A Dash of Insight

What to Expect from the Fed

Tomorrow's Fed announcement should not be much of a surprise in terms of the fed funds rate.  What is at issue?

There is a cacophony of complaints about debt.  A Google search on "Fed printing money" gets 34 million hits.  Wow!

In any public policy issue there is an easy side -- simple to explain, playing to predispositions -- and a tough side.  The tough side generally requires open minds, education, and some analytical skill.

When we made the transition from the academic world to financial markets, a key attraction was exploiting bogus investor fixations.  We have learned that it works extremely well in the long run....

The "Easy Side" of Fed Policy

The easy to understand part of Fed policy is that they are doing a lot of lending, accepting more varied collateral, and greatly expanding the monetary base.

There are some who believe that these policies have already put the US on the path to disaster.  Since other central banks have pursued similar policies, it is seen as a world-wide blunder.  It is pretty easy to criticize from the layman's perspective.

Here is an interesting challenge for the pundits taking this viewpoint.  Let them step up to a blackboard, give them a piece of chalk, and present a tiny Econ 101 problem.  It is too bad that this test is not required before blogging.  The result would be a revelation to most of their readers.

We see this viewpoint represented mostly by self-styled economic experts who take a very one-sided view of the problem.

The Tough Side to Explain

The first aspect of understanding Fed policy is realizing that much of the policy action from the past year is substituting for private lending that seized up after the fall of Lehman.  The Fed stepped in to restore what we call "normal and sensible lending."  After Lehman, many businesses could not get routine commercial loans against inventory or receivables.  Banks did not trust each other.  Hedge funds pulled accounts.

We got a quick look at what would happen if we went from excessive leverage to zero leverage in a heartbeat.

Lending ceased.  CEO's cut costs, laying off workers.  Everything got worse, much worse, and it happened very quickly.  Instead of a depression, we had some world-wide leadership that took us back from the brink.

So where are we now?  Here is what you probably do not know.

The extraordinary additions to the monetary  base have not increased the monetary supply.  Here is a nice article from Business Week, Shrinking Money Supply Dampens Inflation Fears.

This is a key quote from author Peter Coy (but read the full article, nicely done):

The Federal Reserve stands accused of risking high inflation by recklessly printing too much money. But as Fed rate setters meet in Washington on Sept. 22-23, they won't see an excess of money sloshing around. Just the opposite. Paradoxically, the latest statistics show a shrinkage in the broadest measures of money.

Investors need to understand that the increase in the monetary base, which is still lower than when Obama took office, has not increased the money supply.  The problem is the velocity.  The additional liquidity has not really stimulated a lot of lending.

For those who would rather watch a video, here is the excellent observation from Bob McTeer.  This is insight from an experienced expert and one dedicated to free markets.  In spite of interruptions from the others in the interview, he calmly explains that the Fed should signal the need for an exit strategy, but not act as though it is imminent.

This is the most important thing we should be watching for in tomorrow's Fed statement.

Misunderstanding the Fed Balance Sheet -- A Costly Mistake

At "A Dash" our principal mission is identifying the real experts on various topics.

There are so many sources of information and analysis.  The business models for financial media depend upon ratings, so popularity rules.  The easiest way to connect with readers or viewers is via the anecdote, the dramatic chart, and analysis that can be explained in "pop economics" terms.

The Fed balance sheet provides a good example.  The bearish element of the punditry has highlighted the dramatic increase in the monetary base and the various Fed programs as a sign of incipient disaster.  At first, many suggested that we were about to have another Great Depression.  Some still maintain this position despite the improving economic indicators.  Arguing in the alternative, these same people argue that we have merely delayed the real consequences.  In particular, we have already sowed the seeds for a new inflationary bubble

We have recommended a more compelling viewpoint.  It is not popularly accepted, partly because it is difficult to understand.  It is not Pop Economics.

Our Take

We highlighted the monetary stimulus in our Summer Quiz.  We followed up with an analysis using a better long-term take on the Fed balance sheet.

Briefly put, the Fed has stepped in to provide lending in markets where the private market has dried up.  This was necessary to limit the impact of the recession.  Fed Chair Bernanke has explained the plan for an exit strategy, to be implemented when normal and sensible lending resumes.

We see this as wise and sensible public policy.  We understand that many disagree, and that is what makes a market.  In particular, we have highlighted the thoughtful and market-oriented analysis of Bob McTeer, former Dallas Fed President and analyst at a free market think tank.  His credentials and expertise are impeccable.  We strongly urge readers to consider his analysis of Fed policy.  Here are some highlights.

McTeer criticizes those who use a compressed time horizon to show the increase in the monetary base.  He thinks this is deceptive, and points out that the analysts have no clear causal reasoning for the prediction of an inflationary explosion.  He is modest in his analysis, accepting that there is room for some inflation protection.

His key point is that the Fed is filling in for a failure of private markets to do normal lending.  This is a process that started with the failure of Lehman and the temporary cessation in commercial paper.  There will be an end and an exit strategy.  He notes that the monetary base expansion occurred eight months ago and has leveled off.  He writes as follows:

Meanwhile, the time to shrink is not close. The velocity of money obviously declined dramatically as money growth accelerated months ago. Under those conditions, rapid money growth is needed to prevent deflation. Anticipating velocity changes may be hard, but seeing them after the fact is rather easy. Just divide GDP (P x Q in the equation of exchange) by M (whichever definition of money you fancy) and you get the income velocity of that measure of money. Having GDP growing slower (negative lately) than M is growing tells you that V is declining.

Put another way: Money doesn't cause inflation; spending money may cause inflation. Money is not being spent at a sufficient rate lately to cause inflation.

and further..

The decline of nonbank credit leaves a large hole to be filled by bank credit until things return to normal. That's what Chairman Bernanke is doing as he purchases debt (assets) other than treasury debt-commercial paper, mortgage-backed securities, packaged student loans, auto credit, etc. Focusing on these purchases and not realizing the hole he is trying to fill would lead you to believe, falsely in my opinion, that seeds of future inflation are being sowed.

and finally...

...(T)he inflationary impact of fiscal deficits depend almost entirely on how they are financed, i.e., whether new money is created in the process. Growing deficits without comparable monetary expansion will push interest rates up sufficiently to get the debt purchased. Higher interest rates are likely to crowd out private investment as the government commands more and more of the financial resources. This is not a good outcome, but it's not inflation.

Conclusion

There is a time and place for various policies.  An ideological perspective that nothing will work is a losing investment strategy, as we have seen in the last several months.  Readers would be well advised to read the entire McTeer analysis.

There is a lot of buzz about what will be the "New Normal."  We expect this to be a return to sensible lending practices, relying on private markets.  The Fed will withdraw as this takes place.

Politics, Ideology, and Investing

Once again we deviate from our scheduled agenda to consider something of immediate significance.

We continue to see a prevailing viewpoint that has a certain pattern:

1. The pundit expected government to be powerless to deal with economic challenges.
2. The pundit is surprised at a massive reaction by the Fed, using many tools that no one contemplated a year ago.
3. The pundit is surprised by aggressive action by the President and the Congress.
4. Mistaken in predicting the government response, the pundit now turns to criticizing everything.  It will all turn out badly.

It is a simple case of confusing ideology, politics, and investing.  Here is a simple fact to consider.  It is a fact, not a matter of speculation.

Those in power in government are continually working to prevent further economic distress, using whatever means available.

Anyone who does not get this fact is out of the loop.  This fact has been true for government officials of both parties.  They are not going to stand idly by and watch a further economic collapse.

Some investors are using a foolish litmus test.  They ask whether a pundit had some sort of prediction related to the economic crisis.  It does not matter whether the prediction was many years too soon.  It does not matter whether the causal mechanism was completely wrong.  Anyone who "called the collapse" is a genius.

It is now a new game, and it is called looking forward.  The time frame is significant. Even long-term investors should be looking a year or so ahead, and preparing to adjust.

The Reality

Anyone with real policy responsibility is actively trying to address economic problems.  The main purpose is helping actual people, not propping up markets, although the market effect is relevant.

When analyzing public policy, it is important to see the perceived public interest. Support for a "bailout" is not simply the direct help to the companies involved.  If there was no impact on the general welfare, there would be no support.  This was true of TARP, the Fed policies, and the Stimulus plan, and the help to auto companies.  None of us may like the specifics of the plans.  That is the nature of compromise.  The key is to look at the aggregate effect.

A Conservative Viewpoint

Bob McTeer is a conservative Republican who writes for a free-market think tank.  Anyone who is "more radical" than this has, by definition, an extremist position.

Concerning the stimulus, McTeer writes as follows:

But my main message here is that critics of the stimulus bill don't serve their side of the debate well by judging it against unreasonable standards. I've heard some politicians say before actual working cameras that the stimulus package must be judged a failure because unemployment has risen further since it was enacted. Some have expressly ridiculed the counter-factual argument regarding what might have been.

Such politicians and pundits are making it harder for me to stay on their side by insulting my intelligence and the intelligence of the American people. Their case would be stronger if they stuck to legitimate arguments, and they wouldn't look so foolish.

McTeer also writes wisely on the subject that we should just let everything fail in the name of Creative Destruction.  After some interesting anecdotes that people can really understand, he concludes as follows:

Destruction resulting from a Tsunami, or its financial or economic equivalent, isn't necessarily creative, and its victims aren't necessarily dumb.

Bank failures in reasonably normal times might reasonably be blamed on management. But massive bank failures resulting from a financial tsunami are another matter.

More people should read his work -- the efforts of an expert with hands-on experience with a free-market perspective.

Conclusion

The positive market reaction is coming a bit quicker than we expected.  The fiscal and monetary policies have a delayed impact.  We will see much more of it next quarter.

There will be some future issues related to withdrawing monetary stimulus and addressing debt.  The prevailing public policy viewpoint is that debt is best addressed by increasing income, wealth, and GDP.  Excessive leverage cannot be resolved by ending normal lending, something that happened last October.  We need to restore a normal economy, stabilizing housing, employment, incomes, and GDP.  The percentage debt reduction will follow.

For anyone with a normal time horizon, it is wise to play for the immediate effect.  At some future point we can consider the questions of leverage.

For investors stuck in a political or ideological position, they have already missed a good move which has more to come.  It is better to be a political agnostic, divorcing one's viewpoints as a citizen from one's investment decisions. 

Some Promising Signs for the Economy and the Equity Market

Here at "A Dash" we try to identify and monitor the best sources and indicators.  This is extremely important.  Without a disciplined approach, the average person gravitates to sources and evidence supporting his/her current viewpoint -- the confirmation bias.

In a time when most of the economic news is grim, it is especially important to seek out leading indicators.  It is equally important to recognize data related to the long-term economic challenges.

The Recession Might be Over.  So says the Economic Cycle Resesarch Institute (ECRI), long one of our favored sources, and accurate on the start of the current recession.  One might contrast the ECRI prediction with assorted pundits who predicted a recession for years before it occurred.

Writing for RealMoney (subscription required, trial available) Anirvan Banerji reports that the ECRI leading indicators are showing significant strength.

What's impressive here is the degree of unanimity within and across these leading indices, along with the classic sequence of advances in those indices. Such a combination of upturns doesn't happen unless an end to the recession is imminent.

Why are so many getting this wrong?

...(I)ndicators are typically judged by their freshness, not their foresight. Because most market-moving numbers are coincident to short leading, while corporate guidance is often lagging, it's no surprise that analysts don't discern any convincing evidence of an economic upturn.

Regular readers know that we are long-time critics of looking to corporate guidance, a concurrent indicator.  The companies are reading the same newspapers as everyone else, and they have little current incentive to puff up expectations.

Please note:  The end of the recession does not necessarily mean imminent happy days.  There will be a period of below trend growth.  This means economic under performance and high unemployment.  Banerji specifically refutes the idea that high unemployment will derail the recovery.

Fed Balance Sheet.  Many are worried about the Fed balance sheet, a topic we recently covered.  Supporting the evidence that there is a definite "exit strategy" is the Atlanta Fed's Macroblog, one of our featured sources.  David Altig goes right to the Fed minutes to support his argument.  This is strong evidence for any objective observer.

Earnings are Surprisingly Solid.  Many critics observe that companies are beating expectations by controlling costs, not by growing revenue.  We expect the revenue growth comparisons to look very good in the latter part of the year.  The key economic losses came after the Lehman failure.  Meanwhile, companies that got lean and mean are poised to deliver good gains as fiscal and monetary stimulus has its full effect.  Employment will lag.

Remaining Problems

There are continuing issues in credit markets and housing.  As we wrote in April, there will be a "wall of worry".  For the individual investor, this means that progress will be gradual and grudging.  This summer is an important time to think about asset allocation, especially for long-term investors.

Most investors will get this wrong, trailing the market by an annualized rate of 6.5%.  Check out Toro's article, "You are Probably Bad at Investing" for some good evidence on this point.  It confirms every story we have seen over many years on this subject.

Individual Investors and the Information Barrier

Here at "A Dash" we see the Summer of 2009 as a key time for investors.  Doug Kass is calling the summer a "snoozefest" but there has been plenty of action within a broad trading range.  Some themes have been working.  How shall we find new ones?

We started our summer research by identifying and highlighting the most important issues in a quiz format.  (While official entries have closed, you can still benefit from recording your own answers first.   As we take up each topic, we will reveal the "official" answers.

Background

Finding the right information is always a big challenge for investors, but the current circumstances have created a perfect storm .

Consider these sources:

• Political pundits.  Some want to find any possible basis for criticizing the President.  Here at "A Dash" we separate the citizen role from the investor role.  We hope to continue our long-term results -- making money regardless of which party is in power.  Consider the current dilemma.
  
  • The opposing pundits see no hope for any success.
  • The "supporting" pundits think that Obama has not gone far enough.
  • The impression for the individual investor is that nothing will work.
• Market pundits.  Some of these sources are selling a book, an idea, or a web site.  The information is not partisan, but it is biased.
• Economics pundits.  In the ongoing debate about policy, the reader can choose from among Keynesians, Monetarists, New Keynesians, or those from the Austrian School.  And we are just getting started!

Many of these ideas may seem tempting.  The results range from heart-felt opinions with an emphasis on one viewpoint, to mistaken information, to blatant misinformation.  It is a perfect storm for the average investor -- dubious information from all sides.

Pradeep Bonde, one of our featured sources, made this important point in a recent article:

There is always a bull market in conspiracies.Some of the popular investment blogs are active peddlers of conspiracy theories. In fact if you want to quickly become popular in trading blogosphere you should peddle conspiracies.

The article deserves a wide reading, so check out the whole piece to see if you can guess the leading conspiracies.

Let us illustrate with one example, the Fed's monetary policy.

The Critics

The many critics suggest that the Fed is making a big mistake.  They are  "debasing" the currency (this word is always present in the critical commentaries) and they have no exit strategy from their policy of monetizing the debt.

The most aggressive criticism illustrates a spike in the money supply.  This accusation comes from a noted political commentator who uses charts with no scales and no background.  Many investors watch this information on the original source or on youtube.  For those who have no money to invest and merely want reinforcement of their political views, this is good entertainment.  Anyone trying to get an investment return, is watching the wrong source.

Who would be better?  Try Bob McTeer, another of our featured sources.  He has the actual Fed credentials lacked by the wannabe commentators, and he is also a political conservative.  As we seek out good sources, we consistently find his observations to be the most sensible and most helpful.    Here is what he says about the money supply, a subject where he is an expert.....

The money supply spiked, and then flattened out. Pre-spike until now still gives us pretty big numbers, but they are getting smaller every day. Yet, commentators treat the money growth statistics as if the rapid rise is ongoing.

and later....

Turning to the different subject of how to lie with statistics, I've seen lots of graphs lately that have had the horizontal axis squeezed together to produce scary money-growth graphs. The most egregious is probably the graph of the monetary base growth dramatic enough to make You Tube. Shame!

As usual, the entire article is worth reading.  More people should read Bob McTeer.

The Data

To support the McTeer viewpoint, we need a simple chart.  Here it is, from the St. Louis Fed.

 

There are two obvious conclusions:

1. A log scale (showing the true percentage relationship over time) and a bit of history shows a very different picture from that of the critics.
2. The money supply spike came at the time of the Lehman failure, not during the Obama administration.  The Fed reacted to an emergency, and is now adjusting policy.

Investment Conclusion

There are plenty of things to worry about.  Fed policy is not one of them.

Many people need to rebuild their retirement accounts.  This means understanding how to interpret information.

Confidence, the Economy, and the Fed Balance Sheet

Poll reports show that President Obama's confidence ratings are falling.  This should not be a surprise, given the record positive levels at the time of the Inauguration.  Current polls show continued popularity for the man, but increasing skepticism about his policies.

For the economy and for investors, there are some specific issues that will play out over the summer.  We set these up in our "Summer Quiz."  Those who have good information and market savvy will score well on the quiz, and also profit in the markets.  We believe that this summer is a key time for investors.  As we reveal the answers, the significance will become crystal clear.

We will continue to reveal the answers and announce our prize winner at the conclusion of the article series.

Background

Economic growth is strongly related to confidence.  When CEO's get worried, as they did after the demise of Lehman last Fall, they cut costs first and ask questions later.  Economic confidence is closely tied to employment, a topic we follow closely at "A Dash."  Employment indicators often lag actual economic progress when employers are quick to fire and slow to hire.

We do not all share a common interest.  It would be nice to think that all hope for an economic recovery, but that perspective is mistaken.  Here are some obvious exceptions.

Political Opponents

Perhaps in a perfect world there would be a few years in a political cycle where everyone in the country all pulled together.  It occasionally happens when there is a specific and imminent common enemy -- after 9-11 for example.  Most of the time private motives dominate over the public interest.

Partisan Politics

Quite frankly, there are many who hope for the economic recovery plans to fail.  There are strong partisan reasons.  The most important members of this group are running for office in 2010.  Their personal stake is huge.  There will be a constant barrage of partisan economic criticism.

Bearish Pundits, Commentators, and Fund Managers

There are many who stand to profit from a market decline.  The many bearish pundits have credibility and book royalties on the line.  The commentators have prestige, jobs, salary, and bonuses at stake.  Sometimes personal motives outweigh a national interest.

Some hedge fund managers have aggressively short positions.  Anyone paying attention knows that these positions are always supported by the Bearish Blogging Network (BBN) where there is direct or indirect compensation for supportive bloggers.

With so many providing so much negative commentary, it is easy to be led astray.  Let us consider a specific example.

The Fed Balance Sheet

A good way to begin is by removing the most obvious issue, question #4 from our quiz.  Information about the Fed balance sheet is readily available, specific, and timely.  Those taking a bearish viewpoint have emphasized the growth in the Fed balance sheet, including loans to various financial institutions.  The critics have suggested that this growth was part of the Obama Administration efforts and also that it puts taxpayers at risk.

Here is a recent report from Macroblog, one of our featured sites:

There are three key facts from this report:

1. The increase in the Fed balance sheet dates from the Lehman failure and the aggressive response, not from the start of the Obama Administration.
2. The overall size is declining slightly.
3. The distribution of assets has shifted from the riskier short-term lending to non-bank financials, moving to agency paper.

Conclusion

From a public policy perspective, the Fed has attempted to restore what we refer to as "normal lending".  The Fed recognized a market failure, where credit markets seized up.  This step is aggressive and temporary.

From an investment perspective it is crucial to understand the nature of the policy.  Some portray the balance sheet expansion as a "bailout" or an unlimited commitment.  This portrayal is calculated to frighten the individual investor.  It it not accurate.

Restoring confidence will be an uphill battle.  It begins with better understanding of the policy.

Full disclosure:  Our current posture, reported weekly, is bearish, reflecting market sentiment.  We see the bearish case as overstated, but realize the evidence will come one piece at a time.

We are working to find the catalysts for a changed perspective.

Street Fighters: Good Information and Good Fun

Kate Kelly's book, Street Fighters:   The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street,  now on our recommended reading list, is a great source of information and fun to read.  It is well-sourced, authoritative, and always interesting.

Does it provide, through a look at Bear, the answers to our financial crisis?  We think not, but that is part of the fun.  The reader can collect information -- raw data -- with real confidence.  There will be many accounts of the financial crisis.  Anyone seeking a complete understanding should consult many sources.

The Approach

Street Fighters tells an engaging tale focused upon how a mighty firm was reduced to rubble in three days.  You know the ending before you start reading, but it is no less engaging.  The author has a nice sense of the characters and has done extensive research into backgrounds.  We not only learn about the major players, we learn what everyone else thought about them.

Such an approach is open to challenge.  Kelly provides footnotes for sources, and acknowledges disagreement.  It is convincing support  for her narrative.

The Result

The reader is treated to a view from several perspectives.  It is an insider's take on the politics within an investment bank.  There is genuine conflict over risk and which products to feature. Even the most jaded reader may have some sympathy for a wealthy guy who spent a lifetime building up his company and his position, only to lose it all in a few days.  This is "inside baseball" at its best.

The story is dramatic and well-told.

Assorted Insights

The reader has raw data to draw conclusions on several interesting points.  Here are some that stood out for us.  Yours might be different.  Please consider the following:

• Significance of CNBC.  David Faber had a story about firms not trading with Bear.  It was big news, but it was later denied by those in question.  The damage was already done.   The issue is how much information one needs to go with a story like this, when the story itself can affect the outcome.  Should Faber have verified more completely before going with this story?  Would it have made a difference?
• Significance of Kelly and the WSJ.  Many readers will already be familiar with the three-part series in the Wall Street Journal.  In the book, Kelly asserts that the series itself -- criticizing Cayne's leadership -- had an impact within the firm.
• Hank Paulson's Role.  Paulson is portrayed as dictating a punishingly low stock price for Bear.  Historians will combine this information with additional information, includeing his reversal on the use of TARP funds, the decision to force TARP on all of the major banks, and other similar decisions.  From our perspective as public policy experts, this is an extraordinary and arbitrary use of powers.  It is on a scale that is without precedent for a Treasury Secretary.
• The Fed Role.  The decision of the Fed to expand lending to include investment banks, only two days after the Bear failure, was extremely arbitrary with respect to timing.  We should all be concerned when public officials make decisions about which firms (and which investors) live or die, and do so without clear rationale.  Bear was allowed to die while others were saved.

Conclusions

Kelly's conclusion is that Ace Greenberg built a firm on some principles and Jimmy Cayne violated those and lost it all.  We are not convinced.

We can now see what happened to many other firms.  It would not have mattered if Bear's leverage and risk had been a little less.  Kelly is probably right in suggesting that Bear was an unloved firm on the Street, and therefore first to be challenged.

It was beyond her scope to consider other causes, although there is a paragraph or two on the trading in Bear stock.  This was something we watched daily on our trading screen.  Those betting against the firm could trade in the thin Credit Default Swaps market (CDS), buy puts (where premiums exploded in issues that were far out of the money), short the stock, pull your hedge fund accounts, and spread rumors.

These events were all taking place.  The sequence of causation will never be determined.  What we do know is that any business depending upon confidence and credit can be destroyed in three days. Those aiding the destruction can make millions as it happens.   If that is a verdict on a business model, the entire banking industry is in question.

Final Take

The book is fun to read and has plenty of raw data with authoritative sources.  You should read it, and combine what you learn with other information.  The story of the 2008 crisis is complicated.  We look forward to reviewing other books on the subject.

Successful Financial Blogging

Let us suppose that one wants to start a successful financial blog.  The start up costs are low, so many will take a shot at this. What defines success?

Part of our experience is advising early-stage companies.  It is a good model for a blog.  What should one do?

• Learn the market.  The blogger needs to understand the readers -- who they are, their viewpoints, and what they want to hear.
• Understanding behavioral finance.  Most readers track on what worked most recently.  That is how the heroes are found.
• Go for the rankings.  The various ranking services start -- and mostly end -- with traffic.  If you write something that appeals to the online audience, you have a better chance of success.  Most of those doing rankings are not qualified to evaluate the content, so ratings dominate.
• Post frequently.  The more you write, the more people visit your blog.  Many raters use frequency of posting as a filter.
• Exchange links.  Be willing to trade links with nearly anyone.  Offers abound.

Identifying the Online Audience

Here is a dramatic example of what works online.  The best example is the recent online poll by Time.com.

In a stunning result, the winner of the third annual TIME 100 poll and new owner of the title World's Most Influential Person is moot. The 21-year-old college student and founder of the online community 4chan.org, whose real name is Christopher Poole, received 16,794,368 votes and an average influence rating of 90 (out of a possible 100) to handily beat the likes of Barack Obama, Vladimir Putin and Oprah Winfrey. To put the magnitude of the upset in perspective, it's worth noting that everyone moot beat out actually has a job.

This tells us very little about who is most influential, but a lot about those taking the poll.

The frequent polls on CNBC and other sites tell us a great deal about the trading audience -- what they believe, their positions, and what they expect.  These polls are mostly skeptical of any government program, the future of our country, and the prospects for the economy.  They are widely divergent from polls that use a scientifically selected group.   These polls show a wide acceptance of Obama and his policies.  This is not a political statement, but merely a look at some facts.

It pays to cater to the online audience.  Andrew Leonard's Prophets of Doom list is also a list of the most popular blogs and commentators (with a few prominent omissions).

Popularity Pays -- for Someone....

Popularity clearly pays for the bloggers.  They are wisely following a successful model for an early-stage effort.

Our mission is quite different.  We attempt an objective interpretation of data, an effort to find the best sources, and a willingness to alter short-term perspective.  In particular, we are skeptical of sources swinging outside of their "happy zone" (hat tip to Ted Williams -- click through to see the famous strike zone picture).

For the individual investor trying to find help from the Internet, this is a minefield.  The information from the popular sources is unrelentingly negative.  Meanwhile, the real story is not so clear.

Investors should pay attention to data, not opinions -- and especially not political opinions.  There is a time lag in the impact of government policies.  It is time to start monitoring the lagged effects of lower interest rates, innovative Fed policies, and the stimulus package.

Why There is No Bottom: Economic Forecasts

Since the stock market seems to have no bottom, investors want to know why.  We shall consider this in a series of articles.  This is Part One, dealing with economic forecasts.

What People Read

We know that individual investors are frightened, a perception fueled by stock market results.  For most, the stock market is the barometer for economic forecasting.

Fueling this is the popular perception of the economic prospects.  The New York Times pulled together a number of op-ed pieces, asking When Will the Recession be Over?

This is powerful material, drawing together the opinions of many experts.  Readers should review all of the pieces.  We know from reader feedback, emails, and calls that it was an important article.

Jim Grant, erudite, polished, and persuasive, tells us, "don't ask when."

Stephen Roach, of Morgan Stanley, predicts late 2010 or 2011.

A. Michael Spence, the Nobel-Prize winning management Prof from Stanford says "unusually long and deep global recession through 2010."  That is if governments get their acts together.

William Poole of the Cato Institute rails against unwise government bailouts, which he believes are making things worse.

Eric Schmidt, Chairman and CEO of Google, expects signs of life later this year, and a resumption of normal lending in 2010, with the Internet playing a key role.

Financial writer George Cooper sees a financial drag extending into the next decade.

Harvard historian Niall Ferguson sees two years of contraction and two lean years after that.

Princeton Econ Prof and former Fed Governor Alan Blinder sees growth resuming in the fourth quarter of 2009, but with many caveats.

University of California-Riverside economists Marcelle Chauvet and Kevin A. Hassett take a probabilistic approach based upon past recessions, and see the probability of the current downturn lasting through 2009 at 50-50.

University of Maryland economist Carmen Reinhart focuses on a return to normal growth, setting out four years or more as the time frame.

NYU Econ Prof Nouriel Roubini sees a three-year recession, with chances for much worse.

A Different Approach

A different approach to the problem is to use a continuing panel, not selected for star quality.  The Wall Street Journal forecasting survey provides such a comparison.

The Journal article on the latest survey carries a gloomy headline, Economists' U.S. Outlook Dims.  The Journal surveys 52 economists, and reports on 2009 as follows:

The average forecast now sees growth in the third quarter at 0.7%, less than half the rate expected last fall. The fourth-quarter picture has also darkened, but just slightly, to growth of 1.9% from the 2.1% seen in November. Five economists see growth declining through the fourth quarter of 2009; they say the current consensus outlook, which says the recession will end in August as GDP growth returns positive, is far too optimistic.

Briefly put, the economic panel has reduced estimates for growth, but is dramatically more positive (less negative?) than the New York Times group.  They see the monthly job loss for the year as 183,000 per month, much better than current rates, and unemployment peaking at 8.8%

A key difference is attention to the stimulus package, which they see as saving about 90K jobs/month.  Interestingly some say it was too large, and others, too small!

Our Take

The entire media approach is very negative.  The New York Times has an all-star cast of experts, but it leaves us wondering a bit.  When an article like this appears it creates an illusion of scientific sampling.  We are also bothered by the lack of attention to the dramatic government intervention begun many months ago, policies with known lags.  The peak of the crisis came right after the Lehman fall and credit freeze.

None of the economic models have any experience with the myriad of Fed programs, not to mention the stimulus package.

Models can be quantitative or qualitative, but are always based upon experience.  None of us have the relevant experience for this particular crisis, so our models are suspect.  It is also natural to highlight experts who have been right -- those who "got it" in the popular Street parlance.  The question is whether the skills involved in predicting the problem are also the right skills for identifying the possible solutions.

We find the WSJ panel to be an interesting counterpoint.  The investment prize will go to those who can identify economic indicators showing any bottoming signs.  With equity prices at depression levels, even a moderation in the depth of the recession could be good news.

Meanwhile, most investors are focused on the headlines.

Learning from Mistakes: The Short Sale Ban

The verdict is in.  There is growing recognition that last September's ban on short selling in certain financial stocks was a mistake.

Most of the professional trading and investment community do not see short selling, per se, as a problem.  There are several debatable issues:  the uptick rule, credit default swaps, and mark-to-market accounting for assets intended as long-term holdings.  Short sales were not controversial among professionals.

The Academic Verdict

There is some fast work from the academic community.  A team led by Columbia Professor Charles Jones, Chairman of the Economics and Finance Division, has a strong data-based analysis of the short-selling ban.  They note that despite the initial pop in these stocks, they actually did worse during the market decline over the period of the ban.  More importantly, they note that liquidity in these issues got much worse.  The average trader faced wider bid-ask spreads leading to more costly trades.  Short sales add liquidity and even fuel rebounds when fundamentals change.  As many noted at the time, there were various ways to avoid the ban, including purchases of put options and inverse ETF's.

The SEC Verdict

SEC Chairman Christopher Cox acknowledges this error.  In a just-released interview in the Washington Post, he is quoted as follows:

Cox said the biggest mistake of his tenure was agreeing in September to an extraordinary three-week ban on short selling of financial company stocks. But in publicly acknowledging for the first time that this ban was not productive, Cox said he had been under intense pressure from Treasury Secretary Henry M. Paulson Jr. and Fed Chairman Ben S. Bernanke to take this action and did so reluctantly. They "were of the view that if we did not act and act at that instant, these financial institutions could fail as a result and there would be nothing left to save," Cox said.

Our Take

We should note first with applause the rapid data-based effort by unbiased academic investigators.  We can all enjoy the effect of the Internet.  Instead of waiting more than a year for academic publication in a peer-reviewed journal, results are now available more quickly.  If there is criticism, that is also available to all.  It is a major improvement in the way academic research becomes relevant.

We find more difficulty in the Cox "go slow" concept.  It is clear that events were moving more rapidly than policy.  Paulson and Bernanke were correct in identifying a problem, but the focus was wrong.

Eventually we will see an academic study that pulls together the key elements:

• The unregulated credit default swap market, easily manipulated with modest amounts of capital;
• The widespread publicity surrounding the CDS trading, implying insolvency of the institutions in question;
• The speculative put buying by those profiting from this pattern;
• The mark-to-market implications for institutions not involved at all;
• The possible manipulation of widely used ABX indices, affecting the entire market.

This all needs investigation.  Will it be on the agenda for the new Obama team?  We hope so.  Learning from this lesson is absolutely essential.