THE ARTIFICIAL RECOVERY?
Friday’s GDP report confirmed a trend that has been persistent across the entire economy: there are few signs of sustainable economic growth. There’s no question that the economy has improved substantially since the 3rd quarter of 2008, but the quality of the recovery has grown increasingly questionable. The GDP figure was largely driven by government spending as opposed to improvement in the economy’s primary driver – the U.S. consumer. In addition to the GDP figure we continue to see conflicting signs in the real economy. In particular, revenues continue to lag and the consumer data continues to be weak. In order for a long-term recovery to develop these trends will need to change.
The most recent GDP results were boosted 3% from government spending. Most of this did not come from the stimulus package, however:
most of that increase came from the defense sector, not the nondefense sectors targeted by the American Recovery and Reinvestment Act. Defense spending grew at a 13.3% annual rate, in part a rebound from a 4.3 first quarter contraction. Nondefense spending grew at a 6% annual rate, contributing 0.15 percentage points to overall growth. The economy can use all of the help it can get, but it’s too soon to declare that federal spending is effectively making its way into the system.
Clusterstock had an excellent chart showing the impact of the recent government spending on the GDP:
Government spending is by no means a bad sign, but an organic and sustainable recovery cannot develop without strength in other components of the economy. Unfortunately, there are few signs of strength outside of government spending. The real source of long-term economic growth, the U.S. consumer, continues to show signs of extreme weakness:
On the employment front the U.S. economy is expected to have lost another 300,000 jobs in July – a staggering statistic this deep into a recession.
Many of the same weak underlying fundamentals are apparent in the Chinese stimulus plan as well. Many people have attributed the sharp global economic rebound to China’s stimulus, but the risks in the plan have become increasingly high. Royal Bank of Scotland economist Ben Simpfendorfer said:
“The risk is that the government, in chasing in an 8 per cent growth target, is relying too heavily on public investment and private residential investment to spur growth, rather than pushing ahead with the type of late-1990s structural reforms that will put the economy back on a high-single digit and, more importantly, sustainable growth trajectory.”
In a recent Barrons article Arjun Divecha, portfolio manager at GMO also believes the Chinese stimulus is largely artificial:
“I believe a lot of the money is not going into productive investment. What we are hearing anecdotally is that a lot is being lent by the banks, which remember, are government-owned. Who are they lending to? For the most part, this money is going to state-owned enterprises, which are not particularly efficient companies.
We know they are buying real estate, and they are doing all kinds of things we don’t think in the long run is particularly productive investment.
Two things are likely to happen. First, longer term, if the banks don’t have a problem with bad loans now, they will almost certainly have a lot more bad loans two or three years from now. Second, from a short term point of view, at some point the government is going to get really worried about having too much credit-creation; that leads to a credit bubble, just like you had in this country and everywhere else. As a result, they will start to withdraw liquidity by tightening the gates on the money. I don’t know when that will be. But I worry that it is coming.
A fair amount of the stimulus money has found its way into the real estate and stock markets because China has a closed economy. So there is no way for money to leave the country. The stock market and real estate have had huge spikes. So when that liquidity is withdrawn, it seems inevitable that the stock market will take it badly.”
In May, Stratfor released a detailed report that says the long-term structural changes of the Chinese stimulus will be very beneficial, but also expresses some concerns:
- This is not a stimulus program designed to restart the economy in the short run. Good stimulus packages are very front-loaded so that they can shock the system with immediate demand. China’s plan is in actuality a five-year plan designed to help develop the country’s poor interior provinces largely by building infrastructure.
- It is not actually $586 billion in cash. Only $146 billion — about one-fourth — of the program will be funded by the national government, and this will take the form of construction bonds. The remaining $440 billion will be up to the regional governments to raise. This will be a neat trick since until very recently — and by this we mean that the idea was only even floated in March — regional governments had no authority (much less experience) in issuing their own bonds.
- The Chinese government is not particularly convinced that the package will work. If Beijing were convinced, it would be tapping at least some of its roughly $2 trillion in currency reserves (its own money), rather than going through the more drawn-out process of dozens of bond issuances (getting access to other people’s money).
The Chinese government itself is growing increasingly concerned about the impact of the stimulus package:
But while investors expect the market — up more than 80 percent this year — to keep rising, Chinese leaders are alarmed. They worry that too much of the $1 trillion lending binge by state banks that paid for China’s nascent revival was diverted into stocks and real estate, raising the danger of a boom and bust cycle and higher inflation less than two years after an earlier stock market bubble burst.
Beijing is trying to tighten credit controls without derailing the economic revival or causing a market crash — a risky path at a time when Chinese leaders say a recovery is not firmly established.
“It’s a very serious threat. The Chinese government is walking a tightrope,” said Mark Williams, Asia economist for Capital Economics in London. “There is the question of what happens if they rein in lending, because there is really no strong evidence that private sector demand is picking up.”
Recent economic data and the stimulus driven recovery isn’t the only place where we’ve been seeing artificially driven signs of recovery. This has been nowhere more apparent than in recent earnings reports. We’ve recently detailed the significant cost cutting that has led to the “better than expected” earnings this quarter. Despite the fact that 70% of all companies are beating earnings, revenues are still declining 15% year over year. The underlying driver of real organic corporate growth is still extremely weak. At some point in the next quarter or two we will need to see real underlying revenue growth or investors will likely grow increasingly concerned about the real underlying strength of the economic recovery.
One of the primary sources of optimism has been the housing market. We have been seeing very strong seasonal strength in housing, however and Mark Hanson at Field Check Group is quick to point out that these are more than likely weeds as opposed to green shoots:
But the season ends now. Every year, organic sales fall off of a cliff beginning in August primarily because kids go back to school in Sept. If organic sales follow typical seasonality trends lower again this year and foreclosure-related resales stay the same or rise (no reason they shouldn’t), then the average and median prices will be pulled quickly back towards the distressed market price.
Mark Zandi at Moody’s reports that the stimulus driven economic recovery is not over yet:
The moment of truth is at hand for the U.S. fiscal stimulus plan. The stimulus that became law in February should reach its point of maximum economic benefit this summer. If the plan is working, retailing will improve soon, and businesses should respond by curtailing layoffs measurably. Early results suggest the stimulus is performing close to expectations, but policymakers should be prepared to provide more help to the economy if things don’t work as expected in coming months.
The government has only infused about $50B of the total they plan to spend:
Accounting for these lags, the maximum contribution from the stimulus should occur in the second and third quarters of this year, when it will add more than 3 percentage points to annualized real GDP. This suggests that if policymakers had not been able to pass a stimulus plan, real GDP would have declined nearly 6% in the second quarter and by more than 3% in the third. With the stimulus, GDP is expected to fall close to 3% in the second quarter and rise a bit in the third. The contribution of stimulus to growth fades quickly, adding just over 1 percentage point to annualized growth in the fourth quarter of this year and the first quarter of 2010 and actually detracting from GDP growth by the second half of 2010. The impact on jobs and unemployment is also significant, as the stimulus results in approximately 2.5 million more jobs by the end of 2010 than would have been the case without it, and leaves the unemployment rate almost 2 percentage points lower.
Despite the upcoming stimulus boost, Zandi is still skeptical of continued economic strength in 2010:
Risks to this sanguine script are skewed to the downside. Odds remain uncomfortably high that the economy will enjoy a bounce from the increased stimulus this summer but then fade with the waning stimulus by the summer of 2010. This scenario is more likely if the administration’s foreclosure mitigation efforts don’t quickly begin to reap benefits. Without a measurable increase in mortgage loan modifications, foreclosures will continue to surge, further undermining house prices, housing wealth, the financial system, and the economy’s prospects for a sustainable recovery.
Prepare for the worst
Policymakers should thus be quietly preparing another round of fiscal stimulus for early 2010. Effective additional stimulus might include more help to state and local governments, whose budget problems will probably be even worse next year; an expanded housing tax credit to address the foreclosure crisis; and a payroll tax holiday. Delaying increases in marginal personal tax rates, now legislated to occur at the start of 2011, would likely also make sense. Higher-income households may begin to rein in spending in 2010 as they prepare for the higher tax rates.
It is premature for policymakers to publicly consider all this now; the current stimulus should be given a chance, and the nation’s long-term fiscal challenges are daunting. But if the Great Recession has taught us anything, it is to prepare for the worst.
“Prepare for the worst” is good advice. While the stimulus driven recovery is likely to continue into the end of the year there are mounting signs that the underlying quality of the recovery is poor and the sustainability of the poor fundamentals are unlikely to provide above trend growth any time soon.
Great work TPC
Good stuff TPC– If one wants to see improvement in Employment/Economy/GDP—one must Rebuild/Grow a sustainable Manufacturing Base–does anyone see this ?? The stimulus plans DO NOT build this sustainable Base. The Chinese are building a manufacturing base to expand/grow their economy– and they have plenty of consumers to sustain that base–In the future they WILL NOT need the US consumer to maintain their economy. Does anyone see Rome burning?
The GDP report is another attempt at the (BBD) “Blame Bush Doctrine”
Revisions in the method put the worst GDP declines in 2008–surprise–surprise.
Now if we could only find away to put all this unemployment in 2008–??
Does this give you confidence in the solutions of this administration?
Let me be clear–Rebuilding the manufacturing base –means expanding what we have PLUS- building New Manufacturing Industries–of course you will get a seasonal blip at this time of year– in expectation of the holiday season and some restocking –so far not that big of a blip
It is hard to resist the bullish tone, past 1,000 just like a rocket ship. Will seasonality late August, September be different? There needs to be a catalyst, perhaps China will pull back.
I get goose bumps all over reading this
PERFORMANCE BY INDUSTRY
Six of the 18 manufacturing industries reported growth in July. These industries — listed in order — are: Nonmetallic Mineral Products; Paper Products; Printing & Related Support Activities; Electrical Equipment, Appliances & Components; Transportation Equipment; and Chemical Products.
The 10 industries reporting contraction in July — listed in order — are: Machinery; Plastics & Rubber Products; Wood Products; Textile Mills; Miscellaneous Manufacturing; Furniture & Related Products; Computer & Electronic Products; Food, Beverage & Tobacco Products; Fabricated Metal Products; and Primary Metals.
WHAT RESPONDENTS ARE SAYING …
“[There is concern about] overall health of strategic suppliers — continue to see new suppliers filing Chapter 7 or 11, posing significant risk to supply chain.” (Machinery)
“We believe our inventories are now at the bottom of this cycle, driving stronger demand for raw materials.” (Paper Products)
“While our aftermarket business has improved slightly, we are still awaiting an increase in OEM demand.” (Transportation Equipment)
“No stimulus for manufacturing.” (Fabricated Metal Products)
“Looking at another round of shutdowns to align supply with projected demands.” (Nonmetallic Mineral Products)
MANUFACTURING AT A GLANCE
JULY 2009
Index July June
% % Change Direction Rate of Change Trend (Months)
PMI 48.9 44.8 +4.1 Contracting Slower 18
New Orders 55.3 49.2 +6.1 Growing From Contracting 1
Production 57.9 52.5 +5.4 Growing Faster 2
Employment 45.6 40.7 +4.9 Contracting Slower 12
Supplier Deliveries 52.0 50.6 +1.4 Slowing Faster 2
Inventories 33.5 30.8 +2.7 Contracting Slower 39
Customers’ Inventories 42.5 43.5 -1.0 Too Low Faster 4
Prices 55.0 50.0 +5.0 Increasing From Unchanged 1
Backlog of Orders 50.0 47.5 +2.5 Unchanged From Contracting 1
Exports 50.5 49.5 +1.0 Growing From Contracting 1
Imports 50.0 46.0 +4.0 Unchanged From Contracting 1
OVERALL ECONOMY MFG Sector :
Growing Faster 3
Contracting Slower 18
A lot of the pessimistic views are coming from excessive staring in the rear-view mirror, as was the case with the overly bullish views that dominated the peak.
Looking at the real dollar GDP figures, consumption has basically flattened, while business investment is extremely low and inventories are being burned off. Unless things completely fall of a cliff, this situation is begging for a bounce.
The question to ask at this juncture is whether the consumers who still have jobs will start spending, preferably in Q3 or Q4. I say that they will begin spending once their fear burns off and confidence returns. Since their fear comes from the risk of unemployment, falling housing prices and eroded retirement accounts, a stabilization of unemployment combined with the recent cyclical bull should increase confidence, which will increase spending.
Meanwhile, employers that are hanging in can’t cut too many more bodies, given the severity of the cuts that they’ve already made, which means that any additional consumption should result in some downtick in the unemployment rate, the news of which will feed confidence. Consumers have built up savings in recent months that can be converted into consumption, and the cycle gets its bounce.
That being said, that news is not necessarily great for stocks. If you believe that the market has already priced in most of the recovery (you can include me in that camp), then we may well see a short-term surge in stock prices that helps to set a sloppy trading range but that isn’t necessarily followed by an extended true bull market, particularly as interest rates begin to rise from their historic lows, which in turn should make bonds appear to be more attractive. It is quite possible that we will have decent GDP growth and sloppy stock prices simultaneously, and I wouldn’t try to correlate the two too closely.
If one wants to see improvement in Employment/Economy/GDP—one must Rebuild/Grow a sustainable Manufacturing Base
No, we really don’t. That is not a requirement for near-term GDP growth, and if that’s what you’re watching as a leading economic indicator, then the rebound will pay you right by.
In the short run, recovery will come from consumers consuming and businesses replenishing inventories, and a lot of that will come from the form of imports that make consumption affordable when it otherwise wouldn’t be if the products were built domestically. The US does need to address its excessive fondness for imports over the long run, but that has nothing to do with markets in the short run.
MBA,
Sounds like you’re quite optimistic, huh?
Optimistic for stocks? Not really. If the Dow hits 10k or so over the next year or so and then levels out, I don’t see how that would be particularly bullish.
There isn’t much bargain hunting to be done right now in equities, in my opinion. But that doesn’t mean that things are going to collapse. We may be in for a period of sloppy trading, in which the swing traders make money and the buy-and-hold types underperform.
We should separate economic growth from stock performance. They don’t neatly correlate, as far as I can tell. Stocks generally rise after recessions, but the degree to which they rise varies, and those rallies can fall apart well below the subsequent downturn.
On the economic front, the world isn’t ending and things are stabilizing. It’s still rocky, so there is a possibility of some technical series of events that could pull the rug out, but it’s hard to completely dismiss the light at the end of the tunnel. Things bottom when they stop getting worse, not when they’re fully back to normal. Those who are awaiting the return of Dow 14,000, <5% unemployment and $500,000 houses in the ghetto may be waiting awhile…
MBA,
That seems pretty reasonable. Not too far off from my own thinking I guess. We’ve no doubt stabilized, but the idea of above trend growth is still laughable in my opinion.
TPC,
I would like to get your thoughts on the TARP payback from the big banks and large regionals regarding something that has been bothering me greatly of late.
Back in the meltdown stage, the banks rec’d cash infusions from the Treasury and this cash came with strings attached regarding compensation.
Since then, the banks have been on a tear since March and just recently GS, BBT, JPM, and others except BAC and C have extracted themselves from the grip of Uncle Sam.
Do you think I am thinking to much to conclude that the bankers having saved themselves from insolvency early last year and now free from Treasury control, have created the perfect last gigantic screw-over of the American people since they managed to paythemselves handsomely their “rightful” compensation all in coordination with the ex-Goldman crew now at Treasury only to later, maybe the 3rd QTR, cry again to Congress and the American people in hopes of getting another bailout post the gigantic fakeout of the past few months.
In other words, did all transpire just some bankers could pay themselves handsomely only for the carnage to resume again after they get paid the big bucks.
Wondering,
CTC
Mmmm, MBA…
I see the fear, confidence, consumption, unemployment scenario playing out over a considerably longer time frame. My opinion is not so much based on data as my finger in the wind with an eye toward big historical cycles and what I view as a wide array of potential trigger events.
Things may not be broke irreparably, but consumer trends from recent decades may not be the best guide, imo. I suspect another ‘Doh!’ moment not too far in the future, over the next 12 months, perhaps.
from Howard Silverbatt’s report (with 337 issues reporting as of 7/31/09):
The real situation is much worse than it appears on the surface.
Based on the same companies, actual weighted operating earnings are -1.7% BEHIND estimates and -36.8% lower than Q208. (In Q1 operating earnings were down 39% vs PY) Sales -15.6% under Q208. (In Q109 sales were down 10% vs PY).
Nonetheless changes to the index (removal of GM, etc) will result in the operating earnings shown to be down by much less. The issues included in the operating earnings per share for the index has changed so much.
Earnings were -29% lower in Q2 2008 than Q2 2007. They are now again -36.8% lower in Q2 2009 than in Q2 2008. That means earnings are down -55% versus Q207.
He also says that the lack of write-offs, impairments, layoffs and write-downs has helped and is a positive sign, but sales remain key as you can just cut costs so much for so long.
I wonder since there were very vew write-offs in Q2 2008 and many financials showed better GAAP than operating earnings this quarter, if write-off have been delayed and will show up in future quarters.
Also according to Howard Silverblatt:
Only 40.8% of companies beat their estimates, with 25.7% beating last years EPS and 16.4% beating both. That is quite a different story than is continually reported.
http://www2.standardandpoors.com/spf/xls/index/SP500EPSEST.XLS
Thanks Rob. Good stuff as always.
CTC – there is no doubt the banks took advantage of the taxpayer. Unfortunately, we live in a system where the banks are so intertwined in DC’s workings that the government caters to them whenever they need it. The bankers scared everyone into thinking that this problem could be solved if we gave them cash when in reality the problems exist with the U.S. consumer. There is no doubt in my mind that we have simply kicked the can down the road. We have fixed none of the structural problems that got us into this mess. We might experience a 2003 type recovery, but the problems with consumers and housing will resurface once the massive government aid wears off.
My opinion is not so much based on data as my finger in the wind with an eye toward big historical cycles and what I view as a wide array of potential trigger events.
This is a much longer downturn than normal. If you want to rely primarily on cycles, then a recovery should have already started.
Earnings were -29% lower in Q2 2008 than Q2 2007. They are now again -36.8% lower in Q2 2009 than in Q2 2008. That means earnings are down -55% versus Q207.
Year-on-year comparisons get people into serious trouble at the top and then cause them to miss the bottom. We could take the same point and, with a bit of rearrangement, make a similar observation with respect to the year that the Dow peaked at 14,000:
Earnings were 10% higher in Q2 2006 than Q2 2005. They are now again 8.8% higher in Q2 2007 than in Q2 2006. That means earnings are up +19.6% versus Q205.
Obviously, making this sort of year-on-year earnings comparison is exactly what helps investors to miss the tops until long after the fact. They missed the top because they kept looking backward, causing them to drive at high speed straight into it. Those who got stuck wouldn’t have seen the inflection points by looking two years back, and those who could see things peaking would have seen them by forecasting future developments, not by making comparisons to a different portion of the trend line.
Stock prices are based upon future expected performance. The issue isn’t with 2007 earnings and how they compare, so much with what can be reasonably expected in Q3 and Q4 given the present circumstances.
Rob and/or TPC or others,
I have an ignorant question, but when do earnings become ‘official’ and get incorporated into the P/E that is reported on market websites? And why does the P/E vary when you look up the same stock on Morningstar, Yahoo, Bloomberg, Ameritrade account, etc? (I don’t mean what is difference between trailing vs. forward PE, but what seems like should be the exact same measure. Is it just a matter of how often they update the data based on price fluctuation – if so, shouldn’t that frequency information be clearly indicated?)
Rob, regarding the earnings information that you so graciously provide (thanks!), when would the information from Silverbatt begin to register with more investors? Related to my first question, is there an official report (from S&P?) that would revise earnings downward and make everybody (or less in the loop investors) go “oh crap!”
Thank you!
Matty
MBA,
“This is a much longer downturn than normal. If you want to rely primarily on cycles, then a recovery should have already started.”
I was thinking of cycles of longer duration – and I am aware that I am probably on shaky ground. “history can only be lived forward, and understood backward” or something like that, maybe the aphorism applies to an individual life…
In any case, I’m thinking about big secular shifts (recently begun in ~2000?)when stocks trade sideways or down for extended periods, debt cycles, generational cycles, failing hegemony, stuff like that. I readily acknowledge that I eat that stuff up and organize it around my own biases. That’s part of why I am so keen to learn from folks like TPC who I think are good at forming actionable, near-term forecasts in order to make prudent investment decisions. i.e. I missed out on the bulk of the runup this spring and summer because I was spooked by my long-term bias that we have a lot of imbalances to work through nationally and globally. That’s where I’m coming from…
m
Angry MBA,
I guess my point was missed. The point is the earnings did not improve quite as much as all the excitement over better than expected earnings would suggest and sales growth was very low.
Overall earnings still remain depressed even after a large amount of cost cutting which has increased unemployment to 9.5% and U6 unemployment to 16.5% none of which includes employees on furlow several days each month without pay.
The sales figures are misleading. Sales are down 15.6% in Q2 versus being down only 12% in Q1. For Q2 if you take energy companies out of the mix, then sales are down 10% versus prior year and if you also back out materials sales are down 8% versus PY). For Q1, without energy and materials sales were only down -6% versus PY.
That means that in Q2, excluding the effect of commodities, sales are down -8% versus PY, wheras in Q1 they were only down -6% in Q1. There is a seasonal effect on sales so in someways a same quarter prior year comparison in necessary. Ex energy and materials, there appears to be continued deterioration.
If we compare Q2 2009 to Q1 2009, aggregate sales are only up up 3% based on the companies reporting so far. If you take out energy, sales are up all of 1.5% and if back out materials, then sales are up all of 1.3%.
Overall considering seasonal factors and excluding the rising price of oil and other commodities, it looks like sales are down or maybe just flat versus Q1.
By sector, industrials were down -9% vs PY in Q1 and are down -15% vs PY in Q2. (Looks like quarter on quarter deterioration.) Consumer discretionary was down -17% in Q1 and is down -18% in Q2. (Slight deterioration). Consumer staples are down -2% in both quarters. Tech seems to have mildly improved, being down -13% in Q1 and -11% in Q2.
Notably utility sales were down -5% in Q1 and are down -12% in Q2. Significant reduction. (Also Q2 versus Q1 2009 is down -16%.) Not sure how much maybe commodity price pass-through. (Electric usage goes hand-in-hand with economic activity. It is used as a check on the GDP numbers coming from places like China wheras statistics are even more manipulated than in the US.)
I completely agree that the year-over-year comparisons are backward looking but they do provide prospective on the magnitude of the decline, as well as the magnitude of growth. The quarter on quarter changes provide a sanity check for how much progress is currently being made. As we saw in the GDP report the primarily thing holding up growth is government spending.
I did forsee the magnitude housing crisis and sold most all of my stock in mid to late 2007. I bought tentitively in March, but I clearly misjudged the extent to which the markets would rally without any sizable correction. (So far I avoided a large loss, but also largely missed a potentially big opportunity.)
My concern is that the markets have overshot the extent of economic progress which will be made this year. World trade has declined dramatically. Will it really spring back or are we now stabilized at a lower level. Large export economies (Japan, Germany) are springing back a bit but from a very depressed level. China’s rebound seems to be more government stimulus than export driven. Rail and port shipments remain at depressed levels and show few signs of rebounding (current July statistics).
What is an investor to do now? How much upside potential versus downside risk in the near-, mid- and long-term? To me it seems that the risks are substantial in both directions. Momentum could drive the S&P 500 up to 1,200 although expectations seem to be for the mid 1000s probably followed by a correction. On the other hand, unexpected deterioration in economic news could potentially trigger a sharp pullback which could feed on itself by investors wanting to lock in recent gains.
The markets seem to be quite manic-depressive. Three weeks ago all talk was of a re-test based on less than great economic news and technical levels, now all talk is of how high we can go based on better than expected earnings and technical levels. (Per Howard Silverblatt the overall the earnings were actually a bit below expectations and only 41% beat estimates, although I have only seen the statistic 70% beat reported.)
I think that effect of mass unemployment has not begun to hit yet and may be very under-appreciated. Certainly a big wave of foreclosed homes will be hitting the market in coming months after delays, modification attempts, large number of vacant homes being held off the market and new unemployment driven foreclosures. Is the potential for unexpected negative news priced into the market? How quick of a recovery is priced into the market at this point? Judging on the progress from Q1 to Q2 we are at stabilization but recovery is yet to be seen.
Might there also be a risk that instead of the expected inventory building upswing that is universally expected we may see a Q3 which is still flat overall. Inventory to sales levels STILL remain very elevated overall.
Q2 was very light on write-offs. Maybe we will see in increase later this year. Last year write-offs were low in both Q1 and Q2 (following large write-offs in Q4 2007, but then increased dramatically into Q3 and the kitchen sink quarter of Q4. (Did Q408 and Q109 really account for all losses that will be seen over the coming quarters?)
The point is the earnings did not improve quite as much as all the excitement over better than expected earnings would suggest and sales growth was very low.
In my view, the earnings surprises were a matter of setting low expectations. (The analysts look better undershooting than overshooting — it’s much safer these days to be pessimistic.) Consider that a technical gift that should have encouraged you to be long for the short-term. (I agreed with TPC’s prior neutral-to-protected-bull stance; I think that he was a bit premature with the more recent move to all-cash, but I can’t fault his motivation for taking profits, given all of the tops that we’re hitting at this moment. A technical minor correction could start any day now.)
But again, I see the earnings discussion as rearward-looking. We were looking to Q2 to see whether companies could reshuffle things around to survive and convert their employment cutbacks into something positive, and they did so quite nicely. The fact that their earnings came largely from cost reductions is not a surprise, but from our perspective, this quarter should have been a test to see whether things were so bad that the businesses would just fail or implode, not whether they were going to rebound with full revenue growth, the latter being wholly unrealistic. It’s obvious that things are awful compared to 2008 and 2007, but we knew that going into this and should have already priced it accordingly.
The forward looking question concerns Q3 and/or Q4 revenue. Since we know that companies are now well positioned to turn revenue growth into earnings — that’s the essential lesson of Q2 — the questions to divine are (a) whether consumers will spend more, and if so, in which sectors, (b) which companies are managed well enough to take advantage of that spending and (c) what the leading economic indicators will do and how those changes will impact the mood.
If you want to compare current U-6 unemployment levels to when the recession started, then about 90% of the workforce that was fully employed then is still employed now. The question is basically centered around this 90%. If the pre-recession group was responsible for most of the consumer’s 70% of previous GDP, then this fully employed group produced about 2% of GDP.
The challenge is for the 90% that remains standing to do some spending so that they can produce something that gets us closer to 1+% growth. If they do, businesses will respond with hiring and production, and the way out will be much clearer (and stocks probably quite overpriced.)
In real terms, consumption was plateauing during Q2 while consumers simultaneously saved money. You can see that savings as an indication of ongoing hoarding or else view it as pent-up consumption. If this were Japan, I’d vote for hoarding, but as this is the US, I see pent-up consumption. Housing inventories are declining, and conditions are being created for spending. Perhaps the mood will permanently downshift, but I seriously doubt it and wouldn’t bet too heavily on that.
The markets seem to be quite manic-depressive.
I agree with that. It has been a trader’s market for some time, and remains so.
like fundamentals matter? listen up all… MR Big Government wants to instill confidence, so it tells the big boys to run it up and we shall help, by hyping, promoting, and spewing any verbal diareah you deem appropriate, just tell us how to dribble out the green shoot news….like managing the banks stress tests…and have each one come out about a day or two apart, reiterating that they are strong, gonna beat earnings and gonna repay the tarp….
then, ramp ramp ramp it up
cause a flush consumer is a happy consumer
this house of cards is nothing but that
no semblence of mkt action correlated to the economy
6 million poor joes outa work and increasing…..
the inmates are running the asylum so bet with them until the balloon is pricked
me…? i stay all cash….
enjoy the scam
E,
The problem is that ultimately that cash may really be trash. There has been a strong tug of war over the past 2 years between the necessary deleveraging which favors cash AND attempts to reflate asset prices, which especially to the extent that the Fed actually monetizes the new Federal debt will devalue that cash.
The US Fed is one of the best bubble blowers the world has ever know. This year they also rounded up their buddies at central banks around the world to help blow which had helped stabilize the dollar against other currencies. I think that they have decided to back off on buying Treasuries, which is a good thing. Although they are still hell bent on supporting still elevated home prices by buying mortgage backed securities.
Compared to late 2007 when the Fed started blowing hard again, cash (and its buddy US treasuries) are still (for now) ahead over most other asset classes from Chinese stocks to oil. One notable exception is gold (which some people consider to be real money). Since 2007, assets zoomed up and crashed, but so far this year cash and treasuries are once again losing ground fast. Gold is more or less holding steady. The unfortunate thing with gold is that it formed one of the bigger bubbles the world has seen in 1980.
If you believe the US government’s CPI figures, which you must if you invest in TIPS, then gold’s current value should be somewhere between $250 and $350. If you don’t believe the CPI figures then take gold at the 1955 price of $35.15 and adjust by the change in mean income for year-round male workers (increase from $4.6K to $61.3K) and gold might be worth $465 based on increased purchasing power, but that doesn’t discount productivity improvements.
Gold’s price was $20.67 from 1880 until the US the devalued the dollar versus gold in 1933. Adjusted to today’s dollars using the CPI gold cost $265 in 1922, $261 in 1929, $267 in 1930, $293 in 1931 and $325 in 1932. Moving forward to 1955, gold cost $35.15 or $282 today’s dollars. In 1965, $35.50 or $243 in today’s dollars. In 1972, gold cost $63.84 or $328. Then the bubble based on inflation fears formed by 1980 gold cost $595 or $1,550 in today’s dollars. The bubble slowly deflated and by 1984 gold was back to $641 in today’s dollar and by 2001 down to $271 which equals $330 in today’s CPI adjusted dollars. Gold rose steadily from 2002 to today on fears of inflation due to Greenspan’s and then Bernanke’s bubble blowing.
It remains to be seen which will win out in the end, the bursting of the credit bubble (deflationary pressure) or the attempts to blow new bubbles (inflationary pressure).
Angry MBA,
The market may look fowards, but it takes its clues from the past. In 2007, earnings topped out in Q2, the market topped in Q3 after Q2 earnings were reported. The market started down in Q4 after Q3 earnings were reported and came in 15% under Q2 earnings. The market rallied into May 2008 are Q1 earnings came in better than Q407.
The market tanked on the Lehman and AIG crisis, but then really tanked again on Q4 2008 earnings which were reported in January and February and ultimately came in negative. The market rebounded off the artificial bottom in March and positive earnings in Q1 2009 kept the market moving higher. The Q2 earnings while better than expected are not all that much better than Q1 earnings and sales have barely improved, in fact sales seem to be declining to flat. The extra government provided income was largely saved.
How will the market react if sales and earnings don’t improve in Q3 over Q2? The year over year comparison will be easier. Will that be the focus? One should expect Q3 to be better than Q2 for the market to continue to march higher. The market aleady seems fully valued for 2010 earnings projections near $74 and that seems a mighty big jump from current earnings.
I just wonder how much the markets are really just trading on technicals rather than earnings. What do we know now that we didn’t on July 10 that justifies the market being at 1,000 or higher versus 880?
The market tanked on the Lehman and AIG crisis, but then really tanked again on Q4 2008 earnings which were reported in January and February
The declines really happened in February, thanks largely to Tim Geithner’s perceived failure to develop a suitable replacement for TARP and some other gaffes. The declines due to earnings were largely priced in by the end of the year, IMO. (And Geithner was reportedly given a speech coach, which seems to have helped him quite a bit.)
The extra government provided income was largely saved.
Sure, the consumer was retrenching. But the question going forward is whether the consumer will continue that course, or whether they’ll resume their old ways. I’m generally skeptical of new paradigms, and I have serious doubts that the core values of the American mindset — live well, spend big — has permanently changed, so I see savings as pent-up consumption. Combine that with loosening credit markets, and there should be more spending.
What do we know now that we didn’t on July 10 that justifies the market being at 1,000 or higher versus 880?
I would look at both points as possibly being within a fair trading range. Seeing 880 again is not an impossibility, if you accept the premise that we’ve set a new band.
I know that you’re looking for a philosophical place to land. I’d suggest that this is a trader’s market and that you don’t need an underlying philosophical outlook to trade. I’d be watching for drivers and tangible representations of consumer confidence, such as durable goods spending, new jobless claims and housing inventories/ prices, for improvement. If you don’t see them by fall, then revisit your short instincts, as you might really need them.
TPC, Angry MBA,
I bailed on the market in mid and late 2007 so I sold almost my entire stock holding – very near the top. I did the same in late 2000 with my individual tech stocks but not my 401K and other stocks which I mostly rode down and back up. I decided I wouldn’t make the same mistake again in 2007.
The whole trader’s market idea has screwed me up. I traded the market ups and downs all 2008 and into 2009 using small trading account. I especially traded off the November lows and March lows and did quite well. Nevertheless, I didn’t move most of my 401K money or other money back into the market in March. So far that seems to have been a very big mistake.
Now I am at a loss for what to do next. With my 401K, I can not move in and out quickly or use trailing stops. I need to decide to go in, stay out or dollar average in (and out) to/from bonds and cash.
My fear is that we only go up with no pullbacks, no corrections and if I don’t put my 401K money back in then I will miss the opportunity. (Most of the funds are currently down 35% from where I pulled out (even emerging markets which is up 73% since March). At the same time, I fear that the market has come to far too fast and that there must be a correction at some point (especially now that fewer and fewer people expect a major correction any time soon). As you can tell I am stuck on the idea of a correction / retest at some point.
The current fair value of the market could be between about 750 and 1150 now depending on how future earnings and sales develop. Nevertheless, with a longer-term horizon, say over the next 5 years (say 2014), the market may go on to reach or even surpass the 2007 highs. That is a would be 55% gain from here. Nevertheless, I still see great risk to the downside as I see big risks for the world economy, not just the US.
TPC liquidated his equities on Friday due to the currently poor risk reward relationship that he sees and the apparent appearance of greed in the market.
I see (almost fear) the near-term upside potential as 1,200 (provided there is a big short-squeeze to break above 1060) that takes the market right up the chart to just before the crash. I see near-term downside as 900.
Technical analysts see the S&P 500 getting to as high as 1060 or so and then predict the that there may be a signficant correction of 20% to 30%. Such a correction would take the market to 750 to 850 which would be a good base for the market to build on and would be a sucessful retest of the March lows. It would also fit with historical precident. (But it seems what most people expect doesn’t happen).
Depending on what multiple you give current earnings, the valuation of the S&P 500 might be anywhere from 685 (57 earings, 12 multiple) if you assume earnings have stablitized but will remain flat for some time with a few ups and downs (there are still significant risks for the financials from foreclosure, consumer credit and commerical real estate; there is also a risk both up and down to commodity prices). If you assume a surprisingly rapid recovery then maybe a 20 multiple is appropriate which would give a valuation of 1,150 or so for now and rising in the future. The flipside is that the rapid recovery would likely result in higher interest rates which would both act to slow the recovery and put should put downward pressure on the multiple.
Near-term +20% upside potential (5% more likely), -30% downside risk (5-10% more likely). What is one will a long-term perspective to do?
cash is king, cant be more simplier than that…..
if (IF) mkts tank, get in
otherwise you are at the mercy of massive dumps
weak dollar
fiscal deficits
deleveraging
all bad
stay out….unless the pitch is fatter than even mr buffet or mr TPC likes it
otherwise, eventually you will get burned
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