Sunday, August 28, 2011

Weekend rant: the Doomers tell a compelling story -- until you look at their record

- by New Deal democrat

A commenter has asserted that I rely on nothing more than post-WW2 data, and therefore my conclusions are bogus, totally ignoring the numerous posts I have written, including a five part series I wrote close to 3 years ago, looking at pre-WW 2 economic indicators. The alternative, presumably, is to rely on "fundamental analysis." As I pointed out last week, most of what passes for "fundamental analysis" consists of agglomerating charts and opinion pieces in support of an opinion that is already held. That sort of "analysis" misses or ignores contrary data as it comes in, and gives you no more guidance than flipping a coin as to what is going to happen next.

But if the "analysis" rests on the same ideology as that held by the reader, it will be enthusiastically accepted. The analyst's feet are almost never held to the fire. If 6 or 12 months later, it is proven wrong, well so what? By then we're on to the next "analysis" that now proves the opinion correct. But if you actually want to be guided by reason and logic, and want to overcome your own biases, you need to examine past "fundamental analysis" and see just how often previous assertions have proven false.

Here's another example, as recent as just yesterday. The following story - that Wall Street has run out of suckers will be familiar to readers of the Great Orange Satan. Here is a summary:
Wall Street has a problem. You see Wall Street functions much like Las Vegas. Their immense wealth depends on the continuing myth that their games aren't rigged, and the willful denial of reality by the suckers.
Wall Street may seem all powerful, but like Vegas it has an Achilles Heel - if the people don't feed the beast it will starve. If the greed of The House gets to extreme, and the rigging of the games becomes too obvious to ignore, people will stop gambling at the casinos and in the stock market. The House goes broke. That tipping point, where the willful denial of Main Street starts to break down because the game rigging is so blatant, may have finally been reached.
Against the backdrop of unusually low equity trading volumes, even for a typically sleepy August, continued strong flows out of equities into bonds, and high-profile hedge funds shutting down, a bitter truth is dawning for investment professionals. Namely, that the ranks of retail investors, commonly derided as "dumb money" by the Street, have made the right call on US equity and bond markets ....
$50.2bn has been pulled from US equity funds on top of the $74.6bn in outflows during 2009, while $152bn has flooded into US bond funds

The [pump and dump] game doesn't work if the dumb money decides not to play. If the dumb money can't be convinced to buy the overpriced assets then the smart money is stuck. Eventually they will have to sell those assets, and pump-and-dump doesn't work when the only ones playing are the Wall Street insiders.
Which brings us back to the stock market. Remember last May? Economic forecasts were being revised upwards. Most economists said we were in "good shape". Bonddad came back to Daily Kos and proclaimed long-term victory over the doom-and-gloomers. Ironically, Bonddad's victory dance was on the exact same day as Wall Street's Flash Crash. I said double-dip recession, like several other bloggers.
It was right around this time that the "dumb money" decided to not believe the happy talk and stopped investing in the stock market. The overall stock market has dropped about 9% since then.

In fact, so many bloggers remained negative in the face of the economic establishment that an economist at the Federal Reserve said in June that bloggers didn't understand economics.

In July, I warned that the leading indicators were crashing, as did many other blogger. In a call-out diary, Bonddad said the leading indicators were fine.

[graph of LEI, and LEI minus yield curve]

Since that time the housing market has literally crashed with all signs pointing downward. The 2nd Quarter GDP was revised down. The unemployment numbers, both monthly and initial claims, were dramatically worse than expected. Regional economic surveys, such as the Philly Fed Index, have disappointed.

The "dumb money" didn't buy into the false hype. The "smart money" did. Now the "smart" money is stuck with these overpriced assets.
No, this wasn't yesterday's top-rated diary at DK. It was the top rated diary almost exactly one year ago, on August 30, 2010, by the same diarist on the same theme, namely Wall Street has run out of suckers and so the stock market is going to dive.

Yesterday, that diarist made a compelling "fundamental" case that the retirement of the Baby Boom generation meant a generation-long bear market in stocks. He even went so far as to make the following guarantee:
Consider the simple fact that sending your money is a sure-fire loser for this past 11 years, and for the next 16 years.

Ponder that for a moment. You are assured of losing money on Wall Street for 16 years!
When you ponder the compelling case made by that diarist, that earned close to 300 recommendations, consider the following:

- it isn't news. I heard the exact same argument being made on the late Louis Rukeyser's "Wall Street Week" 15 years ago; namely, that there would be a secular bear market once Boomers had to start cashing in their retirement funds.

- while the Boomers were a very large generation, the echo boom is nearly as large.

- alone among industrialized countries, the US's population is booming, as the tsunami of mainly Latino immigrants adds to the younger population, as do their children.

So a guarantee of losing money for the next 16 years seems a little, ummm, overconfident.

Beyond that, consider the diarist's variation on the same theme one year ago: that Wall Street is a rigged ponzi scheme and the market is sure to go down, because the rubes have finally figured out they've been taken to the cleaners. That one also was top-ranked, also earning over 250 recommendations.

Since that time, contra the diarist's prediction, we've had 4 quarters of economic growth, and no double-dip recession. Instead of crashing, the 3rd and 4th quarter of 2010 showed good but not great growth. The diarist got that one dead wrong. Housing sales have gone sideways to slightly upward since that time.

And about that dumb money that he was trumpeting? How did it fare? On August 30, 2010, the S&P 500 was at 1048.92. Even after the recent crash, on Friday it closed at 1176.80. That's up +12.2%, plus dividends. The DJIA was at 10009.73 on August 30 of last year. On Friday it closed at 11283.54, up +12.7%, plus dividends.

The Doomers and their "fundamental" analysis tell compelling stories, that command your agreement. Until you look at their record.

P.S.: The economy sucks, it has sucked for multiple years, and it looks to suck for at least several more years to come. The economy isn't being helped by the Washington lobotomy factory, as Bonddad puts it. But the key to understanding what lies ahead isn't by having a "story" and then cherry-picking charts and graphs to make the story. Rather, it is to look at the same data series over and over and over again, keeping in mind their historical place in the business cycle, and give equal attention to them when they go down, and when they go up.