So Much for the Decoupling...

World markets are plunging in response to fears and expectations that the United States will be (or already is) in a recession that will be both long and deep.

Headlines around the globe are rather stark:

Major Indexes Drop Sharply On Worries Over U.S. Economy [WSJ]
Europe Starts to Feel Pinch as U.S. Slowdown Spreads (Bloomberg)
Global markets plunge on U.S. recession fears (CNN/Money)
US recession fears sink global markets [AP]

So much for that decoupling thesis.

What is rather incredible about the past few years are the number of pinheads who so totally got this wrong. Not your run of the mill liars/idiots who insisted Housing and Credit would have no broader impact; these hacks were merely blind incompetent cheerleaders. No, what really stunned me is the number of otherwise intelligent people who, once again, claimed "it's different this time."

It's one thing to be wrong, but it's another thing to have your entire philosophical world view invalidated. That included the primacy of seeing what is going on in the real world, of understanding what the official government data really means, of not ignoring broad and deep concerns amongst the population.

It's one thing to guess a specific data point wrong -- does anyone reliable forecast NFP? However, it's a horse of an entirely different color to stay wedded to a completely invalidated heuristics, or ignore economic truths with a long history of being right.

Consider these statements which we heard over the past few years:

The Yield Curve no longer mattered
The population is upset about Iraq, not their own finances
Earnings at an unusually high % of GDP are sustainable
The Business Cycle has been defeated
Real Income gains were irrelevant
Mean reversion no longer works
Supply side tax cuts pay for themselves
Dow Theory is antiquated and no longer works
The (so-called) Fed Model = equities are vastly undervalued
There is no significant Inflation.

I'm sure there are more, but I'm only on my first cup of coffee.

~~~

QUESTION: What other economic statements, investing beliefs or market philosophy have been shown to be wildly false? What investing beliefs are horrifically and expensively wrong? I do not mean specific calls, but rather, the larger rules and philosophies that are now being shown to be utterly incorrect?

Comments

[Vladimir Se...:]

"rate cuts work" will be another one of those soon.

2008 Jan 21 11:07 AM

[Research123:]

Aside from the herd of lemmings that are rushing to push us all of the financial cliff because it makes for good headlines, exactly what is it that suggests a worldwide recession is looming (or is it now going to blossom into a depression according to the breathless pundits?) Don's point to the equity markets, as they are only predictive and are more likley than not being moved by the heavy hands of a bazzillion hedge funds throwing their weight around. I am intyerested in real data, of which their seems to be precious little these days.

2008 Jan 21 11:26 AM

[Michael B. ...:]

Keep your eye on this chart. Credit spreads. When these blow up, then the market has a reason to sell. Until then, this is completely fear and profit driven (everyone and their mother is short).

markit.com/information...

2008 Jan 21 11:34 AM

[Research123:]

The chart posted by Krause is an excellent touch point to keep us grounded in facts not hedge fund hype.

2008 Jan 21 11:51 AM

[David Lentz:]

The trade imbalance doesn't matter.

2008 Jan 21 01:07 PM

[virilio:]

because of decoupling BRIC investments won't plummet faster than domestic equities

2008 Jan 21 02:10 PM

[A.S.D.:]

This is artificial. Hundreds of billions of dollars are at work on the short (for the lack of a better word) side, and pushing hard to collapse most of the world economy. There is no comparing 2000 to 2007/2008. Do you remember Nasdaq or tech stocks 1999-2000, or the market-manic general population? There was no mania and not many extreme valuations this time. Most people I know were very nervous the entire 2007 and kept 10-30 percent cash and large gold positions if going long. Any of us who lost this round have only ourselves to blame-learn your lesson and move on. This has been a fixed game for a while now and the only way to win is to get to know the heavy players who started this play in 2006. I do wish someone could organize a US based movement against shorting (not just in the cash market). I don't buy any of the arguments that it's beneficial to the markets. It's just another way to make a buck or a billion and it's usually destructive. I really hope the the US government gets interested in the "shorting game", instead of wasting time passing new mortgage laws two years too late.

2008 Jan 21 02:24 PM

[E.D. Hart:]

Gold is a barbarous relic with no predictive power= bad investment

If growth comes down, inflation comes down= we are headed to lower inflation in a recession

2008 Jan 21 03:37 PM

[alpha24seven:]

@foreigner. Blame the shorts for the CDO debacle, housing valuations, commercial RE collapse (coming) ridiculous valuations on BRIC companies with no transparency etc. We all have to find blame somewhere...

2008 Jan 21 04:17 PM

[Reinko:]

To Michael B. Krause:

Were the FED money auctions not desinged for keeping all kinds of spreads down? Well here in Europe long lasting libor still hangs high above the ECB stuff so it has not worked much (although libor in the USA is more down lately).

To Barry Ritholtz: You are a good writer man! My compliments...

2008 Jan 21 05:32 PM

[Research123:]

Subprime mortages outstanfind are $1.3T or so. A 25% total loss is only $300B. Markets have dropped by a multiple fo this amount. Fear and greed are driving this train wreck, not any rational thought process.

2008 Jan 21 05:32 PM

[TA:]

Research123 is 100% correct - this site is full of what's become the herd pushing the market down as fast as possible on absolutely nothing but sheer panic. There is no difference between this and the inverse in 1999 - bubbles always happen both ways.

No one know how to think for themselves, no wonder so many people get taken. All you can do is profit from it and ignore the rest.

2008 Jan 21 09:06 PM

[jstratt:]

I must commend the author on this timely piece.
Apparently Tuesday in the US will be down 5% based on futures. Since I dont intend to sell I guess it doesnt much matter. I dont intend to buy additional shares tomorrow either but may in the next week. Frankly it has been a while since a good bear market with some fear involved. It was only months ago that I could see people taking huge risks with little additional return required. It made prudent financial management look out of style. Still a little calm is in order. The shoes that have dropped to date dont justify a Dow under 12000.

2008 Jan 21 09:22 PM

[A.S.D.:]

Althought I personally don't like shorting (if I were stupid enough to leave my front door open-it doesn't give you the right to rob me), I didn't mean to say the guy who's shorting amazon for a few beans is responsible for pushing this snowball. You don't really think the US subprime lending is about to bring down, even for a day, the world economy! There is no defense against multiple, hundred-million-dollar attacks against whole sectors by some of the same players who caused the issues "alpha24seven" is refering to. For a minute I really believed GS would get in trouble for pushing defective products from one desk and shorting them from another, but I understimated the level of coruption in the government and the apathy on the part of general public who watches as 5 years worth of home equities and retirement investments are stolen while home owners get blamed for creating a bubble and more old victims turn predator each day. GS is by the way one of this industry's more respectable firms in my opinion. Yes the shorts didn't really start this, but without them the damage would be fractional. Is there any hope for a popular movement against coruption in the financial industry and a ban or limitation on professional shorting.

2008 Jan 21 09:39 PM

[huangjin:]

Supply side tax cuts do pay for themselves. What they don't pay for is a major expansion of Medicare, a war in Iraq, a new Homeland security bureaucracy, and an expansion of the Department of Education.

2008 Jan 22 09:24 AM

[Bangkokexpat:]

My candidate:

A weak dollar is good for the economy.

2008 Jan 22 10:14 AM

[Sr. Pessimist:]

Europe will eat it, but it won't eat it as bad as the US. The EU accounts for something around half of the world's productivity. America will crap out while Europe will survive. American workers are productive at doing what they're told to do, but only 1 in 10 Americans are such workers. The rest tell them what to do in one way or another. So Europe will feel a pinch, but won't crap out as quickly as the expired capitalist fraud sham that is America.

American investment banks will knowingly con foreign banks into investing into their bad securities, but foreign banks won't be as easily misled next time. There won't be a next time. Foreign banks won't trust American banks anymore. And they shouldn't. This country is rigged backwards and upside down.

2008 Jan 22 11:00 AM

[wearetheworld:]

Yesterday the European Markets lost 350 billion of market value in one trading session. So the next time the sellsider from GS call on HSBC or Citi ...who is going to answer the phone?
When trust is not part of the process the process comes to stop.
You do not short your own clients into bankruptcy..good luck in 08 GS

2008 Jan 22 01:07 PM

[Lamont:]

foreigner: The shorts didn't cause this. The evaporation of risk premiums from 2003-2006 and unfettered faith in hedging instruments (CDS, monoline insurance, etc, etc) along with lax lending standards and some outright fraudulent issuance of loans caused it. The Greenspan Fed could have done something to nip this all in the bud, but they believed that the market could evaluate counter-party risk much better than the government. In fact, they just allowed a huge bubble to blow up in the risk markets -- not just mortgages, but all kinds of debt instruments and equities. Throughout 2003-2006 pretty much everything was priced for perfection.

There had to be a shaking out of weak hands in all sectors. That means that people without sufficient income to pay their mortgages needed to be foreclosed. Institutions which lent that money or bought those CDOs needed to lose. The risk preimiums on the CDS market needs to widen to reflect the fact that recessions happen and defaults on corporate debt happens. Again, people and organizations need to lose money because the state of the economy from 2003-2006 was unsustainable.

Blaming the shorts is like trying to chop off your runny nose when you've got a cold. Its just a symptom, long after the fact.

It also is a completely predictable response -- the shorts were blamed for the crash in 1929 as well.

And I don't see a big call to ban shorting when shorts are getting squeezed and having to cover during a bull market. Amazon probably wouldn't have hit $90 recently if it wasn't for shorts having to cover as it ran up like crazy in 2006. The shorts that didn't have weak hands and get flushed out are now going to make a profit on Amazon as they should (although I'm kind of expecting Amazon to post some decent results for Q4 compared to everyone else since they'll benefit from the exchange rate, so I wouldn't call for shorting Amazon just yet... Profits on the short side I think will have to wait until we're further along into this correction).

Anyway, the business cycle happens, recessions happen, stock markets correct and fall. The risk premiums on *everything* from 2003-2006 did not price any of that risk in, and those risk premiums are now being adjusted by the market. Don't whine about the shorts. And really you should be thanking them for overly-emotionally punishing stocks in the short term when 6-18 months from now you're picking up bargains at the bottom...

2008 Jan 22 02:14 PM

[A.S.D.:]

Please read again. I never said that the average short caused this. I specifically said go a head and short Amazon if that's your style. My problem is with many professional shorts this round because some of them are the same players who were behind the issues you refer to as the root cause of this downturn and now benefit from going short. Keep in mind that if you have lost big dollars, one way to get the money back is by bringing down the value of as many asset classes as possible in order to buy back in for pennies on the dollar for the ride up.

2008 Jan 22 03:41 PM

[Tedspick:]

Where is this trashing of supply side tax cuts coming from? We are staring right into the doom of a lapse of these cuts coming up in several years because there is no hope a democratic congress will do anything but let the cuts expire. I would guess markets are looking forward to that piece of bad news. Past history of tax cuts offer a clear message that they work and so does the underlying logic.

2008 Jan 22 10:30 PM

[WAKEUP:]

The current recession will be longer and deeper than any professional is now predicting. The fear in the workplaces and social gathering places is palpable; the realworld people (read "workers") are frankly and openly stating that they are tapped out. The moneysuckers who plan the cycling of money to 5% of the world's richest people overdid it, this time. Joe Ordinary is broke; he will not buy a refrigerator for at least five years, and he has no realistic plans, now, to ever buy a better house.

2008 Jan 23 12:07 PM