Has the Recession Arrived?

Has the long forecasted recession arrived? My answer is YES. Here is why:

* The banking system is crippled with huge mark-to-market losses on securities held to maturity. (See: Shulmaven: Winter Comes to the Bank Stocks) Further the loan losses associated with bad commercial real loans have yet to be recognized. Hence lending is being curtailed across a broad front of borrowers.

* New claims for unemployment insurance reached an 18 month high last week at 264,000. The labor market is nowhere near as strong as it was.

* The price of copper made a new low for the year at $3.72/pound down 14% from its January high. This is the metal with a Ph.D. in economics, although as my friend John Lipsky always reminds me it is from the Universidad de Cattolica de Chile. 

* The stock market has gone nowhere over the past two years with nominal stock prices down 1% and real stock prices down 14%. Hence the consumption fuel coming from the wealth effect has evaporated.

* First quarter consumption was flattered by an 8% increase in Social Security payments, obviously not to be repeated for the balance of the year.

* Although real GDP is likely to to be up in the second quarter because of a modest swing in inventories, real final sales will decline and that will set the stage for a decline in both final sales and the overall GDP in the third quarter.

* Because inflation will remain sticky, the Fed will need a significant move up in the unemployment rate before pivoting to a lower interest rate regime. Thus the Fed policy would allow for a mild contraction in the economy.

My Amazon Review of Robert Shiller's "Narrative Economics: How Stories Go Viral & Drive Major Economic Events"

Telling Stories

My UCLA colleague Ed Leamer always reminds me that human beings are story telling animals. Here Yale economics professor and Nobel Laureate Robert Shiller has written a whole book on the subject as to how convincing narratives, whether true or false, can influence economic behavior. Some of the narratives he discusses are:

·        Housing prices can only go up.

·        Technological advancement leads to unemployment.

·        “New Era” booms in the stock market.

·        Gold is the only true store of value.

·        It is socially unacceptable for wealthy people to be extravagant in hard times.

When these ideas go viral they obviously can effect economic behavior. In order to track how viral an idea can be Shiller uses the science of epidemiology to track its rise and fall counting its appearances in publications or in the case of today how it trends over the internet.

Although Shiller doesn’t really give us a formal analytical framework as to how we can integrate a narrative into making predictions about economic behavior, he certainly makes the case that economists have to take into consideration prevailing narratives when trying to understand the macro economy where both booms and slumps can get exaggerated by the presence of mass psychology. This concept is far from new, but Shiller expresses it in a different way.

The full amazon URL appears at: https://www.amazon.com/review/R4XHVF8GCEJOX/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv

My Amazon Review of Baruch Lev and Feng Gu's "The End of Accounting and the Path Forward for Investors and Managers"

Tension is Mounting in Financial Accounting

Accounting Professors Baruch Lev and Feng Gu have written a very important book on the need to update century old accounting practices. They open their book by presenting the financial statements for U.S. Steel in 1902 and 2012. There point is that not much has changed from an accounting standpoint, but from an economic standpoint U.S. Steel’s profitability dramatically declined over the century.

Lev and Gu describe in great detail the accounting and finance literature demonstrating the 50 year decline in importance of traditional accounting data’s influence on stock prices. Although stock prices do move in the very short run in response to earnings announcements, over the intermediate term they respond far more to non-accounting data.

According to Lev and Gu the problem with current financial accounting is that it ignores intangible assets that are developed internally, for example research and development, trademarks and investments designed to improve organizational efficiency. All of those expenses are expensed. The authors would capitalize them, which is exactly what occurs when those assets are acquired in a merger or by individual purchase. Second accounting today is more about estimates rather than hard facts. These estimates would include the provision for bad debts, pension expense, stock option expense, and even revenue recognition. Finally accounting does not take into account such unrecorded events as the receipt of a patent, a new drug approval, the signing of an important contract, and the rise or fall in the number of subscribers. It is this last category that seems to matter the most to investors. For example yesterday Netflix reported better than expected earnings, but far fewer than expected new subscribers. The result the stock dropped 15% in a heartbeat.

To remedy the situation Lev and Gu would like to see corporations present a more fuller “Strategic Resources and Consequences Report.” This is really a very enhanced management discussion and analysis section that would take into account the issues raised above. The problem here is whether accountants are capable of producing such a report and whether or not management would be candid enough to put it in writing. One would hope so, because it goes to the heart of what serious analysts are interested in.

This is not an easy book for the lay reader, but for the professional investor and manager “The End of Accounting” is a most useful book.

The full Amazon URL is:

https://www.amazon.com/review/R1LOUCU1A8PFM6/ref=pe_1098610_137716200_cm_rv_eml_rv0_rv