How to Skew Bad Economic Data to Inspire Investor Confidence

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by Eric Fry: J.P.
Morgan and the Great Silver Caper

 

 
 

As we begin
a hopeful New Year, investors face a vast array of “knowns”
and “unknowns.” Most of the knowns are uninspiring, at
best.

But so what?
The unknowns can be whatever we want them to be…at least until
they become knowns. Here… Let us show you how easy it is to
turn an uninspiring known into a truly inspirational unknown…

Earlier this
week, the Institute for Supply Management (ISM) announced that its
index of manufacturing activity was 57.0 in December – a slight
increase from November’s 56.6 reading, but still well below
the 60.4 number from last April.

Seems like
an uninspiring report…until you pick up the following day’s
issue of The Wall Street Journal. “Factory Activity
Surged in December,” the Journal proclaimed. Based on the numbers,
the Journal’s account is simply false. But that’s
not what counts here. What counts is the Journal’s rose-hued
assessment of future factory activity – i.e. the glorious
unknown. In other words, factory activity did not actually
surge in December, but it is probably going to in January, right?

Here’s
another fascinating example of dream-weaving: late last week, Moody’s
announced that commercial and industrial (C&I) lending squeaked
out a 0.2% increase in the fourth quarter. Armed with this thoroughly
uninspiring data point, The Wall Street Journal declared,
“Banks Open Loan Spigot.” False.

The only spigot
that’s open inside America’s largest banks is that one
that pours capital into proprietary trading desks. As the nearby
chart illustrates, the volume of “trading assets” at US
banks has been soaring. These would be the same “trading assets”
that have been producing the perfect and/or near-perfect trading
results at Goldman Sachs, JP Morgan and others.

Is it any wonder,
therefore, this portion of bank balance sheets is inflating, while
traditional components – like actual loans – are either
deflating or doing nothing? If you had access to cheap, subsidized
government funding, along with simultaneous access to a quasi-monopolistic
cartel on the sale of the government’s own securities, would
you bother making a loan?…Nah, we wouldn’t either.

But we digress…

Let’s
take a peek at another uninspiring data point. Just this morning,
the Labor Department announced that initial claims for unemployment
during the past week increased by 18,000 to 409,000 newly
unemployed individuals. Bloomberg News responded with the
twin headlines, “Unemployment Claims Over Past Month Drop to
Lowest Level Since July 2008,” and “Dollar Rallies on
Optimism Over Stronger Job Market.”

See how easy
this is? If you get a tepid factory utilization report, no problem.
Call it, “US Factories Ready to Power Ahead as Economy Gathers
Steam.” If you get a lousy retail sales report, don’t
worry. Describe the setback as, “Blizzard Impedes Resurgent
Consumer Spending.”

Go ahead; try
it at home. It’s fun for the whole family.

You could say
that investors are good at making something out of nothing. But
isn’t that also what LSD accomplishes? Outside of the financial
realm, chronic self-delusion usually requires some combination of
therapy and/or rehab. But inside the financial realm, self-delusion
is not only normal, it is often very profitable…at least for
a while.

“What
is fascinating in the markets,” economist David Rosenberg observed
recently, “is that so many people can be right despite all
their assumptions and lines of reasoning being totally off-base.
That was the case in 2010 – go back to the consensus in Barron’s
a year ago and you’ll see that the bullish prognostications
at the time were optimistic because of visions of a sustainable
V-shaped recovery taking hold.” The Dow rallied about 13% during
the year, even though a V-shaped recovery never materialized.

But that was
last year. What about this promising new year?

Well, as Rosenberg
points out, a short list of knowns provides little comfort:

  1. Stubbornly
    high unemployment rate (at 9.8%, not far off the recession high
    of 10.1%)… Continuing claims today, at 4.1 million, compared
    with 3.1 million back in 2008; extended benefits today are at
    819,000 versus zero back then…
  2. Deflating
    home prices – in fact, not only did Case-Shiller home prices
    decline 1.3% month-over-month in October, but all 20 cities showed
    a sequential decline, and this last happened in February 2009…
  3. Huge state/local
    government budget gaps ($65 billion this year) will be closed
    with tax hikes, user fees and service cutbacks. The biggest myth
    being promulgated today is that the economy must be doing better
    because state/local government revenues are on the rise. Dude!
    That’s not the economy! It’s called tax increases…
  4. Surging
    energy prices – oil prices have broken above $90 a barrel…
  5. Slowing
    global growth, as flagged by the decline in the Chinese stock
    market…

“From
our lens,” Rosenberg concludes, “at current valuations,
the good news appears to be fully priced in and then some.”
Nevertheless, Rosenberg admits, “[Only] a fool would say that
this overextended market could not become even more extended in
coming months.”

Reprinted
with permission from The Daily
Reckoning
.

January
7, 2011

Eric J. Fry has
been a specialist in international equities since the early 1980s.
He was a professional portfolio manager for more than 10 years,
specializing in international investment strategies and short-selling.
Mr. Fry also publishes investment insights and commentary under
his own byline as Editor of The
Daily Reckoning
. His views and investment insights have appeared
in numerous publications including Time, Barron's, Wall Street Journal,
International Herald Tribune, Business Week, USA Today, Los Angeles
Times, San Francisco Chronicle and Money. He appears regularly on
business news stations like CNBC and Fox.

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