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Robert Shiller

Let's reassess the probability of another recession by taking a look at several important economic indicators:

The Anxious Index
The Philadelphia Fed recently released this quarter's "Anxious Index". As you'll recall, this is a forecast of 36 (anonymous) individuals about the next quarter's GDP growth, or lack thereof. For more details on the survey, see the previous link.

The last time we checked in with the Anxious Index was in June when it was below 10%, implying that we had a very low chance of another recession this quarter. The second quarter results for the Anxious Index is slightly higher at 16.8%. The last time the Anxious Index increased was in the last quarter of 2008 (see chart).

As I previously mentioned, a recession arrives promptly when the Anxious Index jumps to 30% and beyond. While we can no longer scoff at the improbability of such an event, it is still not at this important threshold.

Click to see larger chart in a new tab:
anxious index long term chart Aug 2010
Source: Federal Reserve Bank of Philadelphia

While they are projecting slower growth for the economy, they still see it growing steadily. This raises the odds of a downturn but it is still not likely. The forecasters see GDP growing at just under 3% for the next 2 years.

As well, the forecasters surveyed have reduced their growth projections for the next two years. They also see slightly higher unemployment than they did last quarter but they expect a gradual reduction in unemployment - down to 9% by the third quarter of 2011.

Expectations for inflation are lower this quarter but the forecast's consensus does not expect deflation to occur. Over the horizon, expectations of future inflation is lower but still positive. The probability of deflation in 2010 or 2011 is coming in at between 1.6% and 4.3% (depending on year and measure of inflation). Inflation expectations have held steadily over time with little change.

Business Cycle Index
According to Russell Investment's Business Cycle Index, the US economy will claw its way back into positive territory:
Continue reading 'Reassessing The Probability Of A “Double Dip” Recession'

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The equity markets were nervous today about the Federal Reserve Chairman's testimony that the economy's outlook is "uncertain". Most indexes sold off more than 1% after gapping up in the morning.

While the effect of Bernanke is the reason most cited for today's sell off, a technical explanation would be that since topping in April, equities have been in a downtrend. Today's gap up simply brought price in line with the downtrend line and contained it. On the chart below, this is the downtrend channel (blue lines) with lower lows and lower highs that I've been harping on lately:

S&P500 technical overview downtrend Jul 2010

The other interesting aspect of the chart is that basically stock prices has been chopping around for the past 9 months. The red horizontal line is the short term top formed on September 16th 2009 when the S&P 500 reached 1068.76 - this was also a very rare occurrence: a 20% move above the 200 simple moving average.

To be fair, the S&P 500 did eventually climb about 14% higher until April 2010 but it then gave back everything and ended up right back down at the September level.

At the start of the month, before the latest rally, the S&P 500 was 8% below its long term moving average. Right now it is just under it (less than 3%).
Continue reading 'Technical Overview Of S&P 500 Index'

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Since we've discussed at length the reasons that this is an important low for the stock market, last week a reader asked me to give a bit more weight to the other side of the argument.

To do that we have to give turn our backs on technical indicators and give our attention to econometric indicators. Among these is the nervous attention lavished on the "double dip" scenario. At the beginning of the year we looked at the Google search trend for those dreaded words. Since the prevalence of searching for "double dip" gives us an indication of the sentiment out there, I thought we should update those charts.

Rather than just update the Google trends search results for "double dip", I went a step further and compared its weekly results with the weekly Leading Indicator index from the ECRI for the past 12 month period:
ECRI leading indicator compared to google trends double dip Jun 2010

We still see the two spikes from last year - the first in August 2009 and the second in November 2009. To understand the chart, I should explain that the Google Trends data is relatively scaled. This means that each point is presented relative to the average over the time period (12 months). So the most recent data point from last week at 3.38 means that searches for "double dip" last week were 3.38 times that of the average for the past 12 months.

The first spike, signaling an increase in concern about a weakening economy, happened last summer in August. When we compare it to the ECRI's LEI we see that it was a considerable amount of worry for nothing. If we look at the year over year chart of the LEI we can see that the index was still expanding quite rapidly:
Continue reading 'Should We Be More Worried About A “Double Dip”?'

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Let's face it, this market has been driven by technicals not by any real fundamental health. So what happens when the same folks leave and take their rationale with them, fundamental investors may not be as keen to support the bids.

The recent softening in bids shouldn't be a surprise. On October 15th the S&P 500 briefly traded 20.81% above its long term moving average. Now, it is only 14% above it. It was back on September 16th that the S&P 500 index first reached the 20% Maginot Line. Between then and now we had 4 other instances where price briefly pierced minutely above the 20% barrier only to be pushed back. Compared to historical precedence, this is part for the course.

As I presented in the detailed historical research report (What Happens This Far Above The 200 Moving Average?), usually when price moves this much away from its long term trend it has been unable to continue at the same pace. That's what we're seeing today as the S&P 500 is now below where it was trading on September 16th.

In this short video you can see the headwinds arrayed against the S&P 500. Both by the breaking of the uptrend line from March 2009 and the approaching downtrend line from the top of the bear market (October 2007):

INO video SP500 screenshot Oct 2009

One of the most important sectors, the Philadelphia Banking Index (BKX) has broken this uptrend line. We are also seeing some serious breadth (advance decline) weakness which is never really good but especially bad news while the market is so near a top.

Two institutional money managers have turned negative on the market recently. Jeremy Grantham of GMO Partners and Bill Gross of PIMCO. Click here for details on Grantham's reasoning and to download his full quarterly report. Gross goes further than Grantham saying: "almost all assets appear to be overvalued on a long-term basis". You can read his full commentary here.

For those who like to look at fundamental data like the quaint P/E ratio, here is a very long term chart, courtesy of Prof. Shiller:

PE cyclically adjusted Shiller data very long term chart

As you can see, a lot of air was let out of the bubble. But, to mix metaphors, the pendulum didn't swing back enough. During previous important market lows, the P/E ratio has fallen to much humbler depths. Thanks to the 60% rally from the March lows, we are once again back above the long term average. Which is unsettling, especially when you remember that Shiller uses a 10 year smoothing of the earnings data to iron out short term noise.

October's P/E earnings, according to Shiller's methodology is about 20 - well above the long term historical average of 16. Normally, a P/E ratio of 20 corresponds to economic expansion in its 5th year, not a major recession like the one we're experiencing now. So understandably, Prof. Shiller is skeptical of the recovery in the equity market making the inevitable comparison to the aftermath of the 1929 crash and saying that "it can't be trusted to continue".

And turning our attention momentarily to the options markets, the equity only ISE sentiment index came in today at 191. Which means that while the equity market had a negative day with red all over the monitor, retail option traders tenaciously clung to hope and bought almost twice as many calls.

And if all that wasn't spooky enough for you, to coincide with Halloween this year we have the 80th anniversary of the Great Crash of 1929. Boo!

SFO cover magazine free offer.pngNo, there is no free lunch. But for my US readers, there is a free trading magazine subscription in their future.. For a limited time, you can get a complimentary subscription to SFO magazine (Stocks, Futures, and Options).

It takes less than a minute to sign up and you need to provide some basic information. But as I mentioned, you need to be a resident of the US (because you need to provide a US address). Enjoy!

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The Crash Confidence Index

While his work on valuation and bubbles receives more attention, Prof. Robert J. Shiller has been studying stock market sentiment for a long time. He has created several surveys which measure different aspects of sentiment. One of these is the Buy-on-Dips confidence index which we explored back in March. Unfortunately it has only about a 100 data points and doesn't seem to provide much value added.

Today I wanted to check in with another one of Shiller's surveys, the Crash Confidence Index. This new index, like the Buy on Dips confidence index, is limited in sample size but from the brief available data it seems to be provide much more insight.

The Crash Confidence Index is the percentage who think that "the probability of a catastrophic stock market crash in the US, like that of October 28, 1929 or October 19, 1987" is less than 10%. So the higher the number, the less likely a crash is perceived as being imminent.

The highest level for institutional respondents was 58 on April 2006. While individual investors were the most confident on October 2003 when 49% believed that a crash was unlikely.

crash confidence index chart Oct 2009

Not surprisingly, we tend to extrapolate the present into the future so during the darkest days of the stock market, further catastrophic declines in the form of a crash appear more likely. During the low of the last bear market cycle (November 2002) the institutional respondents were very pessimistic (only 21% believe a crash unlikely).

During this bear market cycle, institutional investors were the most pessimistic in February 2009 while individual investors took longer to be persuaded that things were improving. They were most pessimistic in April 2009. Since then both camps have recovered sharply. However, if you notice, we are still at very low levels historically.

If we compare the sentiment during the recovery from the last bear market bottom the difference is remarkable. In the six months from November 2002 to May 2003 the institutional Crash Confidence index almost doubled while the stock market as measured by the S&P 500 had hardly budged at all.

Today, we have a stock market that has rallied almost 60% and yet, the Crash Confidence index in relation to that performance, has gone from 18 to 28. While that is a respectable recovery in sentiment as measured by this index, it is hardly commensurate for the performance that the stock market has lavished on us.

To learn more about the Crash Confidence index visit the Yale Center for Finance.

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