Where's the Bottom?

Economies move through a series of expansions and contractions known as the business cycle. This should not be news to anyone with even a modicum of financial acumen, yet it amazes me that those who are tasked with understanding this basic concept get it so wrong time after time.

What I am referring to is the need to “call a bottom”. When I started out in my trading career, the trading aphorism I heard most was to not try to “catch a falling knife”. Yet day after day, I see some politician, financial pundit, or media type who will tell you with all certainty that the “bottom may be in” and the recession may be over. What they’re NOT telling you is that just like everyone else, they really have no idea where the bottom may be and that all of their guessing is nothing more than a way to pat themselves on the back at cocktail parties 6 months from now in the random chance event that they were right!

Let’s debunk some of the myths about economic “bottoms” and tell you what you need to know.

Less contraction does not equal expansion! When economists say a recession is over, all they are saying is that economic output has stopped contracting. And while that may be true, the “logical” conclusion that they draw is that if the economy stops contracting, then it must be expanding, which means growth. This couldn’t be further from the truth. Economies can experience long periods of non-growth or stagnation, after having been stabilized. Don’t believe me? Ask the Japanese.

Stock market returns do not equal overall economic conditions! While it’s great that the market has had a good run since the March lows, people are still losing jobs (though less rapidly), banks are still not lending, housing prices have not stabilized, and we have a ginormous mountain of debt to show for it. Now I’m not trying to pee in anyone’s cheerios, but at this moment in time the “logical” conclusion that the economy can’t move back into contraction-mode is WAY too premature.

We may not have a letter of the alphabet to describe this economic condition! While it is convenient for financial pundits and media types to throw around the classic ‘V’ or ‘W’ or ‘U’ shaped bottom comments, I’m not so certain that what ends up happening will resemble anything close to what can be written in the English language. Now while I realize that doesn’t make for engaging cocktail-party fodder, perhaps the back-slappers will just have to sit this one out.

Government intervention may have created false conditions! Now I’m not going to argue whether the stimulus packages were necessary or too much or too little or whatever as only time will tell how effective they were. Of course then I can write an article about the fallacy of assigning specific credit or blame to the stimulus, although that’s another topic entirely. The point is that we can’t necessarily determine what the outcome is until after it occurs. All of the projections and estimates are just educated guesses and should be treated as such going forward.

As you can hopefully see, trying to pick bottoms will leave you with little more than stinky fingers. Rather than trying to guess cause and effect, investors and traders alike should proceed cautiously and really stay focused on what they see and not what they hear. Because if history has taught me anything, it’s that when everyone is saying the bottom is in probably means closer to the opposite.

But rest assured, if they keep calling bottoms, eventually someone will be right. And I’ll be the first one to throw that guy a pizza and ice cream party. But for now, I’ll keep my ears closed and my eyes open.