Bond and equity markets both reacted negatively to comments from Countrywide Financial Corp. (CFC) CEO Angelo Mozilo. In a CNBC interview he spoke about the problems in housing and predicted a recession would result.
Should investors heed this warning?
At "A Dash" we have tried to emphasize two themes that can have a great payoff for longer-term investors. The themes may also benefit traders, although the timing is trickier.
• Identifying the expertise of the source. The Countrywide CEO obviously has great information and insight concerning his own business. He is providing additional information about something of current concern, and that is useful. He is not an expert at predicting recessions. There is no evidence that he has experience or added value in considering how the housing situation will affect individual or business spending, countervailing factors, or a quantitative forecast of the effects. He knows about housing.
Try this comparison. Suppose a CEO was making an extremely bullish forecast about his own company. We might view this with some skepticism. Applying the same attitude, one might conclude that the CEO of a business that was struggling would want to make the problem seem as great as possible. Compare the Countrywide comment with the Bear Stearns CFO who responded to questions by saying it was the worst credit market he had seen in his 22-year career. He was trying to explain what happened to some leveraged hedge funds, among other things. These sources are experts at what happened in their own companies, but might be seen as biased when projecting impacts on the overall economy.
• What has already been "priced in" to the current market? The sources cited have absolutely no expertise on the stock prices of other companies, normalizing earnings, or other factors that investors should consider.
Where to Look
Investors should look to those who are experts at taking all economic factors, viewing the impacts with quantitative impacts, and making forecasts that are tested by prior results. In particular, it is important to understand that recession forecasters are predicting something that typically is an unlikely event. They have few past cases to work from, particularly in the modern era. Any economist recognizes the impact of the housing problem in GDP forecasts. They differ in the size of the impact. At "A Dash" we have tried to highlight sources that have avoided "false positives" in the past, including the ECRI. Many recession forecasters place no time frame on their predictions, moving the date forward each year as they are proven wrong. Sidelined investors have missed an opportunity by listening to these predictions.
One should also consider how much earnings forecasts have already been reduced to reflect recession chances. This is the only method to figure out what is "baked in."
Where Not to Look
We suggest avoiding pundits who cite each statement from a housing source as important fresh information. Many of these pundits seem to think that they are the only ones with any vision. They repeatedly claim that others "do not get it."
In fact, everyone "gets it" in that they are aware of some GDP loss. The difference is that some forecasters attempt to quantify the effect, while others (mostly non-economists) cite each statement as proof without sound analysis on quantifying the effect.
It is a curious fact that pundits who are not economists strongly believe that they have greater insight than those who studied for many years to learn theory, data analysis, and forecasting. They operate from a stereotype of homeowners that reflects only a small segment of the population.
The many market pundits who take a bearish view of the economy can find plenty of specific statements and data to support the housing effect. The difference between the real experts and the pretenders is the ability to quantify those effects.
Having arrived at an economic forecast, the investor must still ask how much the market already reflects a negative perspective. There is an advantage to buying when fear has been priced into the market.
We rarely have the opportunity to gain a contrarian trading advantage -- buying fear -- by relying upon the real experts. Now is such a time.