Barry Ritholtz Wants Investors to Stay Cautious

Mike Norman, anchor, HardAssetsInvestor.com (Norman): Welcome everybody, to HardAssetsInvestor.com’s video series. I’m Mike Norman, founder of the Economic Contrarian Update. With me today is Barry Ritholtz, CEO of Fusion IQ and blogger extraordinaire. Barry, welcome; thanks for coming on the program—I appreciate it.

Barry Ritholtz, CEO, Fusion IQ (Ritholtz): Thanks for having me.

Norman: Barry, you and I have spoken many times in the past and you were one of the first people I spoke with to have a very, very bearish outlook, not just for the economy, but also for what was going on with the subprime market and the financial sector.

Let’s take a look at that situation right now, with everything that we have seen recently: very aggressive Fed actions … certainly many new conventions by the Fed … the stock market seems to be stabilizing. What do you make of the situation now?

Ritholtz: Well, let’s take the stock market first and then we’ll look at the broader situation. The market has more or less seemed to find some temporary floor. Some of it is a mistaken belief that the Fed has saved the day; some of it is also based on the belief that the JPMorgan (JPM) and Bear Stearns (BSC) deal is the sort of crisis that marks the bottom. I think it’s a short-term bottom; maybe it will run a few weeks or a few months, but we haven’t gotten to the point where the full economic slowdown and the full impact to earnings are reflected in either stock prices or analyst estimates.

Norman: Why do you say it’s a mistaken belief that the Fed has saved the day? If you look back historically, this is textbook, OK? You have a financial meltdown, you have an economic calamity, the central bank steps in, and if it steps in aggressively—historically, these have been textbook examples—you do stop and you tend to turn things around. Why are you saying this is a mistaken belief?

Ritholtz: It’s a great question. When you look at the times when the Fed steps in and saves the day, typically in a normal cyclical recessionary slowdown, they juice the economy, they stimulate things, and the cycle then swings to the upside.

Go back to January 2001: The Fed stepped in, very aggressively cut rates, taking them down to levels not seen before. And yet they were unable to save the day at that point in time. Markets dropped significantly; the S&P got cut in half; the NASDAQ was down 78%. The Fed can’t always resolve something when prices in markets just get so many standard deviations away from the norm.

The reason I think the Fed isn’t going to have an impact this time is this entire cycle that we’ve dealt with—from the lows in March 2003 or October 2002 to the recent highs in 2007—has been a very backwards cycle. It hasn’t been your normal cycle. You come out of a recession, there’s some expansion, you get some hiring, you get some wage increases, people start spending money (durable goods expand) and you get a whole virtuous cycle. That’s not what happened this time.

This present cycle, we had the Greenspan Fed take rates down to generational lows—levels not seen in half a century—and then kept it there for an unprecedented period of time: well over a year. That never happened before. That started this inflationary spiral—that and all the money the Fed was printing—that made all of the hard goods that you and I have been talking about for a good couple of years, everything from gold to base metals to what have you…

Norman: The Fed raised rates for a period of two years. We went from 2004 to 2006 when we had 17 consecutive rate increases.

Ritholtz: Quarter-point increases.

Norman: Yeah, but we went from 1% Fed Funds Rate to 5.25%. You blame the Fed for creating this commodity boom, this so-called inflationary spiral, but for part of that period, it was raising rates.

Ritholtz: Well, it was raising rates, but you look at the history of where the ten-year Treasury yield has been—we’re still at relatively low rates.

Norman: You want to do a Volker-style rate like 21%?

Ritholtz: The reason I bring that up [is that] I want to put this into context. Under normal circumstances, you come out of a recession, you get an expansion, and the hiring and the wage increases that go with that expansion is what leads to an uptake in consumer spending, and again the whole virtuous cycle.

The reason I point this out is we had something very, very backwards this time. We had this huge boom in credit, a complete drop in lending standards, and a huge boom in house prices. When you bring 2 or 3 million people that really can’t afford homes into the market, you send prices through the roof. That led to a whole bunch of consumers doing a lot of mortgage equity withdrawal, pulling cash out of their houses, buying cars, taking vacations, refurbishing their homes. That was a huge portion of the GDP growth we’ve seen over the past four years.

Under normal times, when consumer spending rolls over, the Fed can work to fix it. Based on the mortgage equity withdrawal more or less going away and the increase in lending standards, there’s not a whole lot the Fed can do to resurrect that.

Norman: All right, well, Barry Ritholtz still cautious. Stay tuned folks, for the second part of my interview with the blogger extraordinaire, Barry Ritholtz. I’ll be back.

Comments

[User 68127]

Where has Barry been? Why doesn't he post on Seeking Alpha any more?

[iThinkBig]

Ritholtz nails it. I would like to see suggestions from Ritholtz on long-term fixes to our economy. My take is declaring energy crisis and government subsidies to the tune of $150 B - $200 B to create competing product against big oil. Money would come from Treasury and this would create a global investment opportunity in America rather then commodities making Americans and the global community poor (minus the top .001 percent). Giving the global consumer what they need is always a good business model.

[Paul D.Castro, CFA]

Of course Barry wants investors to stay cautious. Barry's behind the curve. Each of the major indexes (DJIA, S&P, Nasdaq) have recently bested their February 1 highs and appear to have embarked on a new uptrend. The longer investors stay cautious the longer Barry can play catch-up. If you read between the lines Barry is saying "this time is different", the 4 most dangerous words throughout the history of investing.

I used to read Barry's blog but I've stopped because he (and especially his readers who post comments) are just way too nihilistic.

[reming]

I think Barry is right on target. How can the economy bounce back with so many debtors being left behind. It will take them quite some time to dig their way out of debt and begin spending again. Those of us who managed to avoid that trap are trying to stay above water due to inflation.

[galewhitaker]

Paul
The best analyst in the world (Marty Chanard) shows data that proves that this rally does not have the support of the institutions. Only the public is participating. The implication is that when prices get ripe the institutions are going to hit the sell button. I think that the big time traders know that when that when the full effects of $120 oil are felt by the economy the equity market is going to tank big time. Just consider the hundreds of thousands of folks who are going to lose their jobs when the airlines collapse because of high fuel prices. Imagine how tough its going to be on industry when they can no longer afford to ship their stuff by air. I think Barry is right to be cautious because we have run out of cheap oil and it really is different this time.

[WAKEUP]

THE most potentially dangerous aspect of investing in the stock market is listening to the attitude of persons such as Paul D. Castro, above, who try to make anyone who identifies real danger in a given market seem out of touch, or "behind the curve."

[James Cullen]

I think Barry had a spat with Seeking Alpha, so he no longer lets them syndicate his content.

[curious cat]

gale
industry can absorb the higher price of oil, until it moves back down some. they have not passed along the increase costs because they cannot. the competition gets greater as cheaper goods are continually imported to us. at some point, you might think, the price of goods being imported cannot keep coming down, but they do, because we have had huge deflationary forces at work. how can wal-mart continue to sell at lower prices? answer: they are the largest and strongest negotiators. if japan cannot sell to them at a lower price, they start buying from china. once china starts asking for too much, they move to india, then africa etc. europe has been handling higher oil prices and competing with us for a long time now.

of course, employing alternate energy and investing in research are excellent options and create additional industry here too. i'm just saying that the long awaited collapse will not happen any time soon. the markets will vaccilate in a range until they recognize this. many quarters of earnings and govt numbers will be reviewed and eventually calm will return and the liquidity will be squeezed out of the financial system through the constant deflationary forces being imported.

sure, lots of people who should not have been in the housing market are going to be evicted, but they will become renters. some assets will be cheaper than they used to be, like housing and cars. that's called deflation. maybe america can start buying back our currency now that it is cheaper. that's what a ceo of a large corporation would do with their stock, right?

when the tech stocks crashed and took down the rest of the market, lots of people were suddenly worth less money, they managed to continue running their businesses, going to work everyday, and looking to the future. that's what people who have to pay off their mortgages do.

[sliman]

Barry has been WRONG for so long who cares what he thinks!!!!!!!!!

[fran]

CURIOUS CAT--

buy back our currency??? what asset woukld you recommend we use? the interest on our debt or the net savings of the citizenry? in order to buy[exchange] assets one must have assets of similar value. lead to gold perhaps?