I’ve read this stunning post from Big Picture about a bunch of high-profile bottom callers in this market (Dow 20,000). I think most of them have a vested interest to drive sheeples back into stock market, and they will bend their reputation to do so.
But I want to get back to basics – what is a recession and what is a bear market, because we need to keep our records straight. Ok, suppose for a moment that the financial crisis is over. All the mortgage related losses are written down (another $200 bln to go) and Feds take the rest on its balance sheet (not that I think it will happen), there is no more bank failures (he-he) and the panic settles (aha). What’s next?
What is exactly a recession? First of all not every recession starts with financial crisis. It doesn’t have to be this way. As I’m trying to simplify things I think that recession is a culmination of a credit and inflation cycle, the natural sequence of events that are out of control of government and central bank.
The recession happens for the same reason the toy truck pulled by rubber cord will accelerate or stop even if you pull it very carefully. The economy runs on debt. Any entrepreneur who can prove the bank that he can get better return on money then the cost of borrowing will get funding. The bank is borrowing on money market and lends it long. Both the bank and the entrepreneur are risk takers, the money market is risk-free (except some rare cases, but this is not important). So all the risk and all the risk premium is spread in wide web between the money market and enterprise.
Let see the corporate AAA and BAA bond yields (click to zoom):
On this picture you see:
- Spreads between AAA and BAA corporate bonds are increasing around recessions (sometimes during, sometimes after). That is a measurement of risk aversion
- Interest rates for corporations are usually elevated during recessions, while money run into treasuries
- The Kondratieff wave is visible very well
To keep it short the recession happens when money are expensive and hard to get. This is a vicious cycle, the problem reinforces itself. But lets resolve a chicken and egg problem – what comes first – jump in interest rates or recession? It seems to me sometimes it happens one way, sometimes another. When the economy is booming the demand for credit may just exceeded the supply and yields will go up not because of risk aversion, but just because of lack of money or mounting inflation. Last year the opposite happened, the credit supply was cut because of the mounting losses in CDOs and derivatives. So the trigger could be different each time, but once the recession starts there is no stop until the money return back to the credit market to chase early profits.
So the recession ends when there is a new interest to lend, which clearly overcomes the risk aversion. If we get back to March of 2008 we can clearly say that there is no sight of recover at credit markets. Even if subprime losses are over nobody lends to subprime borrowers. The corporate spreads are widening, TED spread is over 1.5%. What those nuts are expecting here?