Hussman - Born on Third Base

John Hussman's latest investment letter is a must read:

Barry Switzer, the former head coach at the University of Oklahoma, once said "Some people are born on third base, and go through life thinking they've hit a triple." Among the fascinating aspects of the recent economic "recovery," probably the greatest is the failure of analysts to understand that this growth is none of the private sector's doing.

Wall Street seems to have no concept at all that every bit of growth we've observed over the past year can be traced to government deficit spending, with zero private sector expansion when those deficits are factored out. As I noted last week, if one removes the impact of deficit spending, "the economy has recovered to the point where the year-over-year growth rate since early 2009 now matches the worst performance of any of the 50 years preceding the recent downturn." In effect, Wall Street's is seeing "legs" where the economy is in fact walking on nothing but crutches.

Similarly, it is apalling that Ben Bernanke can say with a straight face that many of the "investments" made by the Fed have been repaid "and some have even made a profit," without immediately noting that the two primary sources of these repayments have been, directly or indirectly, the U.S. Treasury, and savers who are receiving near-zero interest on bank deposit instruments.

If we fail to recognize that the "good news" reported over the past year is due not to a recovery in intrinsic economic activity, but instead to massive government intervention, we risk being blindsided as those synthetic effects gradually erode.

.........The following is our refined set of "Aunt Minnie" criteria for identifying oncoming recessions. See the November 12, 2007 comment Expecting a Recession for details. In every instance we've observed these conditions, the U.S. economy has either already been in a recession, or has been within a few weeks of what turned out in hindsight to be the official beginning of a recession. There have been no false signals.

1: Widening credit spreads: An increase over the past 6 months in either the spread between commercial paper and 3-month Treasury yields, or between the Dow Corporate Bond Index yield and 10-year Treasury yields. This criterion is currently in place.

2: Moderate or flat yield curve: A yield spread between the 10-year Treasury yield and the 3-month Treasury yield of anything less than 3.1%. As of last week, the 10-year Treasury yield was 3.22%. The 3-month Treasury bill yield was 0.08%. So virtually any decline in the 10-year yield from here will put this criterion in place.

3: Falling stock prices: S&P 500 below its level of 6 months earlier. This is not terribly unusual by itself, which is why people say that market declines have called 11 of the past 6 recessions, but falling stock prices are very important as part of the broader syndrome. This criterion is currently in place.

4: Moderating ISM and employment growth: Manufacturing PMI (at or) below 54, coupled with either total nonfarm employment growth below 1.3% over the preceding year (this is a figure that Marty Zweig noted in a Barron's piece years ago), or an unemployment rate up 0.4% or more from its 12-month low. At present, both of the employment measures are in place. Last month, the ISM PMI dropped from 60.4 to 59.7.

For all intents and purposes, unless the credit spreads, the S&P 500, or the yield curve reverse, a further decline in the Purchasing Managers Index to 54 or below would be sufficient to confirm a "double-dip recession." Note that by itself, such a level might not be particularly troublesome. But in concert with the other evidence we observe, it would be sufficient to complete the syndrome of risk factors.