Yessirree Bob. We'd bet our bottom dollar on it. Now that the consensus of guru-dom has decreed that RECESSION is staring us in the face, heretofore "invisible" counter-recessionary forces are starting to make their appearance. Just in time to make monkeys out of the experts for the UMPTEENTH time? We think the chance is 50/50. (Ha, ha. That's our idea of a joke. After all, if Mr. Greenspan, Dr. Summers, and a galaxy of brilliant lights can solemnly intone that the chances of a recession are 50/50, why can't we join in the fun? Has it occurred to any of the guru-groupies on Wall Street and in the financial media that the profoundly intoned 50/50 risk "assessment" is the equivalent to the risk assessment produced by flipping a coin? In fact, we would respectfully advise businesses who regularly pay out fees of hundreds of thousands or millions of dollars for these 50/50 "predictions" issued by the seers to cease paying and instead rely upon the flip of a coin. It would be vastly cheaper and no less reliable).

The latter, in our view.

The media has been making mucho hay with the supposed muni bond crisis. Media stories and reports have focussed upon the prospective downgrades of the credit ratings of the companies which insure municipal bonds. According to the media accounts we have seen, these downgrades will/may produce a litany of horrors:
--the insurers themselves may go bust;
--many tens of billions have already been "lost" because of the drop in muni bond prices caused by the deterioration in the viability of the insurers;
--the value, safety, and security of muni bonds will be substantially depreciated by the failure of the insurers, or by their loss of the coveted AAA ratings which enable them to remain in business;
--municipalities will have to pay much more for their borrowings since they will no longer be able to insure with AAA insurers, whose AAA rating automatically extends to any municipal issues they insure and thus reduces the interest rate said issuers must pay investors;
--financially hardpressed municipalities will take an additional and continuing hit to their finances as they must pay a higher rate of interest to buyers.

Earlier this week the European Central Bank (ECB) injected MORE than $500 billion into the European banking system. This is, far and away, the largest single liquidity injection any central bank anywhere has ever made, insofar as we know. According to news accounts, it is more than 5x as much as the massive liquidity injection made by the ECB at the onset of the subprime crisis last August.

We believe that this action speaks VOLUMES. What does it tell us -- the fact that the ECB (a very conservative central bank, by the way) found it necessary to flood the banking system with this unprecedented sum of money?
What does it say about the success/failure of ECB/Federal Reserve efforts to contain and reverse the crisis over the past 4 months if the ECB NOW finds it necessary to supply 5x the cash it supplied at the outset of the crisis? The facts, we think, speak for themselves.

"Life is a comedy to the man who thinks,
and a tragedy to the man who feels" -- Sir Horace Walpole

In the realm of intellectual endeavor in which we find ourselves immured, we frequently think of the brilliant insight of Sir Horace Walpole. The tragedy in investing is that most people miss the moves up but manage to catch the full moves down, selling instinctively at the bottom. The economic and lifestyle consequences for the generality of investors is negative, often sharply so.

Because the contemplation of tragedy is so painful, dear reader, we prefer to focus on the aspect of comedy.

For the student of the "investing world" -- if we may so term it -- there is an abundance of material from which to draw. Consider, for example, the rising Greek chorus of dire warnings about the recessionary tidal wave which is about to swamp us.

When the yield curve inverted, well over a year ago, giving us a highly reliable signal that substantial economic weakness was likely 12-18 months in the future, it was greeted by dead silence from the cognoscenti. (Or, to frame it another way, we may invoke the ancient Roman saying:

At bottom, investing is identical in its requirements for success to all other fields of human endeavor. It requires sufficient intelligence, ample analytical ability, thoroughness, painfully acquired knowlege, diligence, intense application. It also requires emotional self-discipline, the ability to put wishful thinking aside, the ability to be self-critical, an openness to new ideas, the willingness to change thinking patterns and operational behavior in response to changing conditions or new insights. Success in investing demands respect for experience but not blind obedience to it.

Investing, in the final analysis, boils down to ONE ESSENTIAL, IRREPLACEABLE ELEMENT. This element is: COMMON SENSE!

In the realm of investing, there are many corollaries to the primary commandment of COMMON SENSE. Among them are:
--Caution, particularly when emotions run strong;
--Extra-criticality when herd movement is driving prices and generating intense emotional heat;
--The ability to stick to the long view, as formed by careful analysis and so long as it continues to be confirmed by underlying trends, REGARDLESS of apparently confuting immediate developments;

This post is intended to address the issue of the relationship between FED easing cycles and stock prices. It is NOT intended as a comprehensive analysis of the relationship between FED policy and stock prices.

There is a very clear relationship between FED easing cycles and stock prices. Easing cycles, in DUE COURSE, boost stock prices. The enhancement of stock prices fostered by FED rate-cutting is variable, but it has been positive on all occasions save one, insofar as we are aware. The rate cutting cycle generates a bull move in stock prices for several reasons.

Generally, the market performs its function as a leading indicator of the economy. The FED, in contrast, is generally RE-ACTIVE to economic developments, which are a LAGGING CONSEQUENCE of prior FED monetary policy. In plain English, the normal sequence is as follows:
(1)The FED raises rates and drains liquidity from the financial system as the economy heats up and inflation fear at the central bank ascends;
(2)The market falls, pricing in a sequence of rate hikes, the bulk of which HAVE NOT YET OCCURRED. Moreover, the market prices in the weaker economy and softer corporate earnings which normally attend and follow the rate-hiking cycle;

The public dialogue that FED policymakers hold with themsleves bears increasing resemblance to a dialogue among the deaf, the dumb, and the blind. These officials have been dead wrong about the crucial economic and monetary issues since the accession of Bernanke -- the strength of the economy, the likelihood of strong economic growth continuing, the growing threat of inflation, the insignificance and easy containability of the sub-prime crisis, the need for higher interest rates (then, stable rates, now, slightly lower rates). The FED has seen no need to increase liquidity in the financial system and has declined to increase the inflation-adjusted monetary base by more than a pittance. The FED has been dead wrong about the real estate bear market -- their initial response was: what bear market? Then the market was "cooling." Now it is having a "correction." What will they term it tomorrow, we wonder, as they seek to remain BEHIND THE CURVE BY A HEARTY MARGIN?

We were assured by the media during the period when the FED made its 2 final rate HIKES that the new Chairman, Dr. Bernanke, was unhappy with them but felt he could not oppose them. He was "building credibility," we were told. Alas, we were all too credulous, it would seem.

We have attempted to think through the FED's amazingly inept performance since the sub-prime crisis broke back in the summer, but we remain dissatisfied with our explanations to ourself. Consequently, we have decided to set about seeking the answer to this riddle via an entirely HYPOTHETICAL exercise.
We are going to give the matter over to a detective. Here is our imaginary dialogue of the future:

Moneysage: We cannot understand it. Who could possibly be responsible for this bad economic downturn? It could have been avoided with well-thought out behavior.

Detective: A crime has been committed. Whenever a crime is committed, a detective looks for 3 things:
(1)Means
(2)Motive
(3)Opportunity

Moneysage: But who had these things?

Detective: Well, who had the means?

Moneysage: The FED

Detective: Did anyone else have the means?

Moneysage: No

Detective: Who had the Motive?

Moneysage: Why, no one. Who could possibly want a recession?

Detective: Who would benefit from a recession?

Moneysage: Well, let's see. It would benefit...CREDITORS! These folk would be paid interest in increasingly valuable dollars as prices fell during the recession. And the value of their loans and bonds would rise!

Detective: Very good, Moneysage. But let me ask you this: did creditors have the means to cause a recession?

Several weeks ago The Great Unwashed (including yours truly) were permitted a brief gaze into the inner sanctum of Treasury policymaking. The media conveyed to us the revelation that the Treasury was acting as the prime mover in a "plan" to prevent a SIV debacle. These bank-affiliated Structured Investment Vehicles (SIVs) were, as we are all now aware, essentially gigantic gambling casinos. They all made the same bet and, surprise, surprise, were confronted with a one-way market when the bet turned sour.

Unfortunately, the continuing health of our economy requires a robust banking system. Successful banks require skillful and prudent management. Turns out that top banking executives receiving 8 and 9 figure compensation packages were neither skilled nor prudent. These gentlemen placed the liquidity, and, ultimately, the very solvency of the insititions with whose care they were entrusted, in grave jeopardy. And that is where they remain today.

As we contemplate prospects for the American equity market, it occurs to us that it might be useful to present our "catalogue of stock market magic."
In our view, there are three types of "magic" related to stock price appreciation. Two of these we deem "true magic." The third we adjudge "phony magic."
The two authentic types of "magic" are not really magic, of course. What they are is legitimate generators of gains in stock prices. There are two varieties:
(1)Earnings growth;
(2)Multiple expansion.
The false source of gains in stock prices is: mania arising from herd stampede.

In examining the history of stock prices it readily becomes clear that certain stocks have racked up immense gains over a multi-year period because of impressive earnings growth. At some point in the growth cycle, the inception of dividend payments occurs. Generally -- though not always -- dividend payouts grow over the course of time. This bolsters further the value of the stock, and underpins the long-term growth in price.