Reality Check

As one can see from the tone of my posts, I think markets have just lost it. At the root, of course, is the usual central bank remedy for all evils – liquidity pumping.  Then mania is fueled by seasonal mal-adjustments to the incoming data (see the ECRI piece) and a desire to believe, augmented by media campaigns associated with the various elections underway – USA, France, and soon Germany. Just look at the Apple hysteria. I mean, Apple is a great company, but the most recent iPad announcement was b-o-r-i-n-g (faster CPU! better screen! oh please) and yet was greeted as the second coming.

This, from zero hedge of course, is one of the better charts that shows graphically that markets are “lost in space”:

A similar chart, which shows the divergence between the published (lagging) data flow and the actual contemporary data is from John Hussman’s weekly update:

It looks like the published data should be turning any time, indeed some of the non-sentiment data such as durable goods orders have done so.  ECRI and its CEO, Lakshman Achuthan, maintain their recession call which he explains in this recent piece. Of course, ECRI has its chart too, which shows the coincident index growth rate falling significantly as long ago as January.

Achuthan blames much of the apparent strength in the data on inappropriate seasonal adjustments.

Most data, both public and private, are seasonally adjusted. But the nature of the Great Recession seems to have had an unexpected impact on the statistical seasonal adjustment algorithms that are hard-wired to detect when the seasonal patterns evolve and change over the years. This is normally a good thing, but when the economy fell off a cliff in Q4/2008 and Q1/2009, it was partly interpreted by these procedures as a lasting change in seasonal patterns. So, according to these programs, data from Q4 and Q1 would be expected thereafter to be relatively weak, and therefore automatically adjusted upwards. Our due diligence on this subject indicates a widespread problem, resulting in many recent economic headlines being skewed to the upside.

The net of all of this is that:

  • We have had an exceptionally mild winter. This implies that seasonal adjustments based on normal winter weather have overstated economic indicators that are normally depressed by storms, low temperatures and other winter weather issues. In addition, the effect of the 08/09 financial crisis mentioned by Achuthan has generally caused seasonal factors to be additionally exaggerated.
  • Hussman’s and ECRI’s independently collected realtime data show a slowing economy. Their leading indicators also show slowing and both have called for recession. Commodity prices for other than energy have been falling since the middle of last year, confirming a slowing in demand.
  • Not even mentioned is the coming impact of rising energy prices, driven by cheap money, Iranian religious fervor and U.S. adventurism in the Middle East. This works just like a tax increase and slows the economy.
  • The stock market doesn’t believe any of this. It seems to believe that the U.S. will be a safe haven of economic strength, unaffected by the travails in the rest of the world, especially Europe and China.
  • Two of the leading commodity countries, Canada and Australia, have huge housing bubbles whose collapse will be driven by, and will aggravate the effects of, falling commodity prices.

And last but not least, remember that Goldman Sachs is recommending that the muppets sell bonds and buy stocks. Of course, this means Goldman itself wants to buy bonds and sell stocks.

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