ECRI: A new recession is a done deal

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ECRI: A new recession is a done deal

Postby Lbill » Mon Oct 03, 2011 10:28 am

Recession call from the Economic Cycle Research Institute posted on 9/30:
Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there’s nothing that policy makers can do to head it off.

ECRI’s recession call isn’t based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down – before the Arab Spring and Japanese earthquake – to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not “soft landings.”

Why should ECRI’s recession call be heeded? Perhaps because, as The Economist has noted, we’ve correctly called three recessions without any false alarms in-between. In contrast, most of those who’ve accurately predicted a recession or two have also been guilty of crying wolf – in 2010, 2005, 2003, 1998, 1995, or 1987

Here’s what ECRI’s recession call really says: if you think this is a bad economy, you haven’t seen anything yet. And that has profound implications for both Main Street and Wall Street.

http://www.businesscycle.com/reports_indexes/reportsummarydetails/1091
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Postby beardsworth » Mon Oct 03, 2011 10:37 am

Also discussed in this CNBC video with ECRI's Lakshman Achuthan

http://video.cnbc.com/gallery/?video=3000048636

and in John Hussman's new Monday morning "Weekly Market Comment"

http://hussman.net/wmc/wmc111003.htm

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Postby etarini » Mon Oct 03, 2011 10:55 am

There was also a good interview on Bloomberg Surveillance with Tom Keene.
I listened to it twice through while mowing the lawn Saturday.

http://media.bloomberg.com/bb/avfile/News/Surveillance/vEVSaoh5P.qM.mp3

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Postby deci02 » Mon Oct 03, 2011 11:33 am

I used to pay more attention to ECRI but after a while saw them issue a lot of spin as their predictions proved to be less reliable then they claimed. Here's an article that validated what I was seeing at the time I had lost faith in their self proclaimed perfection.

http://globaleconomicanalysis.blogspot. ... cting.html

I still do read what ECRI has to say from time to time since I do think they attempt serious analysis using relevant data. But that doesn't mean they have a case closed crystal ball.
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Postby Lbill » Mon Oct 03, 2011 11:57 am

deci02 wrote:
I used to pay more attention to ECRI but after a while saw them issue a lot of spin as their predictions proved to be less reliable then they claimed. Here's an article that validated what I was seeing at the time I had lost faith in their self proclaimed perfection.

http://globaleconomicanalysis.blogspot.com/2009/10/look-at-ecris-recession-predicting.html

I still do read what ECRI has to say from time to time since I do think they attempt serious analysis using relevant data. But that doesn't mean they have a case closed crystal ball.

The article linked to was dated Oct, 2009. I had to wade through a lot of stuff that debunked ECRI, but then got to the bottom line, where these forecasts by ECRI appeared:
Achuthan concedes stocks are an imperfect leading indicator. That being said, there's a strong chance "we don't have a downturn in the stock market of any significance anytime soon," he says, citing ECRI's 100-plus years of data on business cycles.

"We are in the early stages of the recovery and it looks to be a lot stronger" than the consensus for modest 2%-3% GDP growth, says Lakshman Achuthan, managing director of the Economic Cycle Research Institute (ECRI).

Furthermore, the recovery will be "V-shaped" and is now "virtually unstoppable" - at least through the first half of 2010 -- Achuthan says, citing a "positive contagion" in the economy right now, based on leading economic indicators. Most notably, the ECRI's index of Weekly Economic Indicators just hit a new record high.

Seems like these were accurate at the time, as things turned out.
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So What?

Postby Bill Bernstein » Mon Oct 03, 2011 2:54 pm

I too pay attention to economic forecasts, but for the opposite reason: the best returns are earned when things looked the grimmest.

Think: would you rather buy stocks at times like 1932, 1974, 1982, or early 2009, when the world looked like it was going to end, or in 1928, 1965, 1999, and 2006, when the forecasts are rosy?

(Or, as Peter Lynch said, he spends about 13 minutes per year thinking about the economy, and that was 8 minutes wasted. Or, put another way, when risks rise, so do expected returns.)
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Postby Lbill » Mon Oct 03, 2011 3:05 pm

Dr. B - I like to buy stocks when things look grim and they're not at 20x 10-year earnings (which they still are). I'm waiting for grim news and 10-year multiples that are more in line with the grim news. I'm sure that time is down the road a bit further.
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Postby bob90245 » Mon Oct 03, 2011 3:18 pm

Lbill wrote:Dr. B - I like to buy stocks when things look grim and they're not at 20x 10-year earnings (which they still are). I'm waiting for grim news and 10-year multiples that are more in line with the grim news. I'm sure that time is down the road a bit further.

So just wait for an additional 25% market drop when P/E10 will be 15X before buying your stocks, right?
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A Good Strategy

Postby Bill Bernstein » Mon Oct 03, 2011 3:21 pm

When it works.

And it usually does. But when it doesn't, you're stuck in cash for a long, long time. Maybe forever.

Re. the CAPE:

1) It currently contains not one, but two earnings recessions. In 24 months, that's no longer true and its value will automatically fall.
2) The 16x historical average is meaningless, since those data begin in 1871, when industrial stocks sold at 4-5x earnings. Post-1951, the average is 19.
3) The 12-month trailing PE is 13. I'm not displeased with that. Further, small, value, and foreign stocks are even less expensive compared with historical values; the EAFE is approaching single-digit PEs.

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Postby Lbill » Mon Oct 03, 2011 3:21 pm

So just wait for an additional 25% market drop when P/E10 will be 15X before buying your stocks, right?

I like to play games of chance only when the odds are in my favor, or not play at all...
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Postby Lbill » Mon Oct 03, 2011 3:27 pm

Re. the CAPE:

1) It currently contains not one, but two earnings recessions. In 24 months, that's no longer true and its value will automatically fall.

If the ECRI is right, it might contain three earnings recessions pretty soon. What will that do to CAPE? We live in parlous times.
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Re: A Good Strategy

Postby letsgobobby » Mon Oct 03, 2011 3:27 pm

wbern wrote:When it works.

And it usually does. But when it doesn't, you're stuck in cash for a long, long time. Maybe forever.

Re. the CAPE:

1) It currently contains not one, but two earnings recessions. In 24 months, that's no longer true and its value will automatically fall.
2) The 16x historical average is meaningless, since those data begin in 1871, when industrial stocks sold at 4-5x earnings. Post-1951, the average is 19.
3) The 12-month trailing PE is 13. I'm not displeased with that. Further, small, value, and foreign stocks are even less expensive compared with historical values; the EAFE is approaching single-digit PEs.

Bill


Thank you Dr Bernstein. I agree with you 100%.
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Re: ECRI: A new recession is a done deal

Postby crl848 » Tue Nov 01, 2011 11:49 am

letsgobobby wrote:
wbern wrote:When it works.

And it usually does. But when it doesn't, you're stuck in cash for a long, long time. Maybe forever.

Re. the CAPE:

1) It currently contains not one, but two earnings recessions. In 24 months, that's no longer true and its value will automatically fall.
2) The 16x historical average is meaningless, since those data begin in 1871, when industrial stocks sold at 4-5x earnings. Post-1951, the average is 19.
3) The 12-month trailing PE is 13. I'm not displeased with that. Further, small, value, and foreign stocks are even less expensive compared with historical values; the EAFE is approaching single-digit PEs.

Bill




Thank you Dr Bernstein. I agree with you 100%.


Seeing as this post was linked in the Economist Buttonwood blog, I had a look at Dr. Bernstein's comments in more detail.

Point 1 is absolutely correct, if you assume that earnings grow (for the sake of argument) at 10% for the next 3 years, the PE10 in 2014 will be around 16x. But that is after 3 years of stocks going nowhere, of course.

Point 2: I'm not so sure about this one. Looking at the graph of PE10, the market did not trade at 4-5x earnings in 1881 (the earliest Shiller datapoint). It traded around 16x until 1907. The average PE10 prior to 1951 is 14.4x, so not in this kind of single digit space. It is true that the average post-1951 is just under 19x, but this of course includes the TMT bubble years that significantly inflate the ratio. There is an argument for excluding the unprecedented valuations of 1997-2001 from the average, and doing so reduces it to 17.2x. After all, would you want to include in your fair value calculation a period whose valuation delivered subsequent 5 year nominal total returns on average were 0.6% and 10 year 1.9%? This is the argument made extensively by Hussman (passim) and Shiller himself (who has advocated a 15x average in the past, i.e. the 1890-1990 period). Thus if the fair value is really 15-16x, then the S&P needs to stay at current levels for another 3 years to reach it.

Point 3: I agree that European stocks look better value but it is not significantly clear to me that the S&P is cheap (though it certainly does not appear wildly expensive).
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Re: ECRI: A new recession is a done deal

Postby bob90245 » Tue Nov 01, 2011 12:24 pm

crl848 wrote:Point 2: I'm not so sure about this one. Looking at the graph of PE10, the market did not trade at 4-5x earnings in 1881 (the earliest Shiller datapoint). It traded around 16x until 1907. The average PE10 prior to 1951 is 14.4x, so not in this kind of single digit space. It is true that the average post-1951 is just under 19x, but this of course includes the TMT bubble years that significantly inflate the ratio. There is an argument for excluding the unprecedented valuations of 1997-2001 from the average, and doing so reduces it to 17.2x. After all, would you want to include in your fair value calculation a period whose valuation delivered subsequent 5 year nominal total returns on average were 0.6% and 10 year 1.9%? This is the argument made extensively by Hussman (passim) and Shiller himself (who has advocated a 15x average in the past, i.e. the 1890-1990 period). Thus if the fair value is really 15-16x, then the S&P needs to stay at current levels for another 3 years to reach it.

History is history and you can exclude portions if you want. But that would be data mining.

Babe Ruth hit 43 home runs in 1927 -- if you exclude the unprecedented number (17) he hit in September. Ruth's record of 60 home runs wouldn't be broken until Roger Maris hit 61 home runs in 1961.
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Re: ECRI: A new recession is a done deal

Postby trico » Tue Nov 01, 2011 12:33 pm

I was able to get may allocation to 90/10 bonds/stocks on the rally last week. Looks like I should get to 95/5 bonds/stocks on the next rally.
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Re: ECRI: A new recession is a done deal

Postby crl848 » Tue Nov 01, 2011 1:09 pm

Goddam Shiller, datamining his own database! When will these academics ever learn?

Btw isn't using data since 1951 datamining too?
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Re: ECRI: A new recession is a done deal

Postby bob90245 » Tue Nov 01, 2011 1:46 pm

crl848 wrote:Btw isn't using data since 1951 datamining too?

Yes, it is. But for a different reason.

Not sure where the cut-off year should really be, 1951 or something else. But arguments I've seen say that the world of corporations and the economy have evolved over the years. Is the modern corporation and economy really representive from data pre-1930's? Or data pre-1900's? Rhetorical question...
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Re: ECRI: A new recession is a done deal

Postby crl848 » Tue Nov 01, 2011 2:17 pm

A good point. Many argue that this time is really different. Jeremy Siegel did extensively in the last (2008?) edition of Stocks for the Long Run, citing the *cough* Great Moderation.

It's a tricky call. My view is that one ought to make this argument throughout history. The mutual funds and computer aided whizz kids of the late 1960s were a substantial advance over the robber barons and market manipulators of the '20s, for example. In that case, we should observe a rising valuation/falling cost of equity over the long term. But looking at long term valuation history, we don't see this pattern. PE10 traded in a tight range until about 1995, since when it has been substantially higher than previously. This has coincided with the Greenspan/Bernanke put and poor equity returns. It is thus possible to argue that, when estimating fair value (not just calculating a mathematical average), use all the data and even (per Shiller) exclude obvious outliers which are by definition a bubble.

Regardless of whether one picks 15, 16 or 19x, one should recognise that accepting a higher equilibrium valuation means accepting lower equity returns. It's not at all clear that proponents of higher valuations understand this.
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Re:

Postby HomerJ » Tue Nov 01, 2011 2:34 pm

Lbill wrote:
So just wait for an additional 25% market drop when P/E10 will be 15X before buying your stocks, right?

I like to play games of chance only when the odds are in my favor, or not play at all...


I like to be the house, stay in all the time, and get the decent positive return overthe long-term.
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Re: ECRI: A new recession is a done deal

Postby bob90245 » Tue Nov 01, 2011 3:23 pm

crl848 wrote:Regardless of whether one picks 15, 16 or 19x, one should recognise that accepting a higher equilibrium valuation means accepting lower equity returns. It's not at all clear that proponents of higher valuations understand this.

Maybe. But one can go about estimating future equity returns without using valuation guidance. One can simply say, per the Gordon Equation, earnings growth plus dividend yield. And Bogle has recently put that (if memory serves) at roughly 5 plus 2 to get 7 percent expected equity returns.

If one wants to argue that PE compression might knock off a percent or two from that estimate, they can do so. It's really just a guess, anyway.
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Re: ECRI: A new recession is a done deal

Postby crl848 » Tue Nov 01, 2011 3:53 pm

Good debate, I hope it's not too boring to go on and on, I am sometimes accused of this amongst my colleagues.

Arguably, you are using valuation in invoking the Gordon model (the dividend yield part). And, by accepting the current below-average 2% yield (plus 5% growth), your estimate of 7% expected return is quite a lot lower than the historical average, which is more like 9% (geometric). So, if one is prepared to accept higher-than-average valuations, one should also expect lower-than-average returns.

Also, the 5% long term growth figure is a bit suspect, as for example the historical real dividend growth rate has been much lower than GDP growth (1.4% according to Dimson et. al., quoted in the Economist on Oct 15th), which is about 3.5% nominal. I know growth may be higher in the future due to changes in payout ratios, but research by e.g. Arnott & Asness casts doubt on this. Suffice to say that, in my view, the 7% nominal return estimate looks at the high end to me.
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