The Global Slow-down Will Accelerate

By Comstock Partners

Slowing growth as well as deficit and debt problems in the Eurozone, U.S., China and the emerging nations increases the odds of a deflationary global recession and a renewed down leg in the ongoing secular bear market.

The Eurozone crisis is worsening as economic growth is being hit by front-loaded austerity measures that is exacerbating budget deficits and reducing tax revenues.  The southern-tier nations, particularly Spain and Italy, cannot get credit as interest rate spreads have widened to unsustainable levels.  Funds have been flowing out of the disadvantaged nations and appear on the verge of a full-fledged run if financial aid in some form is not provided in the very short term.

As we write, the EU is meeting in emergency session to take up measures to shore up the finances of Spain and Italy with the hope that they can buy enough time to start planning on longer-term solutions.  For the last two years the EU has enacted one emergency bailout after another only to have to come back and try again within a short time.  Most likely, they will come up with another short-term plan this time as well, although how much time it will buy is questionable.

The U.S economy has been slowing in the last two or three months.  Either downside surprises or actual declines have been reported in key economic indicators relating to consumer spending, new orders, production and employment. A number of major companies have either revised down their second quarter earnings estimates or reduced their guidance for the second half. As a result, second quarter earnings estimates for the S&P 500 have been declining and full-year estimates probably will drop as well.  When we further consider the dysfunction in Congress, the “fiscal cliff”, the prospective end of operation twist, the elections and the prospect of renewed fighting over the debt ceiling, the threats to an already fragile recovery are high.

The Chinese economy is slowing, perhaps by more than the official numbers show.  The NY Times has reported that many local and provincial officials have been falsifying numbers to hide the true extent of the problems.  China’s economic model is heavily dependent on capital investments and exports, while internal consumer spending remains a relatively small part of GDP.  Although Chinese officials recognize the need to increase consumer spending as a percentage of GDP, that is a long-term solution.  In the meantime, exports to Europe, China’s top customer, is falling now and cannot be offset, except by ordering the building of more plants that will produce goods for which there is no current market.  All in all, it seems that it will be difficult to avoid a hard landing.

The slowdown in Europe, the U.S. and China is also impacting the economies of the emerging nations, which are heavily dependent on exports.   Declining growth is also driving down commodity prices.  Despite all of the talk of decoupling, it seems apparent that the economies of all nations are linked and that there is little prospect of an oasis of prosperity in an increasingly dependent world.

Unfortunately, the monetary and fiscal authorities are out of ammunition.  With short-term rates near zero and the 10-year bond yielding 1.6%, there is not much more the Fed can do.  At the same time fiscal stimulus is restrained by debt and deficits that are too high relative to GDP.

In our view, the current situation is reminiscent of the dot-com top in early 2000 and the subprime top in late 2007, when investors remained in denial that the economy was highly vulnerable.  We believe that the April 2nd peak in the S&P 500 marked the top of the uptrend from the March 2009 lows, and that a major market decline is ahead


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Comstock Partners, Inc. analyzes economic and financial conditions from a long-term macro-economic perspective and makes adjustments based on cyclical and shorter-term considerations. In pursuit of its goals, the firm invests in various asset classes including domestic and foreign stocks, bonds, currencies and derivatives including indices and options

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  1. Regardless who wins the U.S. presidential election, neither of them is going to allow the fiscal cliff to happen.

    Obamacare also contains 500 billions in taxes, something many forget. (Even if I support the law and would even like to see the public option in there).

    Still, the last recession started in 2007. That’s 5 years ago, and next year it will be 6 years. How much longer can an economy avoid recession? History tells us that no longer than 10 years, and that is under optimal circumstances, something the world isn’t exactly awash in right now.

    What I am watching is the increasingly declining personal savings rate(now at a meager 3.4 %) coupled with negative real personal disposable income gains. Obviously, those two trends cannot go on together forever as the American consumer takes more and more out of their savings accounts to fuel consumption growth, while their real personal disposable income declines and/or stagnates.

    I think most people are too fixated on big events like the fiscal cliff, while serious, the underlying secular trends are more important. The fiscal cliff may trigger an event, but it won’t be the main cause of it. Just like Lehman triggered the subprime, but wasn’t the root cause.

  2. Although I’m in overall agreement, I’m not sure I follow your point about personal savings. The trend in the personal savings rate is a little unclear:

    It’s down since the recession, but certainly up since 2005-2007. And as long as it’s greater than inflation, people are saving, no? So the consumer isn’t really taking money out of savings to fuel consumption growth.

    I wouldn’t be surprised to see another recession (or even two) before the balance sheet recession ends. We do need to clear out bad debt before a real recovery can happen. But I’m not sure if we’ll actually see a recession (which clears bad debt out faster), or if the Fed’s plan for a “soft landing” here will work: i.e., consumers slowly deleverage with low savings rates and mild inflation.

    So I think the shocks may indeed be important, as they could destabilize the soft landing. Instead of 3 years of 2% real savings, we might see a recession and 1 years of 6% savings + a wave of defaults.