By Kevin M. Wilson
The markets have been grinding upward lately, but with low volumes and generally tentative daily price action. Bulls argue now that there will be no US recession, profit margins will shrink a bit (but not that much), and the global economy, although weaker, will turn in a decent performance again this year. Bulls also think the European Debt Crisis has been contained, and in any case the ECB and Federal Reserve are about to print lots of money so that politicians everywhere can keep their jobs. Bears argue now that the European recession, which began in 4Q/2011 (even in Germany), will be deeper than expected and cause damage to economic growth around the world. Also, China’s slowdown will damage world trade; therefore, in light of all this, there will be a global recession and an associated bear market. Bears think at least one Euro-zone member (Greece) will be leaving soon due to default, and that markets will really behave badly for a while as a result of this circumstance.
The support for the bull case is in part that markets have continued to move up, even though earnings and profit margins are now widely expected to fall from record levels. However, the notion that markets are good predictors of economic trends is a bit weak right now, given that the Federal Reserve has been doing everything it can think of to artificially prop markets up with monetary stimulus. Bulls also point to the recent improvement in US unemployment, but fund manager John Hussman (www.hussmanfunds.com) has pointed out that this is a typical trend observation in the three months before the onset of the average recession. Bulls were also very enthusiastic about retail sales over the holidays, but now the data are in, and it turns out retail sales only went up 0.1% in December, and ex-gasoline sales actually fell by 0.2%.
The bear case, meanwhile, is becoming more and more compelling because of deteriorating data in the US, continuing problems in Europe, and new signs of slowing activity in Asia. The OECD Leading Economic Indicator has gone strongly negative, as have the Purchasing Managers’ Manufacturing Indexes for most countries in the Eurozone, suggesting that the recession in Europe will not be a mild one as many expect, but rather a fairly deep one. This is very bad, both because the Eurozone is a major player in world trade, and because the entire EU bailout package for the weak economies in Europe depended on an assumed 2% GDP growth rate. Now however, it looks like EU GDP will drop at least to -1.0%, and maybe lower, which means the new austerity budgets just put in place will cause severe hardship and even worse downward momentum. This afternoon we have news that the French sovereign debt has been downgraded by S & P, which will in turn cause the elaborate structure for the European Financial Stability [“bailout”] Fund (EFSF) to fail in its purpose, since a AAA rating was required for it to work. In the US, the Ceridian-UCLA Pulse of Commerce Index (PCI) has just gone negative, suggesting that Industrial Production (IP) will soon follow, since they are highly correlated. The PCI is an interesting index because it measures the amount of diesel consumption by the US trucking fleet; it has been declining since late 2010.
With respect to market data, stock indexes now appear to be over-valued, over-bullish, and over-bought, suggesting that a correction may be imminent. The AAII bullish sentiment/bearish sentiment surveys are indicating a hard sell signal, technical measures are reaching their highest levels, and earnings season has been replete with profit warnings so far. Nevertheless, the bulls still seem to be in charge. This is best understood by taking human nature into account; thus, when market players are really bullish, they tend to ignore even the most damning evidence against their stance. This generally continues until a moment of profound surprise and fear sets in, when even the most complacent investors and traders notice they are (in effect) in an airplane without a motor. There are signs that the present bullishness could last for a while yet, but if stocks go much higher the bear market that began in May will be over. I have trouble picturing how that can be. This is especially perplexing in the face of global economic deterioration, a potentially major financial crisis in Europe that involves sovereign defaults, rapidly falling US profit margins, overwhelming government debt throughout the developed world, fiscal tightening in most of the same countries, widespread deleveraging and deflationary price trends, and widespread political dysfunction in the West. We are at a major pivot point, after which we will look back and say either, “There in early 2012 is where we lost control of events and suffered another financial crisis and global recession,” or “There is where the major issues were resolved, and a deeper crisis was avoided.” We hope for the latter but we have prepared for the former.
Weekly Comments: Pivot Point for Economy and Markets?
By Kevin M. Wilson
The markets have been grinding upward lately, but with low volumes and generally tentative daily price action. Bulls argue now that there will be no US recession, profit margins will shrink a bit (but not that much), and the global economy, although weaker, will turn in a decent performance again this year. Bulls also think the European Debt Crisis has been contained, and in any case the ECB and Federal Reserve are about to print lots of money so that politicians everywhere can keep their jobs. Bears argue now that the European recession, which began in 4Q/2011 (even in Germany), will be deeper than expected and cause damage to economic growth around the world. Also, China’s slowdown will damage world trade; therefore, in light of all this, there will be a global recession and an associated bear market. Bears think at least one Euro-zone member (Greece) will be leaving soon due to default, and that markets will really behave badly for a while as a result of this circumstance.
The support for the bull case is in part that markets have continued to move up, even though earnings and profit margins are now widely expected to fall from record levels. However, the notion that markets are good predictors of economic trends is a bit weak right now, given that the Federal Reserve has been doing everything it can think of to artificially prop markets up with monetary stimulus. Bulls also point to the recent improvement in US unemployment, but fund manager John Hussman (www.hussmanfunds.com) has pointed out that this is a typical trend observation in the three months before the onset of the average recession. Bulls were also very enthusiastic about retail sales over the holidays, but now the data are in, and it turns out retail sales only went up 0.1% in December, and ex-gasoline sales actually fell by 0.2%.
The bear case, meanwhile, is becoming more and more compelling because of deteriorating data in the US, continuing problems in Europe, and new signs of slowing activity in Asia. The OECD Leading Economic Indicator has gone strongly negative, as have the Purchasing Managers’ Manufacturing Indexes for most countries in the Eurozone, suggesting that the recession in Europe will not be a mild one as many expect, but rather a fairly deep one. This is very bad, both because the Eurozone is a major player in world trade, and because the entire EU bailout package for the weak economies in Europe depended on an assumed 2% GDP growth rate. Now however, it looks like EU GDP will drop at least to -1.0%, and maybe lower, which means the new austerity budgets just put in place will cause severe hardship and even worse downward momentum. This afternoon we have news that the French sovereign debt has been downgraded by S & P, which will in turn cause the elaborate structure for the European Financial Stability [“bailout”] Fund (EFSF) to fail in its purpose, since a AAA rating was required for it to work. In the US, the Ceridian-UCLA Pulse of Commerce Index (PCI) has just gone negative, suggesting that Industrial Production (IP) will soon follow, since they are highly correlated. The PCI is an interesting index because it measures the amount of diesel consumption by the US trucking fleet; it has been declining since late 2010.
With respect to market data, stock indexes now appear to be over-valued, over-bullish, and over-bought, suggesting that a correction may be imminent. The AAII bullish sentiment/bearish sentiment surveys are indicating a hard sell signal, technical measures are reaching their highest levels, and earnings season has been replete with profit warnings so far. Nevertheless, the bulls still seem to be in charge. This is best understood by taking human nature into account; thus, when market players are really bullish, they tend to ignore even the most damning evidence against their stance. This generally continues until a moment of profound surprise and fear sets in, when even the most complacent investors and traders notice they are (in effect) in an airplane without a motor. There are signs that the present bullishness could last for a while yet, but if stocks go much higher the bear market that began in May will be over. I have trouble picturing how that can be. This is especially perplexing in the face of global economic deterioration, a potentially major financial crisis in Europe that involves sovereign defaults, rapidly falling US profit margins, overwhelming government debt throughout the developed world, fiscal tightening in most of the same countries, widespread deleveraging and deflationary price trends, and widespread political dysfunction in the West. We are at a major pivot point, after which we will look back and say either, “There in early 2012 is where we lost control of events and suffered another financial crisis and global recession,” or “There is where the major issues were resolved, and a deeper crisis was avoided.” We hope for the latter but we have prepared for the former.