Don’t Try Catching a Falling Knife (The Economy)

John Browne
Saturday, Feb. 9, 2008
Trying to catch a falling knife can be dangerous — very dangerous, especially when it is pointing downwards!

Likewise, trying to time the bottom of a market can be dangerous. If you mis-time a top or a market bottom, you risk losing actual money.

We have recently seen figures reported for consumer confidence; home prices and purchasing manager orders are falling. In turn, retail sales are markedly down, as is our growth index.

In addition, the important Baltic Dry Shipping Index is down. This is a measure of demand for world dry cargo shipping (excluding, for instance, oil).

The dry shipping index decline indicates that, as I said a few weeks ago, the so-called "decoupling" of the rest of the world from the U.S. economy remains a myth.


In short, if America sneezes, the world still looks set to catch a cold. Global demand elsewhere will not make up for a shortfall in the U.S. economy.

Indeed, the looming American recession may affect the rest of the world even more badly, since much of the rapid international growth has been attributed to countries with a very low level of internal demand, compared to export demand, which is largely to the U.S.

This will likely hurt the future earnings of our major exporting companies especially hard. It could also be particularly hard on U.S. exporters if, as I said last week, our U.S. dollar begins to recover as it become increasingly apparent that the U.S. will be the first world economy out of recession.

Furthermore, the U.S. monetary base (cash and reserves at banks) appears to be decreasing, lending yet further credence to the idea that cash is becoming progressively scarce — a hallmark of a recession and of falling asset prices.

Today, most, if not all, major indicators of consumer demand and productive economic activity are negative. Indeed, it is hard to find a positive indicator.

It is true that inventories have shown an increase. But this is because they had trended negative, creating shortages that had to be made good.

Likewise, productivity has apparently increased of late. But this also reflects adversity — the threat of unemployment, which understandably spurs productivity.

In addition to the increasing evidence of the recession I have long forecast, yet further evidence accrues of added downward economic pressure.

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The housing figures point to increasing gloom in this vital area, putting our economy in the position of someone struggling to do push-ups with someone standing on their shoulders — very tough!

Meanwhile, our government's only effective reaction to this growing economic emergency is a stimulus package amounting to less 1 percent of GDP — that's throwing gasoline on a fire!

In addition, there is increasing evidence that our present lending gridlock is morphing into a solvency crisis.

In this respect, the threats of credit-agency downgrades in the bond insurance industry raise further concerns, especially in the face of rising default risk.

Yet more worrying is the presence of the head of the Federal Deposit Insurance Corporation (FDIC) in Washington, apparently (we understand) seeking to expand the FDIC's powers.

This tends to add weight to the rumors we are hearing of possibly severe problems at a major U.S. bank. It caused us even more concern that the FDIC spokeswoman, when faced with this question, merely replied, that the possibility was "very remote."

We would have felt decidedly more happy with a flat denial.

So, it is hard to find credible good news out on Main Street.

Meanwhile, the stock markets are falling despite a massive cut in interest rates, down 1.25 percent in just two weeks — a overall cut that went way beyond Wall Street's wildest wishes of just three weeks ago.

So, at long last, it appears that our stock markets are beginning to reflect the really serious economic problems ahead, despite massive interest rate reductions.

However, in face of almost overwhelming evidence of recession, certain Wall Street cheerleaders appear to not only continue but to raise the intensity of their cries that "stocks are cheap! It's a great time to buy and make money!"

This amazing logic is based largely upon falling price-to-earnings ratios, based, in turn, upon forecast earnings.

As we all know, forecast earnings are notoriously inaccurate and yet they provide the basis for the arguments of the cheerleaders to buy so-called "cheap" stocks!" In short, they are costing investors big money by giving them the wrong advice.

Think of it. How pleased would you be with a surgeon who, charged with fixing your left arm, amputated your right arm instead?

As I have said before, an item is not cheap, no matter what the price, if it is likely to fall in value or, in this case, continue falling. It is only cheap if it is likely to rise in price, or continue rising.

I believe our economy is facing a recession, made deeper by both the housing and solvency crises.

In light of this, I feel our stock market is still expensive. It is a falling knife.

Don't be tempted to catch it. Step away (to cash, short-term Treasuries, ETFs that short the stock markets, and to gold) and wait until the stock market knife has hit the ground.

Even if you are late to pick up that knife, you will be alive financially and able to use it effectively in the subsequent battle to make money based upon investments that will, by then, be truly cheap!

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