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Lagging Indicators...

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November 26, 2007 – Comments (7)

I am reading a piece by John Hussman, Financial Markets Anticipate Recessions Before They are Obvious.  It is worth reading.

I have quoted the introduction,

“'This month, market action produced a recession warning. Our investment position does not rely on a recession, so we hope that this signal is incorrect. It is quite true that consensus economic forecasts remain relatively upbeat here. Unfortunately, most economists have never fully internalized the “rational expectations” view that market prices convey information. Of course, accepting this view does not require one to believe that prices convey information perfectly (which is what the “efficient markets hypothesis assumes). But where finance economists take this information concept too far, economic forecasters don't take it far enough. As a result, economic forecasts are generally based on coincident indicators such as GDP growth and industrial production, or pathetically lagging indicators. This tendency to gauge economic prospects by looking backward is why economists failed to foresee the Great Depression and every recession since.

- Hussman Investment Research & Insight, October 3, 2000.

A year later, the NBER business cycle dating committee (the body that officially dates – not forecasts – recessions) confirmed that the U.S. was in recession. By then, the S&P 500 had already lost over 35% of its value. Indeed, by March 2001, which the NBER identified as the official recession start-date, the S&P 500 was already down more than 25% from the high it had set just a few months earlier. A large portion of bear market losses occur while investors are still denying the probability of a recession. By the time that a recession is well-recognized, significant damage has already been inflicted."

Some where in this piece he talks about how prepared the average investor is to absorb 20-30% losses and chasing a rally.  More importantly, he questions why we invest in the first place, which of course is to make gains.  Why take risks when there are strong indicators that the risks are serious?

Having been on the unprepared side of seeing 1/3rd of my capital wiped out in about 3 months after my first entry into the market I have no tolerance what-so-ever for screaming risk.  I bought into the garbage that financial advisors know better and that they are competent.  I admit I blindly followed advise, but I did look after the fact and I question how they ever earned a high school diplomia let alone something that gives them creditials that suggest they are an "expert." 

Historically the credit markets had a leverage on capital of 1 to 12.50.  Today by selling the mortgage backed securities the leverage is 1 to 30, and the equity is falling.  There is nothing in anyone's personal experience to assess this risk based on past experience.

Today will likely be a strong day on the market and I re-iterate my position that smart money is selling into strength.

 

7 Comments – Post Your Own

#1) On November 26, 2007 at 4:01 PM, GS751 (27.63) wrote:

over the long run 20 or 30 years usually the smart ones usualy don't go bust and the dumb money does.

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#2) On November 26, 2007 at 4:35 PM, abitare (85.79) wrote:

Good post, again. I am up almost 3000 points in a month. Being bearish can be rewarding very quickly, as people abandon a sinking ship a lot quicker then they board.  

I own two ultra shorts. I am short about five companies and I am 30% cash. 

I have run out of Red thumbs and I am targeting stocks with the greatest run ups. Shipping, solar, retail, building, financials.

But I could easily Red Thumb about 1000 stocks. It is tough to figure out which stocks are going to get his the hardest. 

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#3) On November 26, 2007 at 5:22 PM, floridabuilder2 (99.34) wrote:

I'm not sold yet on a bear market...  the fed can't be that stupid to let it happen....  if housing is in the tank and stocks follow suit, you can guarantee a deep deep recession....  you can throw currency inflation out the window... the fed has to take action and cut rates....  with that said.... i still don't know how im hanging around the top 100 caps players with as many green thumbs as i have out there

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#4) On November 26, 2007 at 6:35 PM, dwot (55.62) wrote:

Pre-market was showing strength...  I guess it did not hold up today....

GS751, I think it makes an enormous difference as to when you enter the market.  My timing was simply awful my time in.  Being down 1/3rd means you need to gain 50% to get back to where you started.

Abitarecatania, the change in leverage in the banking industry, along with low rates, along with loose lending standards is far more serious than people realise.  I don't want to miss a rally, however, Hussman's statement that people don't want to miss "any" rally really hit home.  I couldn't care if the markets rallied tomorrow and went up 10% by the end of the weak.  There is no foundation there, it can never be predicted, and the financial markets have created a global disaster.  

And it is hitting all over the place.  Any "great" company you are invested in could be waiting for accounts receivable from a company that is fight for its financial life because they parked their money in CDOs.  The ability for this thing to raise its ugly head where to least expect it is profound.  It has already frozen some tax payer's money for all kinds of things, such as education.  Those things are going to have to paid for twice through taxes.  Yukon government has $1200 per person of tax money frozen.  That's about $5k per worker.  How are they going to pay the bills that money was supposed to pay?

Floridabuilder, I doubt cutting rates will work this time.  Banks and investors have already learned a lesson.  Cutting rates won't bring back the loose lending standards.  It won't pay back the debt and the number of people who have become indentured slaves to their debt won't be participating in the economy regardless of what happens with interest rates.  There has yet to be a credit bubble with a happy ending and more of the same has never fixed the problem. 

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#5) On November 26, 2007 at 7:54 PM, TheGarcipian (32.99) wrote:

Hi dwot,

I agree that cutting rates won't entirely fix the problem, but it will help soften the landing (not that Bernanke has a lot of room left to do so). Lowering interest rates will allow those otherwise financially-sound companies to restructure their bad MBS debt into better packages which they can then sell to others down the chain, effectively spreading the pain out a bit.

Q. How do you eat an elephant? A. One bite at a time, and into lots of mouths. The problem, of course, is that there aren't a lot of mouths out there ready to attempt such a feat right now. But lowering interest rates will create a better environment to facilitate that appetite in more players. It will help, but it won't make the whole thing disappear. You are right about the impending global disaster: without a system of cross-checks and standards in place (mutually-agreed upon and strictly adhered to) that we all assumed existed in the banking & mortgage industry for decades (how ignorant we were of that!), we will all have to work together to soften the blows worldwide. And by "we", I mean China, India, Latin America & the US.

Can't we all just click our heels together 3 times and go back to this past July?  I'm not looking forward to the next 6-9 months,

--Gar

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#6) On November 26, 2007 at 8:11 PM, retailsails (97.00) wrote:

Since the last rate cut, JUMBO mortage rates are up, the treasury curve is more inverted, LIBOR has spiked up, and all everyone wants to buy is short term treasuries that are yielding barely more than inflation....so, uh what would another rate cut do?

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#7) On November 30, 2007 at 5:22 AM, mgiv (98.27) wrote:

The companies I'm into, recession shouldn't matter.  A U.S. hiccup for a few months isn't going affect China's consumption of iron ore or aluminum, or long term dry bulk shipping contracts going out several years.  Shouldn't stunt growth for GOOG either, wouldn't companies advertise more during recession?  Won't affect utilities either.  It's a good time to be brave if you choose the "right" stocks.

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