The Great Recession

They call economics the “dismal science.” The term was coined by the 18th Century Scottish Philosopher Thomas Carlyle in response to the economic theories of the Reverend Thomas Malthus. Malthus was an early economist who predicted that mankind would starve to death because population growth would far exceed the growth of food production. According to the “Malthusian Theory,” population would grow geometrically while food production would only grow arithmetically eventually leading to the “Malthusian Catastrophe” of worldwide starvation.

Arithmetic Progression 1, 2, 3, 4, 5, 6, 7, 8

Geometric Progression 1, 2, 4, 8, 16, 32,


Malthus’ theory was wildly popular in its day. It was embraced as an obvious and inescapable truth. It was also, as we now know, wrong. It turns out that civilization learned how to increase food production at a rate that far exceeded population growth. Innovation won out over pessimism.

The Holy Roman Empire was neither holy, nor Roman, nor an Empire.

In most instances economics is neither dismal, nor a science. It is at best an inexact science and at worst a collection of flawed competing theories. These flawed theories get trotted out before an eager public anxious to embrace again the most dismal predictions during times of economic turmoil. Currently, one of the prophets of disaster making headlines is Peter Schiff. Known as “Dr. Doom,” Schiff is the son of the well-known tax-anarchist Irwin Schiff. “Dr. Doom” predicts that the US economy will collapse because of the lack of a manufacturing base coupled with rampant consumption. Schiff, who served as economic advisor to Presidential candidate Ron Paul, has been predicting this disaster for the last 20-25 years and his fans argue that he is now finally being proven right. Most serious academics dismiss Schiff’s theories as “Malthusian.”

We are enjoying sluggish times and not enjoying them very much.”

- George H. W. Bush -

Are we in a recession? As with all things economic, it turns out there are two competing theories. According to the traditional view, we won’t know until late February or early March of next year when we find out for sure that we experienced an economic contraction in the fourth quarter of this year. According to a second theory, we have been in a recession since December of 2007. The National Board of Economic Research made this announcement two weeks ago. Since most of us have known intuitively that this is a recession, I like the second theory. The different standards demonstrate a truth about economics: economists tend to tell us about economic cycles after-the-fact and not before.

How long will this recession last and how bad will it get? Since the end of World War II, the average recession has lasted a little over 10 months. The two longest recessions have both been about 16 months. The greatest economic contraction occurred in the first of these two long recessions beginning in 1973. The largest unemployment rate, 10.8% occurred during the second of these beginning in 1980.




Most experts are telling us this will be the worst recession since World War II. While almost undoubtedly true, this dire warning ignores the fact that post-WWII recessions have generally been mild compared to pre-WWII recessions. Pre-World War II, the average recession lasted 21.2 months. Post WWII recessions have lasted only half as long on average. Since the worst recession of the last 60 years lasted only 16 months, this recession only needs to last another 4 months to become the longest.
Average Length of US Recessions


Post-World War II 10.4 months

Pre-World War II 21.2 months



How will we know this recession is over?

Because of the way these things are reported, the economists will not notify us that the recession has ended until way after the fact. Not surprisingly, the best indicator that the economy is entering or exiting a recession is the stock market. About half the time, when the market declines 10% or more, we are entering a recession. 100% of the time, the stock market heralds the end of a recession with an advance that begins typically 6-9 months before the recession ends. Another signal to look for is a decline in the monthly increase in unemployment filings.

Slaying the Dragon

Economists disagree on how to fight a recession. Keynesian economists suggest that deficit government spending will re-inflate the economy. Supply-side economists suggest that lower taxes will spur corporate investment. These two competing theories go a long way towards explaining the political rhetoric dominating the American landscape today. I am a Keynesian. I like deficit spending. I also like lower taxes. One thing is certain, the Hoover administration created the Great Depression by raising taxes, tightening credit, and slashing government spending.


Different Approaches to Fighting a Recession

Keynesian economists deficit spending

Supply side economists lower taxes, especially corporate tax rates

Laissez-faire economists no government action

Populist economists direct payments to consumers



The Reagan Revolution

Supply-side economists point to Ronald Reagan’s success in ending what “was” the worst recession of the post-WWII era as a victory for tax cuts and the “trickle-down theory.” That argument misses the mark. The real credit should go to Reagan’s substantial deficit spending on defense. Reagan spent billions on defense; star wars, stealth bombers, Abrams tanks, and my personal favorite; refurbishing World War II battle ships to serve as platforms for the new cruise missiles. Reagan increased the federal deficit and defense spending at a record rate. He also created 2.8 million new jobs, the greatest bull market in history, and nearly two-decades of unprecedented prosperity. Take it from the “Great Communicator,” deficit spending works!

Filibusters and the Greatest Heist in History

Just a couple of comments. The short-term rally we were looking for got derailed temporarily this week by concerns about GM and the other Auto Makers.

It looks like President Bush is going to provide the bailout in the short-term out of the Tarp.

The Auto Bailout failed in the Senate last night by a vote of 52 in favor and 35 against. This was a strange result. A majority of the Senate was in favor of the bailout. They had the votes to pass the bill. BUT, they didn't have the votes to stop the Filibuster by the minority.

That minority was led by Richard Shelby of Alabama. Congress, the President, the President-elect, and a majority of the Senate were in favor of the bill, but one lone Senator was able to stop the whole thing with the help of 34 colleagues.

In some ways that is just crazy.

But even crazier was the news the that Bernard Madoff was arrested for perpetrating the largest theft in history. It turns out his $50 billion hedge fund was a giant Ponzi scheme. Madoff used to be chairman of the NASDAQ. He virtually invented it. He ran a number of large investment houses on Wall Street since 1960.

Adding a surreal quality to the story, Karen Finerman on CNBC's Fast Money said; "why admit it was a Ponzi scheme now. this market gave him the perfect cover. Just say you made some bad trades and lost all the money."

It is no wonder people are losing faith in the system, both Wall Street and the Government.

Here's some added irony from Madoff's website:

"In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner's name is on the door. Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark."

I think we will see increased regulation of Hedge funds going forward. That's a good thing.

I think we will see increased regulation of derivative products going forward. Not just the debt swaps that got us into this mess, but the double and triple down ETFs that exaggerated the decline. Also a good thing.

I think we are back on track for a near-term rally. I remain optimistic in the short run.

Santa Claus is Coming to Town

This year for Christmas I want the same thing I always want: A Santa Claus Rally.

I must have been a good boy this year, because it looks like I'm going to get my wish.

Today's 350 point move to the upside is further confirmation that the market is poised for big gains. This may be the best Christmas ever.

Can you hear the bells jingling and the patter of reindeer feet?

My 2-year old son wants a Caterpillar front-loader he can ride and with CAT up $4.50 today alone he just may get it.

If you don't believe in Santa Claus that is alright, rallies like this need to climb a wall of disbelief.

Happy Days Are Here Again

"nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance"


Many of you will recognize the the above quote as the end of FDR's immortal "We have nothing to fear but fear itself" line.

The line of his 1933 Inaugural Address that got the loudest ovation was "This nation is asking for action, and action now."

I have to give credit to George Bush, who stepped up to the plate again for the second time in the last two months to support an unpopular but extremely necessary bailout. I've not been a fan of George Bush for the last several years, but I intend to remember him as a man who responded to a nation clamoring for action in a manner that was heroic.

Bush's call to bailout the Auto industry helped the market immensely.

Today was a critical day. As you know, I have been predicted an imminent "Bear Rally" for about a month now.

Today's action is a strong indication that this Rally began on November 20th.

Over the first five trading days beginning 11/20 the market ran up 1277 points.

It then dropped 675 or 50% in one day.

The two days after this cataclysmic looking drop the market rose 442 points.

The next day it dropped 215 or 50% in one day.

That was yesterday.

Today we were up 259 points in what looks alot like an imminent break out.

I have said for awhile that I expect this "Bear Rally" to be huge and to carry us up to 10,500 on the Dow by mid-January. I'm sticking with that prediciton. I did not pluck that number out of a hat. 10,500 is about 42.5% off the bottom.

I have attempted to position us to take maximum advantage of this rally.

I expect to make alot of money in the next 6 weeks.

Obviously, the one potential cloud on the horizon is a Big Three bankruptcy, but I don't expect that to happen. (If it does, I may change strategy.)

The Great Recession

A couple of comments about the market and the Auto Industry.

The unemployment numbers came out today; the worst one month job loss since December 1974.

That brought total unemployment up to 6.7%, the highest since the early 80's.

The market didn't go down that much on that data. We were off 60-80 points in early trading.

Unemployment is a lagging indicator and I think those numbers are already discounted.

The bigger drag short term is GM and the others.

It is uncertain what will happen to GM and the bailout. Wall Street hates uncertainty.

My guess is that we will get some sort of bailout/restructuring.

My biggest concern is that in their earnestness to punish the UAW that Congress not force a plan on GM that wipes out the debt holders.

If we wipe out the GM debt, Congress is going to have to give AIG another $100 billion or so. The reason for this is an instrument called a Credit Default Swap known colloquially as Bond Insurance. There is insurance on all of those bonds and AIG is on one side of most of them. Startlingly, bond holders were able to enter into these transactions for more than what they owned. Some holders may have insured their auto bonds for twice what they were worth. The cost of paying out those losses could be monstrous.

Additional costs: every 500,000 of jobs lost costs 10-20 billion in unempolyment benefits.

As much as I agree that GM and the others need to be restructured and the UAW contracts have to be renegotiated, I hope that Congress looks at the cost of not doing something and sees the obvious truth that the cost of letting these companies go into bankruptcy could be far greater than $34 billion.

On our side, we own cheap stocks. We own more cheap stocks than we did 3 months ago, 6 months ago, 1 year ago, and 18 months ago. We have been buyers here at these low levels. In my mind that was and is the smart thing to do.

GM's Wagoner to travel by car to Washington

In 1077, the Holy Roman Emperor, Henry IV, famously stood barefoot in the snow for three days outside of Canossa Castle seeking an audience with Pope Gregory VII. In an event know as the "Walk to Canossa," Henry had come barefoot and in a hairshirt to plead with the Pope to lift his ban of excommunication.

Almost a millenium later, GM CEO Rick Wagoner began his own "Walk to Canossa."

GM announced today that Wagoner will travel the 520 miles to Washington and his next meeting on Capitol Hill in a Chevy Malibu hybrid sedan. Wagoner is coming to plead with Congress for the bailout money he say's GM needs to survive.