Bullish data, recoveries, crashes and the psychology of forecasting redux

By Edward Harrison of Credit Writedowns

If you have been wondering whether a statistical recovery is at hand, today’s ISM manufacturing report should be the clincher.  The report was definitely bullish with the ISM index rising to 55.7 and sub-components supporting the understanding that the manufacturing sector is expanding. This is quite a contrast to last month’s weak data and demonstrates that last month was a one-month aberration in what should now be seen as a full-blown technical recovery.

I want to talk about this recovery briefly in the context of the signs that came before it, my own forecasting psychology and what the future holds.


The ISM data

The key data points to see as evidence of a fairly broad-based expansion in manufacturing come from new orders, production and inventories.  The production number came in at an incredibly bullish 63.3, marking the fifth consecutive month of increase. New orders slipped slightly, but were also in striking distance of the 60 range. (50 represents the demarcation between expansion and contraction).

But, from my perspective, it is inventories which are the most bullish data points. The inventories data show that inventories in the manufacturing sector were still being purged in October even while production is increasing.  That means that inventories are likely to make a huge contribution to GDP going forward in Q1 and Q2 of 2010. GDP could again surprise to the upside.

My mea culpa on forecast herding

All of this suggests the economy has been growing since the beginning of Summer. In the early Spring, I indicated that jobless claims were peaking (which added to my stock market bullishness at the time). This call turns out to have been accurate. However, at the time, this post produced very negative sentiments, albeit more from readers on Naked Capitalism than Credit Writedowns – in my opinion because most people erroneously extrapolate a current trend into the future (see my reaction to this from a post weeks later, “Through a glass darkly: the economy and confirmation bias in the econoblogosphere”)

Nevertheless, a piece from NBER guru Robert Gordon that I reported demonstrated to me that I was not alone in seeing the trend reversal in jobless claims. Eventually, in May I indicated that the jobless claims data were pointing to an imminent recovery and remarked that the data had usually been fairly accurate in the past.

And for the record, I have said I see a recovery happening probably in Q4 2009 or Q1 2010 (see my post “The Fake Recovery”).

The real question is how robust a recovery are we going to have and this is directly related to why the jobless claims series has been sending a false signal.  Now, initial claims has been sending a recovery signal since January. Yet, continuing claims continued to rise more quickly until last week.  In the past, one had seen these two series as harbingers of imminent recovery.  But, I am talking Q4 here.  Why? Deleveraging.

In the end, consumers are going to be forced to reduce debt and save more in this more cautious financial environment.  Team Obama does seem intent on re-kindling animal spirits but the personal savings rate has gone up nonetheless.  This will be a drag on GDP growth going forward and means that the economy’s rebound will be more tenuous and slower to develop.  In my view, this means recovery will be delayed and once it gets going it will be weak.  The potential for a double dip is very high.

So, to be clear, first derivatives are starting to turn up and since recession is a first derivative event, we are probably going to see an end to this recession soon enough.  But, with structural problems still remaining, the U.S. economy will be weak for a long time to come.

Why do I bring this up?  Because, despite the data pointing to recovery, I decided the start of the recovery process would be delayed until this quarter or Q1 2010 by consumers repairing their balance sheets – and, in retrospect, in part due to a desire to avoid being too far out of step with the consensus.

I must admit to falling prey to forecast herding, something I talked about in June (admittedly without mentioning my own culpability which I should have done). At the time, I said:

No one wants to go out on a limb with a bold call only to see this prediction proved wrong.  If one fails, it is better to fail conventionally.  The necessary corollary of that statement is this: market forecasters and analysts play it safe by making sure their forecasts are not often far from the consensus forecast.  Think of the consensus forecast as an anchor which restricts the outlook of any individual forecaster afraid of failing unconventionally.

In Roubini’s case – and this logic also applies to media darlings like Meredith Whitney – it does NOT pay to up the ante.  What Faber is saying is that they have already benefitted from the bold and unconventional contrarian market call they initially made.  There is little payoff and much risk from continuing on that path.  A bearish analyst who misses the turn gets the stick.  Just ask the original Dr. Doom, Henry Kaufman.

Roubini is not running with the herd

The one thing that makes me think about my error in tweaking my bullishness has to do with Nouriel Roubini. In the quote above, I said he has little incentive to double down on a bearish forecast at this point in time.  Both he and Meredith Whitney, two voices of caution leading into crisis, have been much more upbeat of late. Are they hedging as I did?  Hard to say.

But, with Nouriel Roubini’s recent FT Op-Ed, this is over. Roubini decried the easy money policy he believes is leading to a dollar carry trade and an increase of risk appetite across a wide variety of asset classes. He believes this experiment will not end well. I share his view.

Roubini, in going public in this way, is officially departing from a more hedged nuanced position he has been using over the last few months as the recovery has taken hold. Yves Smith says:

Nouriel Roubini has officially left the “hedging your bets on the economy” camp.

I applaud him for coming out with this piece and suggest you read it because it may come to be seen as the make or break call in determining his reputation as economic soothsayer.

Recovery is happening, but watch asset prices

For my part, I will look to avoid a repeat of the ‘jobless claims incident.’ Hopefully, I have done by writing my depression post at the beginning of last month, which outlines my view that we are in a cyclical recovery in the middle of a longer-term depression.

I would like to make some amendments to my thinking at the time though. First and foremost, I have come to doubt whether we are seeing a balance sheet recession right now. One reason I am writing this post is because the ISM manufacturing data turned up in May at precisely the same time that the credit revulsion-induced savings rate turned down. Translation: there is no balance sheet recession in the U.S., at least not yet. (see my post “Americans are not increasing savings”). This means the recovery could surprise to the upside. Moreover, the ISM data point to potential upside surprises from inventories, leading to an even more robust outlook.

What I believe is happening has much to do with Nouriel Roubini’s comments. U.S. economic policy is geared toward reproducing the status quo ante via reflation of asset prices (something Bill Gross thinks is the right policy and even Dilbert has made fun of). The policy has been wildly successful so far, with asset prices bubbling over globally. I have called this the fake recovery, but as recently as September I was on the fence about how much uptick we were to get. I never dreamed the recovery process could be so robust given the headwinds we faced.

However, reflation has also given investors a license to take risk. Look at the return of John Meriwether as a telltale sign.  Reflation policies are inflating assets far and wide: European high yield, American high yield, Swedish house prices, London house prices, Chinese property prices, and inducing reckless lending. The list is endless. Even Bill Gross’ piece pointed to inflated prices, a view shared by Jeremy Grantham.

The long and short is we are seeing another asset bubble inflating courtesy of easy money. While Morgan Stanley worries easy money will lead to inflation, former Morgan Stanley economist Andy Xie fears this will end in a double dip. To make matters worse, there is a dollar carry trade now spreading a liquidity seeking return dynamic abroad. This is the additional risk of which Roubini writes, believing it could precipitate another crunch or crash. Ironically, a strong recovery is not necessarily bullish.

Is a double dip or crash a baseline scenario? No, not necessarily – but it is increasingly likely. So, as bullish as I believe the data are, I am more worried about a bad outcome, not less.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward http://www.creditwritedowns.com


  1. DoctoRx

    Well said.

    The markets agree with you. One point I took from today’s ISM data are that widespread commodities price increases were seen by mfr’s but NO shortages of said commodities were seen.
    Is it any surprise that gold is up strongly while stocks have faded today, or that gold closed down modestly only due to dollar strength Friday whilst stocks collapsed? However one defines money and credit, this does look like a rerun of the last cycle, or at least the markets are taking it to be so.

  2. hbl

    There’s a lot to agree with here (including the inventory factor as said before), but I still disagree that this is not yet a balance sheet recession. See the latest Total Loans and Leases of Commercial Banks for one more data point.

    I think the fall in the savings rate in recent months despite the broader debt reduction trend apparent in the credit data has to do with:

    a) Wealthier people (with little or no debt) regaining some confidence and increasing their spending after the free fall in asset prices stopped. A new crash in asset prices would reverse this.

    b) Temporary government-induced spending such as cash for clunkers.

    The evidence as I see it still suggests that those with balance sheets in need of repair are doing so, despite volatile government stimulus and “wealth” effects. Japan’s economy showed positive growth and inflation for years after asset bubbles popped, but the underlying balance sheet recession dynamics were in play under the surface essentially the whole time.

  3. Dan Duncan

    Too often, these reports seem too self-referencing.

    Take today’s 55.7 PMI number…quite bullish, indeed…

    But compared to what?

    Why, other ISM PMI numbers, of course.

    How many commentators drawing conclusions from this ISM data can tell us anything other than “above 50 Bullish, below 50 Bearish and at 50 Neutral”?

    For those who can tell us more:

    1. Who participates in the survey? [Not in the general sense, but specifically…how many different companies are involved, and what is the criteria for being included?]

    2. Were these numbers derived primarily from stimulus beneficiaries (ie Cash for Clunkers)?

    3. Is there a real life example of the questions asked of these managers, or is it all “confidential”?

    4. Why is the Institute of Supply Managers any different from other fact distorting trade groups (ie, the National Association of Realtors)?

    I’m really trying not to be cynical…but in this time when almost every survey and statistical report seems suspect, reports like this do stretch credulity.

  4. mikkel

    Ed, thanks again for describing the dynamics of the GDP and possible surprises. I certainly was one that thought you were slightly crazy in your “imminent recovery.” Although I also have to say that that part of it could be an emotional response to the word “recovery.”

    If you had written that there was an imminent increase in GDP coming I would have been rather sympathetic if skeptical (your post on the mother of all inventory corrections is a great example of changing my thoughts). However to me recovery means stability and increase in activity on the ground level. I am aware you are talking about it in a technical sense but still.

    I am finding the state coincident indexes that the Philly Fed puts out to be fascinating. It really demonstrates how little a technical “recovery” means in the context of on the ground activity. The points in this post again demonstrate why we could get a blow out GDP number but change almost nothing on the ground. To me this is a completely insane way of trying to measure the economy…although I guess it’s about as insane as the actual theoretical underpinnings of the economy.

    You definitely get credit as the only person I’ve read that has suggested stronger than anticipated growth AND a depression.

  5. S

    Good balanced post. I think you are right on about the LT depression. The only challnege for monetary policy at this point is to find ways to obfuscate the truth. The ISM is a dispersion index. Case and point: spoke with a derivative supplier into the cosntruction business who was down ruight giddy at being one of the chosen stimulus recepients. Problem is his retail business is DOA. Listen to the slew of Steel comapny conf calls and be sure to listen to Baosteal over in China comments.

    it is very “wall street” to be reading into an ISM number that is basically a short term reflection of government spend that is itself just borrowed future taxes ffrom an already overburdened economy. The problem is not even the debt so much as it is the productive potential (relaizable as opposed to potential) that so many economists are fond of talking about. I agree with Hugh Hedry – the US GDP is amssivily overstated. There in lies the true problem – Oh the complicated web we weave….

  6. doc kev

    I appreciate you openness and choice to keep an open mind on the date and not to use the date to support a viewpoint. We all need more of this in our discourse and in the media.

    I’m still terribly worried about the HUGE deficits state and local governments have to face for next year and the handling of the commercial real estate debts.


  7. mannfm11

    You might note that these numbers are up from very low numbers. If inventories are still being drawn down, it means that capacity utilization is coming off very low levels. That is kind of like getting a heart beat after an electric shock. Capacity utilization includes stuff like electricity generation and oil refining, so the rest of the economy was down to very low levels.

    My problem with recovery is how it is defined, which means I don’t believe we have one. To grow from 65% capacity utilization says very little. To get down to 530K unemployment claims after nearly a year of panic stimulus by the government and the Fed says the patient won’t be out of the hospital and might never be normal again. The fact that the world is in debt, not just the US, to the point that more debt is likely to be bad debt drives on the idea that not only is a recovery not likely for long, but may in fact be ill advised.

  8. winterwarlock

    New York needs someone to give them $3 billion dollars, or it is going to default in December. Now we move from the corporate balance sheet, male jobs, to the government balance sheet, female jobs.

    There is no economic re-boot throw switch in the Whitehouse, or in the home of the Rockefellers. If you want to reboot the economy, everyone must reboot their own sub-systems.

    This holiday season, look around at all the crap you have sitting around, that you never use, then identify those in your own environment making a conscientious effort to make a go of it, with nothing, and make the appropriate decision. There are more than enough tractors collecting dust in garages for the kids to mow lawns and plow driveways for the old people.

    And when the kids come over to take care of your lawn, invite them in for a soda or a cup of cocoa. They might just decide to reboot your system for you when the time comes, which you will require to continue participating. In fact, the quality of your life will depend on it. If you are worried about having everything you own stolen, nothing you have is worth owning.

    We cannot reboot the old system with free riders hanging all over the gears. The new motor will simply tear off the moorings:

    The Transition from Top-Down, Command and Control to Democratic Economies:

    Everyday, there are fewer of them and more of us, just as the universe designed, under conditions of maladaptive behavior.

    There are three queues. In the first queue are wagon masters loaded with free riders, goods, and a whip. In the second queue are wagon masters with free riders, goods, and a bag of carrots. In the third queue are individuals with wagons full of hay and a bag of carrots. Which queue is the next horse going to draw from?

    I would suggest that everyone without a wagon of their own, go out and get one, and fill it full of hay, and that the number of queues should be increased to match the number of horses coming in for pick-up.

    Neither the governments, nor the corporations are going to be able to help you. For the present NPV window, the demand for horses is going to far exceed the supply, and the horses cannot team up without being consumed by agency.
    The kids already have their new economies up and running; the horses coming back to the queue are doing so only to accelerate speed to equilibrium capitalization, and they are only a subset of the total.

    If you do not see the queues, you are in someone else’s wagon, and the probability of being filtered out by the vortex is high.

    The vortex will get bigger to some extent over time, but you never know when the drop-dead date is going to be reached.

    1. winterwarlock

      For those in other countries grasping to understand how the American people could have fallen so far:

      Family Law is the perfect dissent killing machine, and it delivers kids, the future, directly to institutional control.

      There is no due process, in violation of the US Constitution, and it’s backed by the US Supreme Court.

      Possible outcomes are:

      confiscation of identification papers;
      confiscation of travel papers;
      confiscation of professional licenses;
      confiscation of assets held at financial institutions, globally;
      confiscation of disability, workman’s comp & unemployment compensation;
      confiscation of earnings from independent contracting;
      confiscation of lottery winnings;
      confiscation of any federal or state payment owed;
      confiscation of any tax refund.

      They pay people for their kids, and if you dissent, you are done.

      Like all forms of fascism, it started quite small, hit a tipping point, and grew exponentially to consume the economy. Once the government got its nose in the tent, and realized The People were afraid, confiscation exploded across all sectors of the economy. Economic return to labor fell from 55% to below 25%, people sold off their long-term assets for short-term spending, and the public utility holding companies just turned in the screw. Now, it’s a lottery economy, and The People are afraid to say boo.

      Needless to say, with such a potent weapon, they use it liberally.

      Sooner or later, most everyone gets married, or at least they used to.

      It’s like passing out loaded guns to everyone, and picking up any and all assets from among the fallen victims.

      “I am from the government, and I am here to help you” means give me your assets or become a non-person.

      It’s the same thing that happened in the USSR. Now we have “the computer said, so I did”, “they pretend to pay us, and we pretend to work”, and “arbitrary, capricious, and malicious management, not knowing whether it will be shot from the front or from the back.”

      Merry Christmas.

      1. winterwarlock

        by thy by:

        it’s completely out of control now. the kids are tracking the system proprietors with human flesh machines minute by minute, soon they are going to have no choice but to release prisoners wholesale, and the militias are fully stocked with guns & ammo. It’s likely to get interesting.

        Happy New Year

        1. winterwarlock

          memo to the memo to the memo:

          don’t get the wrong idea. many of the older families in the core of the nucleus, who had nothing to do with this situation, are funneling money into the system to keep it on life support.

          and there are those on the opposite side of the fulcrum quite capable of walking through the fire and making things happen.

          America is not done yet; we just need full disclosure before we can roll out a new economy.

          the old system is dead, and everyone is fighting over the dwindling pie, intead of preparing a new production line to make more pie.

          what America will look like, what the constitutions will look like for new virtual economies, and who all will be left behind, holding tight to the past, I cannot tell you.

          the old assets need to be recycled into new assets. will particular individuals participate, or will they continue to resist, and be lost? who knows.

          ultimately, some people thought they could out-think evolution, the universe, and they are about to be taught once again that we serve at the pleasure of the planet, and not the other way around.

          1. winterwarlock


            for real labor, the Great Depression lasted thirty years, and it was the latest among many. In the old days they lasted over centuries.

            Recession begins when the return to labor hits 50%, and the depth is normally reached when it hits 25%. We are already well below 25%.

            It’s a natural selection process. History repeats over and over again, but it gets faster each time. The internal process remains the same, but the external “symptoms / clothing” increases with fragmentation due to the increasing number of participants.

  9. Skippy

    Will it be ho ho ho or boo who who, with the outiler of a cutting down the last X-Mas tree then default on CC/debt.

    Skippy…this X-Mas will be remembered!

  10. sangellone

    Yeah, all you need is ISM,

    There is nothing you can do that can’t be done,
    Nothing you can sing that can’t be sung
    Nothing you can do but you can learn to play the game,
    It’s easy.

    All you need is to be dumb!

  11. GYSC

    Seen at Across the Curve:
    ” was away from blogging today because I attended a meeting at the US Treasury Department in Washington with senior Treasury officials and a number of other bloggers including Marginal Revolution, Interfluidity, Kid Dynamite’s World, Naked Capitalism, Financial Armageddon, Accrued Interest, and Aleph. The meeting was very interesting and I’ll post more on it later this evening.”

    Wow, Treasury meeting with Yves and Michael Panzer at the same time?

  12. kievite

    I would like to support Dan Duncan rhetoric question that “Why is the Institute of Supply Managers any different from other fact distorting trade groups (ie, the National Association of Realtors)?”

    But I will go further and suggest that economic statistic is now so politicized that it can easily make editors of Pravda proud for their objectivity. We should not believe any of them without deep analysis of the error bounds ( and I think for GDP they are at least +-30% ), hidden agenda and dependencies on other equally flawed metrics of economic performance.

    I think most 401K investors are still living in a fool’s paradise and have yet to understand the gravity of the economic crisis we experience. This partial refund that Mr. Market (aka Uncle Sam) gave suckers in 2009 can be easily withdrawn on short notice.

    Structurally high unemployment is in the cards for the USA and I do not see anything other then a new technological revolution that can change that. The bottom half of US consumers is already cooked and in this sense there can be no recovery, only gradual multi-year slide to the bottom. Structurally high unemployemnt in a service-oriented economy will have disproportionate overall sedative effect on economic activity due to hidden interdependencies (airlines-hotels-restaurants)

    The fact that asset markets are so detached from reality only increases the gravity of the situation and chances for double dip.

    As for GDP is such a flawed measure that in current circumstances anybody who pushes it as a valid indicator of the economy can be counted as a charlatan. GDP deflator can and always will be manipulated for political reasons in the same way as CPI.

  13. Hugh

    Explain to me why this is a make or break forecast for Roubini when we made it 6 months ago. From where I’m standing it looks like Roubini is leading from the rear.

    Almost all the growth we are seeing is related to government programs, whether spending through the stimulus or the military Keynesianism of Iraq and Afghanistan, or Cash for Clunkers or the housing rebates, or the crazy money coming through the government’s credit lines to banks and from there to the various bubbles we are seeing. Inventory growth has been anemic for a reason. There is no demand and so no reason to do much restocking. Housing prices have stabilized in some areas but only because so many foreclosures are being held off the market, creating an artificial constraint on supply. Ordinary Americans are too endebted to deleverage effectively. As for the big boys, they have returned to their highly leveraged ways. And yes, their balance sheets remain as toxic as ever.

    So where in any of this is there even an iota of real, healthy, sustainable growth? And no price gouging in healthcare doesn’t count.

    1. Skippy

      Ditto for me too!

      Lets just see how long the can keep their belay hand on the rope, its smoking right now, wait till it catches fire.

      Skippy…every thing adjusted to the peak or even near it is atrocious and on top of that the crims are backslapping them selves over a little equity’s and sudo asset inflation.

  14. fresno dan

    Good reasons must give way to better.
    Drop dollars from helicopters, and people for a while will feel rich. But state tax receipts are cratering, a mountain range of foreclosures are held in a shadow inventory, pensions are seeing diminishing returns because of low interest rates, not to mention that a 10% increase in something AFTER a 90% shouldn’t be too much to be really happy about.

  15. i on the ball patriot

    Mr. Usury’s Sucker

    Indenture me now!
    Give me some cash!
    I’m going to party,
    I don’t see any crash!

    And if it all stops,
    And the markets do cave,
    The mess will be cleaned up,
    By the many who save,

    Not so fast now,
    Mr. Usury’s Sucker,
    This bubble is different,
    Your asshole will pucker,

    Get used to your chains,
    They are permanent this time,
    Mr. Usury took it all,
    He’s a no good fucking slime …

    Deception is the strongest political force on the planet.

  16. Siggy


    Engaging mea culpa. I see the data a bit differently. I see the development of a modest base with some upside potential. My critical guide remains employment. It’s not improving. The best that can be said is that it’s rate of deterioation is slowing and its level may be stabilizing.

    If one is in the forecasting business, the great trap is the process of extrapolation. That comes out of looking at the wrong clock of history. A really good forecast looks to the probabilities of what may occur. In this environment the prime question is what shall become of the dollar and our standard of living over the next five to ten years. In that consideration there is very little that is positive.

  17. sharonsj

    I want to know what people are buying, besides rebates for cars and houses? Ammo? Food for storage? As someone who is forced to shop at Wal-Mart (only store for 20 miles), I see fewer customers. People are now buying food at Dollar General. More 2nd-hand stores are opening up. The retailers are getting desperate. A big-name men’s clothing store has been running sales of “buy one suit, get one free”–which is now “buy one, get TWO free”, and lately morphed into “buy anything, get two free.” There is no recovery.

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