A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.



The Croesus Chronicles

Pay attention. This is a major turn of events.

The stock market is in a cyclical bull market, not a rally in a bear market. Stock prices and economic activity will rise in a "V" shape, not in a U-shaped, or more ominously L-shaped, fashion as many experts have predicted, and some of us have feared. This trend should continue until at least the end of this year.

Housing prices have hit bottom--and the economy is in the midst of snapping back from a 6% annualized loss in GDP.

Predicting this is Lakshman Acuthan, a highly prominent forecaster at the Economic Cycle Research Institute (ECRI), a consulting company whose research is used by many corporate chieftains and investment managers.

"The harder you throw a ball at the ground, the higher it bounces," says Acuthan in an exclusive interview with Forbes. "You can use this dynamic to predict the economy. There's an 80% correlation between the depth of the recession and the strength of the recovery," says Acuthan.

Acuthan says growth rates bottomed in November and have been less negative since December. The ECRI's leading indicator index and its coincidental index have been signaling an easing of the recession for a sufficient number of weeks to make this major call.

Acuthan has tended to be more positive as his economic indicators signaled an easing of the recession last December.

"The pessimists were too influenced by credit markets freezing, by bank balance sheets and by the precipitous fall in home prices," he maintains. "You don't have to fix these problems before you can have a recovery."

Acuthan is radically suggesting we are too overly focused on the negative GDP number, the weak figures on industrial production and rising unemployment. Better to weigh the decline in the unemployment figures from 640,000 to 610,000 announced Thursday as an important sign that the recession is easing.

This means that Warren Buffett's prediction of obstacles in the economy and Nouriel Roubini's recommendation for nationalization of some banks is no longer necessary. Soros' prediction, made last weekend, that even with a 30% rise in stock prices, this is still a rally in a bear market, is also threatened by Acuthan's increased optimism that the worst has passed. Many large investors have stayed out of the market because of their respect for this bearish view--and their buying may be an additional support driving stock prices.

This would not be the first such extraordinary turnaround in economic activity. The economy's desperate condition from 1929 to 1932 was followed by four years of above-par growth and a huge rally in stocks, which few remember actually quadrupled in price.

One big plus is the rise in housing permits, which is somewhat more positive than housing starts and indicates that the end of the decline in housing prices is upon us. If true, this is the most significant change in direction for the economy. After all, it was the decline in home prices that triggered the free fall in subprime mortgage values, which spread through the financial sector, causing hundreds of billions of losses at the banks.

Acuthan stresses the very powerful psychological fever of pessimism that has gripped Wall Street, especially since March 2008, and involved the failure of several financial giants and the need for a massive bailout from the government.

One major downside: This V-shaped recovery could signal "a return to a boom-bust pattern rather than a mild recession followed by a soft recovery, as occurred in 2001, suggests Acuthan.

"This pattern, if it develops, is bad for the concept of long-term buy and hold investing," he says.

In other words, investors will have to learn to navigate these choppy market moves and thrive on the volatility. For those fortunate or smart enough to have bought the "bottom" on March 9, Acuthan says let it ride.

The key to predicting the durability of the bull market is when the Federal Reserve will recognize the recovery and decide to raise interest rates again to combat the all-but-assured inflation. During the last two cycles, the Fed waited three years to raise interest rates. But it could come sooner this time. Keep an eye on commodity prices.