Saturday, February 17, 2007

Recession Risk and Dow Record Highs

We're living in interesting times, very interesting times indeed.

The Dow hit yet another record closing high Friday even with a backdrop of bad economic data.

But then again, in the relativistic times that we live, what I feel is "bad" may not be so "bad" for you and could actually be "good" or even "great" for you. So let me be clear. When I talk about "bad" economic data, I am referring to the sort that indicates that recession risk is climbing.

As I discussed earlier today and have noted during the course of just the last couple of day, or linked too, there has been some "bad" economic data. But have no fear, the bull is here and the Dow marches higher.

As the week drew on even the subprime stocks, which were severely battered late last week and at the start of the week, managed to rebound a bit. But all is not looking well on the subprime front and this would appear to grease the skids where the economy is concerned. Markit.com's ABX bbb- index continued to fall through the floor:

So investors are now paying just under $1 mln to protect against default of $10 mln in bbb- rated subprime bonds. This thing is headed into meltdown mode.

The Gordon Lightfoot song the Wreck of the Edmund Fitzgerald literally just played on shuffle here in the home office. One of the best set of lyrics....

When supper time came the old cook came on deck
Saying fellows it's too rough to feed ya
At 7PM a main hatchway caved in
He said fellas it's been good to know ya.

It's pretty clear we've long past the stage of "rough" times in subprime... the "main hatchway" has given in now that default insurance rates on subprime debt are at just about $1 mln.

If you think this situation will be contained to just subprime loans - think again. Look what happened earlier this week with Standard and Poor's saying negative things about higher-quality mortgages.

Combined with the overall negative flow of information, it adds up to growing recession risk. How interesting given the stock market's behaviour as if it were a big beach ball under water that just has to pop up (someone else made the analogy, sorry for the lack of credit, but I can't remember who.. was it Zen?).

Think I'm getting a overly carried away about recession prospects while the rest of the world sees growth in the economy forever? Thing again.

Economist David Rosenberg at Merrill Lynch now thinks the recession risk has gone back above 50%: http://rsch1.ml.com/9093/24013/ds/63768_95.PDF. I had warned back in December that warm weather would skew (eg strengthen) data and throw folks off; now that things are getting back to normal weather-wise that data is coming back to portraying weakness.

With respect to the debate over whether subprime spills into other areas of the market, Morgan Stanley economist Stephen Roach cautions against complancy: http://www.morganstanley.com/views/gef/archive/2007/20070212-Mon.html#anchor4374. Scroll down to the next commentary and MS economist Dick Berner has a differing viewpoint.

We won't find out the answer to this question on Tuesday when trading resumes, but who's going to be right? The bulls, or the data points? While the Wall Street bulls remain firmly in control of things and could do so to the point of even more spectacular gains on Wall Street and in world markets, the the sagging economic data points are pointing to an eventual day of reckoning.

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