Can You Put Your Daddy On The Phone?
Once, when I was at a large German investment bank, I noticed the bond market's response to a bearish number was curiously bullish. I don't recall what the release was, but I remember thinking the market response was exactly opposite of what it should be. So I went to the firm's trading-floor economist (who has since become their chief economist) and I asked "What do you think of the data?" He proceeded to give a very tortured explanation of how the data in fact were bullish, but it was clearly reaching for straws. I said "I don't see how that could be right. This looks clearly bearish to me." His response spoke volumes for the way he approached his job. He said "Mike, the market disagrees with you. The market is going up. So it must be bullish."
I don't think economists should be allowed to look at the ticker. Economists who tell us what the market thinks the data mean are useless. I want to know what the data does mean, and then decide if the market reaction is appropriate.
But many, if not most, Wall Street economists do this. If the stock market has been rallying, they interpret data bullishly; if the market has been down, they interpret data bearishly. And that really hurts the profession of economics.
Currently, every economist - even ones who have been right about the recession from the beginning - is falling victim to this bias. With stocks continuing an epic rally, economists from Bernanke ("the recession is probably over") to those at Citigroup ("Housing activity is transitioning from a major drag to a leading source of recovery") and Deutsche Bank ("Don't Fret Declining Consumer Credit") are trumpeting the end of the downturn already.
And this weekend, they picked up a trophy when Jim Grant (who has been bearish on the bond market for the last 20 years or so) wrote a piece in the weekend Wall Street Journal. While I love to read Grant, he doesn't even reach "broken clock" status since to do so he'd have to be right twice. But this weekend he made a classic mistake that is worth mentioning.
Grant observed (while claiming that all economists right now are very pessimistic, which is a sure sign he wants to be continue to be considered a contrarian while he joins the crowd) that the robustness of post-recession recovery has historically tended to be proportional to the depth of the recession. This is a well-known correlation, but the classic error is that it implies no causality. There is an unstated explanation for that correlation; it is that explanation that needs to be examined to see if it applies here or is lacking.
Most recessions end because the economy retrenches to a new, sustainable level of consumption and production, from which level normal growth can resume. Have we done that in this case?
The chart below (Source: Bureau of Economic Analysis) shows the drawdown from peak consumption over the last 60 years (the data doesn't go back, in a quarterly form, any further but this covers the entire postwar experience). Note that in terms of the "amount of retrenchment" in personal consumption, this is one of the mildest recessions on record. That is, it isn't at all clear that we have reached any sort of stable 'base level' from which we might feasibly expect to grow robustly.
Now, perhaps the "recession" question may just be an academic discussion among Grant and some of these other economists about the technical meaning of the word recovery. Grant argues that the first full year of economic recovery from the Great Depression, in 1934...but, while it is true that the economy grew between 1934 and 1937 (before another savage downturn in 1938), most normal people don't consider the Great Depression to have lasted from 1929 to 1933, but from 1929 to 1941 or so.
Perhaps that is what could transpire here. Bernanke could be right that the recession is technically over, if we look at GDP accounts that are currently being juiced by massive government spending. But the "solution" has caused such enormous imbalances - in some cases, even worse than those which caused the last collapse - that the chance of a healthy, robust, multi-year recovery is effectively zero. Could we string together a few quarters of growth? Sure, although if credit continues to contract that can only happen through government spending borrowed from the future. But if this happens, it means the next downturn is only a few quarters or at most a couple of years away, and it will be as savage as what 1938 brought.
I don't believe that is what will transpire, because I think the political will to respond to the slowdown that will accompany the ebbing of government stimulus (and contracting credit, about which I fret) is seriously lacking. We've already thrown the kitchen sink. We are running out of things to throw.
We are surely past the worst of the panic, but that doesn't mean that the ongoing bust in commercial mortgages and consumer credit will be painless. Now, is there a chance that equities go up anyway, even if the economy struggles or starts to contract again? Sure, and there's a chance you can make money buying equities at the exceptionally high multiples we're seeing right now. The Fed's massive money-printing scheme can (and has in the past) led to asset inflation. But that's not necessarily a great way to bet, especially if the reflation scheme is petering out. Money and credit are contracting. Betting on a bubble now is perhaps not the best idea even though there is still massive stimulus working its way through the pipeline.
Our proprietary inflation indicators, interestingly, are not declining very much despite this contraction, because the dollar's recent weakness is providing a counterbalancing effect. We still see core inflation bottoming in 2010, and we will write later this week on the outlook for core-ex-housing inflation.
Disclaimer: This document and any information enclosed within the document contain restricted, privileged and confidential information and are intended for distribution to authorized persons only. If you are not the recipient of this document directly from Enduring Investments, you must not disseminate, modify, copy or take action in reliance upon it unless expressly permitted by Enduring Investments. None of the materials provided herein may be used, reproduced or transmitted, in any form or by any means whatsoever, including but not limited to electronically, mechanically, by way of recording or by the use of any information storage and retrieval system without the written permission of the Enduring Investments.
Certain information contained in this material constitutes forward-looking statements, which can be identified by the use of forward-looking terminology such as "may," "will," "should," "expect," "anticipate," "target," "project," "estimate," "intend," "continue," or "believe," or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of the funds described herein may differ materially from those reflected or contemplated in such forward-looking statements.
With respect to the present document and/or its attachments, neither Enduring Investments, its principals, employees, agents nor its authorized representatives, makes any warranty or representation, whether express or implied, or assumes any legal liability for the accuracy, completeness or usefulness of any information disclosed. Certain information is based on data provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such. Performance information and/or results, are un-audited and their appearance in this document reflect the estimated returns net of all expenses, including the management and performance fees similar to those to be charged by funds sponsored by Enduring Investments. Past performance is no guarantee of future results. Investment return and the principal value of an investment will fluctuate and may be quite volatile. In addition to exposure to adverse market conditions, investments may also be exposed to changes in regulations, change in providers of capital and other service providers and may be leveraged. The use of leverage magnifies changes in both increases and decreases of the value of an investment when leverage is used.
Neither Enduring Investments, nor any of its principals, employees, agents or authorized representatives accepts any responsibility or liability whatsoever caused by any action taken in reliance upon this document and/or its attachments. This document is for illustration and discussion purposes only and does not represent an offering of shares or interests in any security. The recipient of this document must consult the definitive offering memorandum and relevant associated documentation for all details regarding the offering and disclosure of the risks involved. The recipient of this documents and/or attachments is urged to discuss the risks involved with a legal advisor and tax advisor. The private investment funds described herein have not been registered under the Investment Company Act of 1940, as amended, and the interests therein have not been registered under the Securities Act of 1933, as amended (the "1933 Act"), or in any state or foreign securities laws. These interests will be offered and sold only to "Accredited Investors" as defined in Regulation D under the 1933 Act. By accepting this document and/or attachments, the recipient of this document agrees that he/she or the entity they represent meets all qualifications as an accredited (or similar requirements) investor in the jurisdiction(s) which they are subject to the statutory regulations related to the investment in the type of fund described in this document and/or attachments. Enduring Investments assumes that by acceptance of this document and/or attachments that the recipient understands the risks involved - including the loss of some or all of any investment that the recipient or the entity that he/she represents. An investment in the funds described herein is not suitable for all investors.
This document (and/or attachments to this document) is as of the date indicated, is not complete nor has it been audited, and does not contain certain material information about the products to be offered by Enduring Investments, including important disclosures and risk factors associated with an investment in the investment vehicles and is subject to revision at any time and Enduring Investments is not obligated to inform you of any changes made.