A Dash of Insight

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.

Oil Prices and Stock Prices

Yesterday we wrote about the link between oil prices and energy ETF's, including stocks that should be responding to long-term expectations, not the front-month spot prices.  There is a lot of "floating storage" right now.

There is an expiration effect, with a front-month imbalance.  Meanwhile, the effects drive down the prices of anything in the energy sector.

The Role of Speculation - a New Concept for Links Posting

Last night, 60 Minutes had a segment on oil prices, emphasizing speculation and the need for greater regulation.  There were some good points in the segment, but we found the overall impression to be quite misleading.

Regular readers know that we are big fans of those who are the gatekeepers of the Internet, and we feature the sites that do this well.

Here is a new idea:  How about pulling together links on a specific topic, providing the intelligent reader an opportunity to see a range of thought on the issue.  The articles do not always appear on the same day, the general format for the gatekeepers.

Let us give it a try.

Our own explanation about the over-emphasis on the front month.

Eddy Elfenbein's excellent take on what 60 minutes should have asked, but did not.  You can also see the complete video.

Barry Ritholtz analyzing what 60 minutes missed.

Todd Sullivan, looking at how actual supply and demand affected prices.

And most importantly, how a thoughtful economist, writing peer-reviewed work analyzes the role of markets and speculation in influencing prices.  This is not an easy read, because it is detailed and analytical, with plenty of charts.  It is quite clearly argued, and accessible to anyone willing to take the time.  Investors should follow the excellent work of Prof. James Hamilton here and here.  It shows the oil price influence on the recession, and what we should be watching.

Conclusion

It is always a challenge to look forward, but the information is there for those willing to make the effort.  The overall conclusion is that speculation is only part of the effect on prices, with a need to balance the various factors.  Our own view is that forward pricing is a good leading indicator.

Looking Back, Looking Ahead

Today marks some important changes both in market fundamentals and in psychology.  On such occasions we interrupt our regular writing agenda for more specific market commentary.  This is an occasion where readers unfamiliar with our recent work should take some time to follow the links.

In recent days we have tried to provide some perspective on the market turmoil and what to watch for.  Some of these ideas are starting to play out, but there is more to come.

A Review

Here is a brief review of the last few days.

We reviewed a number of popular myths and provided a brief assessment.  We then showed how some shallow thinking was leading many to be excessively negative.

We made timely shifts from bearish to neutral to bullish via our TCA-ETF system.  Investors in the program had a gain of 9.7% today.  Being in the right sectors means a lot.  Our current holdings seem to capture the rapidly revised thinking of market strategists.

We wrote about possible catalysts, including this suggestion:

Housing initiatives.  The Treasury is hinting at a new plan to reduce mortgage rates.  The Fed has already acted.  We expect the market to be skeptical of both, so it may take some real evidence to change opinions.

In addition to the Fed statement today, there was other important news, setting up the rally.  The Obama Administration seems to be embracing a major plan to cut mortgage interest rates to 4.5% for everyone.  We have the full story on our sister site, ElectionStocks.com.  This story is very big in many ways and for many sectors.

Being Modest

We are very cautious with a period of success.  There are so many who think they know so much.  In fact, investors should look not to a single market call, but to long-term history.  We tried to illustrate this with our football analogy.  In our own methods, we try to emphasize the long run.

Looking Ahead

Today's trading could represent a change in market psychology. There are plenty of fund managers who are either caught short or under-invested.  The negative sentiment has been palpable.  The news of scandals and the market declines have tested the resolve of many long-term investors.  We expect some managers and investors alike to shift gears.

There are more catalysts to come.  We continue to collect ideas on this front.  More to come, with several interesting ideas.  Briefly put, those making negative forecasts on the economy, on corporate earnings, and on stocks have a doubtful platform.  They are not just fighting the Fed.  They are also fighting the Treasury and the incoming Obama Administration.

Investors do not understand government policy, and have expected immediate reaction from the many programs.  They have been dazed by acronyms and have lost focus as a result.

There is a firm determination to avoid a major recession.  The market will look ahead, beyond the recession that is now a year old.  This may already be starting.

Conclusion

We have ridiculed strategists calling for a five-percent gain in the next year.  This is silly, when intra-day moves are frequently greater.  The only reason to invest in stocks is an expectation for a major rebound.  Few are willing to talk about valuation, when the consensus mentality disparages earnings prospects.  We note some courage on this front from Morningstar, where they see the Dow as 30% undervalued. (Hat tip to Abnormal Returns, helping everyone see what otherwise might be missed.  None of us can check everything!)

We shall comment further on valuation issues, with a focus on expected and trailing earnings.

Wrong Turn for TARP

A few days ago we wrote our top suggestion for President-Elect Obama.  Several blogging colleagues took up the theme, and we sincerely thank them for their interest and for stimulating discussion.  We plan a more complete review of opinion, but events have, once again, overtaken the schedule.  The current Administration is moving in the opposite direction.

Secretary Paulson announced that the TARP program would not purchase troubled securities, at least not in the way originally envisioned.  He stated that direct investment in financial institutions was a better use of TARP funds with more impact.

A Discouraging Turn of Events

Here at "A Dash" we try to analyze markets rather than to offer prescriptive advice.  The "Letter to Obama" was a rare excursion for us.  While others stray far from their expertise, we like to stick to our "happy zone."

Here are two takes on the wrong turn in TARP.

Market Take.  Market participants, rightly or wrongly, now see the program as a funding source for anyone who claims a need.  They see it as socialism.  Most importantly, they interpret the failure to purchase distressed securities as an acknowledgment that these holdings are worthless.  Briefly put, the Treasury has undermined the very assets they hoped to support, and the leadership has lost the confidence of investors.

Political Take.  The decision to invest in preferred stock instead of troubled assets is an easy course.  It sounds great to the taxpayer.  The companies are held by private investors, so there is an inference of value for preferred shares.  This is better than buying what is perceived as "toxic waste."  It has an easily-understood causal mechanism -- a direct injection of capital.  The downside is that it has eliminated an clear public-interest distinction, inviting nearly anyone to apply for TARP funding.  It fails to address root causes.

Public Policy Take

Quite frankly, the investment and political types are not doing clear-headed public policy analysis.  This involves understanding the following points:

• Focusing on the cause of the problem.  The cause was originally troubled housing loans.  We could have addressed this directly at less cost than the current plan.  Instead, we have allowed mortgage securities to have an ever-decreasing mark-to-market value, and now face similar issues with Alt-A loans, student loans, and securitized credit card debt.  As long as this spiral continues, the need for additional government investment will continue.
• Recognizing the error of using a club instead of incentives.  The government is now instructing financial institutions to do more lending.  We are not learning the lesson of Fannie and Freddie, where the government tried to combine public interest with a private company.  It did not work there, because the government asked private companies to behave more aggressively than their financial statements warranted.  We are going down the same road.  If you were a bank manager with TARP funds, would you choose to strengthen your balance sheet in the face of declining assets, or make more loans?  Simply instructing them will not work.
• Failure to develop and implement a coherent plan.  The current "plan" seems to change weekly.  Everyone sees this, so confidence is lost.  It is the country's misfortune that our leadership was far too slow to address the relevant issues.  We hope that the Obama Administration will carefully develop and implement an incentive-based approach,  but the President-Elect does not yet have control.  Our tradition of transition in government is being tested in a way that has no historical precedent.

The best hope for investors is that the new administration will quickly develop and announce proposals that get to the root of problems.  Their key appointments should reflect this.  The Bush Administration should cooperate during the transition.

It is a major burden for an incoming President.  Never before has a President-Elect had such a responsibility before actually gaining the reins of power.

Economic Data and the Employment Report

At "A Dash" we believe in letting the data drive our conclusions.  This can be boring, since everyone wants strongly held and argued opinions.  In case you do not see the disagreement, CNBC even shows you a crashing bull and bear.

Today's Data

The economic news will provide the headline reason for today's selling, so let us take a look.

• Q407 GDP was revised downward, now carrying a "minus" sign.
• Q108 was revised downward by 0.1% (Yawn)
• Q208 came in at +1.9%, below the consensus estimate of 2%+
• Initial jobless claims spiked to 448,000

How to Analyze

The most quoted commentator on economic data must be Barry Ritholtz, one of our featured sources.  Whenever there is a fresh piece of economic data, we turn to The Big Picture to see what might be wrong with it.  We tried to look at the data as Barry might do.  Let us ask what data is fresh and what is old.  Let us look for one-time anomalies and not make too much of them.  Barry is taking off on vacation (as we did last week) so let us try to pinch hit.

• Q407 GDP -- Who cares?  Old news.  We all know that the economy has been weak and below trend for a long time.  Does it matter whether it is an "official" recession that we do not know about? (more later on recession dating)
• Q208 GDP -- Big inventory drawdown.  Will it come back?  Do companies know what they are doing in reducing inventories?  This is always subjective.  One can say that the companies know, so the inventory drawdown is real.  That was NOT true in Q407, thus the rebound in 2008.  Whatever one's viewpoint, inventories are thin at mid-year.  Something to think about for the second half.
• Spike in initial claims.  Phil Izzo at the WSJ did a great job on this one.  In his article, Economists React:  Jobless Claims "Overdoing the Doom, one of his sources reported the start of a Federal program of extended benefits.  When the federal program began, the process uncovered many people who had not claimed state benefits.  They all piled in this week, so something that might have been a couple thousand a month over many months all showed up this week.  This is a noisy series anyway, so we always use the four-week moving average.  Wow!  That is the kind of scoop that Barry would be all over.

In short, the news was a little negative, but no big deal.  With this analysis in mind and with bated breath, we clicked on The Big Picture for the official answer.

We Struck Out!

Drat it!  Our approach missed Barry's official analysis by a mile.  Barry tell us that this is an ugly, recession set of data.

To our surprise, he is also confident that the current quarter GDP figure will be revised down quite sharply.  He writes as follows:

Bill King observes that the GDP Price Index inexplicably tanked to 1.1% in Q2; 2.4% was expected. Nominal GDP declined to 3% from Q1's 3.5%. Thus, the Q2 GDP benefited by 1.5% points, thanks to the mysteriously collapsing GDP Price Index, down to 1.1% from Q1's 2.6%.Hence, I expect Q2 2008 GDP to eventually get revised downwards to 0.4% or worse.

To summarize, we missed the official Ritholtz analysis, which says that the world is much worse than the numbers suggest.  We are not sure why Barry is so confident about revisions.  Or inventories.  To us, these are dependent upon late-arriving data.  We have no confidence about the direction of changes.  We shall revisit this prediction with interest.

The Employment Report

Regular readers of "A Dash" know that we change opinions when we see changes in the data.  We have been pretty pessimistic on the market over the last couple of months, and we have expected major declines in the monthly non-farm payrolls.

This month is an unusual situation, so we are not making our normal comment.  (Check out last month for a typical comment.)  We usually discuss the monthly change in non-farm payrolls with respect to various other indicators.  We have stressed that this is not a causal relationship.  The measures are all mostly effects of the same economic phenomena.  The unusual circumstance is that one of our key indicators, the ISM index, will be announced after the non-farm payroll number.  Since the ISM index is always reported on the 1st of the month, this is very unusual.

For the moment, let us just say that if the ISM report is in the 49-50 range, as expected, we expect a job loss of about 90K.  This is much weaker than the ADP forecast, and slightly weaker than most economists.

To the surprise of most, it is possible to lose jobs at this pace and still have a positive GDP.  This is because of productivity gains.

Comparing Data Interpretation

Explaining and displaying data combines art and science.  The information itself is objective, as are calculations of trends and changes.  Despite this, there is an element of artistry.

A professor leading a class is motivated to help students find the truth.  One of our old professors described a certain statistical technique as grabbing the data around the neck, squeezing, and insisting, "Speak to me!"

If one starts with a conclusion, however, it is often possible to find support within almost any complicated economic report.  The analyst can look at changes from one period to another, or year-over-year.  One can look at seasonally adjusted or unadjusted data.  One can reject the overall number and look to "internals".  In such a case, the key question is whether the chosen indicator provides important information.

A Case Study: Today's GDP Report

With so many forecasting a recession, or insisting that the current period of slow growth will finally be judged as a recession, many are interested in the official report on GDP.  The estimate for growth in Q1, 2008, was revised upward to an annualized real rate of 0.9%.  While this is well below economic potential, it stayed in positive territory.

Since every economic report comes with plenty of commentary, let us consider the interpretation of the GDP data from three different sources -- all respected analysts who are among our featured sources.

We have provided extensive quotations, much more so than usual, but there is a reason.  Readers should take a few minutes to look carefully at each interpretation and see what conclusions they find.

Gary D. Smith

In his excellent "Bottom Line" summary Gary analyzes the Bloomberg report of the data and draws his own conclusions, including the following:

The economy grew more than previously estimated in the first quarter as Americans shunned imports and exports climbed to another record, Bloomberg reported. Jeffrey Frankel, an economist at Harvard Univ. who is a member of the panel that dates US economic cycles, said in a Bloomberg Radio interview, “I wouldn’t rule out going into recession” later in the year. This statement implies that he doesn’t currently view the slowdown as a recession, in my opinion.

and also this:

The gain in growth last quarter would have been even greater if not for a decline in estimates for inventories. Companies cut inventories at a $14.4 billion annual rate versus an initial estimate of a $1.8 billion gain. Inventories added only .2 percentage point to growth, less than the previously estimated contribution of .8 percentage point.

and finally this:

A measure of total sales, which excludes inventories, was revised to a gain of .7% at an annual pace rather than a .2% drop that was previously estimated. I expect 2Q GDP to easily exceed economists’ estimates of a .1% gain and growth to accelerate modestly into year-end on fiscal/monetary stimuli, lower commodity prices, decelerating inflation, an end to the American Axle strike, a firmer US dollar, inventory rebuilding, an end to the credit market turmoil, strong exports, diminishing housing fears and an improving job market.

Barry Ritholtz

Those reading the Barry Ritholtz blog (and that includes nearly everyone) might get a strikingly different picture.  Barry's key bullet points were as follows:

-Weakest two quarter growth since 2001 recession;
-Private inventory investment added 0.81% to GDP growth;
-Final Sales of domestic product: (GDP growth - private inventories) 0.7% (-0.2% previously)
-Personal consumption expenditure unchanged at +1%  (slowest since Q2 2001)
-Gross private domestic investment: -6.5% (previously -4.7%);
-Residential investment "improved" to -25.5% from -26.7% (most since 1981);
-Business fixed investment: -7.8% (improved from -9.7%);
-Exports weakened to +2.8% from +5.5%;
-Imports weakened to -2.6% from +2.5% ;
-Federal Government consumption expenditure and gross investment: +4.4% (+4.6% previously);
-State and Local Govt: 0.6% (+0.5% previously)

Barry also helpfully notes that if one subtracts trade and inventories, a key indicator according to Merrill Lynch's David Rosenberg, the actual quarter-over-quarter figure was a decline of 0.1%, indicating a "fragile economy."

Briefing.com

Briefing.com provides a timely and comprehensive analysis of every economic report.  Here is their bullet-point summary:

• The revised rate of 0.9% for Q1 GDP was due to an upward revision to net exports (0.6% additional contribution from 0.2%), and nonresidential structures (0.2% higher to 0.0%), and to inventories (0.6% lower to a 0.2% contribution).  All of these were about as expected as the March data on the trade balance, construction spending, and business inventories were out after the advance GDP report and all suggested changes of about this magnitude.
• The revision set GDP trends up for close to a 2% real gain in Q2.  Inventories will add about 0.5% to GDP if there is simply no more liquidation, and net exports and real PCE enter Q2 above the first quarter average.  Any modest improvement in these components in April-June will boost GDP solidly. 
• Real PCE (personal consumption expenditures) rose at a 1.0% annual rate.  This ultimate measure of consumer spending shows that lower home prices and higher gas prices have only dampened consumer spending, not produced declines.  Real PCE is tracking for another gain the second quarter.
• Exports continue to rise sharply and provide a boost to GDP.
• Housing (residential construction) remains a disaster and will continue sharply lower in Q2.  It is now down to just 3.8% of total GDP. 
• Business investment in equipment and software has been surprisingly resilient and will continue near flat in Q2.
• Nonresidential construction has started to weaken and will be a drag on Q2 GDP.
• Inventories provided a modest boost to Q1 GDP (due to a slower rate of liquidation) after taking a slice out of Q4.  Inventories will add further to GDP in Q2 as some accumulation might occur.

Their conclusion is as follows:  The recession has been postponed. (Read the entire article for a more complete analysis).

Our Conclusion

For today, the conclusion is up to the reader.  Three of our favorite sources seem to reach three different conclusions.  What is wrong?  Can we find an inaccurate statement?  Which approach does the best job of illuminating reality -- making the data really "speak?"

The key question is "How many readers can "cut through the spaghetti?" (as a key member of our team often puts it.)

Important News on the Housing Bill

When something important happens, with potential market effects, we interrupt our normally scheduled programming for an update.

We intend to publish the answers to the economics quiz and to announce the winners.  Meanwhile, potential entrants have another day to win this prestigious contest!

The Housing Compromise

At "A Dash" we have written a series of articles on  housing problems and possible solutions.  Since the government steps have been incremental in nature, the market has not really responded.  At some point, there will be a realization that something important has happened.

Last week we pointed out that investors should be watching Sen. Richard Shelby as the indicator of a real compromise.  A Senate Banking Committee compromise was reached today.  While there are more steps in the legislative process, we see this as the real hurdle.

The Significance

We note with interest the opinion of Nouriel Roubini, an outspoken bear on the housing situation.  In two articles, Roubini discusses the merits of the proposal and responds to critics of his viewpoint.  Here is a key portion of his argument, but readers should consult both articles.

Very few reflected on the substance of this proposal and its strong economic logic that would benefit borrowers, lenders and even the government as the fiscal cost of no action (a systemic banking crisis that would trigger a costly fiscal bailout of banks given deposit insurance) is much higher than the potential modest fiscal cost of this proposal.

Conclusion

This is good news for the housing market, the economy, and the stock market.  We shall delve more deeply into the proposal and the effects in future articles.  We shall also examine the reactions of economists and prominent bloggers.

UPDATE, 5/20/08, 1 PM CDT

The editors at TheStreet.com have kindly moved my article on the Frank/Dodd legislation to the non-subscription portion of the site.  Readers of "A Dash" can check out this article for insights from Doug Kass and Jim Cramer, the description of the remaining steps before it becomes law, and the reasons I believe President Bush will sign the legislation.  The process is going to take another six weeks or so, but it will get more attention before then.

Bailout for Homeowners and Lenders?

Developments in housing remain crucial for the economy and for stocks.  Nearly any account of the housing situation includes reports of the number of foreclosures, the inventory of empty homes, and the potential ARM re-sets that may stimulate even more foreclosure activity.

Any help for distressed homeowners would help to shift the supply curve for homes.  This would suggest more stable prices and a lower inventory overhang.  Some have speculated that demand has been suppressed by the expectation of further price decreases.  If this argument is true, then the foreclosure bill might affect demand as well as supply.

The House has already passed a version of the bill under the leadership of Barney Frank.  The Senate Banking Committee is now considering a similar bill.  The Chairman, Christopher Dodd remains optimistic that a compromise will be reached.

The Administration is using a veto threat to affect the legislation.  Their position is represented in the Senate by Richard Shelby (R- Alabama).  Shelby, a former Democrat who switched parties years ago, is calling for more aggressive regulation of the Government Sponsored Enterprises (GSE'S) in the home financing business.  He is also concerned about bailing out the undeserving with taxpayer dollars.

Those in favor of the proposal think that the cost of the bill, perhaps $2 B or so, is easily justified by the benefit for the housing market and the economy.

Putting aside our own opinions on the legislation, we believe that the market would react positively to something helping out homeowners.  For this reason, it is important to watch the key players, especially Shelby.

Meanwhile, housing remains firmly at the bottom of the sector ratings.

TCA-ETF Update

There has been a lot of movement among the top sectors in the last few weeks.  While energy and natural resources choices remain at or near the top, we now also see some technology.  All of the financial sectors have again fallen out of the "buy" range.

The percentage of ETF's earning a "buy" signal is down to 53%, well off the recent highs.  The overall strength ratings are also not as high as in recent weeks.

Listed below is the weekly update.

Musings

Occasionally we find ourselves with a number of topics which are all important, but do not provide the basis for a full column.  These "musings" are still highly recommended for your consideration.

• James Hamilton at Econbrowser takes a look at the unusual movements in InTrade's prediction market contract for a recession in 2008.  He correctly notes the thin trading, and the recent and temporary price decline.  This is exactly our viewpoint.  These markets may show quick moves when someone sweeps through all of the extant bids or offers, but then other players join.  It is price discovery, and the process is not unlike what we see in the housing market.  The political and economic markets have nothing like the liquidity in the sports markets on their sister site, TradeSports.com.  Prof. Hamilton wisely notes the difference between the NBER definition of a recession and that used to settle the InTrade contract.
• There is another good take on prediction markets by Eddy Elfenbein, who correctly notes that they set odds.  The actual outcome does not mean that the odds were incorrect.
• Scott Rothbort, one of our most valued sources, has established a new web site, TheFinanceProfessor.com.  Scott is a money manager, an adjunct professor at Seton Hall, and a valued colleague on RealMoney.  Most importantly, he shares with us the desire to educate investors, helping them to achieve their goals.  His new site has many educational features and is geared to draw content from readers.  Please check it out and visit regularly as we plan to do.  His blog has also been moved, so we have updated our featured listing.
• Thanks to Bill Rempel for reminding us about his earlier work on comparing home price methodologies.  Thanks also to David Merkel, Tim Plaehn, and VennData for their typically constructive comments in response to the question we raised.  We encourage readers to check out the useful and educational discussion on this topic, and follow the links, starting here.
• Turley Muller at Financial Alchemist has a nice series on Apple Computer, Inc. (AAPL), which we own in both institutional and individual accounts.  After hours traders sent the stock as low as 155 and as high as 170 while we were watching.  We shall see tomorrow.  We sold some very juiced May 170 calls against our positions, expecting to profit from the post-earnings reduction in volatility.
• Abnormal Returns has an excellent article on diversification and the benefit of considering additional asset classes.  We have done this in our TCA-ETF portfolio, but we are always looking for new candidates.  The article is a great source both for ideas and general approach.
• Dr. Brett Steenbarger has a free Webinar session on "Reading the Psychology of the Market."  It is after the market close on Thursday.  We know from our personal experience that any chance to learn from Brett is time well spent.

These are all good sources on important issues, of benefit to investors and traders alike.

A Simple and Honest Proposition

Here is a simple and honest proposition:  Data interpretation should lead to conclusions, not the reverse.

If an analyst believes that an indicator is important, and trumpets news about that indicator, it is intellectually dishonest to abandon the measure when it moves the other way.

If one endorses the Baltic Dry Freight index, Dr. Copper, or the inverted yield curve, then one should be willing to change forecasts when those indicators reverse.

Fair enough?

Some of these have recently rebounded, with little attention.  We shall follow up in more detail.

The Application to Housing

Nearly everyone, even those who are not equity investors, is interested in the housing market.  Calculated Risk (a site we feature, along with everyone else!) covers this like a blanket.  There are several key articles today.  Our advice is to read them all.

• A story describing the absolute worst case of subprime lending and packaging.
• Downgrades of a couple thousand securities, formerly in Aaa.  More writedowns?
• The most recent Shiller estimate.  CR objectively notes the discrepancy with OFHEO data (a difference we need to understand) and the use of nominal data.
• Foreclosures soaring in California.
• An analysis of existing home sales.
• An analysis of inventory, at a very high historical level.

It is a great job of telling us all what is at stake and where things stand.

Seasonal Adjustments

We are a bit confused by the analysis from The Big Picture, another featured site.  Barry Ritholtz correctly observes that there are important seasonal factors in home sales.  This is, of course, the reason that everyone else uses the seasonally adjusted data to compare one month to another.  Barry maintains [RealMoney article not yet available, but promised] that we should use unadjusted year-over-year data for comparisons.  We do not understand the advantage of this approach.

Everyone agrees that things are much worse than a year ago.  The seasonally adjusted pace of sales was up 2.9% last month and down 2% this month.  The year-over-year was down 19.9% this month, actually a bit better than last month.  Does that tell us something?  Is it an improvement?

If that is the real test, the year-over-year is going to start looking better in September or October, just because last year was so bad.  Will Barry call a turn in housing if year-over-year flattens out?  That would seem to follow from his analysis, even if the month-to-month seasonal data shows a decline.

We still do not see the advantage of this approach over looking at the seasonally adjusted data.  When one spots a big seasonal effect, as Barry demonstrates, doing the adjustment seems routine.  (We note that he criticizes the WSJ article from last month as not recognizing seasonality, even though it employed the seasonally adjusted data, a 2.9% increase.  Had they used the raw data, the increase would have been 12.3%.  (Check out the data for yourself here).

Questions for further Review

What does it mean for a home to be in "inventory?"

We have not yet seen a good answer to this question.  Let us offer a simple comparison that everyone will understand.  We hold various stock positions.  Each day there is a point where we would buy more and a point where we would sell.  We enter stock offers "away from the market."  Are these offers part of inventory?

Furthermore, if the stock price were to move higher, more stock would be offered.  If it were to move lower, more bids would appear.  The market clearing mechanism involves price discovery, where the market-clearing price is found.  This affects both price and volume.

Applying this to Housing

In our neighborhood, there are people, empty-nesters since this is a kid-friendly town, who are willing to sell at a price that is not realistic.  These homes are part of "inventory" but the offers are not really serious and the sellers are not motivated.

Meanwhile, CNBC reported today that there was a survey as part of the report [UPDATE: here].  18% of homes offered were in foreclosure.  We may assume that these are motivated sellers, as are those who have a job transfer or other personal needs.

Our point is that the concept of "inventory" in existing home sales is a bit elusive.  If prices were to move higher, the "inventory" might increase dramatically.  Things would be worse than we think.  Meanwhile, the existing "inventory" may not really measure the motivated sellers.

Conclusion

We do not have a firm conclusion -- only questions.

We would like to see more analysis where economists looked at shifting demand and supply curves and talked about market-clearing prices.  Instead, nearly all market commentators (mostly non-economists) view both supply and demand as black and white.  This does not recognize that a buyer whose credit score does not qualify at one price may be good enough at another.  This affects the demand curve.

Another question relates to the effect of government programs.  We know that the liberalization of the conforming loan limit on jumbo's has shifted the demand curve.  How much?

We also know that efforts to help those threatened by foreclosure will shift the demand curve.  How much?

No one is analyzing the problem in this way.  At some point -- who knows when? - there will be some bottoming action.  What indicator should we follow to observe this effect?

What is the difference between OFHEO prices and Shiller?  Why?

It will be interesting to see if those who have been the most aggressive in pointing out problems use their methods and indicators that signal the onset of the solutions.