February 5, 2008
Yesterday a 370-point sell off in the Dow triggered monumental sell offs in Asian markets this morning on fears that the U.S. could be entering a recession. Here’s an unofficial official news bulletin. The U.S. is already in one. Yes, I know that the official definition of recession is marked by a decline in GDP for two or more consecutive quarters, and that this hasn’t happened yet as the 4th quarter U.S. GDP was 0.6%. Yeah right. Like I believe that or any other politically manufactured key economic indicator. First of all, the 0.6% is an annualized figure so the 4th quarter GDP growth rate was 0.15%. Anyone out there really think that changing a few numbers here and there won’t change a negative GDP rate into a barely positive one fairly easily? But we need two quarters of negative growth rate for an “official” recession don’t we? Ok, then wait until next June, counting on a bull market to arise from the ashes, and see if this belief won’t cost your stock portfolio dearly.
For anyone that does not know that the U.S. government consistently massages the reporting of key economic indicators, just study the formula used to determine “core” inflation and every other inflation statistic that they report. Did you know that the formula used to calculate inflation today doesn’t even remotely resemble the formula that was used to calculate inflation just fifteen years ago? Under President Clinton, Alan Greenspan, and the Boskin Commission recommendations, the government made many changes to the formula used to calculate the core price index.
The Boskin Commission recommended several changes to the CPI index which included: switching from an equal, arithmetic weighting to a geometric weighting, the use of substitute goods when the prices of goods are rising, seasonal adjustments and so on. By the way, the substitution effect in general is used to substitute cheaper goods in the CPI index when the current goods that constitute the basket rise too much in price. To that, am I the only one that lets out a resounding, HUH???? So if we have inflation, do the following: (1) remove from the current basket of goods the most expensive goods; (2) rinse; and (3) repeat. And this wasn’t the only significant manipulation of the CPI statistic. They are many more. If you really want to know, just visit the Bureau of Labor Statistics and read their explanation for “How is the CPI calculated?”
Because of these significant changes, the CPI, since the Clinton years, has never come close to approximating true inflation in the United States. Some people say that the CPI underestimates true inflation by 4% to 6% but I would surmise that at times it can even underestimate real inflation by as much as 6% to 10% at times. Using the same creative statistical construction that the BLS uses for their calculation of the CPI, I could probably conclude that the average year round temperature in Oahu, Hawaii is 40 ° F (4.4 ° C). So do I believe the officially reported GDP statistic or any other key economic indicator released by the government? NEVER! It is my belief that every single economic indicator is “massaged” to make them look better than reality. With the CPI, it is quite easy to prove this. With other statistics, it is more difficult to prove. But in every case, the circumstantial evidence is more overwhelming than O.J. and his bloody gloves.
Case in point. The U.S. Federal Reserve cut interest rates by 1.25% in 8 days, the largest interest rate cut in such a short time span in a long time. The cumulative reduction of the Feds Funds rate has been 225 basis points in about four months. To me, such desperate measures must indicate desperate times. Furthermore, one of the members of the Board of Governors of the U.S. Federal Reserve publicly stated that he was against any further rate cuts but then changed his mind and voted for the latest 0.50% rate cut. My question is why? What are they seeing behind the scenes that is so terrible but still not yet revealed to us? For one, since Congress forced the largest financial institutions on Wall Street to open up their books to them so they could see how they were valuing CDOs and other derivative products backed by subprime mortgages, I believe that they received a peak of a much uglier picture than that which is being currently represented.
So will it really matter if the Feds step in with another rate cut, or two, or three? My final answer, as I wrote in a previous article, “The Fed’s Rate Cut: A Recipe for Future Disaster,” is that these rate cuts will not provide the solution. In fact, there will be a point of diminishing returns as each subsequent rate cut pushes the dollar closer to a precarious cliff, as the stability that the Federal Reserve seeks to inject into the U.S. and global economy continuously fails to take hold, and as the onslaught of bad news from the financial sector that I expect to come to light during first quarter earnings 2008 continues to plague stock markets. That said, hold on to a wild ride this year that is not going to be pleasant (or supremely pleasant depending on which side of the fence you reside on). To prepare, there are many things one can do. I will discuss these things in a future article, but for now, to be fair to subscribers of my Global Stock Picker investment newsletter, I’ll keep them quiet for a while longer until these ideas are firmly profitable.
[tags]U.S. recession, inflation, U.S. Federal Reserve, U.S. stock market crash[/tags]