Speaking in Chicago on Tuesday, Alan Greenspan was asked to name his two favorite economic indicators.
“Can I expand the two to maybe 400?” he replied.
Few of the most conscientious active investors have the skill or research resources of the former chairman of the Federal Reserve for the job of tracking market-sensitive data.
The trick for active investors is to avoid favorites and pick indicators that are relevant to their investment goals and current circumstances. What worked last year might not work this year.
Two months after the subprime mortgage calamity erupted, the market for debt securities remains on edge, Greenspan told a meeting of the Association for Corporate Growth’s Chicago chapter.
“We’re now in a state of fear, and it’s going to be necessary to work our way through that,” Greenspan said.
A barometer kept by Harris Private Bank of global illiquidity, meaning the difficulty in borrowing or paying off debt, has moved ominously higher in recent days, back to levels not seen since the troubling market period of 2002. The indicator spiked higher in September, receded and jumped higher late last week.
“It wouldn’t mean so much if we think we’re going to get it to abate quickly,” said Jack Ablin, chief investment officer at Harris Private Bank. “We’re not going to go back [to a low reading] very quickly.”
Yet on Tuesday, the Nasdaq 100 index, home of many of the most popular technology stocks, climbed to a multiyear high, streaking past Friday’s Wall Street sell-off. Profit gains by companies such as Google, Intel, Apple and Amazon.com were a pleasant alternative to the mortgage mess.
As we saw Friday, with a 367-point drop in the Dow Jones industrial average, the stock market easily can be spooked by fears in the credit market. But not always.
Most investors are unfamiliar with the dynamics of the credit market. Two things to keep in mind:
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Twenty years ago, the stock market Crash of ’87 was caused by the failure of those creating and selling equity investment instruments to design them correctly. Innovations in assembling and trading baskets of stocks were laudable but woefully immature and flawed.
Today, efforts to provide tradable and diversified instruments for investors in fixed-income portfolios, as opposed to equity portfolios, are in a similarly immature state. The system is working badly.
For example, Greenspan said he expects that one complex invention in the credit markets known as collateralized debt obligations will “fade from view.”
Second, an important difference between stocks and fixed-income investments is the requirement placed on most borrowers to pay cash regularly to holders of their debts. Issuers of stock have no such obligation to shareholders, even if they pay cash dividends.
That’s why Ablin’s barometer and similar measures of liquidity matter these days.
Theodore Koenig, chief executive of Monroe Capital in Chicago, said that outside the arena of home mortgages, the ability of borrowers to handle their debts has not worsened.
Indeed, securities backed by credit card debt, commercial bank loans to businesses and other non-mortgage debt have been losing value mostly because of guilt by association with mortgage-backed securities.
“In other secured markets, they’re not yet seeing an increase in defaults,” Koenig said. “As long as these defaults rates don’t increase, I don’t think they’ll be a spillover effect” from the housing woes.
Liquidity indicators that bear watching include the value of the yen versus the dollar (a higher value is bad news), measures of stock market volatility (the best known is called the VIX index at the Chicago Board Options Exchange) and yield gaps between high-quality and low-quality debt securities (smaller gaps are better than larger).
So do default rates for non-mortgage debt, available from credit rating agencies such as Standard & Poor’s, Moody’s Investors Service and Fitch.
These indicators are probably front and center among Greenspan’s favorite 400.
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