Recession warning and why we do need to guard our capital

Our analysis at my firm Venable Park has suggested the mounting threat of a fresh global recession for some time now. Today money manager John Hussman confirms that his composite of historical indicators has also now officially registered a set of readings which have “always and only been associated with ongoing or immediately impending recessions”. Here is Hussman today:

“…the ISM reported Monday that its Purchasing Managers Index dropped unexpectedly to 50.9, the slowest pace in two years. That report, coupled with an early slide in the S&P 500, completed the remaining holdouts (conditions 2 and 3) of the Composite. Coupled with the slowdown in year-over-year GDP growth, the composite of economic and financial evidence we presently observe has always and only been associated with ongoing or immediately impending recessions. This is not an opinion or a viewpoint, but a fact of the data…

I emphasize the word “composite,” because there is simply no single, infallible indicator of oncoming recession. In order to infer information from noisy data, you have to combine multiple lines of evidence to amplify the “signal” and suppress the “noise.” This is what we do in our ensemble modeling (where I can be justly criticized for the time it took to acceptably solve our “two data sets” problem). It’s what we do in our stock selection. It’s even what we’ve applied in our research on autism genetics . Any single indicator, whether it is GDP growth, the Shiller P/E, the forward operating earnings yield, the ISM index, the position of the S&P 500 versus its 200-day moving average, the jobs number, or anything else, is invariably subject to random factors that reduce its information content. The only way to get at the “truth” is to look for a convergence of signals that share common information components but whose “noise” components aren’t terribly correlated with each other. The problem at present is that multiple lines of evidence suggest more than just a “healthy correction” in the stock market, or a “soft patch” in the economy.

Recall that during secular bear markets like we are in, recessions historically have happened about every three years and last about 18 months, during which stock markets lose an average of 25-40%. As dramatic as the sell off to date may seem, if we are indeed in or entering the next global recession, we are only maybe half way through the price declines we could see.

My partner and I just completed a survey of the technical damage done to all major stock and commodity sectors through today’s meltdown. The selling has been pretty constant, but big volume is only starting to show up now. Levered players are being forced to sell across the board as losses mount.  The charts have an eery resemblance to what we saw in the early weeks of the 2007-2009 sell off. We should see some big green days in between as we go along (perhaps when Bernanke speaks tomorrow) but that may well not alter the overall bear decline from being the dominant trend for a while here.

Meanwhile as you scan this summary of all world markets today please understand that there is no meaningful capital protection to be had in these conditions by holding a diverse basket of different global stocks and industrial commodities. These are all jelly beans that fall together in these climates. If your financial advisor is telling you the same old party nonsense about the benefits of holding a diversified basket of stocks please COME TO YOUR SENSES NOW.

On the long side the only things that have been gaining are the US dollar, bonds, gold and silver bullion (although not the company shares, and not so much for Canadians since precious metals are priced in US dollars and the Canadian dollar was appreciating the past year against the greenback which dramatically reduced gains from holding U$ based gold and silver.)

Protecting your capital from losses while maintaining liquidity so that you can buy back assets when much better valuations present, is critical to lasting success and peace through cyclical bear markets within secular bear markets. We do not have to be victims of these cycles but we do have to be proactive, realistic and wide awake at the wheel.

Complacency and main stream investment advice and management will repeatedly harm you.  But only if you allow it.