Some Promising Signs for the Economy and the Equity Market
Here at "A Dash" we try to identify and monitor the best sources and indicators. This is extremely important. Without a disciplined approach, the average person gravitates to sources and evidence supporting his/her current viewpoint — the confirmation bias.
In a time when most of the economic news is grim, it is especially important to seek out leading indicators. It is equally important to recognize data related to the long-term economic challenges.
The Recession Might be Over. So says the Economic Cycle Resesarch Institute (ECRI), long one of our favored sources, and accurate on the start of the current recession. One might contrast the ECRI prediction with assorted pundits who predicted a recession for years before it occurred.
Writing for RealMoney (subscription required, trial available) Anirvan Banerji reports that the ECRI leading indicators are showing significant strength.
within and across these leading indices, along with the classic
sequence of advances in those indices. Such a combination of upturns
doesn't happen unless an end to the recession is imminent.
Why are so many getting this wrong?
freshness, not their foresight. Because most market-moving numbers are
coincident to short leading, while corporate guidance is often lagging,
it's no surprise that analysts don't discern any convincing evidence of
an economic upturn.
Regular readers know that we are long-time critics of looking to corporate guidance, a concurrent indicator. The companies are reading the same newspapers as everyone else, and they have little current incentive to puff up expectations.
Please note: The end of the recession does not necessarily mean imminent happy days. There will be a period of below trend growth. This means economic under performance and high unemployment. Banerji specifically refutes the idea that high unemployment will derail the recovery.
Fed Balance Sheet. Many are worried about the Fed balance sheet, a topic we recently covered. Supporting the evidence that there is a definite "exit strategy" is the Atlanta Fed's Macroblog, one of our featured sources. David Altig goes right to the Fed minutes to support his argument. This is strong evidence for any objective observer.
Earnings are Surprisingly Solid. Many critics observe that companies are beating expectations by controlling costs, not by growing revenue. We expect the revenue growth comparisons to look very good in the latter part of the year. The key economic losses came after the Lehman failure. Meanwhile, companies that got lean and mean are poised to deliver good gains as fiscal and monetary stimulus has its full effect. Employment will lag.
Remaining Problems
There are continuing issues in credit markets and housing. As we wrote in April, there will be a "wall of worry". For the individual investor, this means that progress will be gradual and grudging. This summer is an important time to think about asset allocation, especially for long-term investors.
Most investors will get this wrong, trailing the market by an annualized rate of 6.5%. Check out Toro's article, "You are Probably Bad at Investing" for some good evidence on this point. It confirms every story we have seen over many years on this subject.
– There seems to be an implicit message (as indicated by the title) that a turn in the economy implies a turn in the markets. Note that the ECRI indicated a recession end in 4Q ’01 but the market bottomed a year later.
– Regarding your ending message, if you could share insights regarding asset allocation during different phases of the business cycle or lag effects between business cycle turns (as per ECRI) and the markets it would be much appreciated.
Thanks!
jbr — Yes, I do think that there is exceptional potential in some stocks and sectors if we get an economic rebound. This may happen even if employment lags. There were a lot of differences in the 2000-01 cycle, including an all-time peak in labor participation from the Internet and Y2K. You never hear anyone talk about that, so maybe I should follow up on it.
Right now, many stocks that I follow got down to near-depression levels. Most of the rebound is in those related to foreign growth. Another good idea for a more comprehensive article. Think CAT for example.
Thanks for a thoughtful question.
Jeff
As I recall you were touting how cheap the market was, the value of the Fed model or a similar interpretation and generally oblivious to the market dynamics before you as the world was building up for a major dump. And, quite frankly so was ECRI. They finally called a recession after people had lost their ass and that is because the ECRI model is just that. A model. One prone to fail in this type of volatility. They are measuring the wrong dynamics in the economy. Just as the Conference Board does with their “model”. They work until they don’t. A firm grasp of fundamentals points to the fallacy of ideology and belief in some type of model that worked in the past.
DaBears — I have portrayed the Fed model as a gauge of long-term sentiment, which has been negative for many years. I am also more interested in forward earnings than most, based upon data showing them to be better forecasts for many years.
As circumstances change, you should change your opinion. I have also written that the Lehman fall and the refusal of the government to follow through on TARP or address mark-to-market issues changed the investment landscape. I had a lot of company.
Any client who has been with me through the Long-Term Capital crisis, the 2000 bubble, and the latest collapse and partial rebound has done extremely well versus the markets. I share this information with any qualified potential investor.
Briefly put, I have methods that have worked very well throughout my career, and I plan to keep using them. I understand that there were many who “called” this collapse. Each investor should ask whether the methods used for that “call” are relevant for the future.
As to the ECRI, my recollection is different. Perhaps I’ll go back and take a look, but I think they were pretty accurate in the call of the recession.
Please note that until the Lehman collapse, it was not clear that the NBER would make a recession call. They go back and find the trough once the evidence is there.
I appreciate your question and comment, but I think you are putting too fine a point on your observation. Anyone who is offering commentary should and will adapt to new evidence. I try to do that.
Thanks,
Jeff