Recession or BS?

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colin_twiggs

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Friday, November 23, 2007 - 10:06 am:

Mail received concerning Thursday's Recession Warning newsletter:

Colin, I call BS on your latest email. I don't believe your statement: "whenever the yield spread (maroon line) falls to zero, a recession follows." There have only been two official recessions since 1981 in the United States, and it took Gulf War I, the dot.com tech stock bubble, and 9/11 to cause these two recessions. History has shown that it takes extraordinary events to throw the US into an actual recession with two consecutive quarters of negative growth. The liberal media is working overtime to talk our economy into recession, and the last thing we need is objective people like you throwing out unsubstantiated statements about our economy. If you're going to make a statement like that, then show us all the data you used to reach that conclusion. If you're right, then there should only be two occasions when the yield spread fell to zero since 1981. OK, I'm waiting for you to show us your data. Good luck with that, J.W.

Thank you for writing, I enjoy a good debate on issues like this. The data I use is obtained from the Federal Reserve and is presented in the chart below:

ylds

You will note that each NBER certified recession in the last 45 years is preceded by the [maroon line] yield differential (10-year minus 3-month treasury yields) falling to zero. This squeezes bank interest margins causing a tightening of credit and a consequent slow-down of consumer spending and new investment -- which drags the economy into a recession.

The banks thought that they had found away around this: lending on narrow margins and then on-selling the loans into off-balance sheet SIVs in order to avoid the reserve requirements. All this achieved was to postpone the inevitable -- lending on narrow margins is and always shall be bad banking practice, no matter what clever structures are developed to hide this from investors/regulators. What the banks actually achieved was to leverage the problem and allow it to fester into a far bigger crisis than the original threat.

Regarding your points:

The US economy is able to withstand one-off shocks like 9/11 and Hurricane Katrina. The 2001 recession started in March of 2001 according to the NBER - well before 9/11.
Wars can create uncertainty and push the economy into a recession if they are seen as a serious threat to the country as in WW1 and WW2, but smaller conflicts have more of a stimulatory effect due to increased defense spending. Edward Leamer, professor of economics at UCLA, points out that defense spending on the Korean War rescued the economy from recession in 1951 and the Vietnam War performed a similar service in 1967. These are the only two times since 1946 that a housing collapse has not led to a full-blown recession. There is similarly no evidence to suggest that the Gulf War caused the recession in 1991.
Slow-down in software investment after Y2K certainly contributed to the recession in 2001, but this on its own would not have caused a recession: the contagion has to spread to the broader economy. And the most effective vector for spreading infection is the banking system, where a $1 reduction in reserves has a $10 impact on bank lending (and consequently on spending).

What we are witnessing is serious and protracted mis-management of the US economy, where interference with the market-related interest rates has caused a series of consecutive shocks; each shock of greater magnitude than the last -- and requiring a more severe response. The last three recessions have each required more drastic action from the Fed, with lower interest rates than the preceding cycle. The Fed had to lower interest rates to 40 year lows in order to stimulate the last recovery. This is a self-reinforcing cycle, with each wave bigger than the last; so where do we go to from here? The longer we try to postpone the inevitable, the worse it will become.

There are some very clever people running the Fed, but there are also clever people running Citigroup and Merrill Lynch. The problem with clever people is that they are prone to over-estimating their own ability.

The market is more powerful than any individual or organization and if you try to force it away from its natural equilibrium, opposing pressure will gradually build until it becomes an irresistible force.

Regards, Colin

(Message edited by colin_twiggs on November 24, 2007)

holycow

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Friday, November 23, 2007 - 11:12 am:

Colin,

I have attached the latest cpi numbers for your reference. You can get the whole thingy here: http://www.bls.gov/news.release/cpi.nr0.htm

The point I am trying to make is this - "official" numbers are tricky stuffs. So if you are going to debate an "official recession", I think, it is going to be a very long winded and probably a useless exercise.

In general, I believe the on going credit crunch, the dramatic and drastic decline of the US$ and the unprecedented high oil price are "extraordinary(enough) events" that will provide the impetus for a recession. But whether we will ever see an official acknowledgement is another matter.

Cheers.

a very "lame" inflation if we exclude both energy and food, but we know how "inflated" their prices are!

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tbreak

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Friday, November 23, 2007 - 02:41 pm:

There might be a rabbit in the hat yet TA wise

saved

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Tuesday, November 27, 2007 - 01:17 pm:

Colin,
What do you mean by "crash". I can see a major correction coming! Do you think it could have a quick knee jerk reaction, then back down? Reason I ask is a lot of companies have good balance sheets " cash to ride out a storm" and a lot people are in cash right now, being out stocks and bonds all together. I know my stock accounts are virtually cash minus my short term TA trades. Looking for input on how this could all play out. Got to admit I have been following your news letter for about 8 months, and I'm totally blow away how accurate you have been.

colin_twiggs

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Wednesday, November 28, 2007 - 10:10 am:

Saved, By "Crash" I mean a bear market.

Arguments for this include:

A negative yield curve in 2006/2007
the Fed making cuts to the fed funds rate
the full impact of the subprime crisis has not been felt yet
Fedex, often a lead indicator for the economy, broke out below long-term support at $100 and is falling sharply
Dow Jones Transport index is in a primary down-trend
Dow Industrials closed below primary support at 12800, signaling the start of a bear market

Arguments against:

price earnings ratio is 18, indicating the market is in stage 2 rather than stage 3
DJIA reversed above 12800 today

I would say the chances of a bear market are 80 per cent or higher. The only thing keeping the market afloat is the Fed pumping more money into the economy, but this is a "hair of the dog" cure that will only create bigger problems down the track.

Thank you for your support. Please spread the word about our newsletters. The only way we can maintain our free service in the long-term is by expanding our readership.

Regards,
Colin

saved

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Wednesday, November 28, 2007 - 11:34 am:

Thanks for your reply. I would think in the current downward channel that a DIJA close above 12800 is still expectable. I thought today's resistance was about 12970, I guess will see if we can close above 13000 near term. On a side note I'm definitely want to order your chart service...just need to find a way and time to tutor myself to use them correctly. I do really like your stuff.

captain_chaza

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Wednesday, November 28, 2007 - 06:12 pm:

I don't think MAN (as in Mankind) will ever see a Recession again
On Earth, Mars or Jupiter and including those on space shuttles

It just can't happen
BECAUSE
It won't be allowed to happen.

Didn't ya know that the Global Exchanges can now be tweaked like clockwork?

(Just allow for a little time delay for tweaking and Leeway))

SO Why Worry?

Just appreciate that NOT all boats rise and fall with the tides

Some are designed and are being developed for this new age but some are not

It always gets back to the BASIC'S of SEAMANSHIP

"The Wind Calls the Tune"
AND
"Ship Design is Everything"

Salute and Gods' speed

"While we stop and think, we often miss our opportunity." Publilius Syrus, 1st century B.C.

"I believe the future is only the past again, entered through another gate."
Sir Arthur Wing Pinero 1893

"There are two times in a man's life when he should not speculate: When he can't afford it, and when he can." Mark Twain, 1897

colin_twiggs

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Wednesday, November 28, 2007 - 08:47 pm:

Saved,

We could have more consolidation or a reaction above 12800 before the follow-through.

djia

Regarding your second question: have you tried the Getting Started pages?

Regards,
Colin

trader888

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Wednesday, November 28, 2007 - 11:25 pm:

Some charts for discussion regard OZ market.
main message : I agree with Colin that there are signs of a "bear" market coming. Stock market is a probability and risk management game. The risk to the downside is significant. It may not happen as "The Captain" point out - The big brothers are pumping $$$$ into the market, but are enough warning signs out there for me to exercise 3 Rs : Rest . Relaxation . Recreation . Holiday Season coming - I am 70 % Cash 30 % in my life-long stocks. Live to fight another day.

Let me make some basic comments on charts above.

chart1: XAO - now at Stan Weinstein 150WMA / also at level support . Interesting to see if there is a boucce. A break of support level is very bearish

chart2: A-D graph / 200MA ( Stan Weinstein book ) - Few interesting . A-D peak inFeb 2007 then XAO continue to rally. Noted A-D divergence. In Aug A-D drop below 200MA. Stan Weintein MI look bearish. All these are classic signs of market top. Just remember when the herb start to sell it can a very messy sight. Again i don't forcast panic sell may not happen. I like to watch and react.

chart3: Classic 52 Hi - Lo chart showing peroids of corrections / volality

chart4: Show Relative strength large cap/ mid cap / small cap . Note since Feb 2007 LArge caps outperform Again its a signs bull market is under pressure

chart5: Messy chart ( relative strength sectors ) Noted sector leaders : energy / material peak early oct and now trending down . Sectors Health / Consumer staples trend up -- Classical signs of market top..

Happy trading

Regards

eblode

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Thursday, November 29, 2007 - 09:01 am:

Bye,Bye bear market. DOW 321

Eugenio

colin_twiggs

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Wednesday, December 05, 2007 - 01:05 pm:

Des2,
Where did your post disappear to?
The longer-term channels do not have much use in warning of primary trend changes. Here is an example of an S&P 500 channel drawn from 1982 to 1987.

spx

Higher GDP growth is a surprise, but we should not under-estimate the turmoil in the financial sector and the impact that this can have on the entire economy. We need to be exceedingly cautious until this has played out.

I welcome the news that HSBC is unwinding its two SIVs and taking the assets back on their balance sheet. That is the best way to restore confidence. The fact that other banks have not done likewise will leave investors questioning their ability to do so (i.e. their solvency).

Regards,
Colin

cat_lady

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Wednesday, December 05, 2007 - 02:07 pm:

Colin

it was my understanding that the other banks were going to be part of the formation of the super SIV(M-LEC). Last I read was that Bank of America, Citicorp and JP Morgan Chase & Co. had agreed on a structure and that Blackrock would manage the assets. although I'd leave it to others more qualified to judge, the opinion piece I read indicated that "the engagement of Blackrock is the first hopeful sign that this plan may yield some productive results since the firm has the expertise and resources to bring value to the project."

HSBC's going it alone was regarded by some commnetators as a negative :

"since it meant HSBC would not be participating in the Super-SIV, but HSBC would seem to be doing more than its part by assuming $45 billion of the estimated $300 billion problem"

cat lady

Without my morning coffee I might as well be a dog

colin_twiggs

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Wednesday, December 05, 2007 - 02:46 pm:

cat lady,

Creating a super-SIV to replace other SIVs is unlikely to solve the problem. HSBC's direct route is the most transparent and will restore confidence a lot quicker -- but you have to have the capital reserves to be able to do this (something Citigroup and others may not have).

Regards, Colin

maxboost

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Wednesday, December 05, 2007 - 03:41 pm:

Hi Colin,
I agree with you, the only reason Citi Group and the others are doing this is because they dont have the capital.

Regards

des2

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Friday, December 07, 2007 - 09:03 am:

colin

thanks for your reply post. im not sure what happened to my post - i think i may have hit a wrong button and deleted the damn thing!

the point i was trying to make has subsequently been alluded to by captain chaza ie some analysts are suggesting that recessions are economic phenomena experienced in a former era of poorer communication, market understanding and statistical validity. as far as i can find out, there are currently only 4 nations in recession worldwide - zimbabwe, fiji, somalia and north korea - EVERYONE else is growing. [this includes the US which amended up its september quarter growth rate UP from 3.9 to 4.9% last week!] how can we possibly add the US to this list..really?

you have already answered my question regarding long term channels, but can you suggest the timeframe of the yield curve predictivity? am i correct in suggesting that there is a 12 month lag between the first zero signal and the onset of negative economic growth?

this is VERY important as a 12 month buffer has implications for how we behave NOW.

thanks again for your responses - all extremely interesting stuff. we love it!

des

colin_twiggs

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Friday, December 07, 2007 - 11:19 am:

Des2,
If the US joins the list of countries in recession they will have plenty of company (a lot of exporters to the US will be dragged down with them).

The normal time frame for the yield curve is 6 to 12 months. That is how long it takes to impact on bank credit and on investment/consumption.

Regards,
Colin

colin_twiggs

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Friday, December 14, 2007 - 07:59 am:

Question received from JM in South Korea:

Colin, How much weight are you giving to the fact that we are in a presidential election year in the US? You have alot of compelling evidence of an imminent recession. On the other hand, the Fed historically takes extra care in avoiding negative economic circumstances so as not to affect the election.

The Fed normally does its best to postpone the inevitable -- election year or not. It can improve liquidity by pumping new money into the economy, but solvency issues are more difficult.

What we are witnessing is the collapse of a speculative housing bubble, with mortgages increasingly outstripping the value of the underlying properties. The only obvious cure is to lower interest rates to such an extent that it sets off another speculative housing boom -- and then wait for an even bigger crash later.

Regards, Colin

hilarius

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Friday, December 14, 2007 - 08:34 am:

Colin

I'm all for financial discipline and not throwing liquidity petrol on a burning fire caused by past excess liquidity

On the other hand there is the well known principle of containing a bush fire by burning a containment line

Is there not a middle course of providing sufficient liquidity, at appropriate interest rate levels, to enable the excess stock of new housing in the USA to be cleared and a moderate rate of new construction?

This would have the double benefit of keeping people in their homes and at work, rather than out of their homes and on the street

So I am not sure that another speculative bubble needs to follow such a moderated stimulus, especially with the housing industry in the USA in such dire straits

Certainly this means bringing forward some demand for housing, but not necessarily another demand boom

So I would advocate some stimulus to the housing sector but not a lot

The Via Media

With Best Wishes

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

colin_twiggs

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Friday, December 14, 2007 - 09:52 am:

Hilarius,

Perceptions, when they have become entrenched, are difficult to alter. How much liquidity would be required to make housing purchases attractive at existing prices? I suspect that real interest rates would have to fall to near zero.

Regards, Colin

hilarius

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Friday, December 14, 2007 - 10:23 am:

Colin

It is a tough balancing act

I think you are alluding to the disparity between fear based behaviour and fundamental value questions, with the latter being affected by the former

My concept is to take the action needed to fix the fundamental housing over-supply ... that much and no more

Given the fear factor it may be more than the fundamentals justify but less than the fearful are demanding

As and when the fear dissipates the brakes can reasonably be re-applied with higher interest rates

In the meantime I advocate sufficient liquidity to maintain employment levels ... something that was not fully understood in the Great Depression when credit was restricted by Central Banks ... a cure from which many patients died

Also in the Great Depression trade barriers were erected ... now the benefits of a low US Dollar should greatly stimulate US exports

There is always a silver lining ... and if perceptions are what we are discussing silver linings need to be highlighted

Sadly the USA has a lame duck President who is seen to be losing two overseas wars when he could have focused on one

Napoleon and Hitler have been there before and we know what happened to them ... but France and Germany survived and prospered despite their worst efforts

Can America find a leader for the times ... I worry about that

Cheers and Best Wishes

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

colin_twiggs

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Friday, December 14, 2007 - 10:49 am:

Hilarius,

Housing prices are a function of supply and demand. If we assume supply is fixed, the only way to increase demand is by lowering prices. There are two ways of doing this: (1) lower housing prices (2) lower interest rates to make houses more affordable. Both have their disadvantages.

As for supply, lower interest rates may reduce the number of forced sales.

What tipped the US into the Great Depression was the rash of bank failures. Something the Fed is doing its utmost to avoid.

Regards,
Colin

hilarius

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Friday, December 14, 2007 - 10:58 am:

Colin

I agree

Another factor in demand is capacity to purchase

Hence employment stimulated by exports (lower US dollar) should play a key role

It seems to me the following are good indicators of economic health (capacity to purchase) :-

(1) Exports
(2) Employment
(3) Capital Spending

These will be well worth watching closely

Regards

Hilarius

I come in peace to share my thoughts and to shine my candle light on possible long term opportunities

coyotte

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Friday, December 14, 2007 - 11:29 am:

This unfortunately is a trait of Capitalist Systems -- as soon as Speculators enter the Market a Bubble develops.

Would have thought the approach that Hawke/Keating initially had was fair better -- remove the Tax incentives on basic Family Housing, allowing housing prices to then drop to a level where the avg family can then afford their own home .

You only have to look at what happened when they done this -- basic housing prices stagnated for near a decade , housing became affordable to the point it was cheaper to buy then rent --- as soon as they reintroduced Negative Gearing it was the sowing of the seeds for the " Recession we had to have " --- could not believe it at the time , we had done the hard yakka -- prices had stablized then they turned around and done this !

Cheers

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