Interpreting Comments

Bond and equity markets both reacted negatively to comments from Countrywide CEO Angelo Mozilo.  In a CNBC interview he spoke about the problems in housing and predicted a recession would result.

Should investors heed this warning?


At "A Dash" we have tried to emphasize two themes that can have a great payoff for longer-term investors.  The themes may also benefit traders, although the timing is trickier.

  • Identifying the expertise of the source.  The Countrywide CEO obviously has great information and insight concerning his own business.  He is providing additional information about something of current concern, and that is useful.  He is not an expert at predicting recessions.  There is no evidence that he has experience or added value in considering how the housing situation will affect individual or business spending, countervailing factors, or a quantitative forecast of the effects.  He knows about housing.

Try this comparison.  Suppose a CEO was making an extremely bullish forecast about his own company.  We might view this with some skepticism.  Applying the same attitude, one might conclude that the CEO of a business that was struggling would want to make the problem seem as great as possible.  Compare the Countrywide comment with the Bear Stearns CFO who responded to questions by saying it was the worst credit market he had seen in his 22-year career.  He was trying to explain what happened to some leveraged hedge funds, among other things.  These sources are experts at what happened in their own companies, but might be seen as biased when projecting impacts on the overall economy.

  • What has already been "priced in" to the current market?  The sources cited have absolutely no expertise on the stock prices of other companies, normalizing earnings, or other factors that investors should consider.

Where to Look

Investors should look to those who are experts at taking all economic factors, viewing the impacts with quantitative impacts, and making forecasts that are tested by prior results.  In particular, it is important to understand that recession forecasters are predicting something that typically is an unlikely event.  They have few past cases to work from, particularly in the modern era.  Any economist recognizes the impact of the housing problem in GDP forecasts.  They differ in the size of the impact.  At "A Dash" we have tried to highlight sources that have avoided "false positives" in the past, including the ECRI.  Many recession forecasters place no time frame on their predictions, moving the date forward each year as they are proven wrong.  Sidelined investors have missed an opportunity by listening to these predictions.

One should also consider how much earnings forecasts have already been reduced to reflect recession chances.  This is the only method to figure out what is "baked in."

Where Not to Look

We suggest avoiding pundits who cite each statement from a housing source as important fresh information.  Many of these pundits seem to think that they are the only ones with any vision.  They repeatedly claim that others "do not get it."

In fact, everyone "gets it" in that they are aware of some GDP loss.  The difference is that some forecasters attempt to quantify the effect, while others (mostly non-economists) cite each statement as proof without sound analysis on quantifying the effect.

It is a curious fact that pundits who are not economists strongly believe that they have greater insight than those who studied for many years to learn theory, data analysis, and forecasting.  They operate from a stereotype of homeowners that reflects only a small segment of the population.


The many market pundits who take a bearish view of the economy can find plenty of specific statements and data to support the housing effect.  The difference between the real experts and the pretenders is the ability to quantify those effects.

Having arrived at an economic forecast, the investor must still ask how much the market already reflects a negative perspective.  There is an advantage to buying when fear has been priced into the market.

We rarely have the opportunity to gain a contrarian trading advantage — buying fear — by relying upon the real experts.  Now is such a time.

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  • Aaron August 24, 2007  

    Interesting post. You make a good point that this is one of the few chances we get to gain a trading advantage based upon real experts. It certainly is widely known that the housing market is in deep trouble right now, Mozilo said nothing new yesterday.

  • Mike August 24, 2007  

    A recession is inevitable. It’s in the bag. Count it.
    Predicing WHEN the next one will come, however, isn’t so easy. Given all the pundits predicting one, I’m guessing there won’t be one this year or next, and if there is, it’ll be minor. Furthermore, given the much lower valuations in the stock market compared to the last time we went into recession, I don’t expect a significant drop. Imo, 15,000 on the Dow is much more likely than 12,000.
    I’m not much of a market timer, but the thing that concerned me a few months ago was the rise in the 10-year treasury. Since it’s come all the way back down, I don’t think stocks are going to take a beating near-term. We could easily test the lows of last week, but I also wouldn’t be surprised if we continue up from here.
    What I do know is that I wasn’t selling into the lows last week–but I sure picked up some nice bargains from those that were. Just goes to show you, for much of the time markets are efficient. They just aren’t efficient all the time, and the times that they aren’t are extremely advantageous for some investors.

  • Jeff Miller August 24, 2007  

    Aaron and Mike —
    Thanks for your comments. I hope that there are plenty of individual investors who are as savvy as you. Unfortunately, the data show that most of them bail at just the wrong times.

  • RB August 24, 2007  

    After seeing this interview — and I wonder what skills are required to become managing editor of Fortune magazine — I’m now convinced that there are some opportunities for differentiation for the retail investor

  • Jeff August 24, 2007  

    You are stealing my thunder! This interview is part of my next post — something I wrote today on RealMoney. I’ll try to get the follow-up going tomorrow.
    An interesting question is whether bearish pundits who cited cover stories will also cite this one.
    Nice observation!

  • RB August 24, 2007  

    Oh, that’s too bad :). OK, I’ll play the other side: Bill Miller thinks that if the credit crunch isn’t resolved soon, we are looking at a recession next year (of course, he’s bullish)

  • Mike August 25, 2007  

    There’s something I’ve been thinking of with respect to the overall markets. Worldwide, P/E ratios are moderate, in the range of 15. Earnings are excellent, as Hussman constantly reminds us (though he states it as if it’s extremely bearish). If prices were to crash suddenly, we’d see P/E ratios in the 10 to 12 range. (This assumes earnings would stay constant when in fact there’s good reason to think they’ll continue to grow.) Contrast this to 2003, when even after prices dropped considerably and earnings recovered, P/E ratios were still very high, at least in the U.S. In foreign markets, P/E ratios were low, since foreign stocks were soundly trounced by U.S. stocks in the 90s. Since 2003, though, foreign markets have been the place to be, especially when one factors in the effects of the dollar.
    Now that John Q. Public has finally figured this out and is sending record money into international (and value) funds, it’s a sure sign there’s considerably more risk there than just a few years ago. ETFs like ILF and EPP both took at least 20% hits (though both are storming back) in this latest correction.
    One other thing on my mind is the dollar. Given all the talk about it collapsing, I’m inclined to think of why it won’t. One major reason I can’t get out of my mind is its recent performance against the euro. In my mind, of all the currencies that are most likely to weaken, it’s the euro, not the dollar. Growth there is far from spectacular, and they’re seeing just as much of a housing crunch as we are. Long-term, Europe’s potential for growth is minimal due to their population trends.
    Australia and Canada have also experienced surges in their currencies, largely related to commodities. Commodities are as prone to booms and busts as any other market. They’re clearly in boom time again, feeding many emerging markets. As always though, supply will catch up and overtake demand, resulting in a glut and falling currencies.
    That said, I don’t see the dollar soaring anytime soon, but currencies, more than any other market, are a net zero gain. For one to win, another must lose. Many have been gaining on the dollar for various reasons over the past several years. Those trends won’t continue forever. Moreover, for the time being and likely for a long while, the U.S. is still the biggest economy on the planet. Something tells me the powers that be won’t simply allow the dollar to die. (Lots of hyperinflation talk out there. Naturally, I think deflation will be more likely, just not yet.)
    Just some thoughts on a Saturday morning drinking a hot cup of joe….

  • RB August 25, 2007  

    Lots of people, including Hussman, have warned against looking at single-year PE. In fact, Hussman specifically argues for his price-peak earnings multiples to account for such issues as the high PEs coming out of recessions as well as low PEs during record earnings. Gannon has something similar based on normalized earnings.
    Can we get the oldprof’s comments on Donald Kohn’s recent publication indicating that falling house prices will cause consumer retrenchment — I don’t believe Malpass has supported the idea of MEW supporting consumer spending.

  • Dereck August 25, 2007  

    I have been searching for and reading various blogs hoping to find suitable ones to link to in my blog. I especially have come to like yours. I was wondering if you would like to exchange links.

  • Jeff Miller August 25, 2007  

    RB –
    You really have your finger on my research agenda! Many are commenting on the Kohn study and it is pretty obvious that few have actually read it and fewer still can deal with the statistical analysis. On my eight hours of flying this week (Seattle and back) I spent some time with this paper, so I am working on my review.
    So many issues, so little time 🙂

  • Jeff Miller August 25, 2007  

    Dereck –
    Thanks for your interest in my work. I congratulate you on what you have accomplished with your blog, and I have added it to the list of sources where I do a regular review.
    Since you asked the question in the open rather than via email, I am taking the opportunity to explain my policy.
    I often get email requests to “exchange links”. I’m not sure why, since “A Dash” is not one of the big-time blogs. What we write is aimed mostly at people who are not currently looking for information online. By the time our book comes out, maybe more of them will be, but not now. From comments and emails and links I know that our readership is very intelligent and sophisticated, and not stuck on a specific doctrine. Our readers include many investment professionals who work with clients like my own investors.
    That’s what I hope for, but it is not the prescription for a large following!
    But I digress from the “link exchange” question. My approach to writing includes regular reading of many blogs. When there is something extraordinary, I feature that blog and add it. The result is that I read many very useful sources that are not yet on my list.
    This may not be a good method, and I am open to suggestions. Meanwhile, there are many excellent lists of good financial blogs — people who do this much better than I do.
    Several blogs that I regularly highlight do not link back. I do not take this personally. Some of these blogs may have an agenda and do not want to point readers to my work. Others may, I suppose, think my work is not helpful.
    I learned long ago that taking strong positions and developing good arguments is polarizing. Most bloggers really do not wish to engage in substantive debate.
    The fact that I have not yet added a blog that I read mostly means that my own writing has not hit the relevant topics. Often these are blogs focused on active trading rather than long-term investing.
    To summarize, I do not engage in exchanges. My blogroll includes sites that have chosen not to link back — their choice. There are also those who link to us, but I have not yet featured.
    I encourage you to keep writing and develop your work.
    Best of luck,