THE TECHNICAL RECESSION IS ALMOST OVER – DOES IT MATTER?
The technical end of the recession is near. We are going to start posting positive GDP figures in either Q3 or Q4 and at that point everyone and their mother will turn incredibly optimistic about the end of the recession. Many media pundits have already teed themselves up to benefit from this great prediction – as if it is a prediction at all (it’s not). At this point, it’s essentially consensus. But that won’t stop a number of prognosticators from saying “I told you so” when it happens. Unfortunately, this has almost no impact whatsoever on your portfolio and your strategy going forward. We saw the same kind of scenario play out in 2001. GDP posted a positive Q4 print and investors went wild. Unfortunately, the market retrenched and 2002 turned out to be one of the most brutal years of all-time if you were an investor.
Regular readers have likely noticed a deep schism between my economic outlook and my market outlook. It’s incredibly important to note that the economy will not always rhyme with markets. You can be in very long secular bear markets and experience incredible rallies (as I believe we’re currently seeing) inbetween. The same goes for bull markets. You can experience sharp contractions in share prices despite a rip roaring bull market. This is why I feel as though it is important to develop a macro view, but always maintain your micro view. The two do not necessarily go hand in hand. Having a directional bias based on your long-term macro view is a recipe for poor stock market returns.
David Rosenberg had some detail on the topic this morning:
The current consensus forecast for 3Q GDP is 1.0% at an annual rate. But what if we also manage to see a positive print for the second quarter release that comes out on Friday? The consensus is -1.5% QoQ annualized rate, but there is someone out there with a positive forecast (+0.7% — from Ian Morris at HSBC). While the consumer, capex and commercial construction retrenched, there may have been enough oomph out of net trade and lack of a negative contribution out of housing to get us there. It is possible. Go back to the end of the 2001 recession and you will see going into the quarter that followed the 9/11 tragedy that the consensus for 4Q2001 GDP was -1.1% at an annual rate. Well guess what? The advance number came in at +0.2%. That GDP surprise came out on January 30, 2002 and on that day the S&P 500 rallied 13 points (or +1.2%), with the IT sector the top performer, gaining 1.9%, followed closely by consumer discretionary, which rose 1.7%, and industrials rounded out the top three spots, rising 1.2%. Financials were solid, up 1.1% and consumer staples, health care and materials were all up 1.0% on that day. Biggest decliners were telecom (down 1.1%) and utilities (-0.1%). Volatility fell 4.6% and gold was up 1.1%. (In the second round, 4Q2001 GDP was expected to rise 0.9% and when the data came out on February 28, it came in at +1.4%.)
Keep in mind that even with that upside surprise in the 4Q2001 data, the rally in the equity market fizzled in the ensuing months as final sales lagged the inventory re-stocking and the economy endured a mini-relapse in the second half of the year. So keep your powder dry — the current rally bears many similarities to the high-hope bounce in late 2001 and early 2002, which means that there will very likely be better opportunities to buy the market down the road.
The moral of the story is this: forget what CNBC and the NBER tell you about the end of the recession. At the end of the day we’re all just trying to make money in the market. Economists are notoriously bad investors for a good reason: subscribing to the scientific method of wait and see is the opposite of buying the rumor and selling the news – one of Wall Streets favorite games. The market is a forward looking system. The scientific method is a backward looking approach. If we’re still in a secular bear market the recession could very well end this year and you could still get your face ripped off if you decide to go long stocks into the end of the year. Had you waited for the NBER to announce the official beginning of the recession in late 2008 you would have already experienced substantial share declines and nearly bottom ticked the market. In other words, the technical end of the recession matters very little, but let the media pundits and NBER have their day in the sun – Lord knows it’s not helping them make any money.
David Rosenberg is an economist. Does that make him a notoriously bad investor?
“So keep your powder dry — the current rally bears many similarities to the high-hope bounce in late 2001 and early 2002, which means that there will very likely be better opportunities to buy the market down the road”.
Should we listen to his advice? Or should we do the opposite?
Technicals, technicals. There was a story on Bloomberg yesterday that per Bank of America technical analysts the S&P 500′s solid breakout points to gains with the potential to reach 1,055 to 1,065 this year. (Coincidentally? Same as the GS call, supposedly on valuation.) Short-term support is quoted to be 900-930 and restistence at 990 to 1,000. They also say that if the target is hit with the S&P 500 up 60% from the March low that it would be reasonable to expect markets to correct. “History suggests a decline between 20 percent and 30 percent would not be unreasonable to expect.” That would mean a correction somewhere from 850 to 740.
That magnitude of correction relative to the rally off the bottom was seen in most other major bear markets 1932, 1974, 2002-03, etc.
“….the recession could very well end this year and you could still get your face ripped off if you decide to go long stocks into the end of the year.” Looks like based on history the probability is rather high.
The recession does not appear to be nearing an end in many other places. Lithuania’s GDP declined at a staggering 24% annual rate versus prior year in Q2. The UK’s decline in GDP came in worse than expected. Even China’s huge increase in GDP is not reflected in the real economy – electric usage, export volumes, etc. The huge stimulus appears to be driving speculation in assets and commodities more than anything else.
Rob,
I’d be careful taking market advice from Rosenberg. His broad macro themes are generally correct, but his timing has not always been great…
I have to agree with TPC. Rosenberg, Faber and economists in general are thought provoking but not good market timers.
The exact market timing may not be good, but if the forsight to future macro trends are correct, then paying attention to Rosenberg, for example, should help avoid major missteps.
How well did Rosenberg forshadow the coming of the economic crisis? Is it worth listening to his cautionary tale on getting too exuberant today?
In general, the goal is to buy low and sell high. It was pretty obvious that October 2007 was high. It was obvious that late February, early March 2009 was low (but also potentially dangerous). Where are we now for the medium term? High or low? More risk to the upside or downside?
I would like to participate to the upside without ultimately getting my face ripped off.
If I understand your position, you believe that the end of the recession is currenty being priced into the market (as general concensus). If so what really drives the upside from here? Pure momentum?
If this is a major rally within a bear market (which you seem to imply), what would ultimately drive it to correct?
Rob:
The majority of opinion is that we will have a last crescendo into the mid 1000 sPX or higher. I do not see it happening straight up from here. Would expect a retrace back to 920 or so before the last leg takes us to higher levels.
However, here is the thing. Everybody I know is expecting it or forecasting it. Can it do a fake on us? Yes, it can.
So if someone does not wish to speculate on this last move, perhaps the Rosenberg advice is a sane one. Simply sit it out.
On July 10, the boat seemed to be relatively well balanced, but leaning down a bit. Now, I feel like the boat is starting to tip way too far to the other side but at the same time I feel that it is too early to jump off.
There is something about this rally which doesn’t feel right. It seems to be very manipulated. (GS forecast of 650 in February, 666 bottom just short of the call, head and shoulders short squeeze, Goldman Sachs call to 1060.).
Short-term directional bias clearly shouldn’t be based on a macro view, but I feel that long-term directional bias should fit a with the generally correct macro view.
e.g. My decision in October 2007 to sell most of my stocks was maybe just lucky but it fit with the macro view that even though there was much optimism that financial crisis would be contained it seemed very clear that the financial crisis and resulting recession would be much worse than anyone expected. My decision to buy cautiously in early March was driven by lower long-term downside risk, but the cautiousness was driven by the macro view that this event will not be resolved in two years, or even three years and is not simply a financial crisis, but a massive deleveraging which has only just begun. (I now regret the over cautiousness a bit.)
Now the focus is on the improving situation in the banking sector, but I rarely hear much about the continuing collapse in world trade, the feedback loop that mass unemployment here and abroad will cause (it is too soon for the real effects of long-term unemployment to have been felt)
The concensus is that a depression type event has been avoided and the March lows will never be violated. (Tested maybe but even the bears say the low is in.) Concensus that unemployment is a lagging indicator, maybe coincident in this case. Two years ago the consensus was that financial losses would top out at $500 billion max and a year ago the concensus was that the bear market would be ending soon. Last year in June, Goldman called the market far higher by year-end. It started falling soon thereafter. Concensus was that oil prices would continue to rise due to Chinese demand and decoupling the world economies.
There seems to still be enough caution now for the markets to climb the wall of worry, but the markets (if sentiment is correctly reflected in the mainstream media) seem blind to most of the real potential (likely) dangers ahead.
Dean,
Actually my greatest fear is that I am clinging too closely to my mid to long-term outlook since it served me well over the past two years. I actually fear that we not only go to 1060 or a bit higher but far beyond (due to the massive liquidity at the big banks).
I took most of the big money off the table almost two years ago and only modestly went back in in March. I have played the rallies (December, March-May, July) with a small trading account. My fear is that I miss additional upside which no one is expecting. That the market is never allowed to really correct. Did Goldman set the bar higher to draw people in (I would say that is concensus) or do they continually set it too low so they can buy at cheaper levels before driving the market up with short squeezes? Next short squeeze at 1060? They clearly manipulated the market into a short squeeze at 680, again with all the technical talk at 880, now maybe at 1000 or 1060? Maybe the ban on naked short selling will actually have the effect of limiting the power of short squeezes.
I have no real fear of missing the last 8%. My fear is that it doesn’t stop there. I am still far too much in cash.
Rob:
If this is of any relief, I do not think we can exceed another 10-15% up. I don’t have a crystal ball of how this is going to play out exactly but here is the synthesis of various sources as to the most likely scenario:
From now until mid August: market sideways or moderately down
Mid August to Mid September: The last rally we are talking about perhaps peaking circa 1100.
From mid September to roughly December: we are going down, so short it.
From December to summer 2010: we will rally again
summer 2010: short it (this will be the big movement down perhaps SPX 400).
I can keep you updated as information refreshes and reported back to me.
Obamunism will be a negative for the markets whether will get it all at once or over the next few months. Bo-TAX?? nothing like Ugly ,Flat-Chested women to get your mind on the market and the political landscape!! Blood in the Streets in October,2009—Crash Alert
Dean,
You speak with a sense of certainty. Are such trends knowable in advance? Can you say more about how you arrived at these dates?
thanks,
m
Rob
I understand where you’re coming from. I see things the way you do and am as baffled as you. One thing I would say though is that you should resist the siren call of the rising market that is making you feel uncomfortable in cash. Chasing here is what many are doing and it rarely works out well.
If we were on the cusp of a growth period and had broken out on real volume and strength of the sort that characterized sustainable bull markets I’d say it would be OK to scale in, preferably on a pull back just the same. But we all know that’s not the case. RESIST the emotional pull.
Matty:
It’s based on cycles and combination of other disciplines. Not precise to the day though. Usually there is a lag + or – one week or so.