Recession: A Self-Fulfilling Media Prophecy?

by: Todd Kenyon, CFA

I received a refreshing report this weekend from Punk Ziegel's banking analyst Dick Bove. Mr. Bove has been around the financial block more than a few times, and I generally find his work to be unencumbered by the usual psychological errors, group-think, and conflicts of interest found in most Wall Street research.

Bove postulates that the media is unknowingly doing their best to promote recession through a self-fulfilling feedback loop. He receives many calls every day from journalists of all stripes: regional papers to televised media. Before answering any questions, he has been polling each of these folks as to whether they had heard anything positive about the economy in the last two months. Amazingly (or perhaps predictably) not one has conducted a single interview in which anyone had suggested that we would avoid recession or financial failure.

Furthermore, you have supposed free-market advocates like Paulson and Kudlow proposing interventionist programs that make Hillary's ideas look moderate. Consumers and business persons are listening. They are pulling back on spending and becoming more defensive. Call it what you will. feedback loop or death spiral - we may well get a recession (or already be in one) if we don't get some guidance to combat what Bove calls "intellectual bankruptcy".

Bove points out the following:

- A variety of stats show that households are working, growing their incomes and wealth, and slowing spending while actually reducing their debt burdens.

- Fed "caterwauling" (I called it whining in a previous post) needs to stop. The markets control interest rates. Never once in more than 20 years has the Fed moved before the T-Bill. The Fed follows the market, they will this time. Bove: "The market is setting interest rates, not some quasi government agency with gents who write indecipherable, overly-pompous pieces of academic gobbledygook".

- There is a crisis of confidence in lending, not a lack of funding.

- Banks are trading at valuation levels last seen in the late 80s, yet things are far better now. In 1987, 9.5% of all banks and thrifts were designated as troubled. Today, 0.8% fit this bill and no big banks are listed. Second, the world economy today is far different. Back then there was a serious capital shortage, and lesser-developed countries had no reserves, vs. trillions in reserves today. There is no capital shortage worldwide, and we are already seeing overseas fund begin to pour in.

- Banks overall are healthy and should not be trading at 1987-1991 levels.

Feel free to agree or disagree here, but we all know that this is far different from the conventional wisdom. TV business journalism is financial porn, and right now bad news and recession is the fetish of choice for the masses. Bove started warning about the pending credit crisis in late 2006, when the fetish du jour was cheap money and pricey real estate. He was right.

I don't represent that I personally have any ability to forecast the economy. But I do pay a lot of attention to investor psychology. Heck, I used to study fish behavior in a prior life - markets are more interesting even if they are far less rational. I wrote the following on my website in December 2006:

Everyone, almost every last person, is so positive about the market and the economy that regardless of what I think the future will bring, my gut is screaming that we are due for a nasty bout of mean-revision. The term "Goldilocks Economy" is flying out of the mouths of barbers, taxi drivers, and Spongebob. The number of bears out there probably does approximate three, give or take a couple. Not one of the economists in last week's Barron's was bearish. Greg Ip writes a page one article for the WSJ about how THIS TIME IT MIGHT REALLY BE DIFFERENT. Maria Bartiromo is so giddy by 3pm every day that I fear I will have to witness her accidentally swallowing her ears. Cramer will surely spontaneously combust before long, with Larry Kudlow soon to follow ("greatest story never told" - sure Larry, whatever you say)... No predictions, that's not what I do. But if I had to bet one way or the other, I wouldn't put my money on Goldilocks. Every time I've heard that story, the bears win in the end, even if there are only three of them.

Clearly we are at the exact polar opposite in terms of sentiment right now. Something to think about...