Recession Watch: A Balanced Assessment
Equity investors need to think about the chances of a recession. It is a standard risk/reward problem. Here are the questions:
- How much of a haircut would there be to earnings in a recession?
- How much of this is priced in? Do the PE ratios of economically sensitive companies reflect the possibilities?
- If a recession is averted, how does the picture change? Can multiples expand? Are earnings estimates too low?
The answers are crucial.
That is why "A Dash" is monitoring data about the economy. There are many perma-bears. There are also popular commentators who have some other stake in predicting disaster, some sort of self-promotion. It is easy to spot such people because they only cite evidence that supports their existing view.
At "A Dash" we do have a viewpoint, but it is one we are willing to change. Our clients were on the right side of the market during the 1999-2000 period and were mostly out of stocks when the bubble burst. We can change our positions in a heartbeat, and would do so if the evidence so indicated.
That is why our Recession Watch series is more valuable than watching those locked into a viewpoint.
Last week we saw a big reaction to the Philly Fed. It was a bad sign for the economy, but one that investors should put in context. We did that.
There has also been additional inversion of the yield curve. This is a subject that frightens many. For individual investors it has a mysterious and dangerous sound. Many of those talking about it cite old research. Some Wall Street firms use models that they do not believe in themselves and do not reflect the most recent research. We have covered it extensively.
Meanwhile, there is a lot of additional data.
Let’s start with David Malpass, the Chief Global Economist for Bear Stearns. There does not seem to be much public recognition for him despite the fact that he has absolutely nailed the basic economic trends for the past several years. He has a deeper and better understanding of savings, and how it is mis-measured. He has done first-rate work on employment growth and how the current recovery must be measured against the unprecedented peaks of 1999. His economic forecasts have been excellent, as have been his explanations, for more than three years. The man has a finger on the pulse of the market. Traders should have a relationship with Bear, if only to get his commentary. Those who do not can still benefit from his frequent Op-Ed pieces in the Wall Street Journal.
Here is a little bit of what David told clients today:
- He pointed out the "Philly Fed slowdown scare" from June, 2005 where the Index was at zero, basically the same as now. Leading Economic Indicators also had a dip. Check out his article from June 28, 2005 in the WSJ.
- He notes economic strength in manufacturing (outside Philadelphia), unemployment claims, capital equipment orders, bank loans, consumption, government spending, and government tax receipts — the single highest day in history on 9/15.
Investors should also pay attention to Tony Crescenczi, who writes a blog on TheStreet.com’s Real Money site. While this site requires a charge, it is a lot less than the professional version and an attractive value for many investors.
Tony’s blog covers a lot of indicators that others do not notice. He talks about the increase in commercial paper, for example, and why that shows short-term economic strength. Today he posted a nice analysis on why housing will not implode, and also an updated view on the yield curve.
Finally, there are the earnings. Michael Thomson appeared on CNBC today discussing projected earnings of double-digit growth for this quarter, next quarter, and the first quarter of 2007. Maria then made a comment about a "Goldilocks economy."
At "A Dash" we like to look at hard data. In the stocks we follow the analysts have already punished future earnings since they are pretending that they are economists instead of stock analysts. When Michael Thomson tells us that these numbers are bullish, we listen with respect.
9/27 UPDATE: For an extended quotation from the Malpass analysis, see Rich Kaarlgard’s Blog.