It Is All Over But The Shouting
08/15/09
This past week marked the second anniversary of the start of the credit crunch. Stocks, copper, nickel, zinc and sugar all celebrated by recording fresh 2009 highs. But the celebrations came to an abrupt end as caution crept back into investors' minds on Friday when it dawned upon pundits that markets were running away from economic reality. PIMCO's Mohamed El-Erian said as much in an interview on Friday, announcing that stocks would soon come of their sugar high. On top of that, Chinese equities - a leading stock market on the way up - saw a reversal of fortune and declined to a five-week low. To which I say "Perfect Timing." Now, that the majority of the economists surveyed by The Wall Street Journal during the past few days say that the recession that began in December 2007 is probably over, it may be time to sell the news - for a while at least. What the stock market started to discount since March is now showing up in the data. After months of uncertainty, economists are finally seeing a break in the clouds. Forecasts were revised upward for every period, with 27 economists saying the recession had ended and 11 seeing a trough this month or next. Gross domestic product in the third quarter is now expected to show 2.4% growth at a seasonally adjusted annual rate amid signs of life in the manufacturing sector, partly spurred by inventory adjustments and strong demand for the 'cash for clunkers' car-rebate program.
You may say what you like about the 'cash for clunkers' car-rebate program, it has increased vehicle sales in this country. People are taking advantage of subsidies to increase gas mileage of their vehicles, which over time will reduce energy imports. Whether it constitutes a sugar high in the manufacturing sector is debatable. What I see in the second chart coincides with the first chart. Inventories are at historic lows and therefore need to be restocked in a major way. This will take at least two quarters and will help the manufacturing sector in this country. It is also not dependent on whether people buy American vehicles or not. All major car manufacturers have plants in this country and need to order materials, which are currently not in stock. Sales of vehicles and other manufactured goods are rising and new orders are catching up to improving sales. New orders (green line) already soared to their highest level in two years. Production (and profits) should follow suite in coming months. The gain in the manufacturing workweek to 39.8 hours (up 0.3 hours) also showed that that sector of the economy is starting to recover. Gene Epstein said in Barron's last week: "The "V-shaped" recovery now seems more likely, although the upward arm of that V still might not turn up as smartly as one might hope. There have been encouraging signs, however, that real growth in gross domestic product will run as fast as 4% to 4.5% through 2010…. Overall growth could run that high even if the growth in consumer spending crawls at little better than 1%." This is an important statement because it de facto decouples the manufacturing sector from consumer spending, even if it is only temporarily. Real growth of over 4 %? When did you hear that prognostication last? But guess what. I believe it! Total business inventories declined between August 2008 and August 2009 by $160 billion. Restocking of just that loss should add over a full percentage point to GDP. Rising sales and increasing exportsincreasing exports could easily add another 3%. I believe that 4% on an annualized basis could be achieved in the 4th quarter of 2009. Business is normally slow to hire in a recovery, so the next surprise in the payroll data could be job losses running no more than about zero. But if this forecast for economic growth proves valid, gains in payroll employment should become the norm before the end of the year. David Rosenberg (Gluskin Sheff & Associates) connects the economy and the stock market thus: "Based on past linkages between earnings trends and the pace of economic activity, believe it or not, the S&P 500 is now de facto discounting a 4.25% real GDP growth rate for the coming year. That is what we would call a V-shaped recovery. While it is possible, though in our opinion a low-odds event, it is doubtful that the economy is going to be better than that. So we have a market that is more than fully priced for a post-recession world - any further gains would suggest we are moving further into the 'greed' trade."
There is that 4% number again, this time from a sceptic. David Rosenberg has always been a very circumspect and conservative economist. So I have to ask you: "What if stocks are correctly discounting a stronger economy 6 months down the road?" Let us consider the chances. Remember the ECRI's weekly Leading Economic Indicator that I relied on in the first quarter of this year? It just screamed higher with every passing week. The last time the growth rate was this high was February 1983. The annualized GDP growth rate of the 2nd quarter of that same year came in at 8.99%! Any questions? I know, plenty. Me, too. But let us just assume for a moment that something similar might be possible. How would the stock market transition from a current 4% GDP growth scenario to something approaching twice that growth rate? It would have to be violent and surprising. I could envision for example a growth scare in the coming weeks, where some economic data or other (perhaps international) developments create a lot of negativity in the stock market. Institutions are still underinvested, we know that. Cash levels remain historically high and despite a 5 months long rally, the bears are as vocal as ever. I believe an international event would be perfect to create a vicious yet short lived sell-off that intensifies the negativity in the markets. After that, perhaps at the end of September, economic data continue to improve and an explosive rally into year end pushes the S&P 500 to 1200. This may sound like wishful thinking to many of you and I am not predicting this event. However, I can easily give it a better than 30% chance. The Shanghai Composite Index meanwhile may give us a roadmap for the more immediate future. After surging by 90.7% since the beginning of the year and notching up seven straight weeks of gains, the Chinese Shanghai Composite Index has now declined by 12.2% since its peak of August 4, taking the Index back to its early-July level. On Friday, the Index (3,047) dropped to below its 50-day moving average but it is still comfortably trading above its 200-day line. The Rate-of-Change Indicator has broken below the zero line, thereby flashing a sell signal. Let us get ready for a correction in stocks either through price or through time, but let us not get caught up in all the negativity out there. The crash is behind us, not in front of us.
Hermann Vohs
"A pessimist? That's a person who has been intimately acquainted with an optimist."
Elbert Hubbard
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
