IT’S MORE THAN JUST A SCARE
The softening in the economy that we have been looking for is now becoming a reality as a wide sampling of the latest monthly or weekly economic releases clearly indicates that a slowdown is now underway. We cite the following.
On the consumer spending front, May retail sales were down 1.1% and anecdotal reports from various retailers indicate that June appears to be weak as well. The labor situation seems to be fragile as private May payrolls were up only 41,000 and weekly initial unemployment claims have been stuck in a range since November. As we previously pointed out, housing has probably started a renewed downturn. The Mortgage Bankers’ Association pending purchase applications index has dropped 40% since the ending of the homebuyer tax credit on April 30th. This is the best leading indicator of future home sales. Monthly new home sales were down 32% to at least a 40-year low, while existing home sales declined 2%, housing starts 10% and building permits 6%. The ISM manufacturing index dropped last month, and current regional Fed indexes from New York, Philadelphia, Richmond and Kansas City indicate continued weakness.
The widespread current declines are supported by evidence from ISI’s weekly company surveys. Their overall index peaked in April and has since been trending down. On an industry basis the ISI retail survey dropped 4.8% last week and 20% since the April peak. The homebuilders’ survey is at a 4-month low, while the employment survey dropped 3.1% last week and 7% from the recent peak. The transportation survey declined the last four weeks. Semi equipment orders grew only one percent in the latest month, compared to an average of 13.5% over the prior five months.
Generally the indictors showing the most weakness are those that lead the economy—housing, initial claims and consumer spending. This is consistent with the ECRI weekly leading indicator where the latest smoothed growth rate is minus 5.7%, a level that has led the last seven recessions and been wrong only once.
For some time we have believed that the economic recovery was unsustainable as it was supported mainly by government transfer payments and lacked the usual impetus that normal recoveries get from housing, consumer spending and easy credit. Moreover it has been our view that both domestic and global debt was far too high and that the necessary deleveraging would lead to slow growth and more frequent recessions.
For those reasons we believe that current investor concern is fully justified. The market, at current levels is discounting a far stronger economy than is likely to develop in the period ahead. Even if the economy does not undergo a double dip, a slowdown in GDP to 1 or 2% would have highly negative consequences for housing, employment, consumer spending, financial company balance sheets and corporate earnings that is not currently discounted in the market.
Indeed the market technically appears to have formed a potential top in the last few months with a range in the S&P 500 of 1219 on the upside and 1040 on the downside. The last rally stopped at 1131 and appears headed for a test at 1040. Although another rally is still possible, we think that further deterioration in economic growth—-which we expect—-will drive the market well below the 1040 level, and that an eventual test of the March 2009 lows are not out of the question.
My concern with the market at these levels is the amount of bearishness as illustrated in articles like this. In fact, it’s getting harder and harder to find anyone who is strongly bullish. There’s an awful lot of crash talk being thrown about and indeed, when you read sites like Business Insider or Zero Hedge, we’re reaching the level of “crash porn.” From a pure contrarian point of view, I wonder will the market be so accommodating as to do what everyone expects?
We may indeed be topping out, but I think it could go on for some time before we see any strong roll over in the indices.
“Crash porn” permeated through the rallies of the past two weeks as well. Initial unemployment claims up? Rally time! Housing starts down? Bring out the rally monkey!
I wouldn’t rely on blogs to gauge sentiment. I did a quick study a few months back on this and found that blogs (even the most well rounded ones) are generally bearish. Bearish stories are attention catching so they “sell” better. Investors are generally worried about what might trip them up so they’re always nervous and concerned. It’s where the wall of worry comes from.
Anyhow, I personally think blogs tend to tilt towards the bearish side (I know I tend to focus a bit more on the negative than the positive) so it’s not necessarily a great gauge in my opinion. Besides, in this sort of deflationary recession negativity is like a snowball. If you look at sentiment readings in Japan in the 90′s they just went straight downhill. Deflation can compound and make people feel hopeless. It could happen here….
Thank you John Mc!!
My point exactly. We have been getting horrible horrible news and everyone is down. And yet the snp is hovering near 1100.
Owning stocks/commodities is better wealth preservation in this environment, jmho.
“Deflation can compound and make people feel hopeless. It could happen here….” TPC
Let’s hope not. The solution is obvious from both a moral and practical perspective, IMO.
the wall of worry is being put in place. I’m holding out on a rollover in housing until we have a couple more months of data, as the tax credit IMO stole some forward demand. It’s also interesting that nobody has been talking about record low mortgage rates. 3.09% 10 yr. vs. 8% earnings yields, 30-40% dividend payout…seems like many stocks are cheap (and perhaps getting cheaper).
Interesting times.
I’ll beg to differ on your “8% earnings yield”
Are you suggesting that we’ll really see $90/eps for the S&P500 (12x PE)?
Further, the historical equity risk premium (~4%) should likely be higher in today’s environment with slow growth and high earnings and market volatility.
Seems like the real question being asked is “is it different this time”
Seems to me that sentiment indicators like many of the metrics the market participants have been trained to use to determine the future direction of the rates/earnings/price over the past 80 years are being applied within an environment where no one currently alive has any experience working within.
Prognosticators utilize what they know. It seems that common sense, knowing that lessons you were observed growing up where actions have consequences apply to adult life and that practical observation of conditions in adult life should be enough. Statistics on correlations and rates of change are less realible than simply talking with people within your immediate neighborhood, friends around the country/world and observing events and reactions. This should be enough information to formulate an opinion of current conditions and the probable outcome of future events where market prognosticator like Russell, Prechter, Soros or the many legions of bullish analysts from Blackwell, Morgan Stanley, Goldman Sachs create noise and are no better predictors than your gut instinct.
Dear Comstock partners- As smart as you, maybe it all boils down to there is a cloud of worry over the American people as to what and who is running this country. We see a poorly written health care bill, a banking bill with no reform for FNM and FRE),the root cause of the melt down,a voter public very concerned as to how socialist a President we have, who end runs the Congress and Senate and mostly is concerned with his image and not what is good for this country. Bully politics at its best and yes a cloud over this country that make people pull back and may well cause a double dip. Hope not but as I write this there are news stories that the President will force immigration down our throats thru Executive Order-How Shameful…
Yes this is why Americans are anxious and not financially engaged. So you know, I am an American first over a political party.
Thanks for your time…
I have to question the judgement of anyone who gives substantial weight to home sales as the basis for their views on the direction of the economy. Anyone who thinks home sales will be anywhere near normal in less than 5 years is a bit delusional. It’s obvious that we have an enormous oversupply of homes in this country and it will take years of population increases, a much lower dollar, another huge correction in prices, or massive bulldozing to get us there. When the dollar was lower Europeans and Asians were coming in to buy, but I think that has dried up to a large degree, it could happen again though. The glut didn’t come from owner occupied homes, it came from companies and individuals buying investment properties. I don’t think we ever had enough people to live in all the homes we have. Until people see real estate as a worthwile investment again, it won’t move much. Home sales and prices were up in many states this month, including MA and CA, which was up for the 3rd straight month. Anyone expecting more than a rough slow climb out of the housing hole should think again.
What I see happening in the market and the economy is that last July, when it looked like we might have a robust recovery due to restocking of inventories, themarket rallied for 6 months. Now that everyone realizes it won’t be so robust, the markets have corrected and now we will go back to real fundamentals, judging individual companies on earnings as we slowly move on through this recovery. Everything points to slow growth, nothing has really turned negative; retail sales, transports, manufacturing, etc. Unless something major happens, like a war with Iran, which is becoming ever more likely, we’ll continue flat to up as we make our way through. Sadly the big rally may be over and this is the “new normal.”