Monthly Archives: September 2011

Precision without Accuracy

As an old Japan expert, I recall chuckling to myself whenever the Japanese government would release its quarterly GDP numbers.  Inevitably, the announcement would include a phase something like, “This quarter the Japanese economy grew at 2.0145%…” suggesting that somehow that last three decimal places were of critical importance for the world’s second largest (at the time) economy.  Someone somewhere in the vast bureaucratic machinery of the government had decided that the public really, really needed to see those last few decimals.

Clearly a case of precision without accuracy.

Lately, I find myself similarly amused as the “gurus” who appear frequently in the media discuss their outlook for the economy.  Most of those featured as of late appear to be in the bearish camp (negativity sells, maybe?) and gravely opine on their chances that the U.S. could slip into recession.  One will say “a 30% probability,” only to be followed by someone the next day upping the odds to 50% (or whatever).  As if these figures were bids in some kind of morbid auction game, the spotlight forecasters begin to move their estimates around trying to underscore the direness of our straits – “It was 35% chance, but now I see 47.398% chance of a U.S. recession…”

Another exercise in precision without accuracy?

In my simple way of thinking, either we will have a recession or we won’t.  The notion of the “odds” of a recession makes sense only if we could run a number of iterations of today’s conditions and see what happens.  Absent a time traveling machine, we can’t do that.  The probability of a recession is either 0% or 100%, not 30%, 50% or 47.398%.  I realize that speaking of the “probability” of a recession is actually a measure of confidence the forecaster is using to color the tone of his or her opinion.  But at the end of the day, everyone who wasn’t forecasting a recession with either 0% or 100% probability will be wrong…

I’m not an economist, but I do follow their work closely.  It’s interesting to note that for all the discussion about the possibility of a recession in the U.S., the consensus for 2011 still shows positive growth for the economy.  The consensus also calls for stronger (albeit still modest) growth for 2012.  So, why all this strum und drang about the economy?  Well, for one, the stock market has fallen from its recent highs.  Whenever that happens the economy tends to get the blame.  We have seen estimates of economic growth falling and we are painfully aware of the current problems in Europe (although drawing a direct line from these troubles to the U.S. is a bit of challenge given the paucity of European exports from the U.S.)  Yet, sequential growth, at a slow pace, is the consensus view.

Also, we are in the middle of an intense political debate within the U.S. about what to do about the economy.  Whether one thinks the government is the solution or the problem, the debate seems to be negatively impacting consumer sentiment.  The key point for me here is that job growth is somewhat different than economic growth.  Clearly there is a link between to the two, but I would submit that politicians care much more about job growth than does the stock market.  So, while 2.0% GDP growth may be “low” for job creation, it may provide adequate earnings growth for the stock market, especially if the so-called emerging economies continue to grow.  Recall that 50% of S&P 500 earnings come from outside the U.S.

In my view, the stock market ultimately cares most about earnings growth.  Nearly every one of the companies I follow closely expects to grow revenues and earnings next year.  We can debate about how much growth might be needed to get the stock market excited enough to return to previous highs, but I would submit that any growth in earnings for next year should be viewed as a reasonable agreement against a recession.  Or said better, the bottom up consensus view about earnings supports the notion that a recession is very unlikely, regardless of what the “experts” on television are saying.

So, what’s to be done now?  I suggest we simply hunker down during this storm of negativity and do nothing dramatic.  In the coming weeks or months the clouds will likely dissipate and we will probably have a clearer vision of what’s to come.

For someone looking for a simple data point that is a clear positive for the equity market consider this:  the dividend yield on the S&P 500 is currently 2.06%.  The current yield on the U.S. Treasury 10-year note is 1.919% (please note my precision here…).  Rarely (if ever), in my career have I seen the yield on stocks higher than on bonds.  This suggests to me that if stock prices were to be flat for the next 10 years, stocks would still outperform treasuries.  Said another way, investors who would sell stocks now and buy treasuries are betting that stocks will be at a same level or lower than they are now.  Does this seem like a “safe” bet to you?