ISM Comment Leads to an 'Aha' Moment

Sometimes little things make the difference.  For example, early in 2009, I saw a comment on a blog that was arguing with the blogger and most of the commenters.  This comment went as follows:  forget about the injustices you perceive about the bailouts of the banks and bankers.  They have won.  It shows in Jamie Dimon's swagger.  Get over it.

This commenter was right, and thinking about the real-world wisdom it embodied it helped me switch from the bearish posture I had had ever since the summer of 2007-- and uber-bearish after a recession (mild, at the time) was confirmed by the spring of 2008.

In any case, a similar comment from the Chicago PMI report released this morning struck me as also bringing me to a clearer understanding of the markets, this time in a negative way.  Here is part of the intro to this report:

The short term trend of the Chicago Business Barometer, and all seven Business Activity indexes, declined in May.  The Production index fell to neutral while, inexplicably, measures of Business Policy advanced.

This was an 'aha' read for me (note emphasis was added above).

Inexplicably, the purchasing managers' companies were bullish.

A problem that has vexed me a great deal has now been answered.  That problem is that the futures markets show that commercial hedgers have gotten much less bearish as prices have declined.  This is seen in general summary data available on the Web, and please note I'm an amateur at this and don't look at detailed COT reports and the like.  But publicly available data indicate that the commercials in important markets such as copper and less important ones such as palladium are acting as they have during routine price corrections.  However, in 2008, we saw similar activity from the commercials, and it merely presaged a much deeper depression.  In other words, so far as they knew in 2008, the U.S. was undergoing a mild recession, the world was reacting in sympathy to temporarily decreased demand, and normal inventory policies were appropriate.  And indeed, eventually, prices were higher than where they went bullish, but it took a major downtrend and many, many months for them to rise enough off of a much lower bottom for that to occur.

So we have it:  if the fringe views of the ECRI and a few economists such as John Hussman and Gary Shilling (and Econophile Jeff Harding at The Daily Capitalist) are correct, then the U.S. is in or is soon to be in a recession.  In that situation, China will lose even more demand for its exports, and we can expect more economic turmoil globally. 

This fits together an additional way.  A few weeks ago, Dr. Achuthan of ECRI went on TV and said his own 'aha'- he said that what had been going against his forecast of recession (which he had held to steadily since he first made that call around Sept. 20 of last year) was employment.  He pointed to the nascent uptrend in new unemployment claims as evidence that finally, all the diagnostic evidence was in his favor. 

So what did we see today?  Another set of bad numbers on the employment front, both in new claims and in the ADP flash employment number.  The ECRI case for recession not only remains on track, but just this week it put out a report for paying subscribers with the ominous title "More Signs of Global Economic Stress".

So, while the consensus on the Street has to be treating the current stock sell-off as a response to European turmoil, ECRI is doubling down- and it does have a strong track record. 

A mild U.S. recession can be expected to have disproportionate effects on business behavior, and if so, currently "cheap" stocks may get a lot cheaper.

I am not an economist or a professional forecaster, but I do have a knowledge of advanced statistics.  Thus I understand the message of simple statistics well.  In this case, it is that for many years, there has been a strong correlation between recessions in the U.K. and other important European countries and recessions in the U.S.  While correlation is not causation, I do respect it.  Thus, putting all the above points together, my "central tendency" is for greater caution on risk assets than I think the markets are pricing in.  So, again, in murky times when legitimately major events are occurring in the world's largest economic zone, the EU, I like a lot of cash.  Buying into an established uptrend at higher prices only has an opportunity cost, not a real economic cost.

We are, indeed, skating on thin investment ice.

Knowing and saying all this, I now feel I should add that none of this is of any value for short-term market action.  This is intermediate-term stuff.

(P.S. Due to the above, I took advantage of the late-day surge in AAPL to reverse most of my purchases yesterday.  Still long, still love the fundos there, and look for it to get to its now-declining 50 day sma, but I like to prepare for intermediate-term stuff in advance.)