This blog post originally appeared on RealMoney Silver on Oct. 3 at 8:31 a.m. EDT
Last night, I appeared on
"Kudlow & Company" and went face to face with Larry Kudlow and
, I had Herb Greenberg in my corner.
Larry and Dr. Laffer argued that the all-time high in personal net worth and the surge in equity prices are safeguards against a recession in the U.S.
Herb and I disagreed. What follows are the arguments I used.
I said that the stock market is now assuming a more critical role in the domestic economy than ever and that relying on such an asset to sustain economic growth was a slippery slope for both the economy and for investors. Far too much could go wrong.
I asserted that economic bears (such as myself) contend that a record high in consumer debt service as a percentage of disposable income, combined with two years of massive mortgage resets, pose a considerable headwind to personal consumption expenditures in 2007-2008.
When pressed again with the all-time high in personal net worth argument, I told my opponents that there are three parts to net worth: individually owned businesses; stocks and equities; and housing. And housing is being taken out from underneath the consumer, which in turn has resulted in an economic over-reliance on share prices.
In support of my argument, I
the expectation for 2007-2011 home prices, according to market participants in the Case-Shiller futures market. That market, which is predicting mid-single-digit home price declines in 2007, anticipates that by 2011 there will be as much as a 25% cumulative price drop in several key housing markets, with most markets seeing 15% to 20% cumulative declines in the five-year period.
Already, the two states at the epicenter of home speculation (Florida and California) are entering (or are in) a recession. (In my home state, Florida, retail sales have been negative for several months, and Dr. Laffer agreed that the same fate may face California.)
I then told Larry and Dr. Laffer that ample academic evidence suggests that changes in home prices have an outsized impact of wealth vis-à-vis stock price changes. I cited a
study performed by Drs. Christoper Carroll, Misuzu Otsuka and Jirka Slacalek -- highlighted in
magazine a year ago -- that concluded a $100 increase in housing wealth in the U.S. eventually boosts spending by $9 but that a similar increase in stock market wealth would produce only about a $4 increase in spending.
In the second segment, former Treasury Secretary and Harvard President Larry Summers seemed to support my case that it was only a matter of time until the real economy is affected by the depression in housing. Moreover, he alluded to a political sea change that could result in the politics of trade protectionism and higher corporate and individual tax rates -- headwinds that I have
recently. Larry Kudlow continued to use the record level of stock prices as an argument against a recession, but I pointed out that there was ample evidence that a recession can and will start coincident with high stock prices. I cited the recessions that began:
- January 1980 -- stocks ripped by nearly 8% that month just as the economy was entering recession; and
- June 1990 -- stocks ramped by 3.5% that month as we also entered recession then.
Moreover, the early 2000 stock market high was achieved as the recession of 2001-2002 was incubating.
I ended by saying that there is clear evidence of slowing growth, which is being obscured by rising stock prices. The signs can be found not only in the dismal housing numbers but in an awful durable goods report, weak jobs releases, a reduction in consensus earnings estimates and the nascent retail sales weakness.
All of these factors are being confirmed by Merrill's Rosenberg's internal Data Diffusion Index -- it hit a "low watermark for the year" recently -- and the fact that "over 90% of the economic data have come in below expectations in the last month."
The recent market gains, I said, were nothing more than a "sugar rush of liquidity" provided by the Fed and that the logic of taking "bad news as good news and good news as even better news" might be misplaced.
In summary, relying on continued stock market gains while ignoring substantive weakness in the U.S. economy is a slippery slope to future economic growth.
At time of publication, Kass and/or his funds held no positions in the stocks mentioned, although holdings can change at any time.
Doug Kass is founder and president of Seabreeze Partners Management, Inc., and the general partner and investment manager of Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd.