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Frankenstein Economy Revisited

Posted By Barry Ritholtz On October 26, 2004 @ 3:39 pm In Economy | Comments Disabled

October’s reputation as one of the year’s scariest months appears well deserved this year. The frights began piling up weeks in advance of Halloween: Record oil prices, weak corporate guidance, disappointing pre-announcements, the Insurance bid-rigging scandal and a spate of mostly mixed economic reports have been pressuring the indices. This has driven the Dow down to the lowest point of the year.

But this low has set the markets up for the seasonal rally. We have observed that November to January each year tends to be amongst the strongest 3-month periods, while the 6 months from Halloween until May Day has a solid bullish bias. For the intermediate term, we advise investors to think about starting to deploy capital on the long side.

When considering the longer-term, however, we are quite mindful of the Presidential Cycle [1] (mentioned previously [2]). This 4-year cycle tends to see market’s bottom in the 2nd year of a Presidential term, and peak in the 4th year. That proved true for the present 4-year cycle, with lows in October ‘02 and peaks in January ’04. Were that to replay itself out, as we expect it will, 2005 will be the precursor to a significant correction. That is likely to start sometime in the second half of ‘05, and reach its denouement in 2006.

How will that likely come about? A year ago this week, we discussed our fears of the “Frankenstein Economy.” The lifeless, post-bubble financial system was reanimated through massive doses of stimulus. Historical levels of tax cuts, interest rate cuts, increased monetary supply, devalued currency, and deficit spending jolted the economy back to life – at least temporarily.

We may be witnessing the nightmare scenario we feared most last year coming to pass. Colossal though the stimulus was, it could not defeat the immutable business cycle. Recent data points to an expansion that is slowing, mostly due to the lack of both job creation and capital spending. With the stimulus behind us, we continue to see its effects waning. The LEI has dropped for 3 consecutive months, and that bodes poorly for the mid-2005.

Without some significant change in the economic climate, we expect recent trends to continue: a feeble economic expansion with high oil prices ($40-50), modest job creation, and anemic Capital Expenditures.

The 2002-04 stimulus has been extraordinary; Yet the economy remains recalcitrant. What unknown harm awaits when the failed reanimation – Frankenstein’s body, now deceased again – slumps back onto the slab?


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URLs in this post:

[1] Presidential Cycle: http://bigpicture.typepad.com/comments/2002/09/midterm_preside.html

[2] mentioned previously: http://bigpicture.typepad.com/comments/2004/03/4_year_cycle.html

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