The government said the economy grew in the first quarter, at an 0.6% annual rate. Given that the rejiggering of the inflation calculation in the first quarter knocked an annualized  2.4% off, a better estimate would be that the economy shrank at 1.8% rate. At least that is what the same data would have yielded last year. It isn’t really meaningful to talk about a “true” number in economics where all yardsticks are made of rubber, but certainly reports such as GM’s indicate a rapid slowdown in the economy. My guess is more like a -5 to -6% annual rate, with the rate of slowing increasing.

From the Chron, “Dollar’s fall forces new standard of frugality,” a summary of what’s in and out:

Source: Chronicle research, BudgetSavvyMag.com

There’s much discussion over the “shape” of the recession. The main ideas are “V”, “U” or “L”.

I’m in the “L” camp. Or more accurately the “L____…” camp. I just don’t see what it is that will pull us out. For sure, mailing out $600 checks isn’t it. That’s a drop in the bucket. And the fundamental change from debt to savings that I see as necessary will take a long time.

On a more local level, there won’t be a month-end summary this month either due to travel.

Apologies to Georges Santayana. It is late in the second week of October, 1929. The stock market peaked on September 4th, fell nearly 15% and has rallied back 8.5%.

• Annual per-capita income is $750. More than half of all Americans are living below a minimum subsistence level.
• The richest 1 percent own 40 percent of the nation’s wealth. The bottom 93 percent have experienced a 4 percent drop in real disposable per-capita income since 1923. Individual worker productivity has risen 43 percent since 1919. But the rewards have been funneled to the top: the number of people reporting half-million dollar incomes has grown from 156 to 1,489 since 1920, a phenomenal rise compared to other decades. But that is still less than 1 percent of all income-earners.
• The backlog of business inventories has grown three times larger than the year before.
• A recession began in August. During this two month period, production declined at an annual rate of 20 percent, wholesale prices at 7.5 percent, and personal income at 5 percent.

Are you long or short?

Bill Miller is a well-known mutual fund (relative return) manager, who runs the Legg Mason Value Trust. He had a very strong track record as the only manager to beat the S&P 500 over the 15 consecutive years from 1991 through 2005. But the last two years have been a disaster as his returns have plummeted. He was down 19% or so in the first qaurter of this year alone. He has been “doubling down”, adding to his losing positions. Extracted from his shareholder’s letter, here is his rationale:

For planning purposes, here is my forecast: I think we will do better from here on, and that by far the worst is behind us. I think the credit panic ended with the collapse of Bear Stearns, and credit spreads are already much improved since then. If spreads continue to come in, the write-offs at the big financials will end, and we may even have some write-ups in the second half instead of write-downs. Valuations are attractive, and valuation spreads are now about one standard deviation above normal, a point at which valuation- based strategies usually begin to work again, and momentum begins to fade (there is no evidence of the latter yet, as the old leaders continue to lead). Most housing stocks are up double digits this year despite dismal headlines, a sign the market had already priced in the current malaise. I think likewise we have seen the bottom in financials and consumer stocks, but not necessarily the bottom in headlines about the woes in those sectors. Although the economy is likely to struggle as it did in the early 1990s, the market can move higher, as it did back then.

The wild card is commodities. If commodities break, or even just stop their relentless rise, equity markets should do well. If they continue to move steadily higher, they have the potential to destabilize the global economy. We are already seeing unrest in many countries due to the soaring prices of rice and other grains. Oil has rallied $30 per barrel in the past 8 weeks on no fundamental news, save only the same stories about fears of supply disruptions. The typical fundamental drivers at the margin, such as global economic growth, miles driven, and seasonality, would all suggest prices similar to those that prevailed in early February. But none of that has mattered. I agree with George Soros that commodities are in a bubble, but it also appears he is right when he describes it as one that is still inflating, and we still have the summer driving and hurricane season with which to contend.

The weak dollar is another culprit in the commodity cycle. Oil began to rise in earnest when the dollar index broke down sharply in February. The Fed could help a lot by halting its interest rate cuts. Real short rates are now negative. It is not the price of credit that is the problem, it is its availability. If the Fed stopped cutting rates, that would help the dollar, which in turn ought to stall the commodity price rises, and thus
also help the inflation picture. More technically, the Fed, in my opinion, needs to focus on the value of collateral and not on the price of credit. It appears they are beginning to do this, which is a very healthy sign. This is a topic for another letter, but anyone interested in it should consult the work of John Geanakoplos, a distinguished economics professor at Yale and an external faculty member at the Santa Fe Institute, who has written extensively on this issue, and presented to the Fed on it as well. He and Chairman Bernanke were grad students together at MIT.

Despite moving higher over the past month, the U.S. market and most others around the world are down for the year, and fear and risk aversion still predominate. Yet valuations in general are not demanding, interest rates are low, and corporate balance sheets, especially in the U.S., are in excellent shape. That sets the stage for what should be an improving environment for investors in stocks and in spread credit products, if not in government bonds where risks are high and opportunities low, in my opinion. With most investors being fearful, I think it makes sense to allocate some capital to the greedy side of that pendulum, and that means putting cash to work in equities.

Needless to say, I don’t agree. I think many of his “facts” are wrong - for example, valuations are high at a P/E of 23 or so on the S&P 500 and balance sheets in the financial sector, the largest sector of the market, are in terrible shape as the constant capital injections show. But as a bear, I recognize that I need him. When I short, there needs to be someone to sell to. Someone who sees all dips as buying opportunities.

Brokers Believe Worst Is Over and Recommend Buying of Real Bargains

Wall Street in looking over the wreckage of the week, has come generally to the opinion that high grade investment issues can be bought now, without fear of a drastic decline. There is some difference of opinion as to whether not the correction must go further, but everyone realizes that the worst is over, and that there are bargains for those who are willing to buy conservatively and live through the immediate irregularity.

— New York Herald Tribune, October 27, 1929