Recession Obsession.

July 11, 2012

As Independence Day temperatures rose to 100+ degrees, the nation's economy seemed to head in the opposite direction.
The U.S. economy is crawling. Business activity dipped to a three-year low. Employment in slowing. As are new manufacturing orders. And the data showing those industries exhibiting growth declined last quarter.
June's employment offered few surprises. Slightly below expectations. Posting 80,000 new jobs, the figure was far below the number required to lower the unemployment rate. In fact, the number of unemployed was up 29,000. The rate was unchanged at 8.2%.
Yet, amidst the sad headlines hid rays of hope.
Average hourly earnings saw the biggest gain since February. The workweek rose by 0.1 to 34.5 hours. And the number of temporary jobs increased for the month.
Needles in a haystack? Probably. But they offer hope for the future. And they fly in the face of what has become an obsession with recession.
We have previously discussed last year's ECRI recession call, which called for a return to recession in the near term (Recession Tango). But, nine months later, still no recession. Despite the slowdown.
ECRI has been very accurate with many previous calls. Uncannily so. But, even Nostradamus missed forecasts on occasion. True, he was looking 400 years into the future, so we cut him a little slack. The average economist tends to look out a six to twelve months, and still we find ourselves correcting the economic data from the previous quarter.
Point is, the recession prediction game is a tough racket. But, it's a popular one. Why? Because in the age of 24/7 cable/web/satellite/network/print media news, economic forecasts make compelling headlines. Good news? Euphoria! Bad news? Depression!
If my news network plans to sell advertisements for all-absorbent, super-soaking dish towels at 3 am (Sham Wow!), I'd better have a couple of economists willing to explain why the inflation hiccup in China will cost American jobs.
Granted, from an economic perspective, things are far from perfect. In fact, we have increasingly considered the idea that Europe's continuing woes could lead to a large market-wide correction.
Only three days after the Euro Summit that caused markets to jump up last Monday, Spanish and Italian bond yields are back to levels reached prior to the session. Spanish equities are dropping. Again. So, even after the (semi) positive announcements following the most recent meeting of European overlords, we still see that the bond vigilantes have the upper hand. And markets remain weary.
Oh, and Iran happens to be rattling its sabers again. And China continues to report deteriorating economic conditions.
So yes, we're keeping our sell stops tight. But...
We recognize a contrarian indicator when we see one. And when Joe Household and all of the top Wall Street equity strategists agree on anything, one is generally well served to bet against them all.
Currently, they're extremely bearish. Only, bearish sentiment during the heat-induced summer doldrums is nothing new. 2010. 2011. Both of these years also saw the Bears turn on the severe-weather sirens, sending a message of doom and gloom deep into the American psyche. Both summers saw economic slowdowns and scary headlines give way to soft landings. And then the stock market took off like bottle rockets on the Fourth of July, leaving skeptics scratching their heads on the sidelines.
We just highlighted this concept in last week's newsletter: the equity market strategists at the brokerage firms have a very consistent track record. They were hyper bullish in early 2000. They were hyper bullish in Fall of 2007. Consistently wrong is still consistent.
These equity strategists and the economic prognosticators, specifically those suffering from Recession Obsession, are cut from the same cloth. Glorified Wall Street Nostradamus-like soothsayers who have the ability to go back and tweak their incorrect guesses.
And regardless of the sentiment -- positive or negative -- most of what passes for strategy disseminates down through the ranks until some broker in Wichita can provide the same advice that most of his counterparts are giving nationwide.
"These mutual funds/money managers have a track record of protecting client downside in bad markets, and capturing most of the upside in good markets."
"We're going to stick all of your hard-earned capital into some investment vehicles that I don't have to manage and then watch them as they go up and down with the market for as long as you'll allow me to collect fees."
Unlike most of our brokerage firm counterparts, we think that these markets require a tact that isn't business as usual. We call it the Three Little Pigs Economy. Consider that three of the primary drivers of the U.S. economy have been acting like greedy, over leveraged pigs this last decade. The government cannot fix its deficit issues. The banks and brokerages have lost control of their own balance sheets, even incurring downgrades by the ratings agencies. And the average U.S. household? Pure credit-driven over consumption.
In an economic environment that promises wolves in every forest, we see a lot of pigs sitting in straw homes, awaiting the inevitable. The trick is to avoid over exposure to those over leveraged, vulnerable areas, these Pigs in Straw Houses.
You can do so by investing more tactically. And taking a very calibrated approach towards risk. There will be returns to be had. But not for those with a traditional buy-and-hope, ride-the-market mentality.
Meantime, pay little attention to the Recession Procession. I'm not being coy. I'm simply pointing out that the markets can operate independently of the economy for long periods. And, like the markets themselves, the prognosticators tend to overshoot at the ends of the spectrum. Things are rarely as good, or as bad, as we're asked to believe.
Fact is, this market is following the traditional pattern seen in many average presidential election years. As a recent chart by Bespoke Investment Group shows, this market, with its initial rise, potential summer swoon and prospects for a year-end rally would follow the path taken by the average presidential election-year markets dating from 1928 to 2008.
The S&P 500 peaked just ahead of the spring break period, and then made its low just days after it typically does. If the red line is the average of all presidential election years since 1928, and the blue line is this year's trend line, then perhaps we can attain a semblance of how the rest of the year plays out. So far, despite all prognostications, it's been typical.
And when it comes to making investment decisions, I'll follow the historical trends, and the well worn, battle tested paths they've left, long before I follow the herd right off the cliff.

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