Fin/Inv

The Federal Reserve’s minutes were released at 2:00 pm today.  As we’ve been discussing all week, there is a discord among Federal Reserve members.  The degree of dissent is increasing which goes to show they simply don’t know what to do anymore and proves our theory that they are officially out of bullets no matter what they say otherwise.  At this point in time it is all double-speak with the right hand not knowing what the left hand is doing.  Actions of the past have put the Federal Reserve in a pickle.  Do they go full out with QE2 or do they risk deflationary risks. Some comments from the minutes:

“members generally judged that the economic outlook had softened somewhat more than they had anticipated, particularly for the near term, and some saw increased downside risks to the outlook for both growth and inflation. Some members expressed a concern that in this context any further adverse shocks could have disproportionate effects, resulting in a significant slowing in growth going forward”

“Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain, and a few thought that the economic effects of reinvesting principal from agency debt and MBS likely would be quite small. Most members judged, in light of current conditions in the MBS market and the Committee's desire to normalize the composition of the Federal Reserve's portfolio, that it would be better to reinvest in longer-term Treasury securities than in MBS. While reinvesting in Treasury securities was seen as preferable given current market conditions, reinvesting in MBS might become desirable if conditions were to change. A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee's readiness to resume large-scale asset purchases”

In other words, they are caught between a rock and a hard place.  They are fully aware that the economy is softening again and that the first record stimulus and backing did nothing to stem the eventual double dip that is fast approaching.  Do they do it again, knowing full well they are just passing the problem down the assembly line again?  There is an obvious  great divide between Federal Reserve Presidents, don’t expect an real action soon.  Markets don’t like uncertainty…perhaps this is why the market turned red shortly after the release of the minutes.

As I have been preaching for the better part of a year…..the market must purge itself of this problem naturally.  The Free Market must reign and all the bad debt in the system has to work itself out naturally.  Yes, this will result in tough times and have enormous consequences for a while but the end result will be a purged and clean system.

Heroine addicts have often been given methadone to control their addiction.  However, what you are essentially doing is getting them dependant on one drug in order to counter the effects of the other.  They are still addicts, addicted to a legalized drug.  Stimulus is the same.  You are injecting the economy with a drug to keep it afloat but you know full well that the ramifications of that action are detrimental in the long run.  You cure the heroine addict by detoxifying him….cleansing his body of the drug and getting him clean and sobre, not by hooking him up with another drug.  This is the same with the economy.  Purge the system, it will be hard as the economy goes into “economic withdrawal” but having cleaned itself naturally, we will all be better off aftwards.

Obviously the first artificial high of the stimulus didn’t work.  That is painfully obvious to anyone who wants to pay attention.  GDP numbers and other economic data shows that the economy is slipping back into recession with the removal of the stimulus programs.  What’s the difference this time around?  Are we going to stimulate again simply to stave off recession for another year or so?

In not so many words, members of the Federal Reserve know this.  They know this dilemma.  The question is, can we trust them to do the right thing?  If history is a lesson, don’t count on it.

The following was written by Lakshman Achuthan and Anirvan Banerji, co-founders of ECRI:

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“As Geoffrey H. Moore once reminded us, if you can ‘predict’ a recession just as it’s beginning you are doing very well as a forecaster.” We recalled our mentor’s observation in our book, Beating the Business Cycle, and it’s just as relevant today as it ever was.

With the economy slowing, the double-dip recession debate has naturally assumed center stage. Perhaps you already know something about the Economic Cycle Research Institute (ECRI) or the Weekly Leading Index from your favorite analyst, commentator or blog. But, as debates go, this one is becoming heated and ECRI is being misrepresented more often than not. We write this note in an effort to address the more extreme misperceptions.

Recent diatribes from investment managers with blogs have culminated in an accusation that we are dishonest when it comes to ECRI’s forecast track record in the lead-up to the 2007-09 recession. Having ECRI’s forecast challenged is nothing new, but we’ve never had our professional integrity called into question, until now. Criticism of our work comes with the territory, but such charges do not. Therefore we ask you to consider what’s been left out of that narrative and, more importantly, why. Inquiring minds would surely investigate before accepting such character assassination.

One would find that the facts are willfully misrepresented, perhaps in an attempt to undermine ECRI’s credibility when expedient. Our detractor’s declaration is based on a cherry-picked quote from a PowerPoint file (including discussion notes) that we posted on our website on October 5, 2009. Ten months later, on Aug. 4, 2010, the charge was that “ECRI is caught” in an “Outright Lie,” saying that we claim to have forecast the recession in November 2007. This is simply made up.

Evidence offered to support this allegation resides on the third slide of 23 from an October 2009 ECRI presentation titled The Great Recession and Recovery. That slide shows our Weekly Leading Index (WLI) and includes an ECRI discussion note for the presentation saying that the WLI has been around for over a quarter century and that “it has correctly predicted every recession and recovery in real-time.”

In fact, that statement is undeniably true. The WLI peaked and went into a cyclical downturn six months before the recession began. So this is hardly a smoking gun.

In evaluating the performance of any leading indicator, the key question is whether its cyclical turn occurred before the cyclical turn in the economy. If so, the follow-on question is whether that lead occurred in real time, or showed up only in revised data. In the case in question the WLI peak occurred well before the business cycle peak, in real time. That was the point of that slide.

But, nowhere on the slide in question does ECRI claim to have predicted the recession. Nowhere do we equate ECRI to the WLI. To the contrary, a few slides later, we say that ECRI called the recession in March 2008. It’s inconceivable that anyone attending the actual presentation, or reviewing the presentation in retrospect, could come away believing otherwise.

To be clear, our detractors are capable of understanding what we’ve been saying all along. On July 20, 2010 they wrote:

“I suppose you can see how confusing this is when the WLI ‘has correctly predicted every recession and recovery in real time’ yet Lakshman Achuthan also says … ‘In fact, at the very least, ECRI itself would need to see a ‘pronounced, pervasive and persistent’ decline in the level of the WLI (not merely negative readings in its growth rate) following a ‘pronounced, pervasive and persistent’ decline in ECRI’s U.S. Long Leading Index (not discussed in the article), before it makes a recession call.’ That is a clear statement that the WLI cannot in and of itself predict anything unless it follows the ECRI’s U.S. Long Leading Index.”

That focus on our “clear statement” is correct. In fact, ECRI interprets the WLI in the context of our full array of leading indexes (including the Long Leading Index) as outlined in chapter seven of Beating the Business Cycle (Doubleday, 2004). And yet, these critics try to malign ECRI by conflating the WLI’s movements with ECRI’s recession calls.

The Whole Truth

Just go to The Great Recession and Recovery, which provides a clear timeline of ECRI’s forecasts from the fall of 2007 through summer 2009. We encourage you to examine the full presentation firsthand, but here are the pertinent slides from that presentation, starting with the third slide:

click for larger charts

After reading these slides would you really be left with the impression that ECRI claims to have called the recession before March 2008? We don’t think so. Yet if you only saw carefully selected “snips,” while critical parts were withheld, you might understandably begin to doubt ECRI’s honesty.

An aside: why did ECRI hold off on calling recession until March 2008? That’s a whole other story, but we believed at the time, as we believe today, that the recession didn’t have to begin or evolve the way that it did.

Stepping back, it’s important to note that this presentation was hardly the only place where we discussed our recession call in retrospect. Take a look, for instance, at our Oct. 2, 2009 article, prominently displayed for months on our website, which explicitly identifies March 2008 as our official recession call date. There’s no doubt about when we say we made our recession call.

Furthermore, that same article emphatically disproves another line of criticism from naysayers: that ECRI is so scared to make recession calls that by the time we make them they’re useless. To summarize our article, even if you were to be as simplistic as to sell stocks when ECRI says recession and buy stocks when we say recovery, those would be very valuable calls. Here’s what would have happened over the past cycle:

A Measure of Value

If you sold the S&P 500 the day we made our “late” recession call in March 2008, you’d have sidestepped 72% of the cyclical bear market decline (from the October 2007 high to the March 2009 low). Then, if you had bought stocks on the very day in April 2009 we made a recovery call, you’d still have enjoyed 64% of the cyclical bull market in stocks (from the March 2009 low to the April 2010 high) – not bad considering that the first 25% of that rally occurred within two weeks of the market bottom.

If instead you’d had a buy-and-hold strategy for stocks, then at the April 2010 market peak, you’d still be down 16% compared with the October 2007 market peak. But if you’d sold stocks the day we said recession and bought stocks the day we said recovery, you’d be up 39% since October 2007, beating the S&P by 55 percentage points.

Finally, on February 5, 2010, we discussed a chart of the Long Leading Index on CNBC, highlighting the risk of a new downturn in stock prices, which began just two months later. Just how much more does a free service have to do in order to be deemed useful?

Now, please understand that ECRI will never be perfect, and, in any case, we aren’t in the business of making market calls. So, why would some people go to such lengths in an attempt to undercut our credibility? We don’t know, but in this case a search of the fund manager’s blog shows that promotion or criticism of our work seems to depend on whether we reinforce or challenge his views.

Cycles of Credibility?

For example, on Oct. 18, 2008, the WLI and ECRI are held up as supporting evidence for a pessimistic view of the economy with headlines like “Leading Indicators at 33 Year Low,” going on to quote us directly: “With its biggest weekly plunge in 37 years WLI growth has dived to a new 33-year low. This data objectively shows that financial market turmoil is rapidly worsening an already-grim recessionary outlook.”

But a year later, after ECRI forecast a recovery, our views are no longer validating the pessimistic consensus and are therefore suspect – as seen on Oct. 8, 2009, with headlines like, “Can We Really Trust The Leading Economic Indicators?” There followed a list of statements we had recently made about the upturn such as: “With WLI growth continuing to surge through late summer, a double dip back into recession in the fourth quarter is simply out of the question.” (Aug. ’09)

The investment manager went on to share his newfound skepticism: “…what I suspect but cannot prove, is the LEI or WLI (Weekly Leading Index) criteria applied to data in 1930 would have shown something that did not happen: a big recovery was coming.” Then by May 28, 2010 there is a switch back to once again promoting the WLI: “ECRI Leading Indicators Dip Again; Is a Double-Dip Recession Coming?”

If you look at the history, there’s a clear lack of consistency in these arguments. But this is just one example of attacks on ECRI. Far more important is a broad misunderstanding of what ECRI is all about. Where does that come from?

Confirmation Bias

A big part of the “problem” may lie with ECRI’s impressive track record.

Those with a bullish or bearish agenda may be threatened when ECRI or the WLI makes – or seems to make – a call that challenges their views. As we saw a few months ago, when the WLI moves in a way that reinforces the views of one camp and contradicts the views of the other, the former group (in this case, the bearish camp) extols its accuracy while the other (in this case, the bullish camp) tries to explain it away or find flaws with the WLI itself.

Last fall it was this need to challenge ECRI, given its track record, that drove Paul Krugman to applaud an investment manager’s “awesome takedown” of ECRI. Overcoming ideological differences, they were patting each other on the back for impugning our track record.<
Because the respective agendas of these otherwise strange bedfellows required the U.S. recession to persist, ECRI’s economic recovery call stood in their way. At the time, we defended ourselves in detail, and requested Mr. Krugman to acknowledge the correctness of our call if, a year later (i.e., two months from now), ECRI was proven right. Despite four straight quarters of positive GDP growth and seven consecutive months of positive private sector job growth thus far, we’d be surprised if he ever admits the accuracy of our forecast.

In defense of his views, and in an apparent attempt to undercut the credibility of ECRI’s forecast, Mr. Krugman wrote at the time that “this is a really, really bad time to be relying on conventional indicators… historical correlations, to the extent that they exist… can’t be counted on to prevail.” Please make note of this critique, because there are many variations on this theme, rooted in a fundamental misunderstanding of ECRI’s indexes and methods shared by the overwhelming majority of observers.

There are a number of valid ways to describe ECRI’s leading indexes, but “conventional” is not one of them. In fact, the implicit suggestion that the WLI cannot be relied upon because “historical correlations… can’t be counted on” is revealing, and completely off-base – because the construction of ECRI’s leading indexes isn’t rooted in historical correlations or regressions, or in the back-fitting of data. This seems incomprehensible to most conventional economists – monetarists, Keynesians, and everybody in between – because the pseudo-science of econometrics is the only analytical approach they’ve ever been taught. Very few of our critics (or admirers, for that matter) appreciate the fact that we don’t use models because they are singularly unsuited to business cycle analysis – even though we’ve said this six ways to Sunday.

Thus, some critics question our work based on their belief that “historical correlations” wouldn’t prevail in this cycle, unaware that this wouldn’t affect the performance of our indexes, since they aren’t fitted to back data anyway. And detractors, implying that our indexes must have been fitted to the postwar period, suspect that the “WLI criteria applied to data in 1930 would have shown something that did not happen: a big recovery was coming” – unaware that, while the WLI goes back only to 1949, other ECRI leading indexes, including the U.S. Long Leading Index, work very well in the 1930s and earlier decades in predicting recessions and recoveries – without any attempt at data fitting.

When we make such statements, they are typically ignored or met with a wall of disbelief. Indeed, conventional economists – which is to say, virtually all economists – have so thoroughly embraced the “scientific” model-based approach to economic analysis that it’s hard for them to imagine that any other approach could possibly exist.

Physics Envy

At this point we are reminded of Friedrich von Hayek’s trenchant critique of economists’ analytical methods during his 1974 Nobel lecture: “It seems to me that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences – an attempt which in our field may lead to outright error. It is an approach which has come to be described as the ‘scientistic’ attitude – an attitude which, as I defined it some thirty years ago, ‘is decidedly unscientific in the true sense of the word, since it involves a mechanical and uncritical application of habits of thought to fields different from those in which they have been formed.’”

This “physics envy,” as we explain in Beating the Business Cycle, is the nub of the matter. While model-based approaches to analysis are often appropriate in the hard sciences, they aren’t always suited to economics, and are singularly inappropriate for the analysis and prediction of business cycles, which are rooted in a highly complex non-linear system, with myriad feedback loops, lags, threshold effects and diffusion processes, that are virtually impossible to specify properly in the context of a constantly evolving global economy. A model optimized to fit a specific past time period will not only be sub-optimal for the future, but also result in highly inaccurate forecasts if economic conditions are very different from those for which the model is optimized. Moreover, if linearized models are used, as is often the case, in place of more appropriate but statistically intractable non-linear models, the model specification errors may result in wildly inaccurate forecasts.

Because our research group is keenly aware of these issues, we have always eschewed a model-oriented optimization-based approach to business cycle forecasting. ECRI’s focus has always been on robustness, i.e., making sure our leading indexes’ turning points consistently anticipate the economy’s turning points, even in the face of major structural changes. This has been the secret of ECRI’s long-term success, and the reason why our leading indexes once again turned down months before the Great Recession in 2007, and turned up before the recovery in 2009 when the overwhelming consensus was dead against an economic recovery forecast.

But our approach is also inconsistent with recently popular notions – once again based on conventional back-fitting of data – that, somehow, when the WLI growth rate hits a specific negative number, a recession always follows. Firstly, it’s the WLI itself, not its growth rate (i.e., its speed of descent), that’s designed to predict economic recession and recovery. Secondly, historical data going back six decades shows that the nice round number of minus 10% doesn’t work too well anyway as a recession signal. But, most importantly – regardless of unfounded accusations that we’ve “abandoned” our own indexes just because we distance ourselves from these simplistic data-mining exercises – the whole idea is fundamentally flawed. In other words, it’s a bit naïve to believe that some variety of data fitting based on conventional statistics using the WLI will tell you how to predict recession and recovery – especially if, as our critics never tire of asserting, it’s different this time.

To add to the confusion, there’s a belief in certain quarters that some of the most prominent analysts who’ve highlighted the WLI also have access to ECRI’s Long Leading Index (LLI), which looks further ahead. Let’s be clear: they don’t. And some who’ve tried to guess the LLI’s moves based on what they know of other leading indexes have also been way off base.

Separately, few analysts crunching the WLI data realize they shouldn’t be using the WLI in regression models – to make GDP forecasts, for instance. To cite a classic textbook[2] on forecasting, leading indexes – including the WLI – are “intended only to forecast the timing of turning points and not the size of the forthcoming downswing or upswing, nor to be a general indicator of the economy at times other than near turning points.” It therefore warns against using “standard statistical techniques” to draw inferences from leading indexes.

While such techniques require certain assumptions, ECRI’s approach – unlike econometric models – makes virtually no assumptions that could be invalidated. This is a great advantage in “unusually uncertain” times. Yet, by sidestepping models, we also constrain what we can predict. Keenly aware of the limitations of our tools, we focus on turning point forecasts – not magnitude forecasts – whether about GDP growth or the jobless rate. This is also why we avoid advocating or decrying any specific policy measure, except rarely, in the narrow context of policy timing.

A key danger of being wedded to any particular ideology or market view is confirmation bias – the tendency to selectively focus on evidence supporting what one already believes or wants to be true. The resultant lack of objectivity is an enemy of forecast accuracy. That’s why we don’t belong to any particular “camp,” accusations notwithstanding. When our objective leading indexes change cyclical direction, we change our view about the economy’s direction, period. As a result, we find ourselves being alternately feted and reviled by liberals and conservatives, bulls and bears, while we stick to our knitting.

As Good as It Gets

Predicting the economy’s turning points is really hard, and we know that we’ll inevitably make mistakes. That’s why – instead of developing back-fitted models – the entire thrust of ECRI’s research over the decades has been to stress-test our leading indexes under a variety of structural conditions in dozens of economies, understand the conditions under which the approach would break down, and design a durable system of indicators that’ll keep working even under unusual circumstances.

Sure, there are many questions about the economy our tools don’t help us address. For instance, based on our leading indexes we couldn’t tell you what the economy will be doing in the second half of 2011. Dr. Moore taught us that we shouldn’t try to “predict the predictors,” and we’ve learned over the years that he was right. In such a complex economy, we simply aren’t smart enough to know which way they’ll head. What we can do is to closely monitor our array of leading indexes, knowing that they’ve rarely led us astray.

ECRI isn’t in competition to be the first to proclaim recession or recovery. But we strive to make our objective turning point calls both highly reliable and timely enough to be useful to decision makers.

We also spend a good deal of time thinking about the broad backdrop against which these shorter-term cyclical fluctuations occur, and in early 2009 these thoughts brought us to the inescapable conclusion that this decade will see more frequent recessions than most of us remember. These frequent recessions will result from the convergence of higher cyclical volatility and lower trend growth during expansions.

Keeping this in mind, please understand that ECRI’s approach to leading indicator analysis is designed to ensure that our leading indexes are robust enough to function accurately even in unusual economic environments, like we have today. Regardless of ad hominem personal attacks, coupled with confusion about how to interpret ECRI’s leading indexes, ECRI’s disciplined and objective approach to economic cycle forecasting is the most reliable method we know about, for signaling recessions and recoveries.

On Jan. 25, 2008 we publicly described the opportunity to forestall the recession, “A Window of Opportunity” and then on Mar. 28, 2008, we described how that opportunity had been missed in “A Recession of Choice”.

“Forecasting Economic Time Series” by C. W. J. Granger and P. Newbold (Second Edition, 1986), New York: Academic Press.

I really liked this quote from Felix Zulauf’s August commentary:

“Hence, the key question is not double dip or not but how good will economic growth be in real and nominal terms.

When an economy shows the weakest recovery on record despite of the biggest monetary and fiscal stimuli on record, something is definitely different from previous cycles. In our view, it is debt deleveraging. So far, the US consumer and financial institutions have undertaken steps and decreased leverage to some degree but we are nowhere near the end of this process. At the very best, it will take another 2 years but most likely longer until that process is complete.

In the meantime, household income growth or the lack thereof will become the decisive factor. At present, it does not look very encouraging as it is stagnant in most countries or anemic at best. Moreover, in the US, housing is an important balance sheet item for the average household and those prices continue to erode.

Hence, we do not see a lot of hope for a normal recovery pattern. In Europe, the discussion about retirement age has been launched whereby the proposal is to hike the age limit decisively as mathematically there is no way that these pensions can ever be financed based on demographics and tax revenues in a low growth environment. This blows away many dreams of a relaxed retirement period and forces households to save more . . .”

Interesting stuff.

Brian Wesbury is a really good who I usually disagree with as too bullish.

However, his comments about imports, profits and valuation are opposite to what Wall Street analysts are saying.

I especially like his sentiment take on “Economic Hypochondria.”

“Now I’m looking at the political system turning itself into a paralyzed beast. A lost decade now looms as a much bigger risk. The Fed’s running out of powder; Its really powerful ammunition has been expended.”

-Alan Blinder, former vice chairman Federal Reserve, on whether the US could sink into a Japan-style quagmire

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Peter Goodman has a longish article in the NYT Week in Review, What Can Be Done to Cure the Ailing Economy?.

It is notable for a few reasons: Great chart porn (see right), a few good quotes (see above), and a bombshell from Bruce Barlett, the Treasury economist in the first Bush administration.

Bartlett has become a pariah to the Republican party, saying out loud what few people dare to even think. He notes that we are already in gridlock, with the GOP deploying a blocking strategy. He thinks nothing substantive is going to change for a simple reason:

“Clearly, a weak economy in 2012 will be very good for whoever the Republican presidential candidate is. It’s hard to see how the Republicans lose by blocking stimulus.”

That is a pretty damning accusation. Bartlett is essentially arguing that the anti-stimulus crowd is doing so not for ideological beliefs, but for political advantage. He is implying their goal is to keep the economy weak in order to prevail politically.

That is quite an accusation . . . Do any of you buy it?

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UPDATE: August 29, 2010 6:00PM

Bruce Bartlett writes in to clarify my interpretation:

I don’t actually believe that there are any Republicans intentionally blocking policies that they know would help the economy just so that their party would benefit.

But on the other hand, there is no denying that a bad economy is good for the out-party, especially in presidential elections. So what we have is a situation in which Republicans can’t lose. Insofar as they actually believe that their policies would be better for the economy than Obama’s, and insofar as Obama’s policies are in fact bad for the economy, Republicans benefit politically from gridlock either way.

The only way Republicans can lose is if Obama suddenly gives them carte blanche to enact whatever policies they want and we get a 1937-type double-dip from inappropriate fiscal tightening. But then it would still be Obama’s fault for listening to them. As Otter explained to Flounder in Animal House, “You f&%ed up. You trusted us.”

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Source:
What Can Be Done to Cure the Ailing Economy?
Peter S. Goodman
NYT, August 28, 2010
http://www.nytimes.com/2010/08/29/weekinreview/29goodman.html

Intel cuts 3rd quarter numbers citing “WEAK DEMAND”.  Bernanke pretty much confirms that the FED is out of bullets.  Manufacturing continues to slow as does real estate and consumer confidence.  The economy keeps shedding jobs.   I do not see any good news in any of that.  You can’t even try to spin good news out of that.  So what gives?  The stock market tanked this morning after opening higher.  It tanked when Intel, the tech leader announced it was cutting guidance for next quarter citing slowing demand.  Can you get a bigger warning?

The stock market dropped almost immediately on that news and continued to do so even after “Helicopter Ben” released his statement which in my view was neutral and really involved a lot of nothing.  He has developed an excellent knack for speaking out of both sides of his mouth.  Then again, why should we give any more credibility to a man who has sacrificed the future of America by running a 24 hour printing press. 

People, the only recovery that the Federal Reserve is trying to manipulate is the stock market. They are intent on making people “feel richer” and to make things appear brighter than they really are.   There is nothing to see hear.  There is no “Fundamental Basis” behind this stock market anymore.  It is fractured and has been for a while.   The markets don’t trade on fundamentals anymore.  They trade on the amount free money being thrown at it by the powers that be that are intent on ensuring that the American people feel richer when in fact they are getting poorer by the day.

I call bullshit to today’s activity on the stock markets.  Then again, I am not a professional trader, financial advisor or economist.  However, when you have the biggest computer chip maker warning of slowing conditions and GDP sinking back into almost zero or negative territory (which it surely will as you can see by the trend), you can not tell me that fundamentally the market had what it needed to surge the way it did, almost on the drop of a dime.

What I saw today was the stock market applaud the fact that GDP was revised downward but NOT to the levels that had been expected (below 1%).  As a result, the market opened higher but couldn’t sustain the rally.  The move off the “Fundamentals” came with Intel’s guidance revision.  The stock market yawned at Bernanke’s speech and continued to trend lower.  Then, suddenly and almost on que, it went northward without any resistance.  We’ve been watching this game now for a little over a year. 

People…..the Federal Reserve doesn’t know what to do anymore.  Despite the Trillions of dollars thrown at the economy we are slipping into double dip territory.  Bernanke and his team have no more credibility.  As was reported by the WSJ and commented on by me as well, the Federal Reserve is at odds amongst themselves with regards to what to do next.  Do they continue to push the can down the road and create another bubble by keeping the printing presses going full steam to provide “liquidity” to the stock markets or do they face reality and try to work the debt off normally, albeit a little more painfully.  Obviously it doesn’t matter anymore.  They will stop at nothing to make America “feel” richer. 

Whatever the case, today’s news did not warrant the stock market doing what it did leading me to further reinforce my belief that the free market is dead and that anyone “gambling” at the Wall Street casino might as well go to Vegas where at least you stand a better chance.  

The disconnect between the stock market and reality has never been greater.  Bernanke is now speaking out of both sides of his mouth.  We have had a continued decline in GDP since  the post-2008 crash high of 5%.  The FED has no control over employment, Itel warns it sees a slowdown (which won’t help the job market) and yet, we got a 170 point move in the DOW Industrials off the day lows.   As I said earlier…..I call bull-shit.

The Federal Reserve has become the drug trafficker feeding the drugs.  It has made it clear that it will continue to push the drugs it needs to in order to ensure that the artificial “high” doesn’t fade.  I haven’t seen many drug addict stories with happy endings.  This one will be no different. 

URBAN INEQUALITY IN THE UNITED STATES

Chew on this.  According to the United Nations, UN HABITAT:

For many people in the United States, moving up from the lowest economic ranks to the middle class, and from the middle class to the top income echelons, is becoming increasingly difficult. The richest 1 per cent of households now earns more than 72 times the average income of the poorest fifth of the population, and 23 times that of the middle fifth. In just one year, between 2005 and 2006, the richest 1 per cent of the U.S. population increased their earnings by US $95,700, while the bottom fifth took home only US $600 more than the previous year, and the middle fifth stagnated, earning only US $300, or 0.6 per cent, more than they had in 2005.

No other industrialized nation has a greater divide between its richest and poorest citizens.  The rich continue to get richer while the poorer continue to get poorer.  With such a divide one can’t expect the current state of affairs to improve anytime soon.

Aug. 26 (Bloomberg) — Mark Zandi , chief economist at Moody’s Analytics Inc., talks with Bloomberg’s Margaret Brennan about the outlook for the U.S. economy and possibility for
another recession. (Source: Bloomberg)

Zandi on his predictions re: double-dip recession:

“I put it that 1 in 3 right now. If you’d ask me 4-8 weeks ago, I would have said 1 in 4, 12 weeks ago, 1 and 5. So it is rising uncomfortably high. I am assuming that tax rates on upper income households will in fact occur on January 1st. If that doesn’t happen, it could reduce the odds back closer to 1 in 4. But 1 in 3, that is uncomfortably high. Particularly we’re at a 9.5% unemployment rate. If we go back into recession, it’s going to be very difficult to get out of it in any king graceful way.”

On whether the economy will backtrack into a recession:

“I do think that the Federal Reserve will restart quantitative easing over the next few months. I think the economy is going to be, at best, very weak, so weak that unemployment will begin to rise again and I think that will be a signal for the fed to resume quantitative easing.”

On whether he expects job growth in the current market:

“I do expect some job growth, yes, but not enough to forestall further increase in unemployment. Just to give you a number, we need approximately 150,000 jobs per month just for a stable rate of unemployment. Since the beginning of the year, we’ve been getting closer to 100K, subtracting the ups and downs of census hiring. Over the next few months, I would expect no more than 50K given the recent weakening in economic growth. And so that’s not enough to forestall further increases in unemployment.”

Zandi on expectations for Bernanke’s speech tomorrow at the Kansas City Fed:

“The first thing he needs to do is put the string of economic data we’ve been getting into some context. How weak does he think the recovery really is? Then I think he needs to explain more clearly the FOMC’s actions a few weeks ago. Why hold the balance sheet constant? What was the logic behind that? It would be helpful if he could then give as benchmarks for understanding when they possibly could resume quantitative easing, start buying more treasuries, securities and growing the balance sheet.”

On news today that U.S. mortgages with overdue payments have risen in Q2:

“That is a bit disconcerting. It is clear the foreclosure crisis continues on, by my data, we have 4.3 million first mortgage loans are in default or 90 days delinquent and thus headed to default. That is a lot of loans to work through and many will go into foreclosure sale. One more reason to believe that house prices will decline. One encouraging thing was the decline in early stage delinquency. The recent bump up is a bit disconcerting. I do not think it is the beginning of a trend. I am hopeful, that in the next few quarters, we’ll see that come back down again given the tightening in the underwriting and the view that we’ll get some job growth.”

On whether Congress should raise the tax rate for the top 2% in 2011:

“I think if we raise those tax rates, in all likelihood the recovery will still remain intact but I think that is a gamble that would be unnecessary. I do think it would prudent given how fragile the recovery is not to raise any more taxes in 2011. Now in 2012, 13, 14 when the economy is up and running, raising those tax rates in upper income households, I don’t think we’ll have any meaningful impact on their spending and saving on the broader economy and would help with respect to fiscal problems. But I just wouldn’t do it at 2011. It is one more thing for the economy to overcome when the economy has a lot to overcome.”

On what he thinks will tip us towards a second recession:
“It could be, for example, if angst about the European debt situation were to flare up again and we’d see the equity market, stock prices fall another 5% or 10%. I think that would certainly qualify and that could push us back into recession.”

On the European debt situation:

“We’re watching very carefully. The coast isn’t clear. The European economy is holding up better than I would have thought to this point. But it has a lot of headwinds, the fiscal austerity, the financial constraints given the problems in their own banking system, so there is a lot more work to be done. I don’t think they will work to the problem quite yet.”

On tomorrow’s GDP figure and whether he agrees with the consensus is 1.4%:

“I think that is about right. That would be reduction of about a percentage point in estimated growth. Most of that because of a wider trade deficit, some of it related to less inventory. But it clearly highlights the economy lost momentum in the Q2.

Highlights from CNBC:  (See the full story HERE)

• High unemployment and sluggish growth is causing the US economy to lose any momentum it had in terms of a recovery, Pimco's Mohamed El-Erian told CNBC on Thursday.
• "We are going to get confirmation with revised GDP numbers that are down and for the last quarter and downward revision for the third and fourth quarter," said El-Erian. "This will also show slow growth."
• "I think Nouriel is correct when he says the 'US has no spare tire' to fix the economy if something happens," El-Erian said. "I put the risk of deflation at 25 percent and the latest figures show it may be even higher."

My blood boiled when I saw this afternoon's instalment of "Stop Trading" on CNBC.  (SOURCE)  If it wasn't apparent already that Cramer had lost touch with reality then today's show pretty much solidified that view. 

He called the Gloom level "out of whack" and actually had the audacity to state that investors should look away from the negative outlook that many analysts are offering.  He argued that because the "RTH" ETF was holding up along with some retail stocks that this was evidence that the state of the American consumer wasn't as bad as the "gloomers" are painting it.

Cramer fails to accept the total collapse of the American Consumer.  Instead he sees a “mixed picture” for consumers.  He stated that certainly people were shopping but maybe not as much.  At the worst, the situation is “not horrible,” he said, telling investors not to overreact.  He said things were horrible 18 months ago, not today.  Am I wrong but isn't the unemployment rate higher now? Haven't home prices continued to fall despite his housing bottom call in June of 2009?

Let me re-cap some current headlines to see if I'm missing something;

• Last week's jobless claims number was horrible.  Another half a million first time jobless claims;  Let's see what Thursday morning's number brings. We are still hovering near 26 year highs in unemployment.

• We just saw the worst existing home sales decline since 1995 and by some estimates, there is a 14 month supply of homes in inventory. Mortgage rates have tumbled nearly 100 basis points in the past year to a record low of 4.42% for the 30-year rate, but we could not get a jump start in real estate.  It doesn't look like there is much confidence out there does it?  Home sales collapsed a record 27%.  (haven't we been warning about this since the start of the Government home buyer incentive?)

• Durable goods orders today....well, they sucked!  American consumers aren't buying the big ticket items;

• Perhaps a gauge that gets overlooked but is important nonetheless should be considered.   The American Trucking Association released numbers today indicating that "for-hire truck tonnage index" showed a 5% decrease from the previous month (non-seasonally adjusted).  Many might say "what the heck is that index".  This was the second consecutive month that this index dipped.  (source) Do not discount it.  It tells us how many goods are being moved across the country.  ATA Chief Economist Bob Costello said that July’s data didn’t change his outlook for subdued tonnage growth in the months ahead, stating, “The economy is slowing and truck freight tonnage has essentially gone sideways since April 2010.” ;

• Fuel and oil inventories are increasing.  Signs that people aren't driving as much and that consumption is down.  We are now exiting the peak summer driving season.  There is less demand for oil.  This is not what you want to see in a "recovering" economic climate.

CNBC summarized Carmer's comments this way:

If anyone’s wondering what’s causing the crisis in market confidence, Cramer said, look no further than the White House. President Obama should be taking a much more vocal role in advocating for the economy, whether it’s in promoting home buying, explaining why interest rates are so low or defending the work of Federal Reserve Chairman Ben Bernanke and Treasury Secretary Timothy Geithner. Instead, the administration responded to negative comments from Rep. John Boehner, R-Ohio, on Tuesday by sending out Vice President Joe Biden to tout its stimulus package.

“Guys, come on. Don’t be this tone deaf,” Cramer said of the president and his team. “Step out of Washington and realize what’s happening in this country.”

May I be so blunt?...why not....it's my blog. How the heck are people supposed to buy homes if they aren't working!?! The same goes for a nation full of uncertainty about the future of the labour market. People buy homes when they are certain about their future outlook. They do not buy big ticket items if they have concern about their ability to pay for them.

I agree with Cramer when he says that the Administration should do more however I disagree with his views on what the Administration should be doing. They should not be advocating spending. In my opinion it is perfectly fine to be honest and simply tell the people that are going through tough times. What’s wrong with comments like "Manage your money wisely, pay down your debt and get your house in order...we will get through this....it will be tough but we will get through it". What is wrong with simply reinforcing the values that most of of our grandparents survived on?

What the Government should not be doing is giving people incentives to get further into debt to fluff up economic numbers so that the Wall Street players can get fatter on fabricated numbers. By promoting spending the Government would be painting a false sense of reality surrounding the economy. Give people the honest goods. Hey, it might be refreshing for a change and it might just be the ticket that gets Obama some seriously needed credibility. A "no-bull-shit" President for once. Wouldn't that be a refreshing change? Forget more of the flawed programs that offer consumers incentives to buy goods that they simply can't afford.

Instead of spending to save banks and car makers, funnel Government money away from the banks and the fraudsters that helped bring the world to its knees and move it to infrastructure programs. If they are going to print money then why not print it to fix the nation's aging roads, bridges and infrastructure? That would get people working and working people spend. It is economics 101. You work, you buy goods. You don't work, you don't. Why has it been so hard to see? You give a construction worker an income and that construction worker will be confident and secure and in turn more likely to buy that home or that new vehicle. However, what good will it do Mr. Cramer, if President Obama got out there and tooted the "go out there and buy a house" horn with all this uncertainty in the air?

I agree with what Richard Russell said in his piece this evening:

Consumer sentiment has turned bearish. Consumers have "had it" with houses, stocks, techs, Obama and his crowd, the government and rising unemployment. In the meantime, the Obama propagandists have been telling consumers that "the worst is over, and it's bright lights and sunshine ahead." The last thing American consumers need now is a full resumption of the primary bear market. A sinking market, I believe, will put the brakes on US consumer buying and I mean they'll put the metal to the brake pedal.

For reasons cited above, and which Cramer flat out conveniently or perhaps inconveniently overlooks in is daily missives and efforts to pump the stock markets, the gloomers have it right.  They are worried  because they have many reasons to.  They don't care that the Retail Holding ETF was up today.

Bernanke's policies have failed and this failure is supported by the widening divide among the Federal Reserve Presidents.  The evidence is there staring everyone in the face.  Despite the massive printing  the economy remains anemic and there are no signs of that changing in the immediate future.

“The level of gloom that I hear seems out of whack with how ‘eh’ it really is,”  Cramer said.    Mr. Cramer, YOU are "out of whack".

BLOOMBERG NEWS

By Timothy R. Homan 

A slowdown in U.S. business investment may soon hit the job market, further hindering a recovery in the world’s largest economy.

Capital spending, one of the few bright spots in the recovery, declined in July, according to Commerce Department figures released yesterday in Washington. Sales of new homes fell to the lowest level since data began in 1963, another report from the same agency showed, indicating a lack of jobs is crippling housing.

Employers are reluctant to take on more staff until they see more evidence of durable growth, keeping unemployment near a 26-year high and holding back the consumer spending that makes up 70 percent of the economy. A Labor Department report next week may show that private payrolls failed to grow in August for the first time in eight months, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

READ MORE >>>>

Further to my post about the bond vs. stock market conundrum, here are some further warnings from the cyclicals. The first chart shows the relative performance of the cyclically sensitive Semiconductors against Technology stocks. The Semis have been weakening on a relative basis and violated a relative support level in early August.


Looking at the relative returns of the broader Morgan Stanley Cyclical Index against the market, these cyclicals fell through a relative uptrend in early June and have been going sideways against the market ever since. Stepping back, the entire formation (circled in red) looks like an inverted saucer, or dome, top to me.


This is not the stuff of robust cyclical recoveries.

In addition, we had the awful Philly Fed numbers and dismal initial jobless claims readings last week. As well, the latest Merrill Lynch survey of fund managers indicate that a whopping 78% believe that a double-dip recession is unlikely, indicating that the consensus remains bullish. The combination of sentiment readings, the message from market technicals and deteriorating market conditions leads me to a cautious stance.

How We Get Through This Mess
August 20, 2010
By John Mauldin

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How We Get Through
“Where Is My V-Shaped Recovery?”
We Have Met the Enemy, and He Is Us
So Where’s the Good News?
LA and Europe

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This week I spoke to a small group of businessmen/entrepreneurs about the current economic environment, and after my presentation one asked me whether I didn’t have any good news for them, with a kind of gallows humor laugh. And I tried. But upon reflection there is more I could have said, so this week’s letter will be what I should have said to be a little more encouraging.

The group was a Vistage group in which my daughter Tiffani participates. This is an organization of 12 businesspeople (in this case all CEOs of small businesses) who meet once a month to share and learn about better business practices, accountability, planning, and all the aspects of running a business. Every person I have ever met who has been involved in Vistage has had good things to say about it. I have watched it help Tiffani a lot. She truly runs our business now, allowing me to read and write and travel and speak. I am a very lucky man and proud Dad.

I have particularly watched my partners at Altegris really truly transform their business model through their involvement with Vistage. First the CEO, Jon Sundt, joined, and now the partners have all joined Vistage groups focusing on their roles in the business. Sundt was always a good businessman, but the level of professionalism of his whole company has gone up a notch. It is a pleasure to watch them grow, and they give Vistage a large measure of the credit for their success. In fact, when I went to the Vistage web site to get the link, I saw a brief video of Sundt talking about his experience. (http://www.vistage.com/) I am proud to be their partner.

If you have a business and could use some help and professional mentoring, you should look into finding a Vistage group that works for you. They match businesspeople in different industries but with roughly same size businesses. In tough times you need all the help you can get.

I talked to them about the current economic environment and what I saw coming down the road. Long-time readers know that I think we are in for an extended period of slow growth, high and sticky unemployment, and volatile markets punctuated by more frequent recessions. That is what you get when you have a deleveraging environment resulting from a credit crisis. It is what happens when the Debt Supercycle ends. We start the journey to the New Normal and it just takes time.

“Where Is My V-Shaped Recovery?”

Remember all the bulls and cheerleaders late last year and into this one talking about a V-shaped recovery? They were making their projections based on what had happened in past recessions. I (and others) argued that that data was meaningless, as it did not reflect the fact that a balance-sheet recession requires years of deleveraging, is inherently deflationary, and all the factors that produce the normal “V” are no longer in play. Bank lending is still dropping. Savings rates go up. Debt gets paid down. Governments run into limits as to how much they can stimulate the economy without creating large and destabilizing debt. Central banks push rates to zero, and then what? This is a far different environment than we have had for the last 70 years. Using past performance to predict future results when the future environment is significantly different than the period in which the data was collected is misleading at best and worthless at worst, leading to bad decisions. Much better to deal with reality.

And just to show that I am really the optimist in the room, let’s turn to my good friend David Rosenberg, writing this morning under the following headline:

“U.S. RECESSION NEVER ENDED; GDP TO CONTRACT IN Q3

“Our suspicions have been confirmed – the recession never ended. Macroeconomic Advisers produces a monthly U.S. real GDP series and it shows that the peak was in April, as we expected, with both May and June down 0.4% in the worst back-to-back performance since the economy was crying Uncle! back in the depths of despair in September-October 2008. The quarterly data show that Q2 stands at a +1.1% annual rate (so look for a steep downward revision for last quarter) and the ‘build in’ for Q3 is -1.5% at an annual rate. Depending on the data flow through the July-September period, it looks like we could see a -0.5% to -1% annualized pace for the current quarter. Most economists have cut their forecasts but are still in a +2.5% to +3.5% range. What is truly amazing is that despite all the fiscal, monetary, and bailout stimulus, the level of real economy activity, as per the M.A. monthly data, is still 2.5% below the prior peak. To put this fact into context, the entire peak-to-trough contraction in the 2001 recession was 1.3%! That is incredible.

“Interestingly, and dovetailing nicely with our deflation theme, nominal GDP fell 0.3% in May and by 0.4% in June. This is a key reason why Treasury yields are melting.”

Politicians are going to be greeted with a GDP number for the third quarter, right before the elections. Will it be negative like Rosie thinks? I am not sure, but in any event it will not be good. Structural unemployment will still be over 10% and deficits will be high.

Look at the following graph from my friends at The Liscio Report. Unemployment and continuing claims have started to rise again. This is not what happens in V-shaped recoveries, gentle reader. The ONLY reason the headline unemployment number has dropped a little is that the Labor Department has dropped so many people from the labor force. Again, if you have not looked for a job for four weeks, they do not count you as unemployed. If you use the labor-force number from just last April, unemployment is 10.5%. Brutal. Who doesn’t know too many people without jobs?

But it is not just rising unemployment claims. Yesterday’s Phillie Fed report was just awful. Buried in the details was the fact that the hours-worked index is collapsing, consistent with previews to past recessions. Very worrisome. (From my favorite slicer and dicer of data, Greg Weldon: www.weldononline.com)

Bottom line? It is going to be a tough environment for the next 6-8 years. That is just what happens when you have a deleveraging / balance sheet / deflationary / end of the Debt Supercycle recession. It is what it is, and no amount of wishing or finger pointing can change the facts.

Let me take a moment and offer some sympathy to President Obama. This recession/slow period is not his fault. Obamacare? A now-trillion-dollar stimulus? Those he owns. But the recession/credit crisis would have happened if McCain had been elected.

And it is not Bush’s fault. Did he make some mistakes? Oh yes. Squandering those surpluses is huge in my book. Not vetoing all that excess spending is at his feet. And there are other issues, but that is not my point.

We Have Met the Enemy, and He Is Us

There is a great line from the old cartoon strip Pogo: “We have met the enemy, and he is us.” (Ah, I miss Walt Kelly and Pogo. But I show my age!)

Neither Clinton nor Bush forced people to borrow money against their homes. Yes, some of the laws made it easier. Yes, Greenspan pushed rates lower than they should have been. Allowing banks to go to 30:1 leverage was stupid (courtesy of the Bush administration). Repealing Glass-Steagall in hindsight was not wise (Clinton era).

But we the people borrowed and spent. Congress taxed and spent and we voted for the SOBs and collectively asked for more goodies. Maybe not you, gentle reader, because all my readers too smart to have engaged in such reckless activity, but those other guys sure did. Probably the readers of Paul Krugman. (Did I say that?!?)

So, the current problems are not Obama’s fault. But how he deals with them is. Raising taxes in what can only be called a soft environment gives him ownership of the consequences. And it is more than just the Bush tax cuts going away. Obamacare gives us a host of new taxes. (If you want to see more, read http://www.atr.org/six-months-untilbr-largest-tax-hikes-a5171)

So Where’s the Good News?

Ok, I could go on for hours, sorting through the problems. Where is the good news I promised?

Here’s what I should have said to Tiffani’s group: Let’s face it. Running a small business is never easy. I am a serial entrepreneur. I have started and run a lot of very different businesses. Some have been very, very good and some went down in spectacular flames. I can remember some near-death experiences when the economy was booming. I have watched a million-dollar income stream dwindle to zero and there was not a damn thing I could do about it, except enjoy the money while it was there and use it to buy the next income stream. I have had to rebuild several times from scratch as markets shifted drastically underneath my feet. And I’ve changed directions as new opportunities revealed themselves.

In all this I’m like every other small-business entrepreneur out there. It is never easy. But that is what we do. We get up in the morning and figure it out. Some 80% of startups die within ten years. But we pick ourselves up and start over.

I know unemployment is 10%. But that means almost 90% are employed. Consumers are saving more. So adjust. Figure out what your New Normal looks like.

The ’70s were a bitch. I woke up many times in the middle of the night with real pains in my stomach wondering whether to pay the rent or make payroll. So did a lot of people. But look at all the new companies that came out of that era and changed everything: Microsoft, Apple, Intel, etc. Cell phones. The internet. The list is long.

Yes, we have to make our way in this Muddle Through World. It will be challenging, but I can almost guarantee you that when we do get through there will be other challenges. If it was easy everybody could do it and there would be no money in it. Embrace the challenge!

I asked one of my really close (36 years) friends and business associates last year how his business was doing. “We are doing great!” he said. That was not the answer I was expecting. “Why? How?” I asked.

“Well, most of our competitors have folded. We survived and got the business.”

Ultimately, that is how we get out of this. A hundred million families and millions of businesses figuring it out, learning how to adapt to the New Normal. Sadly, some of them won’t make it. But most of us will!

As I said, I am a serial entrepreneur. I have a friend who designs and oversees large teams of programmers of really robust analytic software, very cutting-edge stuff. She is a winner, and I am backing her (I know nothing about software but the rule is, invest in people!). We’ll see how it goes, but my bet is that in a few years there will be a lot of people getting jobs because we take on some risk now.

We are adapting our own business here. We will soon have new websites. I will be doing (at first) an audio podcast called the Mauldin Minute and then (hopefully) by the end of the year morphing into video. That’s the wave of the future and I need to keep up.

I am addicted to information and reading . We are going to try and make some money from my addiction. What would you pay to look over my shoulder and read the 5-10 most important things I find in a week? I will become your personal reader. Will that be a life-style changer? No, but it will provide some income diversification.

When Tiffani made her presentation to her Vistage group about our business, she had a lot of charts and graphs. I was surprised how our sources of income have varied over time. Some previously large (at least on my scale) sources literally dried up within a few years, completely askew from our original optimistic expectations. It was very apparent that we cannot sit and assume things will be the same year to year. So we adapt.

I have been presented with a very different opportunity in a non-finance field that is right in my wheelhouse, as they say. Tiffani and Ryan and I are going to pursue it. Will it thrive? Be a real business in five years? We will see, but I have the ability to take that risk and I am going to do so.

And so will hundreds of thousands of other visionaries and dreamers. That is how we get through this. We work through the ugly and then we get to the 2020s, and I think we will once again be talking about the Roaring 20s! Whole new industries will come into existence. Pay attention to the advancements in robotics. Biotech will be HUGE this decade, but we need to change the rules so we don’t lose the intellectual property and the jobs. Electric cars will boom as we replace our fleet all over the world. Nanotech later in the ’20s. Green energy and nuclear. Artificial intelligence (finally!). Really cheap (I mean really cheap!) wireless high-speed broadband all over the world will open the door to all kinds of possibilities. I met last night with very credible scientists who have developed a way to filter water very cheaply. A desalinization module that fits in a cargo container. Yes, they need a lot of money to finish, but they will figure it out. And on and on. The opportunities are going to be huge. Trillions will be made.

So, we get through this. We Muddle Through. We figure it out, one business and family at a time. And as a culture, a world, we get to a better place. My bet is that in 2020 no one is going to want to go back to the good old days of 2010. We will be excited about the future and all the cool stuff that is happening.

Recessions and tough times are God’s way of telling you that you need to adjust a few things, both on a personal and business level – also nationally and globally. I am an optimist. I believe we will adjust and grow, not just in the US but as an emerging world. There are just so many opportunities.

So, don’t let the problems I write about in this letter make you crawl into a cave. Just be realistic and figure out where your opportunities are. And then go make them happen! You are responsible for creating your own future. And I hope it is a good one. I plan on making mine one.

LA and Europe

I am in San Francisco at the MoneyShow. There is a good crowd and I have dropped in on a few presentations. There seems to be some talk about a bond bubble, whatever that is. I just see Boomers realizing they need to be more conservative, and a deflationary environment.

The bubble is in sovereign debt. That is not going to end easily. For many countries it will end in tears.

It looks like I am going to have to shoot to LA week after next for some meetings and a check-in with the design/imaging/branding group that is developing our new web presence strategies. Within a few months you will be able to comment on my writing, communicate with fellow readers (civilly, of course!), and ask questions which Ryan will try to corral me into answering. Lots of new and cool things coming.

Oh yes, the book. Sigh. A personal situation has delayed me a week, but I swear I’ll get the final chapter written next week and then out to some friends for comments and off to the publisher.

My schedule for Europe is shaping up. I will be in Amsterdam September 11-14, then Malta, Zurich, Mallorca for some fun with my London partner Niels Jensen and team for the weekend, then to Copenhagen for a day (at least one session will be open to the public), and then on to London and back home. Drop me a note if you want to meet, and I will get it to the keeper of the schedule.

And thanks to Charles Githler for being such a great host at the MoneyShow! Amazing, this is their 32nd year of doing the show here. Where does the time go? He was a 21-year-old kid when he started this, and he has created a really significant business, with conferences all over the world. And he started in 1978 and lived through two recessions. It can be done!

It is time to hit the send button. I have yet another presentation in 37 minutes and need a few minutes to prepare. Have a great week and enjoy the moment! I am, although sitting in a hotel room in San Francisco is not my preferred environment. I do love this city. But that, gentle reader, is the small price of the privilege of writing to you each week.

Your ready to get out of this room analyst,

John Mauldin
John@frontlinethoughts.comCopyright 2010 John Mauldin. All Rights Reserved

Echoing a constant theme here at The Fundamental View, Economist David Rosenberg elaborates on just how weak the actual recovery was and why we’re likely to continue seeing weakness.     Special thanks to Pragmatic Capitalisism for providing the video interview.

Ha!

>

Insight on the state of the economy and markets, with Byron Wien, Blackstone Advisory.

At the 7 minute mark, Wien takes Kernan to school.

Airtime: Thurs. Aug. 19 2010 | 8:07 AM ET

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The Congressional Budget Office is expected to release its updated budget and economic outlook for 2010, with Byron Wien, Blackstone Advisory, and Douglas Holtz-Eakin, former CBO director.

Airtime: Thurs. Aug. 19 2010 | 8:17 AM ET

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Final thoughts on the markets, with Byron Wien, Blackstone Advisory.

Airtime: Thurs. Aug. 19 2010 | 8:57 AM ET

Earlier this month, I interviewed famed investor Felix Zulauf on his professional background and investment outlook (Audio here). As per popular request, here is the interview transcript.

————
BARRY RITHOLTZ: Tell us about your background…

FELIX ZULAUF: I grew up in Switzerland, in a small town, I went to all the school. After college, I decided to go [with] a banking career. I regretted it after a year or two because it was so boring — commercial banking, then I finally hit the investment department. It became more attractive. I asked my bosses why stock prices moved up and down, and from their end — I could very soon tell that they had no clue. So I tried to figure out if there were some other people who knew why the markets were moving. And I found some leading opinion people like Bob Farrell. They were all in the US, there were no opinion leaders in Europe. And I decided that I wanted to learn that business and foresee market moves in big ways.

And then I went step-by-step. I started in the equity stock market department in a Swiss Bank in Zurich. And then I transferred to Paris to a stockbroker for a year. There, I really developed my speculative activity. As a young chap, the owner of the shop gave me a credit of half a million dollars. Which was a dramatic amount for a 23-year-old guy, and I started speculating. Went short on the market in the fall of 1973 and you know what happened thereafter into the end of ‘74. So that year I made the first big money.

What was your actual first employer?

The Swiss Bank Corp. I was there for 2 years. And then I was sent off to Paris and to acquainted more with the French language and see another country and another culture and I didn’t want to go to a bank because I wanted to learn more about the investment business. So I went there, came back after a year, moved then to portfolio management (or what they thought was portfolio management), and then went to the US. So in 1976, or 1977, I stayed in New York, put together a trainee program for myself using all of the concept of Swiss Bank Corp. and I trained with Charlie Maxwell in energy and Bob Farrell in Market Analysis and Ed Hyman in Economics and trading in a shop called Salomon Brothers at that time. So I went through Wall Street and all of those firms and it was like paradise.

I’m still friends with many of those people.

It was fantastic. And then the bank called me back to Switzerland in ‘77. And then I changed horses and joined UBS because I wanted to learn money in a more aggressive way, and Swiss Bank didn’t offer me that job. That was ‘77 — I joined UBS and the mutual funds management department and research. And I ran the US equity funds and global equity funds and a raw materials fund and became a global strategist for the whole UBS group. And later I ran the institutional portfolio management department at UBS and then came 1987. I was very instrumental to push UBS equity allocations to the highest in all of Europe. At that time, 65% equity in balanced accounts was extremely aggressive in European standards. And in ‘87, during the summer, I tried to reduce that because I was also part of the investment committee, and I convinced the committee but general management then vetoed it and that upset me so much that I stopped there and liquidated all equities ahead of what thereafter became the crash of ‘87.

And it didn’t make many friends. By hindsight, I think it was the most difficult thing I ever did because I never got the credit for it. I got the blame because all of my friends and colleagues looked terrible next to me. You know, from a political point of view, it was not a good move. But from a trustee point of view, it was the right move and also from a professional point of view, it was the right view.

Then I decided I needed to join a smaller money management operation where I had more freedom and I joined a subsidiary of Credit Suisse at that time as an executive vice president in charge of the whole investment policy. And then came ‘89. The leading portfolio managers were very successful with Japanese equities and I turned very bearish on Japan and they took it as a personal insult that I turned very bearish on Japan.

At 39,000 and something, and I think it was January of 1990…I turned very bearish and pulled… And it then happened and it made it clear to me that I had to go on my own to manage money the way I thought was right.

Before you launched your firm, you had essentially rotated at some of the biggest banks in Europe and you had come to New York and worked at some of the biggest banks in the city. And the takeaway from all of this is that there are institutional impediments for a money manager and a trustee to operate on behalf of the clients.

So I became an entrepreneur and started a new financial management firm. I was 40 with two small kids and no client so the first six months were very tough because I could not attract any clients…which was very nerve-wracking. But after that, the ball got rolling and I managed individual accounts. i just wanted a limited number of individual accounts that I could manage in my own fashion so I could go long and short but not leverage. Which was basically the ways I ran my own money in earlier times. But later on, I moved away from leverage because too much leverage is where you make the most mistakes.

And did you set this up as a hedge fund or as a managed assets account?

It was managed assets for several years and then it was just too much work with individual accounts. I decided to channel everything into a fund and we launched Zulauf (Europe) Fund, the fund for Europe equities (long short) which became very successful. And later we launched a natural-resource related equities [fund] and later a global macro fund. And then I was very exhausted in the year 2000 because I basically did everything myself. I had a few employees — two portfolio managers and analysts but they left at 5 o’clock in the evening and they went on vacation. And if something went wrong, you know, the old story. Basically, you’re married with the company and you’re married with the markets and you cannot let go.

So at 50, and I have to mention that my father died at age 50. I made enough money so I decided to go slower and wanted to phase out really. I feared that I would kill myself. And then I started to sell my company and sold the majority of it to these two employees and for awhile it worked out very well. I was more the senior advisor and giving my advice and my input but I was not running the day-to-day business. They moved into a direction that was further and further away from my philosophy and that created problems because I had raised basically 90% of the asset. And then we decided to split the company and I took my share — one fund, one small global macro fund and kept the name and they changed their name. And we are totally unrelated these days. And so I have just a small shop where I run a conservative global macro fund and advise some large clients and institutions and family offices.

I have to mention that these times are so fascinating that I don’t want to give up running money but I don’t want to be glued to the screen 24 hours a day. And I am the senior advisor to a newly launched global fund in northern California — 300 North Capital run by a gentleman who is a very successful equity manager. He wanted to go global and macro and he asked me to help as a senior advisor and I will advise him on a weekly basis and, if necessary, on a daily basis. I will give strategic input and be the partner in terms of discussing any of his ideas.

This is a hedge fund.

So it’ll be global macro, and you’re going to be the senior advisor. Long/ short and not a lot of leverage. That’s the approach?

That’s right.

Let’s shift gears and talk a little bit more about global macro and your approach. When you’re doing your day-to-day work, what are you looking for? What is a day in the life of Felix Zulauf when he gets to the office?

Well, I’m a believer in cycles. I strongly believe that an economy — all economies — do not move in linear but in cyclical fashion. And so do financial markets. And my goal is to catch most of the up cycles and most of the down cycles, because assets are priced based on where we are in the cycle. So I do a lot of cyclical work. I do not moon cycle but the classic business cycle. There is the 3-5 year inventory cycle that they teach in basic economic theory, then there is the investment-related cycle which lasts 9 years. And then you have the 18-20 year real estate cycle and etcetera. I try to get a big picture of where the major economies of the world are moving and where the risks and pitfalls will be in the next six to 12 months. That’s my work — to find out where we are in the business cycle. And then I apply classic tools like monetary analysis, I do valuations because capital markets go from one extreme to the other. They never go in between and reverse to where they come from — that’s important to understand.

Once it hits an extreme (like in 2000), it does not go to a new level in the historical range in terms of valuations and then goes back to overvaluation again. It always goes from overvaluations to undervaluations.

Den ganzen Beitrag lesen »

Via the Economist, we see this intriguing histogram of Global GDP (below)

The Economist notes:

“Data compiled by Angus Maddison, an economist who died earlier this year, suggest that China and India were the biggest economies in the world for almost all of the past 2000 years.”

But then asks a really silly question:

“Why they fell so far behind may be more of a mystery than why they are currently flourishing.”

They were the biggest economies because they had a the biggest populations, and up until 200 years ago, population size was a dominant factor in economic output.

Once the industrial revolution came along, followed by the information revolution, mere size mattered less. First the Europeans, then the Americans leveraged technology to blow out GDP on a per capita basis. Steam engine, internal combustion engine, silicon makes up for size.

Now, India and China are using industrial leverage, and are moving up in the world on a GDP per capita basis.

Now >

Hat tip Chart Porn

~~~

UPDATE: I see that Paul points to a gigantic Excel table, if you want to play with numbers yourself.

With the passage of a $26 billion state aid package last Tuesday, Congress has now approved over $1 trillion in spending and tax measures to stimulate the economy , according to economists Alan S. Blinder of Princeton University and Mark Zandi of Moody’s Analytics.

The Washington Post breaks down the spending:

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click for larger graphic

Graphic courtesy of Washington Post

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Source:
President Obama signs $26 billion jobs bill to aid state payrolls
Lori Montgomery and Nick Anderson
Washington Post August 11, 2010  
http://www.washingtonpost.com/wp-dyn/content/article/2010/08/10/AR2010081004201.html

Here’s a stat that seems all but inevitable: China’s GDP has just passed that of Japan, to become the 2nd largest country’s economy in the world, after the US. (note these are nations, and not regions, like North America, Europe, Asia).

“China surpassed Japan as the world’s second-largest economy last quarter, capping the nation’s three- decade rise from Communist isolation to emerging superpower.

Japan’s nominal gross domestic product for the second quarter totaled $1.288 trillion, less than China’s $1.337 trillion, the Japanese Cabinet Office said today. Japan remained bigger in the first half of 2010, the government agency said.

China led the world out of last year’s global recession with an economy that’s more than 90-times bigger than when leader Deng Xiaoping ditched hard-line Communist policies in favor of free-market reforms in 1978.

China overtook the U.S. last year as the biggest automobile market and Germany as the largest exporter. The nation is the world’s No. 1 buyer of iron ore and copper and the second- biggest importer of crude oil, and has underpinned demand for exports by its Asian neighbors . . .

While China’s output was also larger in the fourth quarter of 2009, Japan’s GDP rebounded to exceed China’s in the first quarter, according to data compiled by Bloomberg News. According to IMF data using purchasing-power-parity calculations to adjust for exchange-rate differences, China overtook Japan in 2001.”

Goldman Sachs chief economist, Jim O’Neill, notes that the 1.3 billion people in China will overtake the U.S.’ $14 trillion economy by 2027.

>

Source:
China GDP Surpasses Japan, Capping Three-Decade Rise
–Kevin Hamlin, Li Yanping. With assistance from Marco Babic and Sunil Jagtiani in Singapore, Russell Ward and Keiko Ujikane in Tokyo and Zhang Shidong in Shanghai
Bloomberg Aug. 16 2010
http://noir.bloomberg.com/apps/news?pid=20601087&sid=amT8rSlABQTM&

A few items I thought noteworthy for weekend perusal:

Corporations are issuing debt on record terms (and in the junk market in record volume).  IBM recently issued three year paper at a meager 1 percent.  And JNJ just set the record for longer paper — “around 3.10% for the 10-year maturity and 4.5% for the 30-year paper if market conditions hold.”  In a nutshell, while there are many variables at play, front and center is investors’ desire for safety and income.  It also partially explains why junk paper is being issued at a record clip.  Need I say that this dovetails nicely into the demographic theme I’ve been harping on?

The Journal floats a story — I haven’t seen this one in a while — about the “Hindenberg Omen.” Now, I’m open to all manner of data analysis.  But when you tell me (toward the end of your story) that (emphasis mine):  “The Omen was behind every market crash since 1987, but also has occurred many other times without an ensuing significant downturn. Market analysts said only about 25% of Omen appearances have led to stock-market declines that can be considered crashes,” you have pretty much wasted my time.  Wake me up when you find something with an actual correlation — last I checked, 25% isn’t even in coin-flip territory.  And where was this indicator prior to the flash crash, or does that not count?

Third, the Journal’s Kelly Evans did a great one-on-one interview with the inimitable David Rosenberg.  This is not sound-bite, dodeca-box TV.  It’s good stuff, and absolutely worth 26 minutes of your time.

Last, but not least, Economics of Contempt has some of the truly priceless, must-read research that the sell side was pumping out on Lehman Brothers just before the firm went under.  EOC is, in my opinion, one of the blogosphere’s best kept secrets.

Discussing what’s next for the economy with David Rosenberg, of Gluskin Sheff; Richard Hoey, of BNY Mellon, and Sean Clark, of Clark Capital Management.

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Discussing the global economy with David Rosenberg, Gluskin Sheff chief economist.

~~~

Economy Spooks Market Economic uncertainty spooked the markets this week. Scott Minerd, of Guggenheim Partners; Stuart Hoffman, of PNC Financial Services; and David Rosenberg, of Gluskin Sheff, discuss.

~~~

David Rosenberg, Gluskin Sheff chief economist, shares his parting shots.

>

Bloomberg’s Chart of the Day shows the growth in federal payouts to state and local governments, also known as grants-in-aid, in the past half century:

They have increased almost three times as fast as overall spending during the period, according to data compiled by the Commerce Department. Funds were provided at a $525 billion annual rate in the second quarter, a 33 percent jump from two years ago. Most of the money went to pay health-care expenses under the Medicaid insurance program and to cover educational costs. . . .

The federal government provided $131.25 of state and local aid last quarter for every dollar spent 50 years ago. For total expenditures, the second-quarter figure was only $45.75, as the chart illustrates.”

That’s just great . . . Now I have another book to write.

>

Source:
Soaring Federal Aid Bails Out U.S. States, Cities: Chart of Day
David Wilson
Bloomberg, 2010-08-11 14:36:57.821 GMT

I love this paragraph from Bloomberg’s Caroline Baum:

“What we had was a government-prescribed course of amphetamines (to keep it up), antibiotics (to prevent infection) and antidepressants (to make it feel better). It endured regular steroid injections from both monetary and fiscal authorities. And it still has no real muscle.”

Awesome . . .

Here are a few (lower res) shots from Leen’s Lodge, Grand Lake Stream, and Big Lake:

Soaring Eagle

19 Inch Freshwater Salmon

Sunset off the Deck

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10 more photos after the jump . . .

Deck Conversations Starts Early

Lodge (where dinner is served)

Lunch on the Island of Big Lake (john, ken, Paul Stu)

Deck chatter

BCA’s Martin Barnes

My Cabin/Canoe Mate Scott, and our Guide Matt

On the Big Lake, Island, Mountain

David & Paul

Canoes at Lunch, Day 2

The Simpsons Sky

I try to find people to read who a) I disagree with 2) respect their methodology. It refines my arguments, and clarifies my thinking. (Doug Kass is one such thinker).

I am a big fan of both Jeff Saut of Raymond James, and Peter Boockvar of Miller Tabak (Peter publishes the very fine Macro Notes blog here on TBP). So when Saut quotes Boockvar about the lack of deflation, it forces me to think carefully about my position.

Here’s Jeff channeling Peter:

“With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ‘08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high.”

The Treasury rates certainly argue against inflation. But let’s look at two other factors, CRB and CPI.

The CRB is a measure of commodities, priced in dollars. They can rise primarily due to three factors. The classic inflationary reasons are either an increase in demand, or a decrease in supply (or some combination of the two). Too many buyers chasing too few goods produces inflation.

But there is a third factor, based upon monetary considerations: A decrease in the value of dollars. That is what has driven the price of CRB over the past decade. From 2002 to 2007, the US Dollar fell 41%.

>

Dollar Index (DY)

Click for larger chart

>

Hence, the CRB might not be the best evidence of inflation during a period of slack demand. The cost of commodities priced in hours worked yields a different conclusion

As to the CPI, well, it has built into it an inherent error: Owner’s Equivalency Rent (OER). This understated inflation during period of rising house price — think 2001 -2007. As we noted in this Fed report in 2005, during housing booms:

“Downward pressure on rental prices mainly resulted from an increase in demand for homeownership, which was spurred by historically low mortgage interest rates. As housing starts and home sales surged in the recent recession and recovery, the national rental vacancy rate jumped from 7.8 percent in the fourth quarter of 2000 to 10.2 percent in the fourth quarter of 2003. This effect was compounded by the way owner-occupied housing prices are measured in the CPI. The CPI uses a rental-equivalence approach, measuring the value of the shelter services an owner receives from his or her home. Price movements in owners’ equivalent rent reflect changes in prices of rental units that are comparable in characteristics to owner-occupied homes. Therefore, increased demand for homeownership put downward pressure not only on tenants’ rent but also on owners’ equivalent rent — the largest component in the CPI.”

-How Housing Lowers CPI

During the boom, renters became buyers. In the current environment, you must apply the opposite logic: People are reluctant to purchase a falling asset. Hence, traditional buyers become renters.  This drives prices higher, and OER — anywhere from 23% to 30% of CPI — goes higher. This is true even as home prices tumbled in fact, its true because homes pries tumbled. Indeed, falling home prices appear cheap, when measured by Rentals — but that metric fails to consider the causal relationship between the two.

The bottom line to me is that neither the CPI nor the CRB Index gives an accurate read of what is gong on with price increases.

Deflation, not inflation, is present, but apparently not accounted for.

>

Previously:

How Housing Lowers CPI (May 21st, 2005)

Rent vs CPI (June 26, 2005)

From Bubble to Depression via Bad CPI Data (April 7, 2009)

Are Home Prices Too High — or Too Low? (June 28th, 2010)

I try to find people to read who a) I disagree with 2) respect their methodology. It refines my arguments, and clarifies my thinking.

Doug Kass is one such thinker. So too are Jeff Saut of Raymond James, and Peter Boockvar of Miller Tabak (Peter publishes the very fine Macro Notes blog here on TBP). I am a big fan of both of them, so when Saut quotes Boockvar about the lack of deflation, it forces me to think carefully about my position.

Here’s Jeff channeling Peter:

“With Treasury bond yields at or near historically low levels on one hand but with commodity prices near 8 month highs, and with the personal feeling that outside of a home, a computer and a flat screen tv, the cost of living seems to only go higher on the other hand, here is another perspective on the inflation/deflation debate. Since June 1981 when Volker started to lower interest rates from 20% as high inflation rates started to fall, the absolute level of CPI rose 142% to the high in July ‘08 (90.5 to 217). Deflation is defined as a decrease in the general price level of goods and services but to quantify the current fall in prices, the CPI has fallen just 1% from its all time high.”

The Treasury rates certainly argue against inflation. But let’s look at two other factors, CRB and CPI.

The CRB is a measure of commodities, priced in dollars. Commodities rise in price primarily due to three factors. The classic inflationary reason is an increase in demand. Or, you can have a decrease in supply (or some combination of the two). But in any combination, too many buyers chasing too few goods =  inflation.

But there is a third factor, based upon monetary considerations: Any decrease in the value of dollars. In the current circumstances, I believe that is what has driven the price of CRB over the past decade. From 2002 to 2007, the US Dollar fell 41% — and commodity prices soared.

Yes, prices have risen, but its not the surging demand / constricted supply we associate wit the 1970s type inflation. It can be cured by turning off BB’s printing presses.

>

Dollar Index (DY)

Click for larger chart

>

Hence, the CRB might not be the best evidence of a lack of deflation during a period of slack demand. The cost of commodities priced in hours worked yields a somewhat different conclusion.

~~~

As to the CPI, well, it has built into it an inherent error: Owner’s Equivalency Rent (OER). This understated inflation during period of rising house price — think 2001 -2007. As we noted in this Fed report in 2005, during housing booms:

“Downward pressure on rental prices mainly resulted from an increase in demand for homeownership, which was spurred by historically low mortgage interest rates. As housing starts and home sales surged in the recent recession and recovery, the national rental vacancy rate jumped from 7.8 percent in the fourth quarter of 2000 to 10.2 percent in the fourth quarter of 2003. This effect was compounded by the way owner-occupied housing prices are measured in the CPI. The CPI uses a rental-equivalence approach, measuring the value of the shelter services an owner receives from his or her home. Price movements in owners’ equivalent rent reflect changes in prices of rental units that are comparable in characteristics to owner-occupied homes. Therefore, increased demand for homeownership put downward pressure not only on tenants’ rent but also on owners’ equivalent rent — the largest component in the CPI.”

-How Housing Lowers CPI

During the boom, renters became buyers. In the current environment, you must apply the opposite logic: People are reluctant to purchase a falling asset. Hence, traditional buyers become renters.  This drives prices higher, and OER — anywhere from 23% to 30% of CPI — goes higher. This is true even as home prices tumbled in fact, its true because homes pries tumbled. Indeed, falling home prices appear cheap, when measured by Rentals — but that metric fails to consider the causal relationship between the two.

The bottom line to me is that neither the CPI nor the CRB Index gives an accurate read of what is gong on with price increases.

Deflation, not inflation, is present, but apparently not accounted for.

>

UPDATE: August 10, 2010 1:45pm

Peter Boockvar writes in:

“Another point I was trying to get across was that deflation is not always a bad thing as we are led to believe by central bankers. In an economic situation where demand is lacking, lowers GDP growth and thus creates disinflation/deflationary pressure, solving that problem by RAISING the cost of goods and services thru money printing is counterintuitive to the basic laws of supply and demand. The law says that if demand is weak, the cost of things must go DOWN to meet that level and thus create an equilibrium. For those however who are very overleveraged, whether business or individual, deflation is not good as debts are paid with shrinking income/revenue. In conclusion, the debate over inflation/deflation is not as simple as ‘it’s one or the other’ and the policy response to both sometimes misses the proper cure for the actual ailment.”

>

Previously:
How Housing Lowers CPI (May 21st, 2005)

Rent vs CPI (June 26, 2005)

From Bubble to Depression via Bad CPI Data (April 7, 2009)

Are Home Prices Too High — or Too Low? (June 28th, 2010)

Good Monday morning.

Good to be back at my desk, where I will try to ease back into my usual routine after way too much travel the past few months.

Camp Kotok, as it is known, brings together about 40 economists, strategists, fund managers and Fed researchers for a weekend in the woods. Unlike the typical 1,000 person conferences I attend, you really get to spend some quality time with people you mostly know from Soundbite TV^TM. There are not many events where my instinct is to shut up and listen, but this is one of them (my lost my voice was due to the scotch and cigars, not my usual incessant yammering).

The entire event is subject to Chatham House rules — we can use the comments made no background, but we are not permitted to identify the speaker (nor their affiliation) regarding specific quotes. I cannot tell you who got too drunk and danced, who said what about dinner with Alan Greenspan, or which well regarded analyst type, long thought of as a far right conservative, came out of the closet as a liberal.  Such are the rules of the weekend.

I fly from La Guardia to Bangor, hook up with Scott Frew (he drives up from the hedge fund region of Connecticut), and we drive the 2 hours to Leens Lodge. Joining us on the drive this year was Stu Hoffman, Chief Economist of PNC Bank.

Of the many interesting discussions we had on the drive up, the one that is safe for publication (with Stu’s permission) was our GDP conversation. Stu, who I would describe as grudgingly bullish on the economy, takes the other side of John Mauldin’s position regarding the Muddle Through economy.

Stu’s thesis: 2% GDP is unsustainable, and the economy must either break out higher or fade lower. It cannot muddle along at 2% indefinitely.

Why? Stu sums it up thusly: Just as a 747 cannot maintain altitude at 200 mph, neither can the economy sustain a 2% GDP. At 200, the jumbo liner will stall. At 2% GDP, the economy stalls, and will fall into a recession. So the captain of the plane must increase thrust and fly faster, or lose altitude and land.

The economy, according to Stu, behaves the same way. There are virtuous and vicious cycles, and 2% is a form of economic purgatory. It is not encouraging enough to get corporations to ramp up CapEx spending in anticipation of more growth and opportunity. It will not create enough jobs to stimulate domestic retail sales and other beneficial actions.

Hence, the only options are that 2% GDP either stalls, or achieve escape velocity. Stu believes the latter, and is mildly bullish — for both growth, and the markets.

I suspect the economy can also avoid stalling — for now — but that following the 78% SPX pop, market prices mostly reflect the improved economic backdrop. The headwinds of Housing and employment will cap forward economic momentum at 2.5-3% or so. Hence, I expect no double dip, but also a range bound, mediocre stock market.

More on the trip later this week . . .