Saturday, January 30, 2010

Markets Not Loving the Growth or Declining Economic Freedom

The Economic Cycle Research Institute (ECRI) publishes its Weekly Leading Index on Fridays. The absolute level of the index is around 131. Unlike the Conference Board's better-known but arguably less sophisticated Leading Economic Indicators, which is in record territory, the WLI is about 12 points off its 2007 high of 143.
That index peaked in the May-July time frame in 2007, which was the precise period in which Bear Stearns disclosed problems in two of its managed hedge funds. The annualized growth rate of the WLI turned negative later in the summer and except for one somewhat manic move to new highs in the stock indices in the fall, stocks have trended downward since.

ECRI points to a V-shaped economic recovery in its latest press release, U.S. Business Cycle Recovery To Keep Going:

"With the WLI staying near the previous week's 83-week high, the U.S. business cycle recovery is set to keep going in the months ahead," Achuthan said.

He also pointed to government data released earlier on Friday showing that the U.S. economy grew at a
faster-than-expected pace for the fourth quarter.

"With GDP growth rebounding 12 percentage points in just three quarters, the V-shaped recovery foreseen last summer by the WLI is coming into focus."

Somehow the economic and financial climate continues to feel more like Japan post-bubble than Springtime in America. Indeed, this blog has reported that ECRI is now forecasting more frequent recessions than in the 1983-2007 period. This will be good for its business but probably not so good for the country or for investors.

Remembering that many stocks peaked not in 2007 (financials) or much earlier (homebuilders, spring 2005) but in 2008, and that others have gone on to all-time highs, stocks of companies with ongoing record profits, upward earnings revisions, below-market P/E's, that are self-financing, and preferably have strong charts (whether or not they have had profit-taking at some point in the past few months) can be owned in what may well be an economic cycle that is pointing flat to down from a growth momentum (second derivative) standpoint.

While JPM and GS may well be due for kickback rallies, they have broken down on the charts. It appears to this blogger that the same phenomenon that applied to the techs post-bubble is happening to the financials. Their reflex rally is over, and as a group they are dead money until the next economic/market cycle bottoms.

Treasuries may be OK from an intermediate-term standpoint, given the political dynamics that have forced the administration to talk of increasing taxes (on Big Finance) and decreased rate of spending growth.
If the current economic cycle is like the prior one, Treasury rates will move irregularly upward as Fed tightening (or decreased loosening) competes with slower growth. There is a very real possibility that the next economic downturn will involve a decline in the 10-year Treasury to the 2-3% rate.

Meanwhile, absolute levels of return on low investment grade bonds (Moody's Baa) are "too low" at just over 6%. Call me irresponsible, but I just made a modest investment on Greek 5-year Euro-denominated bonds at a 6.5% yield to maturity. Between the country that helped create the modern world and an anonymous company with uncertain finances and an uncertain fate, I'll take Greece.

The U. S. has now been downgraded by the Heritage Foundation to being "mostly free" economically rather than "free". Its drop of 2.7 points (on a scale ranging to 100) and a rating of 78.0 brought us to eighth place, below seventh-ranked Canada (80.4) and far below Hong Kong and Singapore, numbers one and two respectively, which had scores of 89.7 and 86.1.

Considering that Australia and New Zealand were third and fourth and are physically and economically closer to Asia than anywhere else, it is fair to say that the East may not be red any longer, but it increasingly is economically free.

There are many other measures of economic success and growth prospects than freedom per se, especially as defined by a group with the agenda of the Heritage Foundation; Brazil, India and China were ranked 113, 124 and 140 respectively, and the numerical ratings for all of them declined last year even as their economies grew.

The financial world is changing rapidly. Barack Obama had a real chance to pull an FDR, get a Pecora Commission-type show going and promote the major financial system reforms that would provide a platform for a new, better economic structure. Regardless of how the current cycle plays out and whether or not he wins re-election, he has failed us. We are now doomed not to 23 but 27 years of Greenspan-Bernanke. Yuccch!

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