Misdirection and trickery are the name of the game in big-league investing these days, as Wall Street leaders are constantly engaged in trying to trick opponents into doing the wrong thing.
Right now we can see misdirection everywhere we look as brokerage analysts, for instance, talk up the strength of big financial firms even while we can clearly see that fund managers at those brokerages are feeding stock into the market on every rally. So it is times like these when we really need to understand how to keep our eye on the ball and not look where the dealers want us to look.
First of all, on the economy: The U.S. government wants us to think that the gross domestic product rose 3.3% annualized in the second quarter. But we know that is just not true, as I’ve explained in previous reports. (See also: "Remain Skeptical of the Market Bounce."
One of the best insights into how the economy is really doing comes from state tax receipts. This data has been painstakingly collected via phone calls to state tax authorities for years by independent analysts Philippa Dunne & Doug Henwood for their monthly Liscio Report, and they now report that any attempt to tell the public that the economy is not in recession is simply false.
In their latest report, Dunne and Henwood related that the majority of their state tax collector contacts in states have been reporting recession-level receipts for months, and in the past few months those signals have only gotten stronger.
Sales tax receipts forecasts continue to be revised down—in some cases even "chopped in half" as big businesses lose jobs in construction, tourism, leisure, hospitality and financial services. They reported that one state that usually heads into recession later than the rest of the nation is just now succumbing, as its payroll withholding growth has slowed to 2.8% in the past six months; it was at 2.6% in the 2002 recession.
Overall, Dunne and Henwood report, August was a lousy month for collecting taxes, as only 20% of states exceeded their projections, down from 36% in July. The bottom line from one state tax official: Clearly we are in recession. "Let’s stop the talk of being close to the edge. We are in it. Deal with it."
Meanwhile, independent analysts at TIS Group in Minneapolis report that one of the most important signposts they watch for U.S. recession signals is flashing red right now…
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That is the year-over-year change in total loans. The data, which is recorded by the Federal Reserve, shows that during the first half of 2008, changes in U.S. loans outstanding amounted to only $8.5 billion. In each of the last three years, the same figure totaled at least $500 billion and in 2007 approached $700 billion. In other words, credit availability is drying up.
Aiming for the Recession Midpoint
This is valuable information because over the past 30 years, the U.S. economy has experienced only four periods of real economic weakness: 1973-75, 1980-81, 1990-91 and 2000-2002. In each case, changes in loan outstanding fell—and in two spans (1991 and 2000) they virtually disappeared.
So why should we care if a recession has begun?
It’s because one of the oldest rules in the book for investors says that the very best time to start applying cash to the stock market is six to nine months ahead of the end of recession. That is, bear markets usually end when economic news is still bad, and then gather strength by climbing the proverbial "wall of worry" as the economy starts to slowly and imperfectly improve from low levels.
Now the notion that you should start applying cash to stocks just past the midway point of a recession always looks smart in retrospect in history books, when you can see timelines of past recessions and line them up with the stock market. But in real time, as you can see, there is always a lot of debate about whether a recession has even begun much less when it might be half over. (To learn more, check out: "Recession Creates a Vicious Cycle.")
It’s a tricky matter, and investors lose a lot of money trying to guess the starting points of recessions, then extrapolating a potential end point, and then finally estimating where the middle is. There are just so many ifs and maybes involved, it’s largely a fruitless exercise. Inevitably some people get it right and brag about it later, but the fact is that it’s largely guesswork and those who nail it did so by chance.
The only thing we know for certain, then, is that somewhat magically the stock market—a reflection of the beliefs of thousands of smart fund managers—will in fact start to rise quite emphatically about six months before the recession ends. And we also know that by the time that this occurs, most people will not believe that the market is correct, and will keep most of their money in cash much too long.
Buying Power Declining, Selling Pressure Rising
The antidote to all this guessing is to focus single-mindedly on the demand and supply balance for stocks rather than on the thousands of inputs and outputs of the economy. And right now, the bad news is that the demand for stocks continues to weaken and the supply provided by sellers continues to grow.
Buying power as measured by pricing and volume statistics has been falling since mid-August and is now just barely above the levels of the mid-July low. It wouldn’t take many more weak days to push key measures of buying pressure below the mid-July levels. And meanwhile…
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selling pressure is already well above its mid-July levels, which indicates that investors are just as anxious to dump shares now as they were when the S&P 500 made its mid-summer low.
It is this desire on the part of sellers to shed their positions that keeps swamping buyers who are trying to accumulate positions in the belief that the recession is nearly complete. It’s this increase in selling pressure that is responsible for the big 280-point down days lately.
We can simply not have a real bottom until everyone who wants to sell has sold, and then buyers swoop in en masse to scoop up bargains.
Remember this, as it is very important: Selling alone does not make a bottom. There must also be evidence of widespread, rapid, "panicky" buying. The only thing that can cure and end a bear market is a new belief on the part of a very broad swath of investors that prices have reached truly rock-bottom levels, and that if they don’t buy now they will miss the deals of a decade.
To signal this, we need at least one day in which 90% of prices and volume are to the upside. None have occurred in the past year despite several session in which the DJIA has risen more than 300 points.
My studies have shown that until this happens, there will be more in a series of panic selling sessions like last Thursday and Tuesday. So I recommend that you keep your powder dry, lots of our potentially investable funds in cash, and wait for a clearer signal that the worst of the bear market is over and it’s time to start taking risks buying stocks with clarity and confidence again.
I don’t know if it will occur next week, next month or next year—and frankly, neither does anyone else. It may not be much fun, but that’s the way it is. As my father used to say, "time is God’s way of making sure everything doesn’t happen at once."
Of course, that doesn’t mean we can’t engage in profitable short-term speculations—and that’s what we do in Trader’s Advantage, to big profits. Come check out our latest plays.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.