Yielding our Consumptive Zen

“Any whiffs of growth this year are likely to herald a false dawn.”

A simpler articulation of this proposition will render: “the economy will most likely not grow for the remainder of the year.”

Simplified even further, we're left with “we're screwed.” Or at least that's what Stephen Roach, CEO of Morgan Stanley Asia, and Niall Ferguson, a financial historian at Harvard University, think. And sure enough, it seems that any whiffs heralding any more falsehood would bound us to never see light again. Hearing about a 6.2% annual contraction rate, AIG's $30 Billion additional bailout fund, a loss of 650,000 jobs in a month's time, and the Dow's 1997-level pricing doesn't lend argumentative credence to the hopeful side. Many, myself inclusive, may find a tonal conflict with President Obama's somewhat optimistic address to Congress couple weeks back. Truthfully, though – mood aside – no such conflicts exist. Both support a strong likelihood of economic deterioration on every level (falling housing values, employment, real income) for a sustained period lasting up to three years.

But there is actually a sign of hope.

If we all took a moment to dim the lights, take a toadstool position, quiet our minds, light our incense, and find our true inner nerdy economist, the answer may indeed “dawn.” The sign of hope which may reveal itself is one currently narrowly discussed in prevailing economic literature: the yield curve. Any 'Investment for Dummies' books will reveal that the yield curve is the spread between interest rates on the 10-year Treasury note and the 3-month Treasury bill. People such as myself wonder why one of the most powerful indicators (if not, the most useful leading indicator) has gone almost completely unreported. It raises the question of whether or not most forecasting reporters fails to live up to the intellectual standards of a dummy. And what relevance does this value have to any hope?

Putting questions of integrity aside, let us shortly get back to our mini-tutorial. Simply put, the yield spread is a leading indicator highly correlated with upcoming recessions. Its predictive power can range anywhere from 2-6 quarters. Historical trends indicate that a little over six out of seven recessions have been preceded by a negative yield spread. Since the yield curve can be represented mathematically as the 10-year note minus the 3-month note, this would mean that about six of seven recessions have been preceded by (within 2-6 quarters) a higher 3-month note value relative to the 10-month note value.

But we haven't yet answered our own question: how does this tie in to our current situation? A current look at yield spread data released daily by the U.S. Treasury department will show hopeful results: an average yield spread of 2.68% over the past week.

By taking this average value and finding its corresponding probabilistic assessment of upcoming recessions, we feel some relief as we see a 6/7 (85.7%) probability for recessionary recovery four quarters from the present.

That's almost a 90% chance of good news, you fools!

Nevertheless, one may make the argument that our indicators grossly mislead, or that an unexpected or unforeseen factor determines an entirely different outcome than the one indicated above. However, in the face of the current mishap, we can know definitively that the trends above force us to conclude at least one of three things: either our luck has it that our happy indicator does not exhibit its causal efficacy in this case (unlikely), the macro-psyche is undergoing a breakdown at an amplified rate with respect to actual real-world occurrences (meaning consumer confidence is unnecessarily low), or consumer confidence properly corresponds adequately to the severity of the current mishap, yet the rate of recovery is fast enough to avoid a recession extending beyond four more quarters.

What consumers need to do is exactly what I indicated earlier: go home, dim the lights, light a candle, and quiet the mind. Although I will not go into details here, it can easily be argued that a great deal of underpricing today is attributable to low consumer confidence, and not particularly to any non-psyche related business shenanigans.