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Tuesday, October 03, 2006

John Mauldin's Slowdown Debate

By Yaser Anwar, CSC of Equity Investment Ideas

I've excerpted the comments below from John Mauldin's weekly newsletter. It is always interesting to see what portfolio managers opinions are going forward.

"I was on Larry Kudlow's show this last Tuesday. The topic was "Will there be continued growth or a recession in our future?" It will surprise no one that I argued for an economic slowdown or a mild recession. Professor Nouriel Roubini was on with us, and he was even more bearish. But John Rutledge and Kudlow more than balanced our views.

My summary points-

1. You can't ignore the negative yield curve. It is the most reliable forward indicator of future recessions or slowdowns. And it is telling us that a slowdown, at the very least, is on the way. To ignore it must mean you are willing to say "This time it's different." Those are the four most dangerous words you can utter in a trading room. Since the stock market drops an average of over 40% before and during a recession, if the yield curve is right, we are going to get to buy this market at lower prices.

2. There are other indicators suggesting a slowdown/recession, such as the Leading Economic Indicators and the ratio of the Coincident to Lagging Indicators. The data on consumer spending shows it tightly correlated with housing prices, and housing activity has become highly correlated with the S&P on a lagging six month basis, which does not bode well for the stock market, as housing activity is in free fall.

3. Even if we have a "mere" slowdown, that is going to mean disappointing earnings in our future, which will lead to a stock market decline. Yes, earnings are strong now, but we are at a peak in earnings as a percentage of GDP. Earnings growth is mean reverting. That means we will see earnings growth drop back to GDP plus inflation or around 6%, at the very minimum. A recession will mean it drops below that. And that means we get to buy this market at a lower price.

4. The market doesn't look forward, or at least not very well. You can simply go back to August of 2000 and watch the market almost make new highs (other than the NASDAQ and tech stocks). Two and a half quarters later we were in a recession. Oops. The market simply takes the most recent trends, anchors on them and then projects them into the future.

5. Yes, the housing market is only a small part of the overall economy, but it is an important part. It contributed about 1/3 of the new jobs during the recovery. It is highly correlated with consumer spending, which is slowing. Recessions happen at the margin. The world does not end. It merely slows down. If housing slows down by 25-30%, coupled with lower consumer spending, that could easily put us in a mild recession.

When asked about what the rising stock market was telling us, Roubini said he thought it was a sucker rally. I agree. In my view, to be unreservedly bullish on stocks at this point is to ignore what seem to be clear warning signs.

Let me be clear on one thing. I expect the stock market to be higher in 5-7 years than it is today. Maybe in less than 5. I simply think I can buy this market at a lower price at some time in the future. I expect to become more or less bullish during this next recession, or at the very least selectively bullish. But for now, I think it will pay to be patient."

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