Recession or Depression?
Back to the crisis. I want to be a bull, really. I read what Barry wrote on 10 bullish signals, and I think, yes that’s what history teaches us. I have used that for profit in the past. I even have a few more.
Here’s my knockoff of S&P’s proprietary oscillator:
That’s the lowest reading ever, with statistics going back to 1990. For more, consider the discounts on closed-end funds — they are lower than ever. Or, consider that the IPO market is closed. Or consider that every implied volatility measure under the sun is through the roof in ways that we haven’t seen since 1987. The yield curve of the US is wide. Fed policy is accommodative; don’t fight the Fed. Consider that well-respected value investors like Marty Whitman are finally excited about the market. Credit spreads are at record highs in the money markets and in the corporate bond markets. Finally, consider that the lack of insider transactions indicates a potentially bullish situation:
I have a hard time accepting the bullish thesis at this point because of troubles in most of the major banks, and the disappearance of all of the major investment banks. I have a saying that when you have a major market malfunction, there tend to be many things going screwy at the same time. I don’t like to say that it is different this time, but rather, we have to be careful whenever there is a significant hint of depressionary conditions. If that is the case, we should see many abnormalities:
- The Treasury has shifted the TARP plan in order to recapitalize banks. Good move, if late.
- Similar things are afoot in the UK and Germany.
- Many European banks are in trouble.
This is a global crisis, affecting most governments and firms. Our most severe crises, aside from the Great Depression, tended to be local, or limited to just a segment of the world.
Final notes: I warned about this disaster in advance, though I am not as prominent as a George Soros or Jeremy Grantham. I can dig up the references at RealMoney if necessary. Last, as in the Great Depression, some moves by the government exacerbated the crisis, that may be true here as well.
With that, I conclude that we are back to the one key question: are we facing a recession or a depression? If a recession, we should be buying with both hands, but if a depression, there will be better bargains later. At present, given the condition of the banks and the global scope of the problem, I lean toward the depression side of the argument, but I am not totally sold on the idea. There are bright people on both sides of the question. That said, I am not jumping to buy at present, even with many indicators that are favorable. The state of the financial system matters more.
October 12th, 20088:23 am at
I agree that the technicals are favorable and that the sentiment screams that we should be buying. On Friday, I sat with my finger on the trigger for some defensive stocks, but I couldn’t pull it. I can’t stand buying when a slew of earnings are about to come out.
October 12th, 20089:01 am at
There is an old joke among economists that states:
A recession is when your neighbor loses his job.
A depression is when you lose your job.
The difference between the two terms is not very well understood for one simple reason: There is not a universally agreed upon definition. If you ask 100 different economists to define the terms recession and depression, you would get at least 100 different answers. I will try to summarize both terms and explain the differences between them in a way that almost all economists could agree with.
http://lifeinsuranceworld.org
October 12th, 20081:14 pm at
Dave,
I’m glad to see this post. I’ve been wondering if I was the only one with more than a little skepticism that we’re at a buying point.
I’m not a technical analyst but my belief is that most or all of the traditional technical and other indicators now flashing “buy” have not been designed for this type of market environment (i.e. we’re likely outside of the boundary assumptions and conditions those models are assuming). If this were a “routine” trough in the business cycle that everyone could reasonably expect to peak again along the same macro trendline, I’d agree that we’re at a buying point. However, I think there has been a major structural change in the economy that has now changed the macro trendline and is not accounted for in most models.
There is a purely emotional factor to my thoughts as well. I’m deeply skeptical that with so many people now yelling “buy” that we’re at a rally point — the contrarian in me says “run in the opposite direction.” I have this nagging feeling that the first explosion has gone off, drawn in the crowd to rescue the wounded, and the second more potent explosion is about to occur.
I’d be curious to know your thoughts.
October 12th, 20082:32 pm at
david, it seems that the Fed simply cannot allow any more large firm failures (a la LEH) due to the catastrophic cascade of CDS-related failures that would follow. of course, it’s a sign of the times that the central bank is backstopping any and all major financial firms.
October 12th, 20085:00 pm at
You say you are leaning towards depression, but I seem to recall that very recently you wrote you were over 90% invested and that you’ve taken a huge bath recently on your portfolio. Seems weird to pat yourself on the back for prescience with one hand and hold a huge back of stocks with the other.
October 12th, 20087:41 pm at
Whether it is recession or depression, there is one market segment that is insanely cheap and poised to perform very well regardless. Precious metals miners are in a nirvana fundamental environment, yet the market has completely ignored these developments. The shares are trading a record low valuations versus the metal, and this is with margins likely expanding sharply due to lower costs (energy being a big one). If the world is to avoid depression, it will likely be due to extremely aggressive monetary actions on the part of major central banks and this could result in currency instability. This entire game is extremely dangerous in my opinion and filled with a tremendous amount of potential unintended consequences.
Some simple math - the gold/XAU ratio has historically averaged about 4. Friday it hit 8.5. If gold were to stay flat, then the stocks would have to double to get back to average. If gold were to go to $1,500, then the stocks would have to go up 275%+ to get back to average versus the metal.
The gold miners showed very little signs of a terminal bull market rally this spring. The juniors and speculative activity was nowhere to be seen. By comparison, there were a ton of energy micro caps that went up 500%-1,000% in just a few months during the 1st half of the year. Eventually, I suspect similar activity will take place in gold miners. They remind me of the oil E&P names in 2004-2005 when no-one believed that higher oil prices would be sustainable.
October 13th, 20082:53 am at
I’m with you on this James. The falling price of oil and extremely uncertain financial situation with potential inflationary situation down the track and high future commodity prices to boot is all unbelievably bullish for the gold miners.
Also with the carry trade unwind and the hedge funds and quants or whatever probably taking a back seat for a while all the markets should start to behave in a manner more easily understood. The removal of the big broker dealers may mean there is less appitite for market manipulation games.
Could be things could get little easier for the little guy with a little cash….
October 14th, 20085:26 pm at
You can balance all of the bullish signs by one bearish sign. As of close of business today (10/14/08), the S&500 was sitting right about 1000. At that the S&P500 has a trailing ten year average P/E of 16.5. Which is just about the average T10Y P/E since the second world war. Stocks aren’t cheap. Even AFTER the big sell off of last week, and monday’s little pop, stocks STILL AREN’T CHEAP. They do not have a garden variety type recession priced into them, let alone a gigantic bank/finance screwup type recession priced into them.
October 14th, 200811:47 pm at
dlr — stocks are fairly valued here, they aren’t cheap, but I don’t use 10-year trailing P/Es — they don’t forecast future performance well, they give too much credibility to old data.