The Public Begins to See the Light

July 31, 2010

The S&P500 dipped ever so slightly last week.  It fell 0.1%.  The VIX (or fear) index rose slightly as well.  And volume was on the lighter side. 

The macro data were mostly weak.   New home sales rose, but mainly because the prior month’s sales were revised downward substantially.  Still, new home sales in June were the lowest on record.  Consumer confidence came in lower than expected.  Durable goods orders were much weaker than the experts had forecast.  Initial jobless claims just about met expectations, but they were still closer to 500,000 than they were to 400,000 (the traditional threshold for exiting a recession).  The second quarter GDP estimate was worse than consensus estimates called for.  And Chicago PMI was better than expected.

Technically, the S&P is in an uptrend on the daily charts, but it’s very close to breaking below this uptrend.  On the weekly charts, the downtrend is still in effect.  Although the S&P is at the upper bound of the downward sloping channel, it has not decisively broken to the upside.

What makes the S&P’s resiliency remarkable is that it hasn’t broken down in the face of a growing body of evidence proving that the so-called economic recover is fading fast. 

Also remarkable is that the public, with the help of the media, is catching on to this grim reality. 

After Friday’s GDP report, here’s a leading headline in the Wall Street Journal:  “Recovery Loses Momentum.  Outlook for Remainder of 2010 Darkens…”

Here’s a front page story in the New York Times:  “With Recovery Slowing, the Employment Outlook Dims”

But most remarkable, is that the public, and the media, has taken so long to catch on to this ugly turn of events. 

Serious scholars such as Paul Krugman (from the left) and Niall Ferguson (from the right), while not agreeing on the precise causes and prescriptions, have been warning readers for almost two years that the economy will not bounce back soon or strongly.

Krugman had predicted that the US economy would enter a deflationary malaise, similar to what has afflicted Japan for the last 20 years.  Ferguson has warned that the US economy is increasingly at risk of a catastrophic “sudden stop” if our creditors wake up to the growing risk of funding our fiscal deficits.

So far, Krugman has been right, and we could stumble along for a while, Japanese-style.  But unfortunately, if Ferguson’s scenario comes to pass, then there will be no muddling through.  Catastrophic economic collapses don’t exactly allow for muddling.

Either way, the US economy will NEVER recover–in the traditional sense of the word–until its cancer (massive leverage and the people, processes, and institutions that created this leverage) is cured.

And as of now, almost two years after the stock market crashed, the cancer has not been cured.  It is spreading.

It’s Official–Recession is Around the Corner

July 24, 2010

The S&P500 bounced back up 3.5% last week.  Volume was light, so this price move was not confirmed by the retail investor jumping back in with conviction.  In fact, the average retail investor pulled money OUT of the stock market again–14 weeks in a row, according to ICI which tracks mutual fund flows on a weekly basis. 

There was very little economic data this week, but most of it was disappointing.  The housing market index of builders registered the lowest reading since the summer of 2009, near the all time lows.  Housing starts for June fell about 5%, and the prior month (May) was revised lower.  The housing market is clearly set to collapse again.  And there is very little that the government can now do to prevent this impending plunge.   Initial jobless claims were higher than expected.  And although the US government reinstated the full 99 week unemployment claims program, there are thousands–soon to be millions–of people who will drop off this program after the full 99 weeks are used up.  At that point, if they’re still unemployed, they face the dismal prospect of applying for welfare relief. 

Technically, the S&P did puncture the first line of resistance–the 50 day moving average.  Next week, we will see if the next line of defence, the 200 day moving average, will hold.  If the S&P breaks through 1,110 and closes there for a few days, technicians will watch the 1,160 to 1,170 level to see if such a move upward will build the giant right shoulder of the head and shoulders pattern that began with the left shoulder (near these same levels) in January of 2010.   On the weekly charts, the S&P is still in the downward sloping channel that began to form in April. 

The Economic Cycle Research Institute’s weekly leading indicator index broke below -10 to log a reading of -10.5 last week.  In 42 years of record keeping for this index, the US economy has always entered into a recession (new or double dip; it doesn’t matter) when the weekly leading indicator broke below the fateful -10 mark.

So unless “this time is different”, the odds are nearly 100% that the US economy is headed for a contraction sometime over the next three to six months.

This coincides nicely with the long-term technical turn downward in the S&P500.  If, as now expected, the economy enters a recession this fall, the S&P500 will have anticipated this slowdown by about six months. 

And since the housing market was one of the main drivers of the downturn two years ago, it’s no surprise that the renewed drop in the housing market this year will also help push the economy down this time around.

So what’s an investor to do?

Well the S&P500 and many other risk asset markets have NOT yet fully priced in the effects of a true recession.  Ominously–just as in the prior downturn–the only market that seems to be prepared is the US Treasury market; it’s massive plunge in yields is suggesting that the risk asset market price drops will be severe.

So the smart money is busy preparing a buy list.  If, or when, this “risk off” phase begins, the astute investor will be prepared for the big, clearance sale.  The main question that remains to be answered is if it will be a 20% off sale, a 30% off sale, or a 50% off sale.

By preparing the shopping list now, the smart investor will not be frozen like a deer in headlights when the sell-off panic sets in.  The dumb money will be desperately trying to sell.  Make sure you think through–in advance–what you want to buy and at what price.

Christmas might arrive early this year.

Trainwreck in Slow Motion Continues

July 17, 2010

The S&P500 slipped 1.2% last week as the bounce off the early July lows seems to be fading.  After after almost touching 1,100 the S&P fell apart on Friday, without any obvious spark for the sell-off.  The volume, not surprisingly, surged–especially during Friday’s drubbing.  Again, this shows conviction behind the selling.  Not a good sign for the bulls.  The VIX index jumped back up 5% for the week, also supporting the week’s price drop.

The economic data continued to disappoint.  Retail sales were far lower than consensus estimates.  The Empire State survey fell substantially.  Industrial production was slightly better than expected. Initial jobless claims were better, BUT only because they were seasonally adjusted down to account for the automotive industry’s usual (and temporary) summer layoffs.  The only problem with this adjustment is that GM did not have its usual shutdown, so the seasonal adjustment pushed claims down below where they really should have been.  The Philly Fed survey was much lower than expected, and the biggest shocker for the week was the University of Michigan consumer sentiment reading which fell–in one month–by more than it did in many years.  Not good.

Technically, the S&P behaved in a textbook manner.  It bounced off resistance at the 50 day moving average (which also happened to be the resistance provided by the downtrend line that began in late April) and retreated back down.  Although it could still puncture these resistance levels over the next few weeks, the downtrend should remain intact as long as the 200 day moving average is not seriously violated.  On a weekly basis, the clean downward sloping channel is working beautifully.  The S&P bounced down from the top of the channel and is now comfortably near the center.

Let’s review the domestic and global economic situation as of the middle of 2010.

In the US, the Green Shoots, close-your-eyes-and-just-believe, optimists are starting to get worried.  As much as the government (with the help of the media) would like us to think that the recovery is well underway, the ugly reality refuses to stay hidden in the closet.  Not only did the economy never rebound, V-style, from its deep plunge in early 2009, but it is clearly about to relapse and start contracting again.  The Economic Cycle Research Institute’s weekly leading indicator reading, at -9.8%, all but guarantees another recession in the next three to six months.

In Europe, the situation is no better.  The EU and IMF bailout of the PIGS is in danger of being exposed for what it really is–a mask or disguise that’s designed to buy time.  The bailout, at root, might provide more debt to nations whose main problem is having too much debt.  This kick-the-can-down-the-road strategy will not work much longer.  As Greece sinks into austerity, and as the ECB scrambles to buy up pretty much all of Spain’s debt (because nobody in the private sector wants it at existing interest rates), everyone’s wondering who will be next to implode.  Italy?  Hungary?  France?  The list is long.

The we have Japan, Asia’s dead man walking.  According to the most recent Economist, Japan’s banks have just the new (again!) government that they will not be able to keep buying the government’s debt much longer.  If pension funds are now becoming net sellers (because of the rapidly aging and shrinking society), then this leaves the government in a death trap.  Interest rates will need to rise sometime in the not too distant future.  And when they do, Japan will blow up.

Finally, there’s China the seemingly unstoppable juggernaut that’s taking the world’s economy by storm.   The only problem is that this is exactly how the US was perceived in 1929 and Japan in 1989–just before both entered their respective DEPRESSIONS.  China’s export driven and infrastructure dependent growth model is creating massive distortions at home (and abroad).   That which cannot continue, will not continue.  The only question is when.  And by the way, when China implodes, look for accompanying implosions in Australia, Canada, Brazil and parts of Africa.  Why?  Because they’re the economies that feed natural resources to the Chinese manufacturing and building machine.

Where does this leave us?  Tragically, it leaves us watching a train wreck in slow motion, and not being able to do much about it.  We know it’s going to happen.  We know it’s going to be very damaging, to the US and the rest of the world.  And we know it’s going to take time to play out, several years, if not the rest of this decade.

That means that the most important thing one can do is to prepare for this future.  Think about how these events might affect you.  And think about what you might need to do–first, to avoid getting hurt, and then, to gain some advantage. 

Good luck.

Goldman Gets It, and the Outlook is Bleak

July 10, 2010

As expected, the S&P500 bounced up from an oversold level; it rose 5.4% last week.  But volume did NOT confirm the price rise; last week’s volume was among the lowest of the year.  The VIX (or fear) index did improve, suggesting that investors became far more tolerant of risk over the last four trading days.  

Very little economic news was announced during the holiday shortened week.  The ISM services index disappointed by rising less than expected.  Initial claims fell slightly, but they still remain at stubbornly high levels that normally occur during recessions.  Also, continuing claims plunged, NOT because people suddenly found jobs, but because they lost their unemployment benefits.  Over 2 million people are expected to lose benefits in the month of July alone.  Consumer credit stunned economists.  Not only did it fall almost five times more than expected, but the previous month’s slight gain was revised to a whopping $15 billion drop.  Consumers, who make up 70% of the US economy, are severely cutting back their spending.

Technically, the S&P is still in a downtrend from both the daily and weekly perspectives.  The daily charts suggest that last week’s big bounce–although it might have some more to go next week–will be ripe for a pullback soon.  The S&P, on the weekly charts, is starting to form a downward channel, where previous week’s low (around 1,010) touches the bottom line of the channel and a rise to 1,110 would touch the top line.  We’ll see if this channel holds over the next two weeks.

One of Goldman Sachs’ leading economists, Jan Hatzius, recently analyzed the simple, yet unalterable, realities of the US economic calculus. 

As reported in ZeroHedge, Hatzius reminds us that with imports continuing to exceed exports by 3% of GDP, and with the private sector (households and firms) saving 7% of GDP, the public sector (federal, state and local governments) must run a deficit (dissavings) of 10% of GDP to neutralize the negative effects of trade and the private sector.

But Hatzius points out that there is NO political support for the US public sector to run such massive (10% of GDP) deficits much longer.  The US will soon start pulling back from its monstrous (10% of GDP) deficits.  So that means that total demand will fall short of total supply in the US economy. 

The result?  The economy WILL take a turn for the worse–again.

But if the US can’t fire the fiscal stimulus gun much longer, what about monetary stimulus?  Can’t the Fed do more?  Well, rates can’t be lowered much more; they’re virtually at zero percent already.  And printing more money to buy more Treasuries and Agency securities would also not be sufficiently effective to counter the soaring savings in the private sector.

Hatzius concludes by implying that there’s pretty much nothing that can be done to avert another downturn.   Austerity, here and around the world, will almost guarantee that the Great Recession has much more pain in store for us.

Double Dip? No, the Great Recession Never Ended

July 3, 2010

Last week, the S&P500 slumped over 5 percent, its second biggest loss in 2010.  Volume rose, for the second week in a row, adding more validity to the price drop.  The VIX (or fear) index also  jumped up, confirming that investors were getting concerned about the direction of the equity markets.

Virtually all the economic data came in below expectations last week.  Personal income disappointed.  Consumer confidence plummeted.  Chicago PMI slipped.  ISM Manufacturing dropped.  Initial jobless claims jumped up to 472,000–well above consensus estimates.  Pending home sales for May plunged 30%, 15% below May 2009, and the biggest month-to-month drop on record.  Nonfarm payrolls were weaker than expected, even after accounting for the census worker distortion.  More ominously, average hourly earnings slipped and the average workweek BOTH slipped–these usually rise in a recovery.  And factory orders dropped almost three times more than expected.

Technically, the cyclical bear market looks like it’s about to resume.  Because the daily charts suggest that the S&P is somewhat oversold, prices are due for a short-term bounce.  Prices can rise back up to 1,080 or even 1,100 without breaking the strong downtrend that began in late April.  On the weekly charts, not only is the downtrend just now becoming firmly established, but the amount of downside still left is huge.  And this makes more sense when one considers how much the S&P rocketed up after March 2009.

In the near future, the National Bureau of Economic Research (NBER) will have to decide when the recession that began in late 2007 ended, and if so, then will another contraction in economic growth be labelled as its own separate recession (the double dip) or will it become a new separate recession.

The blog Calculated Risk has done some interesting analysis to help understand how this decision might be made.  The author reminds us that for a new separate recession to be named, most economic indicators must have returned to their previous highs.  This happened in 1981, so that the recession that began later that year, was given its own separate label.  Hence, the second recession became the double dip.

But what’s happening now?  Specifically, have our economic indicators returned to the prior 2007 highs?

As the chart below (from Calculated Risk) shows, gross domestic product and gross domestic income (two most of the most important indicators of economic expansion or recession) have NOT returned to the 2007 highs.

This means that if the US economy starts to contract now, or later in the third quarter this year, then the “double dip” label would NOT apply.

Instead, the best way to describe the upcoming contraction would be to extend the length of the original Great Recession.

Some people could start describing the Great Recession, which started in 2007, as the recession from hell.  It refuses to die.

If this slowdown picks up steam–as the markets and most economic reports are strongly suggesting it will–then for almost ALL living Americans, it will become the longest, and deepest, recession in our lifetime.