Fact, Theory, And Markets

by: Paul Nathan

Recently ECRI, an economic cycle research firm with an outstanding track record made a controversial recession call. The short-term indicators ECRI relies on were indeed signaling up, but long-term indicators pointed down. When challenged regarding the plausibility of recession, given all the good news at present and the market's move upward, Lakshman Achuthan, managing editor of ECRI's forecasting publications stood by his call stating, "…the objective economic indicators we monitor, including those we make public, give us no other choice."

This caught my attention since I've been discussing the same recessionary threat from a theoretical viewpoint. In my last article, Why I'm Short Gold, Silver, and the Stock Market, I pointed to resource stocks no longer leading the market upward as a possible tip-off that we are topping, likely with more bearish news to come.

The market doesn't necessarily move in tandem, and the rotation of sectors tells one a lot about the changing economy. For example, as the market leader's move from defensive issues to more cyclical issues, and vice versa, the market is giving us a picture of a world economy going from the safety of defensive dividend paying stocks to one where more risk is taken and more reward sought. Resource and material stocks have been among the leaders of this move - until now.

When fact and theory diverge it is usually exposed by markets. When they converge, it is time to take notice. The market eventually ends up on the side of reality. This may be such a time. Achuthan added to his recession prediction that what he's seeing now in his long-term indicators may not be seen by the average individual for another six months. Interestingly, the market discounts approximately six months in advance. Also of interest, according to both The Economist and The New York Times, ECRI has never issued a false alarm.

In that last article I mentioned that for years, my contention has been that we are in something I call "a world of L," where 0% to 2% growth is our new ongoing reality. And the reason for that is debt. Debt servicing and the de-leveraging of debt place a governor on growth. We just hit 3% growth last quarter, and as this better-than-expected growth is being celebrated, I believe things are already slowing down.

That's why I recently reduced my exposure to resource stocks such as gold, silver, and copper, and in doing so avoided the vicious selloff that befell stocks like Freeport-McMoRan Copper & Gold (NYSE:FCX). But unlike ECRI, in no way do I claim to know when the market will exhaust its upside run, or even if we will endure a new bear market.

Then where does that leave us? Well, money is undoubtedly coming into the stock market, and I tend to follow the money. So for now, I am still doing some buying, albeit cautiously. Any buy decisions have been based solely on my outlook for a given stock, not my long-term forecast for the market in general.

Monday I bought back a few stocks I had recently liquidated at much higher levels, including U.S. Silver Corp (OTC:USSIF) and Aurizon Mines (AZK). I also added to McEwen Mining (NYSE:MUX) and Copper Fox Metals (OTCPK:CPFXF) based on company news and results. But this is some rocky trading, for example shares of Coeur d'Alene Mines (NYSE:CDE), which I'd picked up for much lower than I'd previously sold them, were quickly stopped out at a small loss on the open Tuesday. And since three of my largest holdings are predominantly in silver, I found myself shorting silver via ProShares UltraShort Silver ETF (NYSEARCA:ZSL) in order to hedge my portfolio. I did jump back into FCX. The stock is not only bucking the trend, it's moving up despite fears of a slowdown in China.

But it is important for me to say that even as I buy, I find myself looking over my shoulder for those long-term indicators of Lakshman's, which might just be catching up with us.

Disclosure: I am long MUX, AZK, FCX, OTCPK:CPFXF, OTC:USSIF.