On Kudlow & Company last night, Doug Kass and Larry got into a debate (with Art Laffer refereeing) as to whether markets are a true and reliable discounting mechanism.
Kass’ position was that they are often not. I am found of saying the market was as wrong at Nasdaq 5000 in March 2000 — earnings didn’t matter, its a new paradigm — as it was with Nasdaq at 1100 in October 2002, when profitable debt free companies were selling ofr les sthan book value, and in some instances, less than cash on hand.
Shedding some light on this is David A. Rosenberg, Merrill Lynch’s North American Economist. Rosenberg looked at whether a recession could begin with equities at or near all time highs.
The answer, surprisingly enough, is yes:
"The S&P 500 peaked on July 16, 1990 after a 3.4% burst over the prior month and the recession began that very same month. Go back to February 13, 1980 and you will see that the market peaked and came off a huge 7.8% melt-up in the previous month – and the recession had begun the month before. . .
What we do know is that the economic backdrop has become worse, not
better. Over 90% of the economic data have come in below expectations
in the past month and our internal Data Diffusion Index has hit its
low-water mark for the year . . . "
Stock markets are not always perfect discounting mechanisms:
Source: Merrill Lynch, Standard & Poors
As Jack McHugh points out, many investors seems to think a recession
would either be bullish (because the Fed would continue to ease) or
would be an impossibility (because the stock market, "discounting
mechanism" that it’s supposed to be, is hitting new highs). And he notes that markets also peaked in 1929, even though the highs were seen a couple of
months before the onset of the Great Depression.
McHugh:
"I suppose it’s
possible that the price-worshiping, momentum crowd has it right and
that nirvana lies just over the horizon. Given the worsening problems
in housing and mortgage finance, however, it’s possible, just maybe,
that the quantitative model-builders in equity land will prove to
possess no more genius than their fixed income cousins displayed when
constructing subprime CDOs."
Discounting mechanism, indeed.
I was reading Devil Take the Hindmost a few months back and the author points out that traders in 1929 kept pushing prices higher not based on what companies were doing now, but what people believed they would do in the future. Then I happened upon an article yesterday by Jack Schoen observing that traders currently are trading not based on current economic conditions but on what they believe will happen in the future, say a year from now. Funny, that.
Here’s Schoen’s article if you’re interested:
http://www.msnbc.msn.com/id/21086790/
Now your talking! This thing is getting very close to going bing, boom, bong! The ISM, “sounding” mixed to slightly hinting, that a big rock lays ahead. My guess is that it’s Gibraltar.
Obviously stocks benefit tremendously if the US can continuously devalue the dollar without having interest rates go up.
Florida,
Isn’t that the current theme driving equities. Bad news being ignored cause the Fed is easing to avert a crisis and the liquidity ends up in equities and creates a bubble somewhere. But traders will be able to get out before the economy really stalls out. If we are following the 1998 model then we have a 1999 in front of us.Lots of time to get off the train.
I’m not sure I but it though. the trade is crowded plus Micron’s reaction and news today proves we are in a different scenario.
“traders in 1929 kept pushing prices higher not based on what companies were doing now, but what people believed they would do in the future.”
Also known as the “bigger fool” theory in financial terms.
Obviously you have to differentiate between long term and short term. Short term ‘the market’ is more like a mob, shoving back and forth, driven by some thing or other. Longer term and on average its a discounting mechanism. If more one looks at “the market” in aggregate, than one stock or sector or index, the less time is required for ‘longer term’ to arrive.
The exception to this rule seem to be economists, who never ever seem to ‘get it right’ until all the horses are out of the barn. To that extent they are roughly the equivalent of chief market strategists for the retail firms.
“The S&P 500 peaked on July 16, 1990 after a 3.4% burst over the prior month and the recession began that very same month.”
Yes, but the Soviet Union and the Berlin Wall was collapsing causing the start of massive defense job losses. And, just two weeks later Iraq invaded Kuwait and oil shot up to a record $40 a barrel throwing us into a prolonged recession
If equities markets were a discounting mechanism they should have rocketed up in 2004 and yet they were sluggish, this was the perfect time for acquisitions and yet they were very few.
There is as well a phenomenon which is totally ignored the abundance of parasites in the markets(derivatives), equities, interest rates which are giving a wrong pricing and whoever is flying will only see prices and index (the total amount of derivatives as recorded by BIS is 886 TRILLION USD)
If equities markets were a discounting mechanism the financial sector should have been much lower in price and expected earnings since 2006.
As Fullcarry says, it matters what the market is discounting. It is not just discounting growth and general economic prospects, it is also discounting the medium of exchange for those prospects and the spread over alternative investments. Buying some stocks is a lot like buying commodities and rising share price can be seen as another form of inflation. A good deal of the implied projected earnings growth could just be nominal, not a projection of real growth, just higher prices for the same or even declining sales. Couple this with a belief that the fed will keep rates low and buying stocks becomes the best or only way to chase excess nominal yield. Russell says we might be headed into the big blow off phase yet. Compare Zimbabwe. http://www.mises.org/story/2532
Doug …
This is clearly not Zimbabwe, but we do have a “growth at any cost” central bank here in the USA.
We will repeat the economic experience of the late 1970s.
Hell, we have already repeated the geopolitical experiences of the early 1970s.
It is all in the “nature” of the American character.
To the bears all news, good or bad, confirms their views. Most of the events covered in the news have no correlation to recessions or the stock market.
Attention bears! Stocks are not in a bear market. If you like bear markets, focus on the US dollar. It seems to be in a picture perfect secular bear market.
Kudlow was terrifying. If I were Kass I’d demand a show of respect. Why do I allow Kudlow on my TV? The schedule change moves him off my radar.
Attention last poster! Stocks aren’t pricing in the realities of the bond market. Stocks aren’t pricing in the stone wall experienced in the ABCP market. Stocks aren’t pricing in the realities of the housing market’s tie to GDP.
Most of the events priced into the stock market have no correlation to the news.
werner… maybe you are jumping the gun.
there is no way of knowing whether we will enter a bear market or not? reason: unless all the data about high consumer debt is wrong, we are definitely going to see a slowdown in consumption.
and with all the bad news in the financials….and all that mark to model accounting can only stave off the bad news for couple of quarters not forever.
business spending is going to show some signs of decreased spending in the coming months thanks to all the bad news about economy etc..
so i would not say that we are out of the woods…..particularly when it is proven that stock market usually lag the real thing by atleast 6-9 months.
so bears and bulls….lets just be patient and as months pass by reality will reveal itself….so i guess its not such a bad idea to be in cash right now….except that it hurts when the markets keep going up despite all the negative data about economy.
Up and Comming?
The Twelve Days of Crisis
On the first day of Crisis the markets sold to me
A sub-prime bankruptcy.
On the second day of Crisis the markets sold to me
Two structured notes
and a sub-prime bankruptcy.
On the third day of Crisis the markets sold to me
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the fourth day of Crisis the markets sold to me
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the fifth day of Crisis the markets sold to me
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the sixth day of Crisis the markets sold to me
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the seventh day of Crisis the markets sold to me
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the eighth day of Crisis the markets sold to me
Eight salesmen bilking
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the ninth day of Crisis the markets sold to me
LBO refinancing
Eight salesmen bilking
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the tenth day of Crisis the markets sold to me
Hedge fund Boards all leaving
LBO refinancing
Eight salesmen bilking
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the eleventh day of Crisis the markets sold to me
Over-hyped underwritings
Hedge fund Boards all leaving
LBO refinancing
Eight salesmen bilking
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
On the twelfth day of Crisis the markets sold to me
Central banks succumbing
Over-hyped underwritings
Hedge fund Boards all leaving
LBO refinancing
Eight salesmen bilking
Seven ‘bonds’ accruing
Six fleeced investors
$500 gold calls
Foreclosure loans
Three French funds
Two structured notes
and a sub-prime bankruptcy.
..all of which does omit, of course, “hysterical overblown relief rallies by equities”; “a craven capitulation on the part of monetary authorities to Wall Street’s narrower interests”; “disconcerting weakness at the long end of bond markets”; “rising inflationary pressure”; “the dangerous vulnerability of retailers to deteriorating consumer spending”; “flimsy fiat currencies”; “a scary succession of non-American national property markets waiting to soften, including but not necessarily limited to Australia, Belgium, Britain, Denmark, France, Ireland, Italy, Spain and Sweden”; and “defensive investing becoming paramount” – but then none of these coinages is particularly susceptible to rhyme.
http://thepriceofeverything.typepad.com/the_price_of_everything/
so bears and bulls….lets just be patient and as months pass by reality will reveal itself….so i guess its not such a bad idea to be in cash right now….except that it hurts when the markets keep going up despite all the negative data about economy.
Posted by: techy2468
Hurts like Hell.
Spcwby for the win!!! (I particularly liked “Hedge fund boards all leaving. . .)
If a PM scales back on his allocation to equities and a recession doesn’t materialize, his performance will suffer. And PMs are acutely aware that underperformance leads to redemptions.
Since recessions are the abberation, I think PMs feel compelled to be positioned for the no recession scenario even when the probability a recession is increasing.
Only when they can no longer deny a recession will happen will they reposition the portfolio for risk aversion.
So, I think stocks are poor at discounting recessions not because the PMs don’t see the risks for one rising, but because if they position for one and it doesn’t materialize, the penalty (loss of assets under managment) is so harsh.
How can even a genius market measure and discount the size of the credit fall-out before us? If the extent of a problem is not yet visible, how can “the market” accurately price it? This whole “the market is a brilliant discounter” thing has been proven wrong in the past at the outset of secular shifts. The falling dollar, rising inflation paradigm of today is an era we have not seen for some 30 years. When you can’t see the road due to thick fog, its just plain reckless to keep driving full speed ahead. Risk management demands waiting for some visibility before assessing probable outcomes. The market presently is being driven by reckless players boldly wielding a lot of other people’s money.
neccesity purchases
heard last week on the flavor of Christmas ’07
“Most of the events covered in the news have no correlation to recessions or the stock market.”
Ha ha! That was funny!
Oh wait – you were serious?
ESB
You are on the wrong board (you sound like a bull). TBP is primarily for (long suffering) perma bears.
I think there are 2 issues here:
1) Everyone keeps quoting lagging indicators as a reason we won’t enter a recession (like employment and stocks). Check out new home sales, part time employment, inverted yield curve (which sometimes steepens even as the recession starts), durable goods, etc. These and other leading indicators are all headed down. The lagging indicators are still mixed, which the Bulls somehow interpret as “good news.”
2) The market runs on far more emotion than logic. As Barry pointed out, how can the NASDAQ be worth both 5000 and 1500 within a 2 year period? It makes no sense …and I would insist it is not mis-valued only in bubbles. Buffet has made the 2nd largest fortune in the world over the past 40 years buying undervalued companies.
dan… it will make more sense if you answer any of the comments (try to answer noFate most recent comment) rather than branding “PermaBear” or PermaBull or whatever.
i invite the bulls to bring some reason and some logic……rather than simple empty rhetoric that
* market always goes up
* only way to beat inflation is to stay away from cash
* since we are not into recession right now means we will not go into recesssion (the reason why equities are cheap)
i am beginning to think if Bulls ever use any kind of logic rather than just being strong headed and running into the market will full force??
i am begging all positive thinkers to shed some light on all the negative news…i love contrary views.
techy,
Housing prices topped out in August 2005. This housing slowdown has been so slow moving that it has allowed the other sectors of the US economy to compensate.
Checkout the booming agriculture, healthcare, education and export sectors.
Also check out:
http://www.econbrowser.com/archives/2007/10/not_all_the_new.html
Furthemore, the yield curve has been steepening. Foreign economies are booming. And most importantly personal income is growing smartly.
I can go on….
So as long as interest rates stay low there is no reason the US can’t muddle through.
Larry,
The S&P 500 peaked on July 16, 1990
“just two weeks later Iraq invaded Kuwait and oil shot up to a record $40 a barrel throwing us into a prolonged recession”
Nope.
The national economy had already officially entered recession in June of 1990, before most Americans had ever heard of Kuwait. Poppy Bush repeatedly blames the invasion of Kuwait and subsequent ramifications on the downturn in the economy, but it was the same as present day, the culmination of failed RightWing economic policies.
.
both the ECRI and the LEI model(conference board) use stock prices as a leading economic indicator. the wealth effect and confidence are no doubt in play. with wealth and income more unevenly distributed than ever, these effects have seemingly have much work to do to counter the otherwise sluggish economy, housing bust and inflationary effects of easy money induced asset appreciation.
Werner,
“Attention bears! Stocks are not in a bear market.”
Ah, after SEVEN YEARS, the DJIA is STILL DOWN by about 18% from where it was in 2000, in inflation-adjusted dollars. Only in Bizzaro World is that not a “bear market” in stocks.
.
VJ,
Imagine what it (DJIA 2000-present) looks like in local currency terms to a European or Canadian!
Brilliant “12 Days of Crisis” post by techy2468. Nothing like the holiday spirit.
‘Tis the season…
folks, don’t you see…
back, before, you know, back in the 90’s and before then too, the small retail invester was always the bag holder for the big boys.
Since then, the big boys got ALOT bigger and now, instead of looking for the “housewife bags” they’re letting the dollar tank so we get foreign bag holders… as long as you move fast, trade with a hint of fear, and keep your eyes on the coat in front of you, you (pretending to be one of the sheeple) can make a killing right now…
maybe LEAP on the put side and season to taste and run up with the market on some “ultra” ProShares.
Emotion drives, emotion rules…
Leave Kass and Kudlow alone…. they are media personalities, not traders. They each think that their opinion of the market is reality when in reality all that is real is today’s price.
VJ,
You wrote “The national economy had already officially entered recession in June of 1990”. This is factually NOT TRUE as the economy peaked in July 1990 (http://www.nber.org/cycles/cyclesmain.html).
Oil spiking to $40 as a result of the August 2 invasion of Kuwait by Iraq is certainly a viable trigger for the economy to have peaked the previous month. We can never know for sure whether or not the economy would have peaked at that time otherwise.
Don’t forget that as housing prices fall, guess what else falls along with them: inflation.
Also, all of you complaining about the pain of being in cash, why not buy? I’m assuming that your net worth is not such that it will dent any equity when you get in or get out. If the market wants to go up, follow it up. If it wants to go down, go back to cash. Now that is easy in theory, but obviously harder to execute. However, barring a terrorist attack or a shock of that level, there is seldom a time when the worm turns and us retail guys don’t have time to go to cash before things get nasty.
Checkout the booming agriculture, healthcare, education and export sectors.
*****
so you are saying that agriculture is booming (is it because of inflation??)
does that mean we have increased our export of food products (which are btw subsidised by tax payers money, so i wonder if it is really a good thing??)
Healthcare is booming….now thats a good news…..u mean we are falling sick more because we are aging?? or you are saying healthcare cost has gone up hence we are making more profit and its good for the consumers??
(i know its good for the shareholders, but is it good for consumers and economy??)
once again you say education is booming….what exactly that means….are we exporting education or consumers have started taking more education??
i would like to know how healthcare, education affects consumer spending which is 70% of our economy??
you said exports are booming….i thught we are still running trade deficit??
i wonder what exactly are we exporting now that we did not do three years back??
*****
Also check out:
http://www.econbrowser.com/archives/2007/10/not_all_the_new.html
Furthemore, the yield curve has been steepening. Foreign economies are booming. And most importantly personal income is growing smartly.
*******
foreign economies are booming…..are you saying americans have invested in foreign countries and hence they will be making a ton of money??
how does booming foreign economies going to help american consumers??
(unless you work for a MNC which means you wont lose your job, or you own stocks of a MNC)
personal income is growing….i dont know the exact data about this….if some one knows better please chime in.
******
I can go on….
So as long as interest rates stay low there is no reason the US can’t muddle through.
*****
according to econobrowser we may not go into recession…
and i would say we are risking high inflation
that means there should be no more rate cut??
*****
woodshedder….i will recommend you looking at stock market chart before sept 11?? and tell me what caused that downfall? (pay close attention to nasdaq)
Nasdaq:
Mar-2000 — 4572
Aug–2001–1805
also please take a look at the last three months of indexes…..now tell me how in the hell the worth of a company can fluctuate -+10% (20% variation)in three months?
luckily retail investors are not a big player right now….74% is managed by funds which are mostly invested in the long.
if i am not wrong, did not GS made a ton of money going short last quarter??
Techy2468,
Personal income is growing pretty well… chart here
To me, the issue (if there is one) is the composition and incidence of the income growth. I haven’t seen recent data on it, but anecdotally it seems to be disproportionately composed of bonuses, commissions, options, proprietors income, etc. (potentially more variable than wages) and the incidence seems skewed to the upper end (which has the ability, if not the desire, to cut spending hard and fast).
“now tell me how in the hell the worth of a company can fluctuate -+10% (20% variation)in three months”
Merchant energy comes to mind… all it takes is someone to screw up and precipitate a forced sale of assets.
John,
“Oil spiking to $40 as a result of the August 2 invasion of Kuwait by Iraq is certainly a viable trigger for the economy to have peaked the previous month.”
Um, care to explain how an event that occurred several months after the national economy had already entered recession could be a “trigger” for the recession ?
That indeed would be good trick.
.
The stock market is not the “discounter”– investors are discounters. Discounting is essentially forecasting and forecasting is essentially an attempt to explain something with reason that is unknowable. It can’t be consistently done with accuracy…
techy,
I take it your bearish dogma just won’t allow for anything bullish.
Obviously outside of real estate related areas the US economy is growing strongly if not soundly.
Job growth in education and health care have compensated for job losses in real estate/finanace.
Agriculture exports should add 0.25% to GDP going forward. It might be inflation induced but it nevertheless adds to national income.
Foreign economies are booming which helps US multinational corporations. It also helps our export sector which is growing in double digits.
I am probably more bearish than you. But find your scatter shot approach unpersuasive.
VJ,
How is August 2 “several months” after July?!?
Ah, after SEVEN YEARS, the DJIA is STILL DOWN by about 18% from where it was in 2000, in inflation-adjusted dollars. Only in Bizzaro World is that not a “bear market” in stocks.
VJ,
What kind of weed have you been smoking? You must be talking about the DJIA in some inflation adjusted terms, because in nominal terms it is at new highs.
Regardless, let’s say it is below it’s all time high. That does not negate the fact, that it has been rallying from the October 2002 lows with only a few minor interruptions. That is a bull market!
Now the fact that the DJIA is in a bullish trend does not make the US stock market a good investment. Quite the opposite, it is an unequivocally lousy investment! There are a myriad of reasons. The dollar bearmarket, prodigal spending by the US government on the disastrous war in Iraq and other waste…
I am sure you can expand the list at infinitum!
However, there are excellent bargains and good values to be had in the international stock markets!
John,
“How is August 2 ‘several months” after July?!?”
Haven’t the foggiest.
However, as I previously posted, the invasion of Kuwait, and the subsequent spike in crude oil prices, occurred several months after the national economy entered recession in June.
Try a calendar.
.
Werner,
“You must be talking about the DJIA in some inflation adjusted terms”
Well, let’s check the post:
“after SEVEN YEARS, the DJIA is STILL DOWN by about 18% from where it was in 2000, in inflation-adjusted dollars”
Yep.
Inflation-adjusted is the only manner to properly make a comparison across a period of years.
“Regardless, let’s say it is below it’s all time high. That does not negate the fact, that it has been rallying from the October 2002 lows with only a few minor interruptions.”
So, if you fell down a 100ft well, and after seven years, you managed to climb back up 90ft, you would be ecstatic ?
.
With all the major averages at pretty lofty levels, considering the economic picture we are faced with, now may be a good time to evaluate how exposed you are through your various workplace related investments:
http://economicdisconnect.blogspot.com/2007/10/getting-out-while-gettings-good.html
Jeez. You folks throwing up inflation adjusted dollars must not be beating the indexes. I know I know. The BP is not about investing. It is about macroeconomics. But since you all have brought it up, if one consistently beats the indexes, then one is indeed ahead, in inflation-adjusted dollars. So VJs point that “inflation adjusted is the only way to measure across a period of years” is only correct if one is indexed. And I think VJ’s quote of the DOW being down 18% from where it was in 2000 in inflation adjusted dollars is incorrect, but I do not have the time or care to check. Just suffice it to say that last time I checked, I don’t believe it was that much, and the DOW is indeed higher now.
Secondly, why has no one responded to my assertion that dropping house prices will create lower inflation. Anyone ever checked what percentage of the CPI is housing-related? You might be surprised.
According to this, the DOW at 14160 exceeds the 2000 high in inflation adjusted returns.
http://www.pankin.com/persp063.pdf
Woodshedder,
“So VJs point that ‘inflation adjusted is the only way to measure across a period of years’ is only correct if one is indexed.”
Well, yes, since I posted that in response to the quote:
“Stocks are not in a bear market”
“Stocks” references the broad market.
~
“And I think VJ’s quote of the DOW being down 18% from where it was in 2000 in inflation adjusted dollars is incorrect”
I’m afraid you “think” wrong.
You should know by now from reading my postings that I don’t go around making unsubstantiated posts (unless I’ve ventured into off-hand opinion).
~
“but I do not have the time or care to check.”
Well, in addition to running the varied calculations myself, according to David Leonhardt, an economics columnist for the New York Times:
All the major stock indices are off about an equivalent amount.
~
“Just suffice it to say that last time I checked, I don’t believe it was that much, and the DOW is indeed higher now.”
No, it’s not.
Suffice it to say, what you “believe” is at the crux of your difficulty.
.
Spcwby,
You haven’t been given enough credit. That parody is a work of art!… Thanks for the fun.
—
Now, I’ll chastise you.
With all that creativity, can’t you come up with a better handle than Spcwby?…Why didn’t you put an X or a Z in it as well?…make it even harder to type and harder still to remember. How about a bracket mark or the # sign?
Here, let me help you out a wee bit. I think “Price” is open for use… and I’ve not seen anyone using the moniker, “EveryPrice” either and both of those monikers would fit you according to the name you gave your own blog.
You even linked your blog!… and on it you claim: “Aspiring to spark an informed debate about investment markets, value, and absolute returns.” WTF does Spcwby mean anyway and why would anybody want to make sparks with you?
Who ever remembered anybody named Spcwby?
It makes me sad to have to speak to you this way… it truly does.
I suspect stocks will be “in the discount isle” this month.
(Now, let’s see how bad a call that is!)
I think there is considerable evidence that a recession is near. Housing is 15% of GDP and it is stuck. Auto sales are weak at best.
My guess is by Q2, 2008 we dip to negative GDP growth.
I think this just speaks to the market always overreacting in both directions. The market will always get too far ahead of itself when there is enthusiasm and get too down on stocks when the bears have control.
I think I got it
absent vowels
spcwby = spacecowboy
Schoolhouse Rock – Nouns
http://www.youtube.com/watch?v=Tc-ukN1Rvb8
The market is indeed a discounting mechanism BUT Kudlow is a little overboard. It’s almost as though he believes the market is some mystery and forces of a higher power determine stock prices. He once said something crazy like maybe the market knew that the Iraq war is ending. WTF is that? Does someone at Goldman use a Ouija board to see future activity? That’s almost enough to get a chuckle out of me.
The market discounts what it can see. Sometimes it cannot see that far over the horizon…………And sometimes the smart money pushes prices higher to make a mint while drawing in suckers to distribute to at the top. aka 2000. aka 2006-2007 run.
The discounting ability of the market is relevant today because the market has hit new highs while many believe that the odds of a recession have increased. At this point, the market seems to be betting that positive effects of global growth will outweigh the negative effects of the depressed housing industry and falling housing prices.
The circumstances surrounding prior market discounting failures are probably different from the circumstances today. In 1929, the market couldn’t have anticipated the contraction of the money supply and the passage of the Smoot-Hawley protectionist bill. In 2000, the market overestimated tech’s earnings potential while the bubble rose, and then underestimated the earning potential after the bubble burst. I’m not familiar with the circumstances of the 1980 and 1990 recessions so I’m not sure why the market didn’t see the recessions coming.
The situation today is whether global growth can compensate for the housing slowdown. On the negative side, the housing industry is depressed and house prices are falling. Consumer confidence is at the lowest level since Nov. 2005:
http://www.bloomberg.com/apps/news?pid=20601087&sid=a80Yqs4hl.Gc&
Consumer credit has declined slightly since the beginning of the year, see graph Consumer Credit, p. 7:
http://research.stlouisfed.org/publications/mt/20071001/mt_20070927.pdf
Rosenberg points out that over 90% of the economic data have come in below expectations in the past month and that Merrill’s internal Data Diffusion Index has hit its low-water mark for the year. Those who are forecasting as a recession think that these trends will continue, and slow the economy even more.
On the positive side, people are working. Unemployment remains low, although job growth has slowed. Global growth is strong and unaffected by the slowdown the U.S.
A number of U.S. industries benefit from the global economy, including basic materials, construction, and tech companies related to broadband infrastructure and wireless. Tech companies that deliver value and drive productivity growth for customers, with services such as data center automation, virtualization, teleconferencing, and software as a service, will do well globally.
The credit crunch seems to be easing, and many of the private equity deals are being done. If I read the table correctly on the link below, the spread between U.S. Corporate bonds and the 30 yr T-Bill is 106 basis points (5.86 – 4.8), which is at the low end of the 52-week range of 82 to 157:
http://online.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html?mod=mdc_h_bndhl
Bank lending began to rebound in 2007 after a slowdown at the beginning of the year, see the following graphs, p. 14: Bank Credit, Total Loans and Leases in Bank Credit at Commercial Banks, and Commercial and Industrial Loans at Commercial Banks:
http://research.stlouisfed.org/publications/mt/20071001/mt_20070927.pdf
I don’t see inflation as an immediate concern for the following reasons:
I don’t see the four inflation gauges of gold, commodities, the bond market (TIPS spread), and the dollar signalling inflation.
Gold and commodities are high, but I believe that this is due to rising demand from a rapidly growing middle class in China and other developing countries.
The bond market is the most broad and liquid of the four inflation gauges. The TIPS spread has fallen since the beginning of the year and is near the low end of the range. I assume that the graph Inflation-Indexed Treasury Yield Spreads, p. 11. is the TIPS spread:
http://research.stlouisfed.org/publications/mt/20071001/mt_20070927.pdf
The dollar is low. The low dollar is inflationary because it raises the price of imports. I’ve listened to both sides of the argument of the effect of lower interest rates on the value of the dollar. I’ve listened to the argument that lowering the interest rate will boost the dollar because a growing economy will increase demand for the dollar. I’ve listened to the argument that lowering the interest rate is inflationary and will push the dollar lower. It seems to me that a short-term adjustment in the interest rate won’t have a material affect on the value of the dollar, since the benefits of increased demand from an expanding economy will offset any risk of higher inflation, which seems minimal at this point.
CPI is trending lower, core CPI is up 2.1% from August of last year:
http://online.wsj.com/article/SB119020439779632335.html
The price index for personal-consumption expenditures rose 1.8% from August of last year, but it is at the high end of the Fed’s comfort level of 2%:
http://online.wsj.com/article/SB119098225071042588.html
On balance, I think the economy is weak enough to justify another rate cut without risking inflation. It’s my opinion that the negative effects of the housing industry recession and house price deflation affect the outlook of the consumer more than the positive effects of global growth. The low consumer confidence numbers bear that out.
The recent highs in the stock market, which is increasingly influenced by global growth, doesn’t necessarily reflect future growth/weakness in the domestic economy. I don’t have a model, so I can’t assess the odds of a recession. It’s difficult for me to say what the target Fed funds rate should be.
Guy,
“In 1929, the market couldn’t have anticipated the contraction of the money supply and the passage of the Smoot-Hawley protectionist bill.”
The market crashed and the depression started before the Hawley-Smoot legislation was even enacted, and was well under way before the tariffs went into effect.
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Thin Trading: Fed Fund Futures and Antique Watches
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