Recession. The Technical versus the Real.

It seems as though every cycle comes with its own new lexicon or isolated points of contention.  During the Great Recession, debate circled around “in what inning of the recession are we?”  For weeks this was bandied about by the “experts” whom had nothing better to do than opine on CNBC or Bloomberg TV. 3rd inning, 7th inning, blah, blah, blah.

Similarly, we heard the same debate about “the Treasury Bubble.”  That one had a shelf-life of over two years until (finally) Bill Gross threw in the towel and went home to “cry in his beer.”  (His words, not mine).  Incidentally, his bottom quintile performance speaks, perhaps, slightly louder than his eventual acknowledgement.

The debate du’ jour happens to revolve around whether the country is re-entering recession.  What is sadly comical about this debate is that is revolves strictly around the technical definition of recession1. A period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

I find this debate to be sad due to the fact that, during the exercise of trying to guess whether GDP will fall for two consecutive quarters (and the rafts of graphs, tables, and charts displayed to rationalize one or the other side of the argument); the social damage inflicted by this economy becomes obscured.

At last count, the unemployment rate was 9.1%.  Drive down the street, make a conservative assumption that each home you pass holds only one person actively seeking a job, and understand that (on average), one out of each 11 homes contains an unemployed adult.  Add back the underemployed and those who have simply walked away from the job market and you’ll only have to drive past 7 homes.  That sure feels like a recession.

If you happen to be driving through a minority neighborhood, pass 6 houses and you’ll find someone who is unemployed (source: National Urban League).  Recession?

And while you’re driving by those homes, it could occur to you that 4 out of 10 (on average) are underwater (source: Standard and Poors).  If you’re driving through Las Vegas, 8 of 10 have bubbles rising outside their windows (source: Zillow).  Driving through Orlando, it’s 5 of 10.  That sure feels like a recession.

Let’s keep driving.

With about 46 million Americans now on food stamps, 1 in 7 of the homes we pass will be collecting assistance to eat.  That is 15% of our citizens needing… food.  That sure feels like a recession.

The problem with today’s technical discussion about recession is that it masks the social effects of the present environment.  And from an investment perspective; ignore the social effects at your own risk.

Ignoring the social situation and focusing almost exclusively on monetary policy is short-sighted and ineffective.  If 15% of the country is struggling to eat, 40% of the country has underwater homes, and 9% of the country doesn’t have a paycheck, it strains logic that manufacturing a “wealth effect” by forcing up the price of speculative assets will solve the economy’s woes.  The speculative assets are concentrated with a relative few, and this economy needs broad participation to return to good health.

Further, incessant tinkering with monetary policy has led to bubble after bubble, escalating the social problem each time.

Yet, the debate rages on about recession or no recession, QE3 or no QE3, and risk-on or risk-off.

My thoughts:  If we cannot arrive at a coordinated solution that includes fiscal, monetary, and political sanity, it is hard to consider allocating capital to risk assets.  Sourcing investment returns from areas only loosely associated with risk asset pricing continues to dominate our thinking.

Now…  returning to some observations about the state of our economy, I include some observations from Dr. John Hussman of the Hussman Funds. (

I included the link to Hussman not as an investment recommendation.  Rather, it is a legal condition of reprinting Hussman’s copyrighted material.

“It is now urgent for investors to recognize that the set of economic evidence we observe reflects a unique signature of recessions comprising deterioration in financial and economic measures that is always and only observed during or immediately prior to U.S. recessions. These include a widening of credit spreads on corporate debt versus 6 months prior, the S&P 500 below its level of 6 months prior, the Treasury yield curve flatter than 2.5% (10-year minus 3-month), year-over-year GDP growth below 2%, ISM Purchasing Managers Index below 54, year-over-year growth in total nonfarm payrolls below 1%, as well as important corroborating indicators such as plunging consumer confidence. There are certainly a great number of opinions about the prospect of recession, but the evidence we observe at present has 100% sensitivity (these conditions have always been observed during or just prior to each U.S. recession) and 100% specificity (the only time we observe the full set of these conditions is during or just prior to U.S. recessions). This doesn’t mean that the U.S. economy cannot possibly avoid a recession, but to expect that outcome relies on the hope that “this time is different.”

As always, it’s up to the reader to determine if these facts are “fitted” to support the conclusion, or the other way around.  In any event, Dr. Hussman is a smart guy and usually has some interesting insights.

Another day, Another 4%, and Playing with the Robots

The day began with more bad news from Europe, with an unnamed bank getting  $500 million from the ECB.  That was significant because it suggests that at least one European bank is having difficulties obtaining dollar funds.  These types of transactions, known as Euribor-OIS swaps, were very prevalent during the ’08 financial crisis, so nobody is happy to see them returning.

By the time European markets closed, the damage was pretty significant:

UK     -4.49%

Germany     -5.82%

France    -5.48%

Prior to our markets opening, CPI was released.  Against an estimate of 0.2%, the number came in at an increase of 0.5%.  Even worse, hourly wages dropped 0.1%, exacerbating the consumer’s stress.  At the same time, jobless claims were released, rising by 9, 000 to 408, 000 versus a consensus estimate of 400, 000.  Continuing claims disappointed as well, coming in at 3, 702, 000 versus a 3, 698, 000 consensus.

Not a very solid foundation upon which to build a trading day.

Then, at 10 a.m., three new numbers were released…  one was good, one was bad, and the third was shockingly abysmal.  The first, the Leading Economic Indicators, came in at +0.5% versus expectations of +0.2.  On the heals of this report, existing home sales numbers came in with a miss; decreasing by 3.5% to 4.67 million annually versus the 4.87 guess.

The number that took everyone by surprise was the Federal Reserve Bank of Philadelphia’s Economic Index (otherwise know as the Philly Fed).  The index printed at an astounding -30.7 versus the expectation of +2.  Any number below zero is considered a sign of economic contraction.  NEVER, in the history of the Philly Fed, has the number been less than -20 without being in (or immediately approaching) a recession.  Pulling the report apart, you will find the following stats:

  • New orders dropped to -26.8
  • Shipments dropped to -13.5
  • The employment index dropped to -5.2 (its lowest level since 10/09)

The final news release of the day was the Bloomberg Comfort Index (a measure of consumer sentiment).  The monthly index fell to -34 (the lowest since March 2009…  remember sentiment back then?).  The weekly index dropped to -48.3.  Quite stunning.

Against that backdrop, today’s version of “Let’s Shave 4% Off Stock Prices” does not come as a surprise.  This time, though, I’m not convinced we will see another dead cat bounce like we’ve those to which we’ve become accustomed.  This time, it may well just be a dead cat.

The data indicates that the probability of recession is increasing, and Europe’s inability to be proactive continues to push us closer to the brink.  It’s a dangerous game of chicken that’s being played.

Playing with the Robots

We had some trading to do today.  Our ticket size was about 210, 000 shares and I was trying to execute in 30, 000 to 50, 000 blocks.  As I watched the bids and asks, 70, 000 share lots kept blipping on the screen, going unexecuted, and reappearing again $0.01 from the prior print.  It was a nuisance trying to trade within that environment, but at least there was a lot of liquidity.  That is, until about 2:30 p.m.  Someone must have kicked the plug out of the HFT computer, because all of the sudden the market depth dried up and we were left with bid and ask sizes averaging only 1, 700 shares or so.  This persisted until around 3 p.m., when somebody must have noticed the plug lying on the floor, plugged the robot back in, and suddenly 70, 000 share lots began blipping all over again.

It wasn’t much fun playing with the robots earlier in the day, but it was a lot less fun trading for the half hour they were missing.

A friend of mine, Mark, sent me this link today regarding high frequency trading and the uptick rule.  I’m not mentioning his full name because I haven’t had the chance to ask him if he’d like to be identified on this “prestigious” blog.  Here is the content of the email I received:

The uptick rule for placing short sale transactions was promulgated in 1938 and removed in 2007 by the SEC.  By requiring traders to curtail repeated short selling transactions until interim “upticks” or upward moves of a stock price occur, the rule can deter short selling attacks that are intended to disrupt public markets.  High frequency trading, which many believe is often used to make markets less transparent and fair, can rapidly drive markets lower with massive, repeated selling in individual names or select groups that serve as a proxy for an entire index.  The absence of the uptick rule facilitates high volatility, potentially manipulative trading algorithms.  It is likely that HFTs are behind the historic volatility in the markets of recent weeks.

The video link below is of an interview with one of the legendary investors of our time, Marvin Schwartz of Neuberger Berman.  Mr. Schwartz passionately argues that the uptick rule needs to be restored in order to restore a level playing field to US capital markets.  Please take a moment to listen to his points.  If you feel so compelled, I encourage you to forward the interview to your elected representatives.  Schwartz makes an eloquent and compelling case.  We all have a direct interest in promoting fair and openly transparent investment markets.  My view is that the restoration of the uptick rule will contribute positively to our interest.

Link to 8/18/2011 CNBC interview of Marvin Schwartz on HFTs and the uptick rule

Thanks for the link, Mark.