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Handicapping Recessions and Rallies for Fun and Profit

January 17, 2009 | About:
Is it time to buy yet? If you are willing to close your eyes and hold your nose, you might just make 75% by summer.

You’ve got to love a business that does most of its work looking in the rearview mirror whilst simultaneously plunging ahead at 90 mph.

Whether we are value guys working with year-old earnings figures or technicians plotting out a decade’s worth of closing prices, the whole bunch of us regularly ignore that little “past action doesn’t equate to future gains” caveat most every day of the week.

Heck, those hairy-browed guys who were drawing elks and bears with berry juice on the cave walls of Lascaux were no more or less than the ancient progenitors of the modern stock tip sheet or “Racing Form.”

Trying to Buy a Clue

Not that we have a whole lot of choice here. Wisdom has to be based on experience, which is always about trying to leverage the past into some kind of clue as to what the heck is coming down the pike next.

Right now, what everyone is trying to handicap is just how long the recession will last. Not that most stock traders really care about recessions per se. It’s just another layer of “tea leaf reading” that may or may not offer insight into what they really want to know: “When can I go long?”

An example: late last week, the bean counters in Washington announced that a whole bunch of folks lost their jobs in December. As a “result,” the markets put in a great big red day.

Looking Backward and Falling Forward

Now just about everybody knows that the job market stinks right about now. Even if you personally have managed to keep your job, the odds are pretty good that at least one or two desks on your floor were ominously empty by New Year’s morning.

But when the news hit that the U.S. had lost not 2 million jobs in 2008 as previously predicted (by myself among others), but rather 2.4 million, that “missed estimate” was enough to send Wall Street into a tizzy.

Are they scared that 2.4 million folks would try to camp out on their couch? Naah. It’s yet another attempt to see forward by looking backward.

A Rule That Works Every Time

I’ve got an interesting stat for you concerning unemployment. It doesn’t predict recessions or crashes mind you, just presidential elections.

Seems that our economy has a really tiny window of tolerance in this area. Looking back about as far as the modern records go, I noted that anytime unemployment is over 7% (deflationary) or below 4% (inflationary), the party in power loses the White House.

I was starting to wonder if this rule would hold up, when today’s announcement of 7.2% unemployment came across my wire service feed. My friend Christian Dehaemer says that “A: it happened after the election; and B: the statistical string is too short to generate any reasonable presumptions.”

Still the rule is holding up better than most.

More Guesstimates

Other folks with other rules are also tossing their wizard’s hats in the ring: Boston Fed Reserve Bank President Eric Rosengren claims that he sees the recession deepening in the first half of 2009, but showing signs of improvement shortly thereafter.

Parsing through his notes, Rosengren seems to think that folks will bank their relative gains from fiscal stimuli and falling home and energy prices for the first few months of the year. But come summer, or perhaps early fall, some of that largesse will finally begin to flow to (surviving) retailers.

Others are putting out a less optimistic timeline. Both Justice and I always look forward to Nouriel Roubini’s comments, as he was one of the few mainstreamers whose ideas on the dangers of our profligate ways jibed neatly with our own.

Mr. Roubini is calling for a two-year recession with unemployment rising to 9% and a GDP falling a cumulative 5%. Since we have already seen one year and a drop of around 1.6%, Roubini figures the recession will last through to 2010, with GDP drops each quarter totaling some 3.4%.

The Law of Averages Gets a C-Minus

Finally, there is a stat chart floating about the financial blogosphere (I believe that this is the very first time I have every typed that word without gagging: It is a new century indeed) noting that the average duration for recessions from 1948 through 2001 was a little over 10 months.

More importantly for stock guys and gals, it points out that in nine out of 10 recessions, the stock market sets a bottom about halfway between the beginning and end of the recession.

So let’s see how this all adds up: if the average is 10 months, then the average corner ought to come around the five-month mark. Hmmm: doesn’t quite seem to work this time around, as we are already at the 12-month mark for the recession, and we haven’t seen a real corner yet.

Come to think of it, it didn’t quite work last time around either: The 2001 recession was only eight months long (as least so far as Washington is willing to report), and came smack dab in the middle of a crash that lasted about three years.

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Another Rule That Works Every Time

I am not really in a position to tell you for a fact how long this recession will last. But I do have an unerring system for calling crashes and corners.

I’ve shown it to you before: I overlay a seven-month and 13-month average on top of the S&P 100. When the faster seven-month line crosses under the slower 13-month line, it’s a crash. And I am not talking some little localized dip here, but rather a full-on bear market.

It may be simplistic but it works every time. It also calls real rallies with the same unerring accuracy: When the fast line crosses over the slow line, we are in for a pretty good time for the next couple of years.

Maybe not a perfectly straight line up: heck it’s not like this thing predicts wars in the Middle East or typhoons in Malaysia or any such foolishness. But it is an unerring summation of the long-term intentions of millions of investors.

No Bottom Yet, But That Doesn’t Mean No Opportunities

And what it tells me is that we have not seen the bottom yet. Indeed those two key averages are as far apart as they have been in the recorded history of this system. In fact, we haven’t even seen an initial signal, wherein share prices cross up and over the fast average.

So when can folks start to buy stocks? And what should they buy? Come on, that’s all you really want to know, right?

Since everyone else is making educated guesses, I suppose I can extrapolate just a touch without going off the ranch. Throw on a couple of long-term trend lines and a probable bottom shows up some time around mid-July 2009. With any luck, at all, we should see stocks trend upward for the next two to four years after that point.

Hold Your Nose for a Year or Five

As for what to buy and when to buy it, I suppose it all depends on your tolerance for volatility.

If you are willing to buy now and hold your nose till, say, 2012, I suppose you could buy most any of the surviving finance stocks. I know some pretty smart guys who are picking up shares of American International Group (AIG) right now, figuring on quadrupling their holdings over the next half a decade.

On the same theme, I suppose Ford (F) looks like it will be the survivor amongst the big three American automakers. It actually doesn’t want a bailout from Washington right now, just access to the same sort of lines of credit any large manufacturer needs to survive in the modern era of just-in-time inventories.

A Better Short-Term Bet

Looking to the shorter term, I favor putting a toe in the water now with call options against some the companies that will be immediate recipients of President-elect Obama’s stimulant efforts. In WaveStrength Options Weekly, Bryan and I recently recommended Granite Construction Inc. (GVA), a smallish infrastructure contractor that is positioned to rake a fair share of Washington’s “Really New Deal.”

With some luck, and several billion of Washington’s fancy new dollars, GVA investors stand to make a 75% gain between now and mid-July.

However, without a genuine buy signal under my belt, I am still recommending that portfolios remain weighted to the short side overall.

And personally, I very much hope that the folks who call the stock market bottoms at the midpoint of recessions are really wrong this time around, as that would indicate a grueling three-year recession on par with the worst modern history has offered up.

I really don’t have that much room on my couch.

By Adam Lass, Senior Editor, WaveStrength Options Weekly,

Taipan Publishing Group


About the author:

Taipan Publishing Group
Taipan Publishing Group: Taipan Publishing Group offers investors a diverse selection of financial research services to help boost short- and long-term gains from today's global market boom. Our international team of financial investment experts expose top stock, emerging and frontier market opportunities before other investors can capitalize. Visit: www.taipanpublishinggroup.com

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