In this week’s investment update John Hussman discussed the ongoing Euro crisis and the ensuing bank crisis. More interestingly though, he touched on the fact that equities have become so enticed by the Euro crisis that they’re ignoring the other risks in the market. Most notably, Hussman believes leading indicators continue to point to recession:
“I continue to view economic evidence as consistent with oncoming recession. While there was some enthusiasm over the pop in the Philly Fed index to 8.7%, it’s useful to remember that the Philly Fed index also popped from negative levels in August 2007 to 8.6% in November 2007 (the month our Recession Warning Composite turned negative and the economy went into recession). Meanwhile, the Conference Board’s index of leading indicators places nearly half of its weight on the yield curve and M2, which reduces its robustness compared with broader methods. The slight positive reading last month was driven by those monetary components. As Babson Capital has noted, the non-monetary components of the LEI have historically had a 94% correlation with the index, with much more noise from the monetary components. In fact, in recent years, the monetary components have become negatively correlated with the economic components, so that improvements in the monetary components typically occur despite true economic deterioration. For example, I suspect that last month’s rise in M2 was largely due to investors switching from large money market funds (which have substantial holdings in European bank debt) and into Certificates of Deposit at U.S. banks – hardly an indication of robust economic prospects. Even the Conference Board conceded a very high probability of oncoming recession last month.
Notably, the ECRI Weekly Leading Index growth rate dropped to a fresh low of -10.1% last week, and unlike 2010, the deterioration is matched by weakness in a much broader set of evidence. Suffice it to say that leading data is leading data, and there is typically a gap between the point that the leading evidence turns down decisively and the point where coincident and lagging indicators confirm the deterioration. As for stocks, recession-linked bear markets don’t end before the recession even begins.”
Source: Hussman Funds