Sunday, December 27, 2015

Our Year-End Letter, Part 2: The Economy

There's a saying a truism a strategy known to those in the attention-getting business: It's used instinctively by little kids, deftly applied by certain political candidates and utterly mastered by some folks connected to the world of money and economics; it's called "Any Publicity is Good Publicity" (we'll say "attention" with regard to kids)---be it good, bad, correct or not.

Over the past few months I've been asked what I think about the apocalyptic prognostications of (to name two)  Ron Paul and  Peter Schiff, and of the two-thirds chance of a 2016 recession prediction by Citigroup. As for Mr. Paul, he's always had a soft spot in my heart, for, like him, I am very sympathetic to the Austrian brand of economics (think Frederic Hayek [Road to Serfdom] and Ludwig Von Mises). As for his predictions, well, they're forever dire and, well, he's been making them forever. And I must say that his recent hookup with Porter Stansberry  disappoints me. As for Mr. Schiff, he too touts the Austrian theory and, yes, he too understands that any publicity is good publicity. Schiff has been promising runaway inflation and $5,000 gold for I don't know how many years (more than a few). I'm certain that far too many unsuspecting investors bought his story and invested accordingly. I wonder if he pays for security when he's out in public these days? I'll come back shortly to Citigroup's legitimate forecast.

I'll just sum up my view on unwavering prognosticators by re-sharing this brief 2012 blog post:

While, in the, following, I'm tough on Bill Gross [a truly gifted bond investor], my main point is to emphasize how the factors impacting the global economy are uncountable, let alone unpredictable, and, therefore, can make otherwise brilliant individuals look foolish when they attempt to foretell the future...
Beware the King(s)

The “King of Bonds”, Pimco’s Bill Gross, has given the world a priceless gift. He’s accomplished something other mortals have aspired to, but forever at the expense of their credibility. Thanks to Mr. Gross we finally know precisely what to count on, financially speaking, for the remainder of life as we know it on planet Earth. The guessing’s over. I suppose I should re-think my career path.

Apparently the past century of stock market gains and wealth accumulation was a “freak” anomaly, one to never be repeated. His incomparable (out of 7 billion) brain, has put all the pieces together. He has solved the great riddle; he has determined what he’s dubbed the “new normal”: That is, sub historical-average economic and asset-value growth, in perpetuity.

In essence; he knows precisely how all the world’s individuals will transact their affairs for eons to come.


He foresees advances in consumer technology,





and living standards in general.

old city

future city

He can predict the outcomes of political
power grabs,

political cartoon

weather patterns,

sunny day


and natural disasters.


And has gauged the precise impact of each on the global economy.

He has indeed solved nature’s great mysteries.


What forever baffles me is the correlation between the capacity for thinking and the lack thereof for reason. The sad thing (seemingly, but surely not in every case) being; the larger the capacity of the brain (or perhaps the academic achievement, or perhaps the professional accomplishment), the larger the ego – the larger the ego, the lesser the humility – the lesser the humility, the greater the God complex – the greater the God complex, the greater the following – the greater the following, the greater the damage when a black swan (a purely random event) falls from the sky.

As for Citigroup's 65% chance of a 2016 recession. Well---unlike Messrs Paul and Schiff---at least they left some margin for error. Citi's "rates strategists" are worried about China and I suspect a whole host of other things, but presumably their chief concern rests in the likelihood that one of history's best recession signals is going to turn red far earlier than most folks expect. It happens to be an indicator that I closely monitor---it's the treasury yield curve.

Recessions tend not to occur until after the yield curve inverts---that is, when long-term bond yields fall below short-term bond yields. When, in essence, investors pile into longer-term bonds (sending prices up and yields down)---because they see economic pain ahead and want to lock in higher yields before they plunge under the weight of the coming slowdown.

The white  line in the chart below represents the 3-month treasury bill yield, the green represents the 10-year bond yield, and the red outlines past recessions. The arrows point to each time since the late 1960s that the 3-month yield surpassed the 10-year (times when the curve inverted). As you can see, 8 of the past 10 inversions were closely followed by recession. What Citi's analysts are essentially saying is that the Fed is entirely wrong in their assessment of the economy and that by raising short-term interest rates they will manufacture a downward sloping curve. And, thus, usher in the next recession:     click to enlarge

Inverted Yield Curves

As you see at the far right, the present picture looks fairly tame. We'll see how good (lucky) Citi's experts are in the coming 12 months.

Oh, if it were only that easy; if all we had to do was watch the yield curve and adjust accordingly the minute it inverts my job would be cake.

While I have no doubt that Citi's team comes highly credentialed, I do, at this juncture, doubt that we'll be congratulating them on their predictive prowess anytime soon.

Here's a bit of the data that (along, ironically, with the yield curve), for the moment, keeps me out of the recession camp:

Weekly Jobless Claims


Auto Sales:

Auto Sales

Housing Starts:

Housing Starts

The Chicago Fed Financial Conditions Index

Chicago Fed Financial Conditions Index

The St. Louis Fed Financial Stress Index

St. Louis Fed Finl Stress Index

The Kansas City Fed Financial Stress Index

Kansas City Fed Financial Stress Index

The Cleveland Fed Financial Stress Index

Cleveland Fed Finl Stress Index

The Index of Leading Economic Indicators

Index of Leading Economic Indicators

Industrial Materials Prices

Industrial Materials Prices

If indeed Citi has it right, we'll have to rethink the business cycle going forward. In that we will have experienced an expansion that did not culminate with the usual bout of inflation, a breakdown in the indicators I just presented, and a period of leadership (in terms of investment gains) from those late-cycle sectors that we'll discuss in Part 3.


  1. […] from directly picking on any of them today (I’ve done that plenty over the years—here’s the latest, here’s the one before that), and simply suggest that the next time you hear […]