Businomics Blog

Recession Buy Indicator Says: It's a Recession So Buy Stocks

That's contrarian, of course.  Barry Ritholtz over at The Big Picture has a good explanation.  Here's the nutshell: the "Recession Buy Indicator" looks at the four indicators in the Index of Coincident Indicators, and signals when each of these has declined over the past six months.  That's a rough measure of whether the economy is in recession, and the signal says buy stocks.

Right now the signal says BUY.

Why would it do that?  The stock market tends to be a leading indicator of the economy.  By the time it's obvious that we are a recession, we're stocks are already down.  Once everyone realizes we are in recession, the market is ready to look forward to the recovery.  As Ritholtz notes, there are some exceptions that would clobber an investor who mindlessly followed the rule.  Nonetheless, it's another bull signal.

China's Stock Market: Momentum Players Eventually Lost

In May 2007, I titled a post, "Is China's Stock Market Overvalued?"  I closed with these words:

"... don't get carried away with the momentum play.  It may work early in the cycle, but momentum investors always get burned when the market changes.

Let's take a look and see what happened.  The date of my previous post has a blue marker:

Is the Chinese market low enough to buy in now?  Keep in mind that the market has tripled in three years!  That does not strike me as low.

I still like Chinese investments as a diversification play, but I think it's a fool's game to go chasing price trends.

Bear Stearns Bailout: It's Not Who You Think

The quick read from the press is that the purchase of Bear Stearns by JPMorgan Chase was a "bailout."

Jim Hamilton over at EconBrowser doesn't buy that story.  He says, "$2 a share is no bailout, but instead represents a fire sale price."

I buy that, because Bear had been selling for $57 a share two trading days before the buyout.

But there's more to the story from the New York Times (hat tip to Barry Ritholtz):

Holders of the more than $300 billion in Bear Stearns bonds, in the meantime, are purchasing Bear stock to strengthen their hand in voting for the deal, thus guaranteeing that their bond investments will retain the backing of JPMorgan and its guarantor, the Federal Reserve Bank of New York.

That's who is getting bailed out: Bear's creditors, clients, and counter-parties.  The people whose due diligence was not very diligent.  The people who could help us avoid another debacle by being very, very careful in their credit analysis.

But no, care need not be taken.  If you are doing business with a large investment bank, don't worry. The Fed will bail you out if you are stupid enough to lend credit to an insolvent institution, or if you ask an insolvent institution to hold your securities, or if you pick an insolvent institution to be your counterparty in a derivatives contract.

Dr. Ben rode to the fire in a big red truck.  But his truck was leaking gasoline all over town, setting up the street for another major conflagration that could be far worse than the Bear Stearns fire.

Someone should have pulled Bernanke aside and told him to chill.  The economy is pretty resilient.  It can withstand a lot of turmoil.   Instead, the chairman is too afraid of financial turmoil, and as a result, he's going to get more of it.

Long-term Trends in the Global Capital Markets

The McKinsey Quarterly has an interesting article about the trends that will continue after the current financial market turbulence calms down.  (free, but registration required)  Here are their key trends:

• the continued growth and deepening of global capital markets as investors pour more money into equities, debt securities, bank deposits, and other assets around the world
• the soaring growth of financial markets in emerging economies and the growing ties between financial markets in developed and developing countries
• the shift of financial weight in Asia from Japan toward China and other fast-growing emerging markets
• the growing financial clout of the eurozone countries and the significance of the euro
• the burgeoning role of oil-rich Middle Eastern countries as suppliers of capital to the world, along with the rise of new financial hubs in the Middle East to complement the rapidly growing hubs in London and Asia

The first three make a lot of sense to me.  Here's where I'm not convinced.  The continued growth of the Eurozone countries and the Euro.  Why?  It was certainly a strong trend of the past decade, but what will drive it in the future?  Not internal growth; nobody expects strong growth there.  Competitive advantage?  Rule of law is strong there, much better than in most emerging markets, but you can get that in the U.S.  Market-friendly laws regarding financial institutions?  Sure, but again, you can find that in the U.S. to a large extent.  No Sarbanes-Oxley, so that helps, but the same Basel capital rules apply.  You'd have to tell me something that's not obvious to me before I'll accept this trend into the future.

The final trend, regarding the growth of the Middle Eastern countries, depends on their continuing to reap high profits from oil.  If oil prices stay up, I buy the trend.  But I think there's a good chance that prices have greatly overshot an equilibrium, and the the Middle East will have to take a step down.  But that's an open issue.

What difference does this make to a U.S. business?  First, you've had a strong competitive advantage in raising capital, compared to similar companies in other parts of the world.  You've just taken for granted the strong financial markets in both debt and equity.  However, your competitors overseas will gain easier access to finance, putting them on a nearly-level playing field in this regard.

Second, you may want to widen your perspective as you raise capital, especially if you're a Fortune 500 corporation.  There's lots of capital in overseas markets; don't limit your horizon to the United States financial markets.

Risk Spreads on Interest Rates: Time to Buy Risk?

Jim Picerno over at Capital Spectator has interesting charts about how risk is priced.  Here's one:

Yes, risky assets now have a much wider spread over treasuries than they did last year.  But that was almost entirely because risk earned such low returns last year.  Read Jim's comments about what Mr. Market is--and is not--telling us.

Here's my own narrow-field view:

It's cheaper to borrow if you have low risk, like you're Henry Paulson or Warren Buffett.  If you're credit quality is not pristine, it will cost you more--if anyone will lend to you at all.

What's this mean for the economy?  I still don't see the "credit crunch" people are talking about.  My conversations with bankers and corporate CFOs confirm that aside from the real estate development industry, credit-worthy companies are still able to borrow.  It's hard to have a recession in your economic forecast without the credit crunch.

Who Benefits from the Subprime Mess?

Roger Ehrenberg ( a fellow contributor to Seeking Alpha) has an insightful post on this topic:

who stands to gain from general economic and capital markets uncertainty? I'll tell you - those who have balance sheet capacity and abundant liquidity to pick up bargains while others are suffering. Where capital was once incomprehensibly cheap and available it is now both dear and scarce. And this about-face took less than six months to unfold. Quite simply, capital is no longer a commodity.

Berkshire Hathaway was the first name to come to my mind, but Roger has others.

Global Stock Markets: Some Perspective

Let's get some perspective on the stock markets around the world:

thanks to Dae Beck of the Oregon Office of Economic Analysis for passing these to me.

When Banks and Investment Houses Dump Bad Assets

Barry Ritholtz over at The Big Picture has a good insight into the new guy at Bear Stearns.  Last summer he anticipated a change in senior management and said this:

“Just wait until Jimmy Cayne gets dinged out of Bear Stearns. The new CEO will look at all the junk on the books – problems he had nothing whatsoever to do with – and likely say ‘Get all this shit off of my books. All of it. I don’t care what it cost, I don’t care what its worth, I want all this garbage outta here.’ ”

I tend to be a rational markets kind of guy, but Barry has the right tone for a senior executive.  Banks and investment houses will, indeed, sell far too cheaply just to get rid of the problem.  Remember the commercial lending crisis back in the early 1990s?  The bank I worked for went to customers who had never missed a payment and offered to accept 90 cents on the dollar as full payment--if they would just get their real estate loans off our balance sheet.

Bottom fishing time in the subprime market?  It's tempting, but I'd want to run some very exhaustive foreclosure simulations first to be sure I understood the value of what I was buying.  Valuing modern mortgage-backed computers is not something you do on your old HP calculator.

Investment Returns in 2007

One thing I like about the Capital Spectator is Jim's regular presentation of investment returns by asset class.  Here's what happened in 2007:

When I reproduce these, I assume that all Businomics blog readers are smart enough to know that past performance does not tell you what 2008 holds in store.  My best guess: top performers will be U.S. stocks and foreign developed stocks.  (Note: stock market forecasts are presented for entertainment purposes only and should not be used for investments.)

To provide some humility, look at this baby:

Index Mutual Funds: An Interview with Paul Merriman

Paul Merriman is a guru of investing with index funds.  I interviewed him for the Businomics Audio Magazine.  You can listen to his insights here.

Also available on the interviews page: Marsha Egan on email productivity, Mish on the economic outlook for 2008, Mark Sanborn on leadership, Dan Harris on China, and Mark Thoma on the Great Moderation.