Are Things As Bad as They Seem?

The answer is a simple yes and no.

Economists seem split on this Great Recession. The median consensus seems to be that the Great Recession will end late this year. As we all know, a recession ends when the economy stops falling – not when we recover.

As a sailor, I will tell you that when you get into a big storm you are uneasy. Your actions become very conservative. You over-reef the sails which tend to under power your boat making holding a particular course difficult. Sometimes the storm gets so powerful you need to go into survival mode which entails heaving-to or lying ahull where you usually end up going a different direction than you want to go.

There are no fixed formulas when to do what. Each person, each boat, and each situation is different. But after a few big storms you become more confident of your actions. Many investors due to the magnitude of this storm have gone into survival mode. The economy does not have many storms so most investors' experience levels are very low.

When you realize that the storm is abating – but conditions are still terrible – you shake out a reef and start aggressively sailing the boat. You realize that you survived the worst, and that you have control. You are now able to quantify the storm and can act accordingly.

While the storm is building, you are afraid that you are getting into a situation which would overpower you or your boat’s capabilities. If you leave too much sail up, you risk destroying your sails or rigging – not to mention something worse happening.

In the 1998 Sydney to Hobart yacht race, 115 yachts started and only 44 boats made it to Hobart. Five boats sank, 66 boats retired from the race, six sailors died, and 55 sailors were taken off their yachts, most by helicopter. The yachts which finished the race concentrated on reacting to the storm – and not on racing. Most of us yachties in the South Pacific at that time had to deal with that storm – we concentrated on the storm – not trying to make headway.

Concentrating on making money during this Great Recession may be the equivalent of racing through a storm. No matter how smart you think you are, there are too many powerful events outside of your control. We are in the middle of an economic storm of yet unquantifiable power.

The old salts recognize that every storm is different. A storm with 12 foot seas can be more perilous than a storm with 50 foot seas. It is hard to quantify a storm. It is more than the sum of wind and swell. Many times you have multiple swell trains whose effect is much larger than the sum of the individual swells.

Every recession and depression is a congruence of different events. Each event has a different shape. We want to forecast the effects of the recession or its length. This is not possible as the Great Recession is intensifying. The collateral damage and unintended consequences are yet to be revealed. The damage being done daily to America will remain long after the recession ends. You will hear few voices predicting a strong recovery.

When things look this bad they are usually not as bad as they seem. We over-analyze, and tend to expand the size of the problem. This always occurs when so much negative data exists.

On the other hand, there is no sign yet when the Great Recession will be ending. It is a safe bet that our economy will fall 10% from the December 2007 peak. Our leaders only tell us it will get much worse before it gets better. It is best you take this statement at face value.

There is a mix of “doom-and-gloom” and bull opinion among investors. Obviously, both cannot be right. Chances are neither is right. The bulls are propelled in the belief that you reap what you sow. You put out positive karma, and positive things happen. Positive momentum begets positive results. If you believe things will be bad it becomes a self fulfilling destiny so you must act like a cheerleader grasping at every positive straw.

The doom-and-gloom group has a lot of data to support its position. Today, you have to spin data to find anything positive as we have entered the destructive phase of our Great Recession. Because the data is so negative and we are in uncharted waters, it is easy to build a doomsday economic theory. Doomsday theories assume static conditions but our economy is dynamic and in many ways self healing.

For the majority of Americans who can remain employed, this is actually the best of times. Your wealth, although diminished on paper, is actually larger than ever. The challenge today is not to do something stupid with your money or your wealth.

The storm is still building in intensity. Wait until you know the storm is subsiding before you set out on a course.

Update of Economic News

The New York Fed has continued purchasing fixed-rate mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Selected private investment managers are acting as agents of the New York Fed in these purchases. They have already purchased $69.2 billion prior to this week, and $22.3 billion this week. By mid-year, the Fed wants to purchase $500 billion worth of these securities.

click to enlarge

Nouriel Roubini is growing more pessimistic on the economy, and chances are now 33% that the American economy will fall into a Japanese style “L” shaped recession:

Thus, even if the US were to do everything right and fast enough (on the monetary, fiscal, bank cleanup and household debt reduction) we would still have a severe two year U-shaped recession until early 2010 with a weak recovery of growth (1% or so that feels like a recession even if you are technically out of it) in 2010-2011. But if the US does not do it right this severe U-shaped US and global recession may turn into a nasty multi-year L-shaped near depression like the one experienced by Japan. We don’t have to go back to the Great Depression (when output fell over 20% and unemployment peaked over 25%); even a stag-deflation and Near-Depression like the Japanese one would be most severe for the US and the global economy. And while six months ago I was putting the odds of this L-shaped near-depression at 10% or so such odds have now risen to one third. So time is of the essence and the clock is working against US and global policy makers. The time to stop dithering is well past; and the time to implement a program of forceful, coherent, credible, globally-coordinated monetary, fiscal, financial clean-up and debt-resolution is now. The US and global economy are truly risking a near-depression if the policy reaction is not bold, aggressive, sustainable and credible.

Filing for Bankruptcy: Spectrum Brands (SPC), Fortunoff LLC, Ssangyong Motor Co (003620.KS). Delphi Corp (DPHIQ.PK), the biggest supplier to General Motors (GM), said its value has fallen so much that the company may not be able to cover debts accrued since filing for bankruptcy in 2005, including a $4.35 billion loan. Leaving Bankruptcy is Interstate Bakers (IBCIQ.PK) makers of Twinkies who entered bankruptcy in 2004.

Economic and Investing Outlook February 2009

The markets remain uninvestable for me, and there is no good place to put your money. Conditions remain similar to January 2009 and you can review this analysis by reading We Are the Mushrooms of This Economy . I am watching the gyrations in the Chinese market which appear to be reacting to the huge stimulus program.

In my opinion, we are in the 21^st century’s Great Depression. Because of the safety nets and responses to this crisis, the outcome will be significantly milder, and the time spans much shorter. Recovery is problematic due to debt accumulation by the government and the consumers.

Inflation remains off of the table for the next six months. We are entering a world wide depression which evaporates inflationary pressures except those created by supply destruction.

The trailing indicators continue to show a moderate to severe economic contraction. Below is a list of recent news which either reinforces or contradicts any investment strategy.

Interesting but Not Indicating Anything (yet)

• The National Association of Realtors Pending Home Sales Index, a forward-looking indicator based on home purchase contracts signed in December, rose 6.3 percent to 87.7 from an upwardly revised reading of 82.5 in November, and is 2.1 percent higher than December 2007 when it was 85.9. Home prices are still falling, and volume is low. But it is good news if the volumes continue to increase as this will help the housing price bottoming process.

Positive Leading Indicator Update

• Non Farm Business sector productivity grew at a Y-o-Y rate of 2.7% and 3.2% in the third quarter alone. Unit labor rate costs remain low. But in rather contradictory statistics, the BLS said fourth quarter manufacturing productivity fell by 3% although gained 1.3% Y-o-Y. I assume this statistical anomaly was due to manufacturing layoff rates not keeping up with loss of orders.

Negative Leading Indicators Update

• ECRI’s Weekly Leading Index (WLI) continues to demonstrate deteriorating market conditions six months from now.

Negative Coincident Indicator Update

• Employment in January fell 598,000. High rates of unemployment claims continue. Unemployment for the month of January rose to 7.6% from 7.2%. Lower employment / high unemployment levels indicate when you enter a recession, but do not indicate when a recovery would occur. For this reason, employment levels become a coincident or lagging indicator once you are in a recession. So far in this Great Recession, 3.6 million payroll positions have been lost.

• Personal income, Personal consumption, and disposable personal income decreased in December.

• New orders for manufactured goods in December, down five consecutive months, decreased 3.9% to $362.4 billion. This was the longest streak of consecutive monthly decreases since the series was first published. Excluding transportation, new orders decreased 4.4 percent. Shipments, also down five consecutive months, decreased 2.9% to $377.6 billion. The unfilled orders-to-shipments ratio was 5.82, down from 5.87 in November. Inventories, down four consecutive months, decreased 1.4% to $544.3 billion.

If you would like a summary of all government financial indicators, click here.

Disclosures: None

Comments

[ROLEX18:]

I don't care, I am buying today mini Dow Futures in the last hour as all the action will be there, otherwise it is boring day.

Feb 09 09:38 AM

[Docsroute:]

Thank you Steven for this very thorough , honest and creatively written view of the financial seascape. You are a big help to the little guys like me.

Feb 09 09:58 AM

[rber:]

The US economic buildout since 2003 due to the vast sums of money released by the fed and the housing atm in parallel with the real/shadow bank driven housing bubble is crushing the retrenching american consumer. The subsequent economic fallout has exposed all the weak areas of the economy and has/will continue to claim victims. The consumer represents roughly 70% economy. There will be no recovery until they economy and the consumer rebalance.

Feb 09 11:45 AM

[User 353771:]

Nice article. I think that you are spot on. The storm analogy is a good one. We need to focus on what we can control, not lash out at possibilities.
The problem is that all the current proposed solutions are symptomatic, and by definition, will fail. Banks cannot be allowed to fail, but by that token cannot be allowed to destroy investors wealth through bad management. There are 2 keys to rescuing the US. Firstly to restore confidence in the dollar. This can only happen through a mandated balanced conservative investment portfolio by the banks, who should report to the Fed Reserve Bank, and be guaranteed by them. Reinstituting a gold standard will go a long way to achieving this, and ensuring a check on fiscal policy. Secondly, the US has sold itself out to offshore manufacture in the name of corporate profits, losing much of our competitive accumulative knowledge. We do not have the leading edge on anything anymore, and need to focus on building up our ability to ADD VALUE. This is a cultural issue that must start at the top. Quality, creativity, and humility (not expecting more than we deliver) are the foundations for our survival. We cannot treat our problems as a government issue. We are all to blame. It is time to reflect on our weaknesses and think strategically as a whole. The US are not the greatest anymore, in fact, we're one of the weakest judging by our deficit. If ever there was a need for radical change it is now. And I don't think our bumbling government can manage it as their focus is political (race) as opposed to strategic (surviving the storm).

Feb 09 12:43 PM

[PROXIMO:]

Storm analogy is a good one. Remains to be seen if we are in a tropical storm or a typhoon. My guess is we will know for certain within the next 6 months. Just my opinion. Enjoyed the article.

Feb 09 03:37 PM

[norespect:]

excellent piece it reminds me of the only nautical reference i recall.. in a big storm its more important to be seaworthy, than on course

Feb 09 07:31 PM

[tonyb:]

you do not have to accept mr hansen's advice, but you should respect it, and you should respect him as one of alpha alerts most reasoned and respected authors. i have read your comments in other articles. you are a fool, and a fool and his money soon go separate ways.


On Feb 09 09:38 AM ROLEX18 wrote:

> I don't care, I am buying today mini Dow Futures in the last hour
> as all the action will be there, otherwise it is boring day.

Feb 09 08:51 PM

[The Good Ne...:]

Steve,

I really enjoyed the storm analogy.

Way back I used to work for the National Weather Service. It continues to be an interesting exercise to see forecasters vary so widely on their predictions... particularly when the forecast moves beyond a few days...

Hurricanes especially have a "mind of their own". Statisticians pore over the vast amounts of data produced by one storm in the hopes of predicting the path of the next one more accurately... and still the predicted path is wide.

Many times it come down to which forecast model to you put your trust in and what data was used to load its run.

I appreciated also the compilation of indicators. What is your read on ISM report on manufacturing? It appears that while many of the indexes there still point to contraction, many of them for January point to contraction at a significantly reduced rate...
mast-economy.blogspot....

GNE

Feb 10 01:44 AM

[cartecay1:]

Either this financial hurricane is 1. Passing us by or 2. We are entering the eye, soon to be slammed by the other side.
Those who bet their remaining assets on #1, you'd best be right because you are taking on "lose the ranch" risk.
Of course, there are always those who will fail conventionally rather than survive in an unconventional manner.

Feb 10 08:33 AM

[Ferdinand E...:]

As compared to the depressions up ahead that will be caused by energy shortages and overpopulation, what is happening now reduces to a bad patch.

Feb 10 09:16 AM

[Mr. Twigs:]

Steve, Having barely survived Katrina in New Orleans I get the message loud and clear..."Batten the hatches". Thank you so much for the strong rudder. Allen

Feb 10 09:48 AM

[Conan the B...:]

First of all, the worst is yet to come economically.
But once inside the eye, you stay in the calm for a while.

There is a lull where a thousand Dow points or 100+ on the S&P will be made. Bear rallys will periodically intrude simply because of short covering.( is shorting still allowed?)

Anyway, whenever you compress a move in either direction, you will have a reaction. The January effect never materialized, we are overdue for a bounce. IMO

Feb 10 02:29 PM

[Steven Hansen:]

Thank you all for commenting.

Good News Economist - ISM data uses subjective data factors in deriving their indexes. I try to use objective data, and the commerce department fills that bill.

It is true that the index did indeed improve. But every factor in data decreased from the previous month. If the readers would like to look at the report:

www.ism.ws/ISMReport/M...

it says in part:
Manufacturing contracted in January as the PMI registered 35.6 percent, 2.7 percentage points higher than the seasonally adjusted 32.9 percent reported in December. This is the 12th consecutive month of contraction in the manufacturing sector. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.

A PMI in excess of 41.2 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the PMI indicates contraction in both the overall economy and the manufacturing sector. Ore stated, "The past relationship between the PMI and the overall economy indicates that the PMI for January (35.6 percent) corresponds to a 1.7 percent decline in real gross domestic product (GDP) on an annual basis."

the bottom line of their report is everything got worse than the previous month, it just is not getting worse as fast.

Many indexes are showing this same pattern. ECRI WLI is in the same mode (6 month look ahead on business conditions). As an investor, I am looking for a green light to buy. I do not make money sitting on the sidelines.

Feb 10 06:16 PM

[Conan the B...:]

Late Sept. Paulson comes to the Congressional door, I want $700 Billion, Congress introduces pork. Voting ensues, Not enough Republicans supporting it, Dow drops like a Big Rock. Within a week Paulson gets what he wants.

Obama Stimulus Plan, Republicans against Democrats for. Obama wants both parties to share the Blame if it doesn't work. It looks like he isn't going to get it.

Geithner comes along, makes an announcement that he is going to make a Big Announcement, Nothing, markets tank. Onus is on Congress for a united front.

Will there be one? I certainly hope not. Let the chips fall.

New name: The Financial Stabilization Plan.
My new name: The Financial Bailout Stimulus Plan or
FIBS.

Feb 11 01:37 AM

[Jan Baker:]

Buy American...Hire American?

I'm looking at the unemployment figures a new way. I'm wondering how many of those jobs are presently held by illegals.

Yesterday the Illinois road department released a statement that said they might not be able to take advantage of the stimulus funds earmarked for them because they did 'not have enough workers.' Isn't that curious? That statement usually accompanies industry demands for tolerance of illegal workers, or for more green cards in the techier fields. And it makes me wonder how much of the stimulus package will be going to create or maintain jobs that will or are held by illegals.

Nobody is making any distinctions in the unemployment figures.

But what if the stimulus package said not only Buy American, but Hire American? (Why doesn't it?)

I like Mexican people very much, but I'm not sure I want to print money to get them jobs--and Mexico needs them, too, by the way.

Feb 12 01:56 PM