Monday, June 28, 2010

Hussman - Another Recession on Tap

More and more money is moving to the viewpoint that a new recession (if it hasn't already started yet) is not only possible but likely. The latest is John Hussman whose comments I have posted from time to time.

His weekly commentary found here starts out pretty bleak:

Based on evidence that has always and only been observed during or immediately prior to U.S. recessions, the U.S. economy appears headed into a second leg of an unusually challenging downturn.

Yep, the data has definitely started rolling over and the forward looking data is flashing danger signs.

A few weeks ago, I noted that our recession warning composite was on the brink of a signal that has always and only occurred during or immediately prior to U.S. recessions, the last signal being the warning I reported in the November 12, 2007 weekly comment Expecting A Recession. While the set of criteria I noted then would still require a decline in the ISM Purchasing Managers Index to 54 or less to complete a recession warning, what prompts my immediate concern is that the growth rate of the ECRI Weekly Leading Index has now declined to -6.9%. The WLI growth rate has historically demonstrated a strong correlation with the ISM Purchasing Managers Index, with the correlation being highest at a lead time of 13 weeks.

He than goes and talks about what you could possibly expect from the markets. The problem is (and it is a good problem) for the United States the data sets are very limited because we haven't gone through any major sovereign debt crises. He quotes the widely quoted book This Time is Different by Kenneth Rogoff and Carmen Reinhart. All stuff I have talked about before.

Reinhart and Rogoff observe that following systemic banking crises, the duration of housing price declines has averaged roughly six years, while the downturn in equity prices has averaged about 3.4 years. On average, unemployment rises for almost 5 years. If we mark the beginning of this crisis in early 2008 with the collapse of Bear Stearns, it seems rather hopeful to view the March 2009 market low as a durable "V" bottom for the stock market, and to expect a sustained economic expansion to happily pick up where last year's massive dose of "stimulus" spending now trails off. The average adjustment periods following major credit strains would place a stock market low closer to mid-2011, a peak in unemployment near the end of 2012 and a trough in housing perhaps by 2014

This is how I have felt for months!!!

In recent months, I have finessed this issue by encouraging investors to carefully examine their risk exposures. I'm not sure that finesse is helpful any longer. The probabilities are becoming too high to use gentle wording. Though I usually confine my views to statements about probability and "average" behavior, this becomes fruitless when every outcome associated with the data is negative, with no counterexamples.

Than he just lays it out there.

Put bluntly, I believe that the economy is again turning lower, and that there is a reasonable likelihood that the U.S. stock market will ultimately violate its March 2009 lows before the current adjustment cycle is complete.....Moreover, from a valuation standpoint, a further market trough would not even be "out of sample" in post-war data. Based on our standard valuation methods, the S&P 500 Index would have to drop to about 500 to match historical post-war points of secular undervaluation, such as June 1950, September 1974, and July 1982. We do not have to contemplate outcomes such as April 1932 (when the S&P 500 dropped to just 2.8 times its pre-Depression earnings peak) to allow for the possibility of further market difficulty in the coming years. Even strictly post-war data is sufficient to establish that the lows we observed in March 2009 did not represent anything close to generational undervaluation.

There is much more from his latest weekly update. It talks about inflation and deflation and gives warning to investors about gold. The very things I have talked about over and over the last several months. He brings up the point that the governments are running out of room.

Anyway very interesting read. I strongly believe the S&P 500 will be below 800 by the end of this year and put 50/50 odds that the market will have broken its March 2009 lows by the end of this year. As we have seen already (and this is the pregame show) when the markets begins unraveling this time it will do so very very quickly. We already have a much weaker system with much fewer options.

The next few days will be very interesting as we go into quarter end and start a new quarter. The next couple of weeks could be bloody. The question is if the markets can hold it together through Wednesday or not.


llano llama said...

This was interesting......

Even in 2002, the GSEs were producing large duration mismatches that threatened their solvency to a much greater extent that investors understood, which is one of the reasons I noted in January of that year " I don't even understand why Fannie Mae trades at all." Except for a note or two suggesting that my view was preposterous, nobody cared. But one can only play balance sheet roulette for so long.

A good example of the market remaining irrational longer than anyone could have remained solvent on the short side.

Market Seer said...

I think you could make the same claim with the U.S. government today. The government bubble is much bigger than any bubble we have seen. My guess is if we were comparing it to the U.S. houing bubble that we are somewhere near 2005 ish.

llano llama said...

This was interesting because I haven't seen this spelled out....

The way the bailout money is being used is that, for example, Fannie Mae is purchasing all mortgage loans in its MBS pools that are delinquent by more than four months. It effectively pays off the full mortgage balance on those homes, retires a portion of outstanding mortgage backed securities, and takes ownership of the collateral. Of course, none of those homes can be liquidated at anything close to their outstanding mortgage balances, but that's the deal that Fannie and Freddie made in return for a negligible insurance premium (G-fee), and that Tim Geithner graciously stands behind on behalf of the public. Accordingly, Fannie and Freddie are already sitting on 160,000 foreclosed homes, with losses escalating at public expense. Edward DeMarco, who oversees the government's conservation of Fannie and Freddie, observes "we cannot do this indefinitely."

themog said...

"Fortunately, the U.S. has not observed a systemic banking crisis of the recent magnitude since the Great Depression. Unfortunately, that also means that we have to broaden our data set in ways that investors currently don't seem to be contemplating."

"These lessons are not available to investors who restrict their attention to the past three or four decades of U.S. data."

As simple as these two statements are to anyone thats not an tenured economist or bonehead cnbc contributor, I really enjoyed seeing this as this point alone has nearly made me break my tv on multiple occasions. I think if I had to hear one more idiot justify how cheap stocks are by comparing this period to the typical post WWII recession my head was going to explode.

themog said...

"we cannot do this indefinitely."

how long until a politician is able to stand up and say enough. this is madness and it has to stop without being terrified of losing the next election? if you keep things simple and look at it from that perspective only i think it has to be self evident that a major bust is required to cleanse the system of all this crap. but how long will it take before people realize just because we are americans we arent entitled to a perpetual free lunch?

Market Seer said...


themog said...

Hahaha. Just heard another bonehead fund manager on cnbc state how great of a buying opportunity this was by referencing 11 data points since 1945 and how great returns were in those 11 instances. For additional humor his number one play is short treasuries. I wonder how that is working out.

Market Seer said...

Well did you break your tv when he said that like you threatened to? haha

themog said...

haha, no I spared my TV because it provided me with immediate laughter shortly after his first comment when he added that he loved shorting long treasuries because rates just couldnt stay this low for very long. i guess his thesis makes perfect sense in the context of 1945 on and according to many that is when economic history began.

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