By Bill Fleckenstein

Housing prices are heading lower. Stock prices are heading down. And it's all systems go for a downturn in the U.S. economy, no matter what the bulls say



As I think about recent developments on Wall Street, I am struck by the absurdity of the current mentality. By that I mean: The latest run in the stock market, which peaked as the structured-credit problems made themselves known, had been powered by leveraged-buyout madness, which itself had been powered by lunacy in various forms of structured credit.

Nevertheless, when it became clear that the plumbing of structured credit was a disaster -- witness the lines around the block at England's Northern Rock branches and, to a lesser extent, at Countrywide Financial (CFC, news, msgs) here -- the Federal Reserve felt compelled to cut rates by a surprise half a percentage point. In doing so, Bennie and the Inkjets (thanks to my friend Colin for that moniker) have tanked the bond market and the dollar.

King Quants often gets what he wants
Of course, stock bulls responded on cue -- by racing in for more. Apparently, those with the most stock-market votes, i.e., those who run the most money these days, seem to believe in some sort of immutable law of physics that says stocks must go up each and every day.

Talk back: Are you worried about a recession? Or worse?

Within that money-running group, I have a sneaking suspicion that the bizarre action in tech stocks is a function of quant funds. It seems they don't operate as they once did, when stocks were picked based on fundamental statistics. These days, the characteristics (volatility, correlation, membership in an index, etc.) of stock-price movement are all that matters.


Skies bluish versus bearish
What I expect to unfold is a recession and severe weakness in the equity market. To get a sense of the timing, I was therefore eager to hear the comments of noted speakers last week at a New York conference held by Jim Grant of Grant's Interest Rate Observer. To my surprise, it seemed most of them were not too terribly concerned about the stock market or the economy.

That is not to say everyone felt that way. But I think it accurately encapsulates the opinion of investor Sam Zell, who was downright bullish on world gross-domestic-product growth. He seemed to think that we'd most likely muddle through and that the recent hiccups in liquidity and the markets would not lead to anything very troubling or long-lasting. (Though he just concluded a $40 billion sale of commercial real estate, he didn't sound too bearish on that asset class, either.)

Mohamed El-Erian, Harvard's former endowment chief who is now moving to Pimco as a co-head, was similarly sanguine. But he felt that we would see plenty of volatility in the future and that folks had better learn how to manage risk. He thought the innards of the financial system hadn't quite caught up to all the changes in the world and indicated that would continue to raise issues for folks.

Video: Recession? MSN Money columnist Jim Jubak says not yet

I guess GMO Chairman Jeremy Grantham came the closest to being downright bearish. He was unequivocal in his belief that housing prices will revert to the mean. Likewise profit margins in corporate America (which are at a record) and price-earnings ratios -- implying stock prices were going down a fair amount or, as an asset class, would generate negative real returns for an extended period. Obviously, if he is right about housing prices, I don't see how the trouble I envision is going to be avoided.

The nitty-gritty of the president's committee
An item that I felt folks would find most newsworthy is that the president's working committee on financial markets, known by some as the PPT, or plunge protection team, now has about 20 outsiders who attend certain meetings to advise the committee. One of them is none other than noted short-seller Jim Chanos, who left Grant's conference early last Tuesday to attend a PPT meeting. In response to my question as to why the committee had chosen him and others, he cited one reason: that the panel was worried about adverse publicity and wanted to communicate that there was no nefarious buying of S&P futures, as is constantly rumored.

This is a story that I'm sure will have legs. Though not an earthshaking development, given all the emotion that the PPT evokes, it's a fact worth knowing. Even Chanos -- who is quite bearish on structured finance and who pointed out many of the absurdities that readers are familiar with, such as Level 3 accounting, otherwise known as mark-to-fantasy -- didn't seem overly bearish. However, I did not specifically question him as to his opinion.

Bottom line: For what's often thought of as a bear's conference, I did not detect much bearishness. Perhaps it's right not to be bearish. But it does strike me that perhaps to be quite bearish about the economy and the stock market might be one of the most contrary thoughts of all.

Recession sightings ratchet up
To me, it seems obvious that we are headed to recession and that lower stock prices will ensue. On that score, the Liscio Report noted its recession index, which tracks newspaper articles that contain the word "recession" -- and which has an excellent history of calling downturns in near-real-time fashion -- has shown a sharp spike:

"The reading for September is 104 articles, which is the highest since the index was coming off the recession highs in 2003. It's also 2.9 times the trailing average of the previous three months -- the second-highest reading since the series began in 1980. The only sharper spike was in October 1987. That is a warning.

"If the recent mortgage turmoil remains localized to the financial markets, as that crash did, then the spike is likely to decay quickly. But if it continues to rise in the coming months, we may be on the cusp of recession. One interesting note: When we did the index on September 14, the daily average was 2.8 articles a day. Over the last 11 days, however, the average is 4.4. So it's picking up speed to the upside."

That viewpoint ties in precisely with mine. I am unshaken in my belief, shared by Grantham, that housing prices are headed lower and that we are headed to recession. Though it's not possible to pinpoint the "when" -- because once a market gets a head of steam, it stops only when it stops -- I continue to keep looking for clues.

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Those who would give up Essential Liberty to purchase a little Temporary Safety, deserve neither Liberty nor Safety.

— Benjamin Franklin

The government of the United States is not, in any sense, founded on the Christian religion.

John Adams from the " Treaty of Tripoly, article 11

If there is a recession, the Republicans will blame it on Bill Clinton.

You heard it here. Its going to hit right around christmas .

Seen it coming for the last 3 years.

So when it doesn't, will you concede defeat? I'll be watching.

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Fenian smokes on sausages for a living

WV Peach, BTW.......you need some rogaine, that receding hairline just isn't in style nowadays.

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Fenian smokes on sausages for a living

Nice remark, the politics of personal destruction is a right-wing trademark.

Save the self righteousness for someone who doesn't know any better.

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Fenian smokes on sausages for a living

Yea, Taco is a hypocrite, and pretty thin skinned. Looks like we got another troll......

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"If you're going to tell people the truth, be funny or they'll kill you." -- Billy Wilder

"Never believe anything in politics until it has been officially denied." -- Otto Von Bismark

Trolls have to curse out( I mean Literally) everyone against their ways of thought. I don't. Rarely have I cussed here. Save it.

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Fenian smokes on sausages for a living

You just got here! Already have broad bushed liberals many times....
one of my pet peeves, as you've already seen. It's okay to call a particular poster (including myself) stupid, but you better be prepared then. Okay?

Nothing gets "saved" here, better get used to it.

Oh, and you're comment about WV,uh, is that you in your pic?
Better stow those personal comments pal!!!!

__________________
"If you're going to tell people the truth, be funny or they'll kill you." -- Billy Wilder

"Never believe anything in politics until it has been officially denied." -- Otto Von Bismark