April 16, 2008
Now I’m pretty sure he’s not actually referring to my very short post on the Economist cover, however, somewhere in the more mainstream blogosphere, someone must have used the Economist cover as a contrarian indicator [I actually agree that it is a contrary indicator]. Here is his response;
One of the things that people get wrong all the time is the contra meanings of magazine covers. This is a subject we have discussed for quite some time around here.
The assumption is that if something shows up on a mag cover, whatever the subject is must therefore be all over, hence, its time to go the other way. This is a fundamental misunderstanding of what the cover indicator is all about.
The short version is that when a long running trend, well represented by consensus opinion and stock prices, finally bubbles up to the front of a major magazine cover, THATS WHEN its very very late in the cycle. Hence, it is a contrary indicator.
A recent classic cover was the Time Magazine on Housing back in the summer of 2005. The timing was near perfect, as Housing peaked in August ‘05. However, when something is relatively new, such as the US economic slowdown (see Economist cover below), it is not a true contrary indicator.
Let’s compare these two examples:
• Housing Boom
- Lasted almost 10 years
- Home prices increased 2 and 3 standard deviations from historical means
- Homebuilder stocks ran 500% to all time highs• US Economic Slowdown
- Offically going on for less than 6 months; GDP still positive
- S&P 500 and Dow Industrials made all time highs six months ago
- Equities still within 10-15% of highs
- No consensus for a recessionWhen we compare these two, the differences are pretty obvious as to which one is the true contrary indicator . . .
I actually disagree with his analysis for the following reasons;
*Economic expansions are far longer in terms of time and % gains than are recessions. The reasons for this are Political, Legislative, Fiscal, and Monetary. In essence, the government will always try to facilitate an expansion, even if it is OVEREXPANSION [bubble] and fight to shorten and mitigate any recession. Therefore, even though the timeframe mentioned is 6 months, this in terms of a “Recession” could very well be “late” in the cycle.
*Magazine covers are not touted as “market timing” per se, rather, that the idea has now gone mainstream, and thus it is now in the final stages of the move as the less informed public become aware of the situation. It could of course be argued that “The Economist” is still rather above the average reader, thus not qualifying as mainstream.
*Every recession has been successfully reinflated by the Federal Reserve lowering interest rates. There is however a time lag of up to 11 months. The time lag with magazine covers, with the “Housing” example used, falls rather neatly into that timeframe. Therefore, once again, it can be argued that in the face of interest rates being aggressively cut, very quickly in the cycle, that this recessionary cycle will be shorter in [time] duration than previous cycles.
*Individual equities are nowhere near their [10%-15%] highs. The overall index may well be, but individual common stocks associated with various problematical areas of the economy have declined some 50%+ at their lows. Thus his statement while correct, shows a lack of penetrating thought.
In conclusion, while the Economist cover will be judged in posterity, the arguments put forward in rebuttal simply do not make the case.
