Emerging Economies May Not Save Us

As the US economy, as well as the Canadian and much of the European economies, sinks deeper into recession, many are pointing (maybe partly with great hope) that the emerging markets will bail-out the rest of the world by driving overall demand. Unfortunately, that doesn't seem to be the case with emerging markets not only showing signs of weakness, but showing signs of even more drastic declines than what the developed economies are currently experiencing.

This graph is sourced from Charles Schwab's latest webcast and presents a diffusion index of developed (lower chart) and emerging (upper chart) economic forces. Essentially, a downward sloping line is a bad thing and an upward sloping line is a good thing. What I find most interesting about these charts is the leader-follower dynamic that appears to be taking place. While most analysts and market watchers have been pointing to China and India as possible saviors of the global economy with their fabulous growth rates, it now looks as though the declines in demand from the developed economies is beginning to take its tole on their markets. Moreover, it would appears as though the declines that they are now experiencing are more severe than what the developed economies have seen. 

Inflation appears to be the culprit here. While we've seen low single-digit rates, the developing markets (the blue, in the left-hand chart) are showing near-double-digit rates. More importantly, their pace of inflationary growth (the slope of the line) is noticeably more steep. This is primarily due to wage-pressures. While the US and other developed markets have not seen wages rise, this has not been the case in the developing economies. The rest of the world is facing much greater inflationary pressures than we are at home and this spells great trouble for them in the future. 

So what does this all mean for us at home? Well, put simply, we can't rely on any other economy to help bail us out. We are in a global economy, to be sure, but that economy is by no means uniform. The rest of the world, especially the developing parts of that world, are only beginning to enter their own recessions and everything points to their troubles being worse than anything we will see domestically. On the whole, of course, this suggests a very slow and long recovery. While the developed markets may be better prepared to recover sooner, we are no dependent on emerging markets just as they are dependent on developed markets. As they are likely to sink deeper than we are, their economic pains will most certainly ripple through the rest of the world.

The Interpretation of Polls

CNNMoney is reporting here that their latest opinion polls suggest 3 in four Americans believe that the economy is in recession. Besides the 'duh' factor that goes along with such a headline, I almost laughed when they continued to compare the 75% statistic with the 79% result that they got in a an April poll with the same questions. You guessed it, the article is positive wherein they suggest that the drop of 4% is a good sign of ...something.

Why is this laughable? Well, first off, this is an opinion poll and doesn't actually represent anything about the current state of the economy. Moreover, a drop of 4% in public opinion could be nothing more than an anomaly - especially a differential of only 4%! I do understand that the media is working its spin doctors to turn absolutely every bit of news into a positive headline, but this is getting to be a little ridiculous. Almost every business leader has not only been referring to the current recession as a given, but has gone on to suggest that we're in it for the long haul. 

MBA Interest Surges In Slowing Economy

What are more and more people thinking about as the economy continues to slow? You guessed it, school. The MBA is, of course, at the top of the list for many professionals who are looking to take advantage of the declining opportunities in the marketplace to prepare themselves with a business education - readying themselves for when the rebound come-around.

The MBA Tour, a worldwide tour that brings together between 20 and 25 business schools in one place, at one time, has grown in popularity; attendance was up 30% last year and Peter Von Loesecke, the founder of the Tour and MBA graduate from Cornell's Johnson School, believes that it will continue to grow even more rapidly as the economy worsens. It makes a lot of sense.

A graduate business education, like any other post-grad degree, requires that you take time away from your career and suffer the opportunity cost of that lost income in addition to the, sometimes, staggering tuition costs and related expenses. Clearly, then, the best time at which to take that on is when the opportunity costs are minimized. Whether they realize it yet or not, prospective MBAs are behaving like trained business people already; once they graduate, they'll understand the economics behind their prior motivations.

Bonuses & the U-Shaped Recovery - What to Expect

On the bright side, the job losses on wall street are far less than they were following the dot-com bubble burst earlier this decade. While financial institutions shed about 17% of their forces, those same institutions have only cut about 3% during this latest downturn. Unfortunately, there's a downside to this story.

The downside is that many, if not all, are expecting many more cuts to come. You may have heard people referring to a U-shaped recovery; well, were only still on the left-side, the downward side, of that 'U'. It will essentially be a very slow downward slide that will see an increasing number of jobs lost before we hit the trough of this business cycle. Worst yet, it will be an equally slow climb back up. So, who among us are the most at-risk?

You guessed it; the higher your salary and/or bonus, the more likely you are to get a pink slip. It's no secrete that wages are the #1 expense for financial institutions and they're losing money like a leaky rowboat. To hedge those losses, their first act is to cut their expenses proportionally and the story seems to be that there are many more write-downs to come - more paper losses at these firms necessarily mean more job losses for those working there.

The best thing to do is to stay focused on your long-term career goals. Your career is not your job; it's the union of your experience and education. Losing your job does not represent a loss of your career; it provides you with the opportunity to explore areas that you haven't had the time to review in the past. Use every opportunity to enhance your experience and education and your career will continue to excel.

Credit Spreads As Economic Indicator

Remember the yield curve? Well, to freshen your memory, the yield curve is just the graphical depiction of the relationship between yields (required rates of return) and maturities. So, for example, the curve would tell you the kind of return demanded for their investment dollars when committed for a specific period of time (to maturity) - all else equal. While it might sound like a boring subject, it's actually quite interesting in what it can foretell about expectations for our economy.

Before we get to the credit spreads, you have to also remember that there's not just one yield curve, but many - one for each level of risk determined by investors (and generally based on the ratings issued by the big ratings agencies). The credit spread, therefore, is the vertical distance between two curves - i.e., the difference between the required rate of return demanded by investors in securities of equal maturity, but different levels of risk. Why is this interesting? Well, this difference, referred to as the credit spread, is an indicator of what investor's believe is the relative risk associated with lower-grade investments.

Imagine, for example, that investors believe that we're heading into, or are already in, a recession (I know, I know, how could anyone think that!). If you were such an investor, then  you would likely believe that the lower-grade issuers of these securities were likely to see a slowing in their sales, cash flows and, ultimately, a weakening in their ability to satisfy their obligations to the investors in the securities they issued - yeah, that's you and me. Well, to accept that added risk, you would demand a higher rate of return and this would begin to shift-up the yield curve for securities of similar risk. As that yield curve shifts-up, the spread between it and the safer (investment grade) securities grows.

Ok, so now that you understand the mechanics at work, I'm sure that you can put one-and-one together and see how you can use the yield curve to evaluate what the economy is thinking. If you were to look at the yield curve today, however, you probably wouldn't find what you were expecting. While most people would agree that we're either in, or heading into, a recession, the yield curve doesn't reflect it. With a spread of only 46 basis points, down for a high of almost four times that just a few months ago, we're not seeing the affects of higher commodity costs, rising unemployment and record high foreclosures and bankruptcies. Does this mean that something in the mechanism is broken?

Well, possibly, but there's a silver lining to any dark cloud. Today's yield curve tells us that the average investor hasn't adjusted their expectations to what most others believe is our economic reality. As an investor, this information is golden. As an investor, you should always be looking for information about what will be, but hasn't yet been accounted for by your fellow investors. Doesn't this sound like what we're seeing today? So, the question is, then, what will you do about it? How will you position your portfolio to take advantage of what appears to be an arbitrage opportunity?