God Does Not Protect Willful Ignorance

There is an old saying that goes something like this:

"God protects fools and drunks."

I'd like to add "but if you willfully blind yourself, you're forked!"

The investment message boards these days are chock full of cheerleaders for this stock and that, especially when it comes to financials. "This time is different." "The Fed will cut rates and save all those mortgages." "The numbers will be good." "That bad economic news released today isn't such a big deal - let's BUY BUY BUY!"

Folks, let's outline a few things that cannot be disputed, because they are in the data that all investors have available to them at this point in time.

1. Leading economic indicators - January and February are both down. For the quarter to register an advance, assuming no revision upward for January and February, March would have to register a gain of 1.7%. To put that in perspective, we haven't seen anything like that in the last two+ years; it is VERY unlikely to happen. A year-over-year decline in the LEIs over a quarter's period is important because it is an extremely reliable indicator of recession - it has produced only one false signal since the 1960s.
2. ISM numbers have declined three months sequentially. This economic signal also has a very high correlation with recession within the next six months.
3. The yield curve remains inverted. This too is also a highly reliable indicator of impending recession.
4. Earnings growth estimates have been cut for the year in half. None of the economists polled are now expecting more than 10%, and most are expecting in the mid single-digit range. This is half of what it was for 2006! If the market was "reasonably valued" at the end of 2006, since the market's price generally represents future earnings, it is now overvalued by nearly half!

This is not one or two leading indicators, it is four, and all four point in the same direction! Indeed, I challenge you to find any leading economic indicator that does not point towards a recession at this point in time. (Don't point at jobs data; jobs are a lagging indicator - you lose your job after the business you work for has its volume go to hell, not before!)

We are now within spitting distance of the "annual highs" on the S&P - less than 1/2%. For all intents and purposes we are there. The last three days have seen rising prices but strongly falling volume. The MACD is divergent (bullish) and RSI is rising, but very close to the level before the February plunge (bearish, suggesting a reversal may be imminent.) Call technicals "mixed"; while the MACD and RSI look good, the volume confirmation is not there. As such a strong technical confirmation is not present, but looking at the S&P500 chart alone I'd bet on a breakout to the upside.

Finally, we have to look at the stupidity of the so-called "analysts" and, to a not-insignificant extent, investors. Take DELL, for example. The company announces that it has accounting irregularities a few days ago and gets roundly shellacked. Why? Well, among other things they used the word "misconduct", which raises the possibility that someone has committed a criminal offense! At the least, its a violation of the firm's internal accounting principles. In short, we don't have a clue how the firm has actually performed because it has detected doctored books.

Did we see any analyst downgrades announced in the wake of this story breaking?

Not one.

So what does the market do in the two sessions since the news? Run the shares up two days straight. Huh? Let me see if I got this right - you have the possibility of criminal misconduct in your corporation's books, but that's good for some buying. Have people lost their minds, or am I in the wrong business?

This reminds me strongly of 1999 and early 2000. You had leading indicators pointing to trouble. You had accounting irregularities along with companies restating earnings, and not in a good direction. Yet the market went higher and higher, totally ignoring the signals that were visible to anyone who cared to look.

Of course in the end we know how that little ditty turned out.

I know, I know - "This time its different."

Oooook.

With it being so different, I wouldn't be surprised to see another 500 points up on the Dow - just before we see 3,000 points downward.

Beware folks - what are the odds that four leading signals of our economic future, each individually having high reliability, are all wrong?