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The Waiting is the Hardest Part

February 1, 2009 – 2:02 pm

This has been a week of earnings reports and important economic statistics. We started the week with good news. MacDonald’s earnings were better than expected, but more importantly was the existing housing report which showed an increase in sales for December, not a reduction as expected and it showed a significant reduction in inventory from 11.2 to 9.3 months from the month before. Also, the leading economic indicators report, which gives us a gauge of future health for our economy, was up when the expectation was for it to be down. The beginning of the week gave us some hope.

That hope extended into mid week because of President Obama’s spending package and talk about setting up a good bank/bad bank to buy toxic loans and get them off the back of the banking industry. That hope faded on Thursday as we had a number of poor earnings reports, unemployment claims rising, durable goods sales falling and new home construction falling sharply with an accompanying spike in inventory of unsold homes.

It is obvious that foreclosures have pushed home prices to such a low point that sales that would normally go to new homes are going to used homes. This week’s numbers tell the story clearly. Builders are not going to recover in 2009 even though sales in housing might. The raw data for new homes was that 331,000 new homes were sold for December down from 399,000 in November. Inventory for new homes stands at 14.7 months up from 12 months. As this is the opposite of the existing housing numbers out earlier in the week the conclusion is clear.

Last Saturday at our conference in Berkeley we reviewed the reaction of the stock market in each recession going back to the Great Depression. The conclusion is that the stock market ‘will start’ to rally long before the economy recovers. The average lead time is 4 months with some stock market recoveries starting only a month or two before the economic recovery and some as long as 8 months. The average stock market rally for those few months is 23%. That does not include the continued rally after the economy continues to strengthen. The 23% is only from the start of the stock market recovery to the start of the economic recovery. That is a sharp move up that most people will miss. Also, we will not see the recovery in the economic numbers for at least 6 months past the start. These statistics mean you are not going to be able to look into that crystal ball and determine ‘when’ the stock market recovery will start. There will be bad news everywhere and the stock market will be ignoring it.

Finally, in last Saturday’s conference we looked for the economic recession that most closely matches the current one with a similar fall in stock prices. It appears the 1973-74 recession closely matches in many ways the problems we are having today. In that recession the stock market fell 45.1% from the start to the end of the recession, the stock market started to recover 2.8 months before the economy begin its recovery and the net change up in those 2.8 months was 33.0%.

The question is ‘when’ will this recession end? It is already one of the longest recessions on record if you count the start being that of when job losses began. It is very likely that we will have at least 4 quarters in a row of falling GDP and of course it could be longer since no one knows. Most count the start of a recession with two quarters of falling GDP in a row. Once that happens you are in a recession. So by any definition we are in a recession. This morning GDP numbers for the last quarter of 2008 were reported and it fell 3.8%. That was in sharp contrast to the expectation of at least 4.5% and some were expecting much higher. Most experts are saying that we will see two more quarters of shrinking GDP before the end. Of course most experts are wrong as well.

Since none of us know when the recovery will start you have to make a decision. That decision is all about ‘when’ not ‘if’. Once it starts it is going to be fast and very large if history is any guide. The pain will be in the waiting.

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