By Comstock Funds

A growing number of indicators suggest that the market is running out of steam.  Equities have been in a temporary sweet spot where investors have been factoring in a self-sustaining U.S. economic recovery while also anticipating the imminent institution of QE3.  This is a contradiction.  If the economy were indeed as strong as they say, we wouldn’t need QE3.  The fact that market observers eagerly look forward toward the possibility of QE3 is itself an indication that the economy is weaker than they think. We can have one or the other, but we can’t have both.

At the same time the problems in Europe have been put on the back burner, giving the market some temporary relief—-and we do mean temporary—-from the relenting dire headlines that have often dominated the financial news.  This, too, is not likely to last very long.

The U.S. economy has benefited over the last few months from the inability of seasonal adjustment factors to account for an exceedingly warm winter and the distortions introduced by the fact that the worst of the recession in 2008-2009 occurred in about the same months.  Although it is difficult to put a number on this, we suspect that the seasonal adjustments made the economy appear much stronger than it actually was, and that the payback is about to come.

Adding to these distortions, Fed Chairman Bernanke recently pointed out that Okun’s Law may have been a factor in the improving unemployment numbers.  Okun’s Law, based on empirical observation rather than theory, states that for every 2% change in GDP, unemployment changes 1% in the opposite direction.  Bernanke stated that at the worst of the last recession, unemployment increased by far more than it should have based on the decline in GDP.  Recently, however, unemployment dropped by far more than it should have in relation to the increase in GDP, and that this was payback for the prior distortion.  The takeaway is that the unemployment rate will not improve much in the period ahead, an assumption that is undoubtedly a major reason for the Fed’s continued caution on the outlook and promise of near-zero rates into 2014.

In just the last two weeks it has been noticeable that expectations have become so high that a number of indicators have started to disappoint.  The list includes core durable goods orders, the Richmond Fed Manufacturing Survey, the Chicago Fed National Activity Index, initial weekly unemployment claims, pending home sales, new home sales and existing home sales.  In addition, corporate earnings also show signs of peaking.  The recent ratio of negative to positive earnings revisions is the highest since the first quarter of 2009.  First quarter S&P 500 earnings growth is now estimated at only 0.7%, significantly down from the 16% estimated about a year ago and the 5% estimated as late as January.  We think that when first quarter earnings are reported in a few weeks management guidance will take estimates down even more for the full year.

The economy is also facing the so-called “fiscal cliff” beginning on January 1, 2013.  This includes expiration of the Bush tax cuts, the payroll tax cuts, emergency unemployment benefits and the sequester.  Various estimates placed the hit to GDP as being anywhere between 2% and 3.5%, a number that would probably throw the economy into recession, if it isn’t already in one before then.  At that time we also will probably hitting the debt limit once again.   U.S. economic growth will also be hampered by recession in Europe and decreasing growth and a possible hard landing in China.

Technically, all of the good news seems to have been discounted by the market rally of the last three years and the last few months.  The market is heavily overbought, sentiment is extremely high, daily new highs are falling and volume is both low and declining.  In our view the odds of a significant decline are high.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.


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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  • VII

    Comstock should review what they’ve written since 2011 and their performance. Then decide if this business suites their talents.

    Financial advice is changing…Mutual funds and wall st don’t control the information anymore. Unles they can start making money for clients..I m not sure why their offering their opinion about a topic which they can’t grasp.

    The market is all that matters…no one cares about the contradictions you can find in the Feds views. They want you to make them money comstock…actually…your job is to make money. Not point out why you can’t.

    Further if the economy is bad.. why invest with Comstock? Why not just put your Money in an Armenian bank(in the dry wall of your home)

  • Gordon

    Comstock Capital Value Fund Class A
    Portfolio Manager: Charles L. Minter & Martin Weiner, CFA Ticker Symbol: DRCVX
    Daily Performance
    As of March 29, 2012
    Multiclass Info
    Price Change YTD 1 yr 3 yr 5 yr 10 yr Life
    $ 1.49 + 0.00 -14.86% -12.35% -23.78% – 7.11% – 6.80% – 2.16%


  • Barbadosbob

    Vll your comments are always entertaining

  • Tree Hugger

    Pieces of the sky are crashing into the ground all around my house!

    How did they know?

  • JimmyC

    Turn up Jackson Brown.

  • Crosscreek

    Markets don’t move on economic data, they move on interest rates and corporate profit margins. The stock market is not the economy. What bulls need to worry about is peak margins and rising rates. That’s all.

  • VII

    Thank You:-)

  • Val. N. Popper

    From the Comstock Partners Inc. website:

    Thursday, October 27, 2011:
    “In sum, we believe that the current rally will not last much longer and that the lows of 2009 will eventually be retested. We did not expect the S&P 500 to rise above the significant resistance of 1250, but it did rise above it this week. We shouldn’t be surprised to see another “bear market trap” after the housing and stock market bubble (and the 100% move up from the oversold condition in March of 2009), all within the secular bear market that started in early 2000. It seems that investors in U.S. equities will never learn from past experience, but we would now really be surprised if the market exceeded the early May peak of 1370 on the S&P 500.”

    Are you guys: (1) surprised now?, and (2) have you as an investor (money manager) learned from this experience?

    Note the spread of 1250 “significant resistance”, the breach of which they did not expect, and the 1370 hypothetical stoploss which they did not expect to be exceeded as well (which Comstock ignored anyway — as they are still justifying their bearish stance). Managing “other people’s” money with that kind of very loose definition of acceptable risk is dangerous to the financial health of the “other people” who entrust money to this money manager.

    Comstock justify their bearish stance in these passages from their article “What are the driving forces for the economy” on September 29, which if you have time to confirm, was the day the “EXACT LOW” of this bull trend was posted:

    “We agree with Dr. (Alan)Goolsbee that the consumer is so buried under debt that we will not be able to dig our way out of this mess while consumers’ are paying off debt (or defaulting on debt) and trying to save more. The household debt more than doubled from $6.5 trillion in 2000 to about $14 trillion in 2008. The deleveraging process then began and household debt dropped to $13.2 trillion now (we expect it to drop below $10 trillion). With the enormous inventory of unsold homes (total of about 5 million including “shadow inventory”), we will not be able to depend upon the housing market to help our economic growth within the next few years. . . . Remember, the consumer makes up over 70% of our economy. In addition, residential construction (and other durable goods orders which come from a new home built and purchased) also makes up a substantial part of the GDP. These two drivers of past recoveries were always the most significant, and we find it hard to believe that without them, there will be any economic recovery at all.”

    Very erudite, very Hussmanesque — and very wrong. They missed several important points: The impact of deleveraging or relevering on nominal asset prices, employment and even the recovery of the housing market, has nothing to do with the LEVELS of the private debt reduction or increase (government debt has nothing to do much with the effect — but increase in government debt is positive on the margin in fact). What matters most is the RATE OF CHANGE of private sector indebtedness (you see that same effect of RATE OF CHANGE on the impact of crude oil prices to the economy). That is why it is possible to have a bull market when the rate of deleveraging has slowed down relative to its pace over the previous periods. The positive effect of slowing rate of debt deleveraging gets a boost also from a positive rate of change of government spending (Nomura’s Koo did an excellent work on it). Simple econometric work will show that transmission mechanism is through aggregate demand, which is income plus the change in debt. Thus aggregate demand (as defined) bottomed in Q1-Q2 2009 and has since then gone up and down (with a sharp upwards bias) — asset prices, employment and house prices(activity) have followed suit with various lags (very easy to determine with correct frequency settings).

    Will this bull market last, with those factors in play? Cullen Roche has been saying for some time that as long as the US government keeps deficit spending to the tune of 10 pct of GDP, then asset prices, employment, and housing will continue to hold their ground if not actually make headway — which makes perfect sense. What is ominous for the perma-bears (like Comstock, Hussman and Lance Roberts) is that private sector debt is picking up (in nominal rates and yoy rate of change — even nominal bank excess reserves are falling, but even here it is the ROC that matters). What could provide some temporary good news to perma-bears is that the qoq change is slowing down sharply — which is why ICRI could get a shot at (finally) having a recession by mid-year on their revised forecast (which is actually a cheat, since they unambiguously declared a Q1 recession in September). Even then, my econometric work suggests (not that it makes a difference) that we will see a sharp growth downdraft in Q2 and Q3, but no negative growth. It will be fantastic Q4 and Q1 2013 for asset prices. All of these from a proper understanding how debt interacts with aggregate demand the impact of which subsequently translates into growth and asset prices — and it is not really difficult to prove or confirm the points that I have raised. We shall see . . .

    I actually sympathize with Comstock — it has been a terrible period for many money managers. As an asset manager myself, the issues I have with Comstock is the very loose definition of their risk parameters, and the seemingly set frame work and mind set they have about the markets and their unwillingness to change theri mind (or admit their mistake). The other issue I have is that what I have outlined above is not exactly rocket science so it is amazing how little effort was undertaken to understand the nature of the factor (debt) which they have adopted as linchpin of their strategy. Big mistake.