealed a quarter to forget. It
has long been my suspicion that Y2K played a significant role — the
massive upgrade cycle prior to the calendar flipping sated buyers of
tech. No one really needed much more of anything tech-related in the
first quarter of 2000. The first quarter was a disaster waiting to
happen. With stocks at such lofty levels, the preannouncement season
was the straw that broke the camel’s back. The bubble popped in ugly
At the time, few were willing to believe it. The bulls failed to
recognize the shift and pounded the table all the way from Nasdaq 5100
down to 1100. That disbelief is not atypical behavior. What is
surprising is that some of the same incorrigible characters from that
sad era are coming out of the woodwork. A few recognized (and detested)
faces are once again on TV, peddling their snake oil. Their advice has
been completely irresponsible, and it’s a crying shame they have been
allowed back into the television studios where they can perform more
mischief and do additional financial damage.
And as bad as the postbubble economic environment was, the economic
weakness was further exacerbated by a modest recession and then by the
9/11 attacks. But in my opinion, the most significant negative factor
was and remains the great 1990s bubble, and its repercussions. I
believe that we will be wrestling with that bubble’s economic aftermath
for the rest of the decade.
As is typically the case, the consequences of the popped bubble were
extensive. Huge excess capacity was created at the same time that
fantastic productivity gains were being made. Hiring was frozen and
capital expenditures ground to a halt. The economy had a hangover
proportionate to the huge frat party that was the 1990s tech and
telecom fest. Indeed, the vast majority of the economic woes we
presently faced — anemic growth, poor nonfarm payroll job creation,
declining personal income — are a direct result of being in a bubble.
Market crashes are typically followed by a "refractory period" — a
substantial length of time in which the prior excesses get wrung from
the economy. Japan is at the tail end of a decade-plus-long growth
respite. This process sets up the next healthy expansion. In an ideal
world, the powers that be would recognize this and allow market forces
to work off this hangover on its own. Alas, most elected and appointed
officials lack the discipline and the will to get out of the way.
In our case, the postcrash era saw massive government stimulus:
Personal income taxes were cut, deficit spending soared, interest rates
were dropped to half-century lows, money supply increased dramatically,
not one but two wars were prosecuted, corporate dividend taxes were
slashed, capital gains taxes were cut and capital expenditures were
granted a special accelerated depreciation. Uncle Sam’s unprecedented
and enormous stimulus package included "everything but the kitchen
I suspect this will only make matters worse. We keep taking a "hair
of the dog that bit us" — easy money — to postpone the hangover for
as long as possible. But there is no free lunch, and I fear that this
will only make the ultimate misery that much worse when the bill
finally comes due.
On cue, that stimulus is now fading. The most vibrant sector of the
economy — the real estate complex — is slowing. The Fed has painted
itself into a corner, with inflation on the one hand and a fear of
crimping what’s working best (real estate) on the other. Increased
energy costs are a drag on the global economy. Interest rates and taxes
have been going higher. Earnings momentum, as measured on a
year-over-year basis, has been slowing for five consecutive quarters.
Hiring remains anemic, capital-expenditure rates are unimpressive,
leading economic indicators softening, GDP is fading.
The market has begun recognizing that the first postbubble expansion
was premature. Like an injured runner who pushes himself before he is
fully healed, the stimulus-driven economy is at risk. It has failed to
develop organic momentum of its own, without further stimulus. I expect
this recovery cycle will run out of steam sometime over the next two to
It’s No Different This Time
One of the ironic twists of this postrecession recovery has been the awful performance of the dismal scientists.
But I think I’ve finally figured out what ails them. It’s in the
cliche "It’s no different this time." The problem lies in which "time"
you choose to use as your basis for your comparison. While typical
econometric models use a postwar period as a frame of reference, they
might be better served only working with a subgroup. The 1929, 1972 and
2000 markets in the U.S., and the 1989 Japan market, are far better
comparisons than the typical postrecession recovery.
That is not a particularly happy vision for the macroeconomic
environment, or for equities over the next few years. At this point, I
am much less concerned with inflation than I am with the softening
demand for industrial metals. That’s an early warning sign of a
slowdown in industrial production and the global economy. The same goes
for the slowdown in oil. While the Fed is busy eyeing inflation, it may
wish to instead start watching the warning signs that the macro picture
is further deteriorating. They risk falling behind the curve — once
Understanding the Post-Bubble Economy
RealMoney.com, 4/29/2005 3:30 PM EDT