STATE OF THE MARKET & THE CONSUMER

U.S. Chain store sales rose 0.7% last week, but were down 0.8% year over year according to The International Council of Shopping Centers and Goldman Sachs.   Even as “green shoots” sprout all around us we continue to see little to no sign that the U.S. consumer will rebound sharply.  I still believe the economy (and any future market upside) hinges on the strength of the U.S. consumer.  Today’s ICSC data is not all that encouraging.  We’ll get more clarification on Thursday.

Thus far, investors are very excited about the recent rally, but let’s try to put things in perspective here.  What we’ve basically seen since the beginning of the year is a massive plunge in stock prices due to overdone fears about the viability of the U.S. banking system followed by a massive mean reversion to the upside.  As the Obama administration essentially guaranteed the U.S. banking system confidence slowly crept back into the market in early March. In my opinion we’ve experienced nothing more than a massive mean reverting rally back to the upside.  The S&P 500 sits at roughly the flat line YTD which I don’t think is inappropriate considering the fact that we are seeing some thawing in the credit market, reduced earnings expectations and some signs of life in Asia.   Where we sit now is essentially no man’s land.

As readers of TPC know, I believe much of this rally was due solely to government intervention and the stubbornness of short sellers who tried to keep shorting the banks despite massive government induced short squeezes.  The only reason I became bullish on March 8th was due to potential government intervention and the only reason I haven’t shorted this rally after selling out many weeks ago is due to government intervention.   It’s that simple.  Fighting the Fed has worked during this bear market, but fighting the entire U.S. Government has not.   As we showed in “Analyzing the government rally” the government essentially teed up multiple different events that resulted in the overwhelming majority of the rally.  This led to huge short covering in the banks and melt ups in the overall market.  The momentum has carried through to today and should continue into the stress tests.

So where do we go from here?  I have been cautiously bullish since the rally began, but I still maintain that the economy going forward is going to be very sluggish.  Thursday will be a big tell.  Not only do we get retail sales, but we also get jobless claims and the stress test results.  I continue to believe that the U.S. consumer is overwhelmed with credit card debt and mortgages that are likely to become more expensive as the year progresses.  Wages are declining and job losses are staggering.  This is not a recipe for quick recovery.  The stock market has essentially come back to a neutral point where valuations are not terrible and an argument can be made in either direction as to where stock prices head.  Personally, I think the risks lie to the downside from here.  De-leveraging crises of the magnitude we are witnessing do not end with such a swift shift in sentiment.  The likelihood of a very weak economy going forward is still high and I believe the government is firing the last of their bullets on Thursday when they release results from the stress tests.   I don’t see what the market will cling to after Thursday’s results are released.  We all know the majority of the banks will pass and it has certainly been priced into bank shares.  The market has the potential to become very fragile again heading into summer and if there are any signs that the economy is retrenching or the banks are not healthy (both of which I would not be surprised about) we could easily revisit the lows made in March.

Cullen Roche

Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.

He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.