The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Discussing the outlook for stocks and the economy, with Barry Ritholtz, Fusion IQ and Michael Pento, Delta Global Advisors.

I guess we shouldn’t be surprised about what economists think regarding residential Real Estate. After all, most of the profession missed the housing boom & bust in real time. Too many of the dismal set are still wed to the incorrect idea that we had a housing bubble when the evidence is overwhelming that we had a credit bubble. They misunderstood the impact of the housing boom & bust on the economy, and completely missed the the impact of subprime lending.

Based on that, I do not what to make of the latest, belated downturn in RE expectations by economists. 56% of the 106 economists and analysts surveyed expect home prices to decline this year. That’s up from 40% a month ago. (Data from Professor Robert Shiller’s monthly housing survey, of which I am a participant).

I’ll have more on this tomorrow morning . . . for now, New Home Sales are due momentarily. . .

With all the drama of Europe and China roiling markets, the least eventful event of the week will be the FOMC meeting. Nine of the members will vote to keep policy as is, that is rates at virtually zero for now an 18th month while another, Hoenig, will dissent to the “exceptionally low” for “extended period” wording because he believes it “could lead to the buildup of future financial imbalances and increase the risks to longer run macroeconomic and financial stability.” Even raising rates to 1% “would leave considerable policy accommodation in place.” It’s easy to argue the Fed would be nuts to raise rates with the economy still fragile but I argue its nuts to still have emergency rates with inflation benign but still running at 2% as it’s negative real rates too low for too long that got us into this mess. The current perceived cure was the basis for the disease. Isn’t it ironic, don’t ya think?

Yesterday I mentioned the lack of respect Greece continues to get in their bond market and we can argue that the selling in their debt is mostly from those funds that can’t own non IG paper but the selling is alarming the CDS market as 5 yr CDS today is rising back to the record high of 940 bps, up 85 bps on the day. The 10 yr yield is up 63 bps to 10.4%, the highest since May. Their 2 yr yield, which is fully backed by the Euro bailout package, is up 57 bps to 9.78%. Hopefully when the forced selling is done, things calm down and maybe the action in the bonds are feeding the need for protection in CDS but its something we have to monitor. Portugal sold 5 yr paper at a yield of 4.66%, 96 bps above the one a month ago. Eurobor 3 mo spread to EU 3 month LIBOR rose to a fresh record. The Pound is at a 7 week high as the new UK budget gets its kudos from the market. June Euro mfr’g and services composite index was a touch above expectations.

Even with the average 30 yr mortgage rate falling to 4.75% to the lowest since May ’09, near multi decade lows and vs 4.81% last week, the MBA said purchases fell by 1.2% and refi’s fell by 7.3%. ABC confidence is the bright spot of the day as it rose by 2 pts to -43, matching the highest level since the first reading in Jan.

The following discussion is by Lakshman Achuthan and Anirvan Banerji, co-founders of ECRI:

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There’s been much attention to our work of late, culminating in a report this Tuesday from Bank of America listing several critiques of our Weekly Leading Index (WLI). Apparently, the clinching argument is that “If a single indicator always accurately predicted the trajectory of the economy, the demand for Wall Street economists would be significantly reduced.”

To some Wall Street economists, it may seem self-evident that there should be strong demand for their views. But this is not at all clear to us as far as their recession-forecasting function is concerned. After all, a 63-country IMF study on economists’ recession-forecasting prowess concluded that “The record of failure to predict recessions is virtually unblemished.” In contrast, the IMF subsequently noted that ECRI “has actually had a very stellar record” of recession forecasting.

As we outlined in our 2004 book, Beating the Business Cycle, there is no Holy Grail of economic forecasting, even among our large array of state-of-the-art leading indexes, of which the WLI is but one. It seems that many of the self-styled experts on the WLI either haven’t read the book, or simply don’t understand the parts of the book where we repeatedly state, in no uncertain terms, that ECRI does not use models.

We aren’t entirely surprised. Virtually the entire analytical community has been trained to believe that any and all quantitative approaches to forecasting must involve models, i.e., simplified representations of reality. The idea that there could be rigorous quantitative approaches that are not model-based seems to be entirely beyond their ken. Their understanding of analytical techniques is so model-soaked that it reminds us of an insightful comment from psychologist Daryl Bem: “It takes a very intelligent and non-parochial fish to realize that his environment is wet.”

So it is with economists who cannot imagine that ECRI’s leading indexes are not model-driven or based on back-fitting of data. Thus the BofA report notes that “the ECRI (sic) and other leading indexes . . . fit the business cycle better ex post than ex ante” and that “This is an example of a broader issue in all statistical models of the economy. The data fit much better in-sample than out-of-sample.”

They just don’t get it. While this may be a valid criticism of statistical models of the economy, ECRI’s leading indexes are not, in any sense, statistical models of the economy.

BofA’s ignorance of the facts continues in their use of a 1993 (yes, 1993!) Dallas Fed study of the Commerce Department’s LEI to impugn the WLI. The Fed paper correctly points out that the-then LEI got revised a lot — a situation that hasn’t changed now that the Conference Board maintains the index. However, none of what the Fed reviewed in 1993 had anything to do with the WLI, which is the target of the current BofA report.

Furthermore (not that we’re fans of the Conference Board’s LEI) but the Dallas Fed study may not be valid in the first place, since the results are based on a Bayesian model chosen by the Dallas Fed to generate recession and recovery signals from the LEI. In other words, it isn’t clear whether failures highlighted in that report have to do with the LEI itself or the assumptions and the specifications of the Bayesian model used in that study.

Still, the BofA’s latest forecast of a “recovery, stronger than what we saw in the early 2000s and 1990s, but weaker than V-shaped recovery in the early 1980s” is very much in line with what ECRI predicted — in August 2009. At that time, we said the recovery would be “at a stronger pace than any the United States has seen since the early 1980s.”

BofA’s parroting of our forecast from late last summer reminds us of Jon Stewart’s segment on Nowcasting where experts describe something that’s already happening as though it’s coming (Jason Jones starts at three-minute mark).

Bottom line, neither the “experts” predicting that the sky is falling based on the WLI, nor the other “experts” indulging in misinformed WLI-bashing in an effort to discredit the super-bears, have a real clue to what the WLI is all about. We created the WLI not to be an infallible, stand-alone recession-forecasting machine, but as one small part of a much larger array of leading indexes (each made up of many economic indicators) — like the especially prescient U.S. Long Leading Index. This array amounts to a sophisticated sequential signaling system of the economy’s cyclical turning points. The WLI is designed to be interpreted in this broader context, and its message today is quite simple: A slowdown in U.S. economic growth is imminent, but a new recession is not.

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Good Evening: U.S. stocks fell for a second straight day today, as early rallies on both Monday and Tuesday gave way to selling in the afternoon. The primary catalyst for today’s downbeat session (volumes were light and breadth was poor) was yet more confirmation that housing seems to be suffering a post-bubble relapse, but ordinary profit taking may have also played a role. From the 1042 low on June 8 to yesterday’s 1031 high, the S&P 500, the S&P 500 had risen almost 9% in just 9 trading days. Some sort of set back is understandable in light of these gains, but the selling grew a little more urgent when the twin supports of 1100 and the 200 day moving average gave way this afternoon. Whether stocks will either regain their footing or continue to slip is an open question, and part of the answer may have to do with the perceived health of the world’s largest economy. The debate over whether the U.S. will suffer a “double dip” recession has escalated in recent weeks, so perhaps we should investigate what the fuss is about.

Equity prices began this week with an upside bang when China announced it was finally abandoning the yuan’s peg to the U.S. dollar that had been in effect since the dark days of late 2008. Bourses around the world rejoiced at the news on Monday, but the major averages in the U.S. couldn’t hold their early gains. Perhaps the disappointing reaction in this country can be traced to a notable lack of transparency surrounding this policy change by Beijing, and sellers jostled with one another all afternoon until the indexes finished in the red on Monday.

Stocks overseas were down in sympathy overnight after yesterday’s disappointing finish on Wall Street, but U.S. stock index futures were actually higher going into Tuesday’s open. After rising approximately 0.5% in the early going, however, prices pulled back to the unchanged mark when the latest housing stats came out. Existing home sales fell 2.2% in May versus expectations for a significant gain. The averages then spent the next few hours hovering just over and under yesterday’s closing levels, and not even a Louisiana judge’s injunction to lift the Obama administration’s moratorium on offshore drilling could ignite much buying interest. Small cap stocks, the Dow Transports, and the homebuilders all got weaker as the day progressed.

With two hours left in the trading session, the S&P 500 took out yesterday’s lows and began to follow the aformentioned groups lower. There was no big whoosh to the downside, but market participants didn’t seem happy that the S&P didn’t put up much of a fight before both the 1100 level and the 200 day moving average were taken out. By day’s end, the NASDAQ’s -1.2% loss was the smallest among the major averages, while the Russell 2000 (-2.15%) and the Dow Transports (-3.85%) were the leaders to the downside. Treasurys were the biggest beneficiary of the weakness in equities, and yields on U.S. government paper fell between 3 and 9 basis points across the coupon curve. Perhaps anxious over tomorrow’s World Cup soccer match against Algeria, team U.S. dollar could only muster a fractional gain today. Commodities had no such allegiances to fret and simply followed stocks to the downside. Led by weaker energy prices, the CRB index lost 0.4% on Tuesday.

Risk became a four letter word during the financial crisis, but from March of 2009 until April of this year, investors rediscovered risk taking. The ardor for risk taking substantially cooled from late April through early June, but risk taking was just starting to come back this month when it started to shrivel again this week. Underlying this proclivity among investors to shift from “risk on” mode to one of “risk off” is a concern about the sustainability of the economic recoveries around the world. With brightening prospects for growth in Asia largely offset by the increasingly feeble looking prospects for Europe, the fulcrum of global economic activity is currently centered in the United States. Most economists are of the opinion that the recovery in the U.S. has become self-sustaining, but a growing band is calling for a “double dip” recession.

The final two articles you will find below try to contribute to this debate, mostly on the side of the self-sustainers. The first is a piece by the economists at Bank of America/Merrill Lynch. They attempt to answer those who have pointed to the recent flagging in the index of leading indicators by Economic Cycle Research Institute (ECRI) as a concrete reason to fear another recession in the U.S. Not so, say the BAC/MER team; there is no “holy grail” of economic indicators, not even the vaunted predictive qualities of the good folks at the ECRI. Their point that “each cycle is different” and that good judgement cannot be replaced by any model makes the piece worth reading.

The London-based fixed income team at Credit Suisse also thinks the economic recovery under way will muddle through to middle age, and they offer myriad reasons why in their latest “Market Focus”. This CS team has been among the more optimistic group of forecasters since the turn last year, and they remain so in this latest offering. The thrust of their piece is that history is not on the side of the double-dippers, that failing to reach economic escape velocity is fairly rare. Interestingly, however, they also offer up a gloomy caveat. Though they call it a low probability event, the folks at CS fear that if the U.S. soon does slip back into negative growth territory (likely due to policy errors), then we might end up in a depression.

It’s not a happy thought, especially since policy errors aren’t exactly a rarity in Washington. I will add my two cents to the debate by asking the economists to remember just how this recovery was born — with fiscal stimulus and quantitative easing. An inventory replenishment cycle also contributed to our recovery in GDP, but these are hardly sources of sustainable growth. I worry about housing (all the stats — not just today’s — point to renewed weakness in this important sector), job creation, and the increasingly heavy policy hands of our leaders in D.C. I’m also pretty sure that if the U.S. does falter, the Fed will respond with round two of QE. How this all plays out is not an easy call. The only thing we can say for sure about the double dip debate is that if we do have one it certainly won’t be pretty.

– Jack McHugh

Global Stocks End Longest Rally in 11 Months
U.S. Stocks Slide as Home Sales Spur Recovery Concern
BAC-MER- ECRI No Grail (Removed at MER’s request)
Market Focus — Double Dips

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Tonight, I will be on the Kudlow Report at about 7:20pm to discuss the next leg down in Housing. As noted earlier today, Housing data was weak, falling 2.2% from April. And now that the Tax incentive is over, expect more downwards pressure.

The 3 most important things to note about Housing:

1. Prices remain historically elevated;

2. Shadow inventory — flippers and investor purchased homes — still lurk out there by the millions;

3. We are likely looking at another 5 million more Foreclosures . . .

As I have argued in the past, this will be healthy, cleansing thing.  Painful, but ultimately healthy.

I don’t think I  have been on the show since October 2009.

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Video is here

William Isaac, Former FDIC chief & author of “Senseless Panic,” and Paul Volcker, former Fed chairman, discuss the Volcker Rule, derivatives legislation, the sticky issue of too big to fail, and mark to market accounting with CNBC’s Larry Kudlow.

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For reasons which sound good on TV but really have nothing whatsoever to do with what happened, the markets gave up what little gains they had in the morning, ending the day off by 1.5%.

Whether you want to blame the Housing data or the Treasury Auction or FOMC meeting or the crisis in Europe, you are looking for influences of psychology.

Perhaps a better choice might be to look at where the buyers and sellers are doing battle — the SPX 1100 line has been a skirmish filled area.

New Home Sales in the morning, FOMC announcement tomorrow afternoon, GDP Friday, and a long weekend a week off in the distance . . .

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Anything in the markets grabbing your attention lately . . . ?

via Moolanomy

I find this chart from Ron Griess of The Chart Store rather fascinating: It shows the periodicity of market rallies, as measured from top-to-top and bottom-to-bottom.

I am not sure what it means, but i find it intriguing nonetheless .  . .

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Trading Market Cycles

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