Very little seems to have changed in a month. Bonds and gold are down a bit and stocks up a bit. The news remains riveted to the "subprime garbage" mess as it is increasingly called. My investment accounts are up 5.6% on the year, and with gold (metal) added (metals stocks are in the investment account totals already) I'm up 7.6% on the year. Good enough for keeping a retirement account up with inflation, nevertheless the worst returns since 2002. Partly this is due to a conscious decision, documented here over the year, to switch from a growth bias to an income bias. In a way the market has told me that my decision was timely. Some friends who retired in 2000 did not make the investment bias change in time. They lost substantially from their retirement kitty during the bear market. Nothing can be more demoralizing than losing a lot just after retiring. It changes everything you hoped for, whether your hope was well-placed or not. It's very hard to recover.
I spent the last several days reading Paul Kasriel's 2007 reports. Frankly, I had forgotten about him and hadn't read any of his analysis since about 2002. Kasriel is the chief economist at Northern Trust which is a major investor for wealthy trust beneficiaries. He is normally sceptical or even negative, as most old-line trust officers used to be with their clients before go-go tactics and happy face hedge fund investing became the norm. Kasriel spends most of the time during economic expansions and stock bull markets perfecting his identification methods for the next recession and the associated bear market. If you are looking for bad news, you will find it, and bearers of bad news are not very welcome at the bull's parties. But when I ran across Kasriell's name in my web browser favorites list after a long absence, I wanted to know the worst.
I'll post his URL below, but the major development is that he now has his own recession model based upon on only two indicators: the year-over-year percent change in the quarterly average of the CPI-adjusted monetary base (reserves and currency held by banks and currency held by the non bank public) and the four-quarter moving average of the percentage-point spread between the Treasury 10-year note (bond) yield and the Federal Funds rate. Just two indicators as opposed to the ten used by the Conference Board: the growth of the US monetary base adjusted for consumer inflation, and the spread between the Fed Funds interest rate that the FED controls and the ten year Treasury note yield which it does not control. Well, at any rate the FED doesn't control the ten year note yield directly or immediately.
Then, using a two phase switching probability schema--recession or no recession--and these two indicators, Kasriel can estimate the probability of a recession within the next year. Readings and estimates are made monthly based on twelve month smoothed data in the two indicators. As of Friday, December 21, 2007 the probability is 65.5%, or two-to-one, that we will have a recession within the next year. Kasriel finds the National Bureau of Economic Research's definition for a recession superior to the two quarters of declining GDP often quoted as a definition: "According to the NBER, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." (NBER is the arbiter or score keeper of US recessions.) In other words a recession needn't be a 19th century or 1930's wipeout-- Armageddon-in-our times-- although it presumably could be. Notice there are no dire warnings about credit, the stupidity of Wall Street, presidential election politics, etc. involved in Kasriel's prediction process. Just what the FED does or doesn't do and how the credit market responds. To be sure, Kasriel has opinions on many of the newsworthy economic topics of the day, but they don't figure in his recession model. Since I am primarily a technical analyst--if you'll permit me to include sentiment as part of the technical world--this is my kind of economics. Since 1968 a recession has either started just as the probability got to about this probability level or within a year at the latest. There have been no false signals or missed signals.
Kasriel documents that a stock market decline is important for recession but not definitive for prediction. No recession since 1948 has started without a down year in the SPX, but not every down year was followed by a recession. The SPX closed out 2006 at 1418.30 and this past week at 1484.45, so we're up only 4.7% on the year with a few trading days to go.
In one of his other recent reports Kasriel mentions his view on stagflation by demonstrating that inflation usually peaks during recessions. It is a lagging indicator in that sense. But in view of my last report here, it was nice to hear a professional of some standing who agrees with me on stagflation. Look here for more and also check his "Econtrarian" series as well in the left hand column of the Northern Trust website:
So what's the bottom line? I have continued to prune my accounts and raise more cash and near cash, primarily on strength. I'm still in a quandary regarding bonds. Most of the bonds I own through Vanguard Wellesley and Loomis Sayles Bond Fund and T R Price Spectrum Income are intermediate term with effective durations under 6 years, but they can still take a hit if rates go up. Bonds were very choppy during 2001 and 2002 and did not make the big bond bull run until the recession was officially over, although conditions remained rocky well after the November 2001 NBER "official" end of the recession which wasn't "confirmed" until July 2002.
Given my own inflationary opinion and Kasriel's comments, I am likely to cut these funds back somewhat and go to cash or shorter term bonds with the proceeds. I hate to tinker with what I think is is a reasonable portfolio, so I will probably simply cut back but not eliminate anything entirely. (So far I am not changing the municipal bond accounts.) Just as it was lovely to be able to invest from substantial intact cash in 2003, so would it be lovely again to have a stash of cash to invest if we have another recession and bear market.
Given my own inflationary opinion and Kasriel's comments, I am likely to cut these funds back somewhat and go to cash or shorter term bonds with the proceeds. I hate to tinker with what I think is is a reasonable portfolio, so I will probably simply cut back but not eliminate anything entirely. (So far I am not changing the municipal bond accounts.) Just as it was lovely to be able to invest from substantial intact cash in 2003, so would it be lovely again to have a stash of cash to invest if we have another recession and bear market.
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