Check the major newspapers. Everyone is writing about the economy. For almost five years now, they’ve been predicting strong economic growth just around the corner. And for almost five years, they’ve been wrong. Stumped. Surprised.

The recession ended three years ago, they say. How can unemployment still be so high? How can growth be so slow?

So they make up explanations, usually political. Their economic models failed. Their credibility is in doubt. They must blame someone else. So they blame the government.

Taxes are too high, they say, even though taxes are lower than they were before the recession. Regulations are too strict, they say, even though corporations are making record profits. The stimulus slowed growth, they say, even though it created or saved over 3 million jobs.

And they never mention the housing bubble. Even though everyone and their dog knows that the collapse of the housing bubble caused the recession.

From the end of World War II to the late 1990s, housing prices tracked inflation. There were booms and busts in the 1970s and 1980s, but they always came back to the same long-run average. Then, from 1998 to 2006, they rose approximately 90 percent, after adjusting for inflation. They’ve been falling ever since.

Real housing prices are now about 10 percent above their long-run average, as is the price-to-rent ratio. Which means they still have further to fall, but we can finally see the light at the end of the tunnel.

If you’ve taken Econ 101, you’ve probably heard of the “housing wealth effect.” It says that, for every dollar that housing wealth declines, consumption shrinks by 5 to 7 cents. Since the peak of the housing bubble, we’ve lost almost $8 trillion in housing wealth. That’s $400 to $560 billion less consumption. And that doesn’t include indirect effects, like the resulting stock market decline, which lost another $4 trillion in wealth.

It takes an even bigger chunk out of overall output when you add residential investment, which fell 24 percent in 2008, 22 percent in 2009, and 4 percent in 2010.

Given that knowledge, it’s hard to imagine anyone predicting a strong economic recovery while housing prices still have further to fall.

But the housing market is improving. Residential investment has started to grow again, as has construction employment. Whereas there was a huge glut of unsold homes in 2009, that inventory is almost back to normal levels. Existing home sales have been increasing for the last six months, though new home sales are still stuck near their post-recession low.

The decrease in unemployment is what everyone is talking about, but it’s mostly due to people dropping out of the workforce — being so discouraged that they stop looking for work — rather than a significant increase in jobs. The number of job openings was unchanged in November. 200,000 new jobs in December may sound like a lot, but it would take 100 more months just like it – that’s 8 years — to return to full employment.

A lot is riding on a turnaround in the housing market, including Barack Obama’s re-election. If the administration wants to increase its odds of staying in the White House, it’s not taxes or regulations or government spending that need easing. It’s struggling homeowners.

They can start by appointing an FHFA director who will encourage borrowers with government-backed loans to refinance at lower interest rates. And they need to be more aggressive in investigating widespread mortgage servicing fraud at major lenders.

We are nearing the end of the Great Housing Bubble. It has gone up, and now it’s almost done coming down. Let’s hope we learned our lesson…at least for a little while.

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This op-ed was published in yesterday’s South Florida Sun-Sentinel.

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…the first stimulus bill in 2008, a $700 billion package geared toward government spending to stimulate the economy, and financed with borrowed money, has obviously failed to create new jobs.

He never offers any evidence to support this claim.

I’ve disproven this hypothesis before, but I’ll do so again — first by repeating what I said last time, then with even more evidence. If you’ve already read the first part, you might want to skip to the new stuff, though it can’t hurt to refresh your memory…  

President Obama signed the American Recovery and Reinvestment Act (ARRA) on February 17, 2009. Almost immediately, GDP growth turned around:

Private sector job growth also turned the corner immediately following the ARRA:

A few weeks after Congress passed the ARRA, the stock market unexpectedly began a strong, steady rise:

It’s true that GDP and job growth has been slower during this recovery than previous post-WWII recoveries, but recoveries following financial crises are almost always weaker than recoveries that follow traditional recessions. Compared to other debt-burdened recoveries, this recovery has been better than usual.

Another reason for the slow GDP and job growth is the lack of stimulus. No, that’s not a typo. The ARRA may have injected $787 billion into the economy, but state and local governmentscut their budgets by roughly the same amount. Overall, government spending hardly budged from its long-term trend:

A lot of economists have tried to measure the historical “government multiplier,” or “bang for your buck,” but only a few have studied periods that are comparable to today: deep recessions where interest rates can’t go any lower. Such responsible studies estimate that the multiplier ranges from 1.5 to 2, which means that $1 in government spending increases GDP by $1.50 to $2.

Stimulus critics predicted that interest rates would rise because the government borrowed too much, competing with private investors for scarce lending. Instead, the opposite happened:

In fact, interest rates are the lowest they’ve been in many decades:

Some stimulus critics also predicted that inflation would soar because the government would print money to pay for the stimulus. Actually, inflation is lower than it was before the recession, lower than it was in the 1980s and most of the 1990s, and out of dangerous deflation territory, thanks to the ARRA:

But if you want to measure the effects of the stimulus, says conservative economist Robert Barro,  you need “‘experiments,’ in which the government changes transfer in an unusual way — while other factors stay the same.” Fortunately, we have four such “econometric” research papers.* (We won’t discuss papers that use “models” because, as Barro says, they tend to assume what they’re trying to prove.) Here are their findings:

1. James Feyrer and Bruce Sacerdote, both from Dartmouth, compared jobs growth in each state and county to the amount of stimulus funds spent in that state or county. They used the seniority of each state’s/county’s legislators to determine whether they received the funding because of economic need or political patronage. That allowed them to correct for any possible reverse causation, whereby the jobs growth determined how much stimulus funds were received (rather than the other way around, which is what we’re trying to measure). They found a multiplier of 1.96 to 2.31 for low-income spending, 1.85 for infrastructure spending, and 0.47 to 1.06 for the stimulus overall.
2. Gabriel Chodorow-Reich (Berkeley), Laura Feiveson (MIT), Zachary Liscow (Berkeley), and William Gui Woolston (Stanford) compared jobs growth in each state to the amount of federal Medicaid matching funds spent in that state. They only looked at aid that states received based on pre-recession Medicaid spending, not the aid distributed based on economic need during the recession, to avoid the reverse causation problem mentioned earlier. They found a multiplier of 2.
3. Daniel J. Wilson, of the Federal Reserve Bank of San Francisco, compared jobs growth in each state to the amount of stimulus funds spent in that state. He used pre-recession Medicaid spending, school-age population (a proxy for education need), and highway act (unrelated to unemployment) to determine whether they received the funding because they were hit harder during the recession or because of these non-cyclical needs. That allowed him to correct for any possible reverse causation. He found that the ARRA “created or saved about 2 million jobs in its first year and over 3 million by March 2011.”
4. John B. Taylor, of Stanford, measured the change in consumption at the time when the tax cuts boosted personal disposable income the most. He found no significant increase in consumption due to the tax cuts. He also measured the change in state and local government spending at the time when federal aid gave them the biggest boost. He found that the increase in federal spending was too small to significantly outweigh the decrease in state and local spending.

There you have it: All the evidence points to a stimulus that worked exactly as it was supposed to. If anything, it was too small and had too many tax cuts and not enough spending.

On the tax cuts, it’s worth mentioning, however, that this is not a regular recession. It’s a “balance-sheet recession,” where consumers won’t start spending again until they pay off the debt hanging over them. The tax cuts may not boost consumption immediately, but they help consumers pay off debt and thus speed up the recovery. Of course, this only works if the tax cuts are directed to low- and middle-income Americans with debt to pay off, not to the rich. This is why President Obama is advocating payroll tax cuts, not tax cuts for the rich that Prof. Mishra and Congressional Republicans are so fond of.

==========

* A hat tip to Ezra Klein for compiling these papers (and several more) in one handy blog post.

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It’s a stupid time to start an investment newsletter.

Economists are worried about a “double-dip” recession, public and private debt are at record levels, the world has just escaped two financial crises in three years, and the Chairman of the Fed says the future is “unusually uncertain.” With record-breaking temperatures outside, a smart person would work on their tan until the economy returns to normal.

Trouble is, I don’t know what “normal” looks like.  

See, what makes Bernanke’s quote so potent isn’t the “uncertain.” Our lives are always uncertain, never more so than when we bet on a future state of the world. Which means there’s never a good time to pretend that you know what people should do with their money.

It’s the “unusually” that makes you knit your brow. Only, I don’t think there’s anything unusual about today’s economy.

Allow me a brief analogy. In 1973, psychologists Amos Tversky and Daniel Kahneman gathered several groups of people and read aloud a different list of names to each group. On each list, there was a different number of male and female names — some of them famous, some not. After the reading, each person was asked to estimate whether there were more male or female names on the list they had just heard.

Whenever there were more famous male names than famous female names, the groups guessed that there were more male names — and vice versa. Of course, they were often wrong. There were more female names, but they weren’t famous. The only names that registered strongly in their memory were the famous ones, making it seem like there were more male names.

Tversky and Kahneman referred to their subjects’ erroneous judgment as the “availability heuristic.” (A “heuristic” is a mental rule of thumb.) It’s the reason that people tend to overestimate the number of deaths by car accident and underestimate deaths by medical error. Or why fewer people get on an airplane the month after one crashes.

We have short memories and strong emotions. Whatever is recent or more commonly reported seems more likely.

I’m not implying that fear of another recession or financial crisis is delusional. On the contrary, we should always be on guard for another recession or financial crisis. But we aren’t always as attentive as we should be, are we? It’s only because we’ve recently lived through trying storms that we’re on the lookout for rough seas ahead.

My point, more bluntly, is that this uncertainty is not a fluke. Financial instability is built into modern capitalism. There’s nothing unusual about it.

I don’t know how carefully Bernanke chose his words, but uncertainty has an important history in economic thought. It’s different than risk, which applies to a possibility to which you can assign a probability. When a prediction is too complex or you have too little information about it, that’s uncertainty, an unquantifiable possibility.

Uncertainty is all around us, just not in our economics textbooks. You have to go back to the 1920s and read two of my intellectual heroes, Frank Knight and John Maynard Keynes, to understand that uncertainty plagues every investment. The only people who think investing was easier before the crisis are the ones who didn’t understand how unstable the system was…and probably still don’t.

The legendary tech exec Andy Grove lives by the motto, “Only the paranoid survive.” All investors should too.

So here I am. Because now is as good a time as any. Besides, the planet is only going to get hotter. There will be plenty of sun left for tanning after we’re done surveying the financial landscape.

What Will Make the Economy Grow?

After the European debt crisis stabilized, July was a very good month for the market, up 7.5%:

The Dow is about even since the beginning of the year, but the new GDP numbers have everyone anxious about another dip. According to the latest revision, the recession was even worse than we thought:

We found out that GDP grew 2.4% in the 2nd quarter of 2010, which didn’t sound that bad at first since we thought 1st quarter growth was 2.7%. Check again. The new estimates say GDP grew 3.7% in the 1st quarter.

Good news: We have more GDP than we thought. Bad news: Growth is slowing more sharply than we expected.

What we just experienced was a classic inventory cycle. At the beginning of the recession, firms slowed production and sold off inventory. As inventories began to run low, firms started producing again. They have now restocked.

Inventory growth added to GDP growth in the past few quarters, but we shouldn’t expect that boost going forward. GDP growth will now be much closer to the growth of sales, or “final demand,” and it ain’t pretty:

The weak recovery doesn’t surprise me — or most economists, for that matter. The last three recessions have all been “U-shaped,” with high unemployment lasting long after the recession has ended. The short explanation is that the job market looks very different than it did, say, thirty years ago. Workers have far less power, and shareholders have a lot more. The result, as Robert Reich puts it, is “a great decoupling of company profits from jobs.”

Good news: Stock market valuation is based on profits, and “profits have recovered 87 percent of what they lost in the recession.” Bad news: Because of high unemployment and slow wage growth, consumers have less money to spend. Before the recession, they could borrow to keep consumption high, but they hit a ceiling in 2008. Until jobs and wages recover, profits will be limited by what consumers can afford.

There are two ways around this constraint. The first option is for the government to fill the gap. Unfortunately, the impact of the American Recovery and Reinvestment Act of 2009 (ARRA) will start to decline as we head toward 2011. And we shouldn’t count on ARRA to make up for lack of private consumption when it was barely enough to counter budget cuts by state and local governments. In the fiscal year that started a month ago, state governments have to beg for another $90 billion.

Many investors fear that Congress will move in the opposite direction by allowing the Bush tax cuts to expire. Don’t count on it. Politicians are well aware that the most reliable way to get re-elected is to throw money at their constituents right before the election.

The Democrats’ plan – to allow the tax cuts on individuals above $200,000 and families above $250,000 to expire, and to cut taxes further on middle- and low-income brackets — has some investors worried that small businesses will suffer. The reality is that the tax hike would hit less than 2% of small businesses. Redistributing some money downward would actually stimulate the economy because lower-income households are more likely to spend it.

The second antidote to low domestic consumption is for firms to find more consumers. In other words, export.

For this strategy to work, the dollar must depreciate. For far too long, the demand for dollars in Asia and the Middle East, combined with our excessive borrowing, has kept the dollar “strong” — making exports expensive. American firms need foreign consumers. They need a weaker dollar.

Europeans need a weaker currency more desperately than we do. It’s their only hope of growing fast enough to pay off their debt. During their recent crisis, the euro depreciated significantly, which certainly contributed to the appreciation in the first half of the graph below. As trade economist Menzie Chinn reminds us, however, “The euro is a relatively small component of the US trade weighted exchange rate.” Sovereign debt crises aside, the dollar will continue its descent:

My bet: Short the U.S. dollar.

Ethical considerations: The strong dollar hasn’t benefited most Americans. It has been a boon to multinational banks. The influx of foreign lending contributed to the Great Financial Crisis. The national economy will be more stable and equitable with a weaker dollar and smaller trade deficit. And it’ll speed up production at a time when millions of unemployed need firms to hire more.

Who Will Make the Economy Grow?

According to a 2006 government report, the top exporting industries are transportation equipment and chemicals.

In the first category, Ford Motor Company is the only member of the Big Three that trades on the stock exchange. S&P improved Ford’s credit rating to B+ earlier last week. I’m reminded of Michael Milken, who made his fortune identifying “fallen angels,” blue chip companies that had gone through a temporary rough patch. The rating agencies tended to judge creditworthiness by past performance, not future potential. Take a look at the Great Financial Crisis, and ask yourself whether they’ve learned their lesson since the 1980s. Bottom line: B+ is too low.

My bet: Long Ford Motor Company.

Ethical considerations: The auto companies have earned my disdain over the years by lobbying against energy efficiency standards and for taxpayer bailouts, but Ford is the only one that didn’t eat out of the TARP trough. The quality of their vehicles and their investment in renewable energy have both improved in the past few years. Economists refer to the Heckscher-Ohlin-Samuelson theory, which says that it’s best for everyone if countries allow firms to specialize in their comparative advantage. If American firms lose that advantage to foreign firms, American workers can specialize in something else. But they can’t, can they? The theory assumes that factors of production can take any form. Workers can shift from car manufacturing to computer repair in no time. The theory is flawed. Workers deserve some protection from forces out of their control. Of course, creative destruction is necessary for economic growth, but with the quality ratings Ford’s cars have been getting lately, I don’t think it’s time to take the hatchet to Detroit.

In the second category, Jon Huntsman, Sr., is betting big on his company, and he’s staking the financial health of a cause very close to his heart, the Huntsman Cancer Foundation, on the share price of Huntsman Corporation too. This is as trustworthy a businessman as you’ll find. With his son as U.S. Ambassador to China, Huntsman is well-placed to understand and profit from the export market.

My bet: Long Huntsman Corporation.

Ethical considerations: Huntsman’s ethics are unimpeachable. Better him than, say, the Dow Chemical Company, whose environmental record is improving but still suspect.

What’s Standing in the Way?

Two complications should inspire humility about those long positions. First, the stock market is overvalued by historical standards. The most common measurement is the inflation-adjusted price-to-earnings ratio, where earnings are averaged over the last 10 years:

As much as we ridicule the “New Economy” claims made during the dot.com bubble, it really does look like we’ve reached a new plateau in the past 15 years. I’m not willing to concede that it’s permanent, but I will hypothesize that it won’t disappear until Reich’s “great decoupling” reverses gears. The numerator, stock prices, is investors’ valuation of future earnings. If investors have reason to believe that companies can maintain faster earnings growth than they have in the past, the P/E ratio should increase. In an era when shareholders have more power than workers, this may not be an irrational judgment.

Another possibility is that the stock market will seesaw sideways for the next couple years while earnings rise, until the P/E ratio is back to its historical average. It’s impossible to know which path is more likely. Notice that the curve spends very little time near the average. It deviates for whole decades before returning to trend. Observers in 1940 would have expected a strong bull market; instead it underperformed until the mid-1950s. The P/E ratio also reached today’s inflated level back in 1961, but anyone who shorted the market then would have lost out on the biggest bull market since the 1920s. This is the uncertainty that Knight and Keynes were talking about.

Bottom line: Keep a healthy portion of your portfolio in other investments.

The second complication is housing prices, which remain more than 50% above their historical average:

Since the end of the homebuyer tax credit, MBA purchase applications have resumed their descent, almost a sure sign that home prices will come down further:

For every dollar lost in housing wealth, consumption falls by 5 to 7 cents. With Fannie and Freddie buying mortgages, the decline should be gradual, but it’ll still take a bite out of GDP.

Bottom line: Betting on the recovery isn’t necessarily an immediate winner. Don’t be surprised if you have to weather a few false starts in the next six months.

What Else Is Overvalued?

Speaking of historical averages, gold is out of control. There is no rational reason for its value to have increased almost 300% in the last five years. You might say it was a “flight to safety” by investors looking to get out of the stock market, but the bubble began before the Great Financial Crisis. Mostly, gold has a lot of old wives’ tales behind it. It is not a good hedge against inflation, it is not a good hedge against rising commodity prices, and it is not a good hedge against a falling dollar. The big boys know it’s a bubble, and they’re riding the wave. You don’t want to be caught without a seat when this music stops:

Timing the end of a bubble is high risk stuff. Who knows when people will come to their senses? The flight to safety may not have triggered the bubble, but it did accelerate it. As bond spreads come down, look for investors to move back to riskier investments.

My bet: Short gold.

Ethical considerations: This bubble isn’t benefiting anyone except speculators. Get that money out of gold and into productive investment!

What About the Rest of the Commodities?

Gold aside, commodities are the place to be. Like gold, there are a lot of myths about commodity futures. No, they’re not riskier than stocks. In fact, they’re slightly less risky:

No, they’re not less profitable than stocks. They’ve delivered almost the exact same return:

No, technological progress doesn’t keep their prices from rising. And no, they don’t only go up when there are speculators or a falling dollar or high inflation.

Despite a huge slide during the Great Financial Crisis, they continue to deliver superior returns:

That’s the Rogers International Commodities Index, my favorite because it’s the most diversified and its founder has the best pedigree. If you want to invest in it, you can use an ETN, but make sure you know exactly what you’re getting into. ETNs carry their own risks. (See here, here, and here.)

Commodities are the place to be because, no matter what happens to the U.S. economy, the world is going to need a lot more commodities. Land is getting scarce, and developing countries like China need raw materials en masse. Peak oil is real, and climate change is going to make the weather more volatile and severe.

Some investors are worried that China has been stockpiling commodities and is about to slow its growth, but if so, it’ll only be temporary. China has the best approximation we’ve seen in a long time to what the great economist Arthur Lewis called “unlimited supplies of labour.” They need to keep production moving at a strong pace, lest the rural migrants riot in the streets. Water shortages will make it hard to irrigate enough fields to feed all those mouths.

My bet: Long commodity futures.

Ethical considerations: High prices will encourage the industrialized nations to conserve and maybe even give entrepreneurs the incentive to invent a cost-saving technology, but they also make it more expensive for poor people to eat. Research indicates that rising food prices threaten to throw millions into poverty in the developing world. Fortunately, if you use an ETN, you won’t contribute to this rise. An ETN is a debt security where the issuing bank promises to pay you a return based on the index’s performance upon maturity. It doesn’t buy any actual commodity futures, and neither do you.

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Next month, I’ll explore other asset classes.

Question everything I say. Do your own research. Keep your portfolio diversified. And always consider the ethical ramifications of your investments.

There’s plenty to be uncertain about, but look on the bright side: In the long run, the economy always goes up.

~~~~~~~~~~

Graph sources: Google Finance, Menzie Chinn, Dean Baker, Doug Short, Calculated Risk, Gary B. Gorton and K. Geert Rouwenhorst, Beeland Interests.

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DISCLAIMER

All material presented herein is believed to be reliable but I cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.

Opinions expressed in these reports may change without prior notice. Anthony W. Orlando may or may not have investments in any funds, programs or companies cited above.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN MANAGED FUNDS. WHEN CONSIDERING ALTERNATIVE INVESTMENTS, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

Communications from Anthony W. Orlando are intended solely for informational purposes. I believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided “AS IS” without any warranty of any kind. Past results are not indicative of future results.

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Coming from one of the world’s leading experts on econometric predicting, Hamilton’s improved mood says more than all of Jim Cramer’s rants put together. He cites increased activity in the auto industry, an uptick in home sales, a slight increase in consumption, increased expectations for third quarter sales in several large industries, and significant recovery in the Aruoba-Diebold-Scotti Business Conditions Index. (Full disclosure: Frank Diebold, one of the authors of the index, is a good friend and former teacher of mine. He is also a world-class econometrician, but I have not asked him for his outlook at present.) Indeed, those are most of the important measures of whether individuals and firms are starting to spend again, which is precisely what is needed to end a recession.

Hamilton is not taking a stand on whether the recession is over and cautions that the end of “Cash for Clunkers” could prick an artificial high in auto sales, personal income still hasn’t risen, and unemployment shows no signs of falling. But the latter two usually follow on the heels of the other indicators he cites, and the positives seem to greatly outweigh the negatives. So why isn’t Hamilton’s emoticon smiling?

A lot of it has to do with the “shape” of the recession, as economists have explained it to the public of late. A “V-shaped” recession, like we used to have in the 1960s and ‘70s, implies a sudden end to the recession and a sharp return to growth. A “U-shaped” recession, like we had earlier this decade, means growth will be slow and unemployment will continue to rise for awhile even after the recession technically ends. Because consumers are still “deleveraging”—that is, because they have more debt than twentieth-century consumers had—most economists predict the latter, as spending won’t return full-force until they pay off their debt. If nothing else, such an expectation warrants a neutral face instead of a smiling face. The economy may grow again, but it’ll be a long slog before we return to the good old days.

There is, however, a third possibility: a “W-shaped” recession. Granted, it’s rare and frightening, but several well-known economists warn it is very possible. The last time it reared its ugly head was the early 1980s, when the economy dipped into two recessions within the first three years of Ronald Reagan’s first term, and before that, it was the Great Depression, when the initial recovery was brought to a halt by deficit hawks who forced Franklin Roosevelt to raise taxes and balance the budget in 1937.

Investors disagree. All summer, the story has been the stock market rally that looks to be pulling us out of the recession. After a terrifyingly close call from the collapse of Lehman Brothers to the passage of fiscal stimulus, banks have raised capital, Detroit has escaped bankruptcy, and one-by-one economic data seem to be following the stock market’s lead and forming a bottom.

But something is amiss. “We’ve never had six-month period before where we’ve lost two million jobs and the market’s gained 50%,” says Wall Street expert Barry Ritholtz. “That’s simply unprecedented.” Ritholtz thinks the rally will reverse, and if today’s dismal performance is any indication, investors should pay attention.

So who’s right? Let me first say that you should never ever make a financial decision based on my opinions. If financial economics teaches us anything, it’s that the stock market is next-to-impossible to predict, and even if it weren’t, I’m not confident enough in my financial savvy to be responsible for your risk-taking. That said, I’m with Ritholtz on this one, for the following reasons:

1. As indicated above, unemployment will remain high for some time, and with unemployment comes…
2. …foreclosures, which show no sign of slowing down. Government intervention has helped many people, but if we want to make a dent in the larger economy, stronger intervention is required.
3. A whole slew of adjustable-rate mortgages still haven’t reset—which is to say, some homeowners are about to get hit with higher interest rates—so you can expect more defaults.
4. Repeated reports indicate banks still have too many toxic loans on their books. If the Obama administration had taken the advice of many of us and run the worst offenders through FDIC receivership, we wouldn’t have this problem, but alas investors will start to get worried if these reports keep coming.
5. September is historically a bad month for the stock market.
6. Far more insiders—people who know what’s under the hood, so to speak—are selling than buying.
7. The easiest way to measure valuation is the price-to-earning (P/E) ratio. If stocks are selling for a lot more than their companies are earning, beware. The historic P/E average is 15. Right now, it’s 100+! Even if you use the more stable “operating earnings” because you think reported earnings have been depressed too low by the credit crunch, it’s still overvalued at 20+.
8. The output gap—the difference between what we should be producing and what we are actually producing—is still significant. Some economists recommend another fiscal stimulus. I worry about dynamic timing, which is economist-speak for “It took you so long to spend the last stimulus, how do I know this one won’t be delayed until the recession is over?” The last stimulus clearly boosted the economy before most of it was even spent. John Maynard Keynes would call that the result of “animal spirits”: Consumers knew the economy was about to get a jolt, so they started spending again. If the stock market dips or foreclosures increase, however, another immediate stimulus should boost “consumer confidence” like the first one did. If Congress can’t get its act together fast, though, it’ll only add excess inflation after the recession ends.

Economists have two fears: (1) From March till now, we have been in a “bear market rally,” which means the rise in stock prices has been false hope amid a longer decline. (2) The entire economy will turn down again.

The first is a financial concern, the second a broader economic one—though of course the first affects the second. I am not predicting anything, but I am saying that we should be cautious for the 8 reasons above. And I am admonishing the Obama administration and Congress for failing to prevent these fears with mortgage cramdown, a larger stimulus with fewer tax cuts and more spending, and nationalization of certain banks. As James Kwak said earlier today, the fact that the TARP loans are showing profits—which Ritholtz rightly debunked as incomplete analysis—only indicates that the government made a bad bet and got lucky. I hope they (and we) continue to get lucky, but for now I’m with Jim Hamilton: I’ll smile when we’re sure this is all over.

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