Daily Investment Interpretations

Thursday, March 26, 2009

2009-3-26:  
    The NASDAQ increased
58.05 points (3.8%) to 1,587. The Dow climbed 174.51 points (2.25%) to 7,925, and the S&P 500 gained 18.98 (2.33%) to end the day at 833. Oil was up slightly at 53.85, while Gold rose $4.20 to $942.20
    The articles below recite the economic statistics that were released by the Bureau of Labor Statistics this morning.
U.S. ongoing jobless claims rise 122,000 to record 5.56 million
: For the week the ended on March 21 (last week), first-time claims for
jobless benefits rose to 652,000 from 644,000 the week before last, bringing the four-week average to 649,000. The average of the number of people collecting state unemployment benefits jumped 123,750 to stand at 5.33 million (a new record). (This number's a little tricky, since unemployment benefits run out after six months, or after nine months with the current three-month extension. Next week, the Bureau of Labor Statistics will report on the closely watched non-farm payrolls and the unemployment rate. 
GDP revision shows 6.3% decline in fourth quarter
    Economists were expecting a
6.7% drop in GDP, so this was good news. Orders for durable goods were expected to drop 1.2% in February; instead, they rose 3.4%. But the fall in durable goods orders for January was revised downward to 7.3% from an initial estimate of 4.5%. The paragraphs below, taken from the article linked above, seem to me to capture the prognostications for a turnaround in the economy later this year, and for the thesis that the market quietly bottomed on March 9th.
The Bullish Case:
   
"Current projections look for GDP to fall at a 5.1% annual pace. GDP is expected to fall 2% in the second quarter, according to a survey of economists conducted by MarketWatch.
    "
'It is far too early to get bullish on the economy, as a lot could go wrong between now and mid-year, we still have no evidence that the meltdown in the labor market has begun to abate, and the federal government seems to be working very hard to sabotage a recovery', wrote Stephen Stanley, chief economist for RBS Greenwich Capital.
(
This next paragraph was written by the authors of this article and not by Stephen Stanley.)
    "Most economists don't expect GDP to grow until the second half of the year, when the leading edge of the $787 billion fiscal stimulus plan begins to have an impact. Growth next year is expected to be so tepid that unemployment is likely to keep rising
."
    This seems to me to be in direct contradiction to John Kenneth Galbraith, Paul Krugman and others who have estimated that the fiscal stimulus package would need to be at least tripled to fill the projected gap in GDP over the next few years. Similarly, Secretary Geithner's "legacy" assets plan is deemed by these economists to be a program that won't have the desired effect of restoring banks with "legacy" assets to health. Also, there's a spectrum of opinion about whether the economy will recover this year or next.
Academia Versus the Real World
    Before continuing with the bullish case, there's an intriguing article that I'd like to introduce:
Goodbye, Homo Econmicus, by Anatole Kaletsky, editor-at-large of the "Times" (London Times). What Mr. Kaletsky describes is the idea that for the past three decades, given political pressure, academic economics departments have been teaching two ideologies that have no experimental or real-world support: the rational expectations hypothesis(REH), and the efficient market hypothesis (EMH). The author says, "Models based on rational expectations, insofar as they could be checked against reality, usually failed statistical tests. But this was not a deterrent to the economics profession. In other words, if the theory doesn’t fit the facts, ignore the facts. How could the world have allowed such crassly unscientific attitudes to dominate a serious academic discipline, especially one as important to society as economics?" He continues,
    "
To make matters worse, rational expectations gradually merged with the related theory of “efficient” financial markets. This was gaining ground in the 1970s for similar reasons—an attractive combination of mathematical and ideological tractability. This was the efficient market hypothesis (EMH), developed by another group of Chicago-influenced academics, all of whom received Nobel prizes just as their theories came apart at the seams. EMH, like rational expectations, assumed that there was a well-defined model of economic behaviour and that rational investors would all follow it; but it added another step. In the strong version of the theory, financial markets, because they were populated by a multitude of rational and competitive players, would always set prices that reflected all available information in the most accurate possible way."
   He adds that the efficient market hypothesis (EMH) assumed that market fluctuations were Gaussian, implying that the odds of a one-day movement greater than 25% were about one in three trillion. In fact, four such events have occurred over the past 20 years, beginning with the Crash of '87. This, he says, should have marked the end of EMH. Instead, the theory was retained and the facts brushed aside.
    The efficient market hypothesis has always seemed to me to be utter eyewash, consistent with the lament that "
The stock market has predicted nine out of the last four recessions." The stock market peaked on October 11 as the current economic wave was just about to break. Equally to the point, valid information is all but impossible to obtain.
    What's crucially important about this article is that it's saying that
the leading economists of our day are relying on theories that are absolute eye-wash,. Political expediency has trumped the scientific method (the emperor's new clothes). 
   
In other words, our leading economists are using grossly-faulty roadmaps.
     The Cyclical Bull Within the Secular Bear seems to me to be a companion piece to the above article.  This article contrasts what the author calls the efficient-market arguments of Professors Jeffrey Sachs and Paul Krugman. This author takes to task Professors Jeffrey Sachs and Paul Krugman for being totally out of touch with what's really going on in the financial markets. The author argues that neither of these ivory-tower academicians take into account the positive wealth effects as trillions of dollars are pumped into the world's economies, and "
the forces of pro cyclicality begin to work their market magic." He contrasts this with hedge fund manager Andy Kessler's description of "the insider game that's being played, providing a far more accurate picture of how things really work in our still juiced-up financial system, and the role credit default swaps play in facilitating bear raids - which then have the effect of collapsing economic activity in the real economy (Soros’ reflexivity in action)"
    Note that the title of this article refers to the cyclical bull market within the 2000-2018 super-bear market. Note also that the author expects the liquidity injected by governments to turn everything around.

Back to the Bullish Case
    The basis for optimism seems to be the idea that the dramatic measures being taken by the Obama Administration will cause the economy to bottom within the next few months. If GDP falls 5.1% this quarter, and 2% next quarter, then the case for optimism would seem to me to be pretty good. By early July, we'll know. In the meantime, this is an absolute Tower of Babble.
    The case for the bullish case might be that certain signs of spring are appearing. And in this vein, here's a very interesting piece from Minyanville: .
Enter the Manager of the World's Largest Hedge Fund:
    I was once again ready to turn seriously bullish when, tonight, I happened to read an article about Ray Dalio, the manager of Bridgewater Associates, the world's largest hedge fund (with $38 billion). Mr. Dalio is a very thorough analyst of, among other things, what's going on in the stock markets and the world's economies. Mr. Dalio says, "
It seems very likely that stocks will get materially cheaper. We have to go through an important debt restructuring process, and a lot of assets are going to be for sale, huge numbers of assets. And there's going to be a shortage of buyers."
    Obviously, Mr. Dalio isn't an ivory-tower academic. 
    Today has been a wipeout for me. I'll try to add to this tomorrow.
    To recap what's happened, consumer spending in 2007 reached 71% of GDP (up from its long-time average of 63% of GDP), driving the savings rate negative. That's 8% above the historical average rate. In absolute terms, this would amount to 8% X $14 trillion, or about $1.12 trillion a year above the historical average. (Presumably, if the government could somehow provide an additional $1.2 trillion to consumers that they would spend, that should bring the economy back to its 2007 level. But the world has changed since 2007. Giving people that money now wouldn't induce them to rush out and spend it.)
    Now, most people are fearful and have switched from overspending to saving. To me, this is a little like a situation in which everyone is standing on one side of a boat, causing it to list dangerously. Then everyone runs from that side of the boat to the other side, causing it to list dangerously in the other direction.

    
Be careful in bear rally

Hugh Johnson has doubts

Mortgage rates fall to record lows; 30-year at 4.85%

Brightening picture lifts U.S. stocks

(see  Durable-goods orders jump in February, surprising economists. Also,
"'We strongly doubt that the February gains represent anything more than statistical noise in these often volatile data, particularly given that large downward revisions are often associated with ongoing declines,' wrote Josh Shapiro, chief U.S. economist at MFR Inc, in a note to clients."   
    Then just below this:
"But Steve Gallagher, chief U.S. economist at Societe General, said the report was "consistent with our view for positive real GDP in the second half of 2009.")
    These two paragraphs, supporting exactly opposite theses, demonstrate the "Tower of Babel" that is the financial media.