Archive for October 2nd, 2012
Lewenza: A Schism Exists Between Equity Returns and Underlying Fundamentals
Tuesday, October 2nd, 2012
U.S. Equity Strategy, Q4 2012
October 2, 2012
Attached is Senior U.S. Equity Analyst, Ryan Lewenza‘s (TD Waterhouse Portfolio Advice) U.S. Equity Strategy Q3/12 Update report.
Highlights include:
· The good times keep on rolling for U.S. equities, with the S&P 500 Index (S&P 500) gaining 5.8% in Q3/12 and 14.6% year-to-date (YTD). Technology continues to outperform, with the Nasdaq Composite up 6.2% in the quarter and 19.6% YTD. It made little difference in returns if one made a growth or value call, with both indices gaining roughly 5.7% in Q3/12. Small caps lagged modestly, with the Russell 2000 Index up 4.9%, however small caps started to perk up late in the quarter.
· Over the last quarter we have witnessed a schism between equity returns and underlying fundamentals, with stocks continuing to rally in the face of weaker economic data. In our view, investors are overlooking the weakening economic trends, and focusing more on the recent announcements of additional liquidity injections from a plurality of central banks.
· U.S. GDP growth averaged 1.8% in H1/12, with TD Economics forecasting a slower 1.6% for H2/12. For 2013, TD Economics expects growth to be below-trend at 2%, with “fiscal austerity likely to be the major factor restraining the pace of growth.”
· U.S. corporate profits have been very strong and supportive for equities over this cycle, however, profit growth is slowing materially. On a quarterly basis, earnings growth has slowed from 9.7% in Q1/12 to flat growth in Q2/12. Based on consensus estimates, earnings growth is forecasted to go negative (-2.2%) in Q3/12, which would mark the first negative quarterly growth rate since 2009.
· We are introducing our 2013 S&P 500 earnings forecast of $102.25, which based on our estimates would represent profit growth of 3.3% in 2013, compared to 7.1% expected for 2012.
· The technical profile for the S&P 500 remains bullish. While we believe the market gains are likely to be more muted under QE3, than those seen during QE1 and QE2, we still see the potential for another push higher into Q4/12. Under this premise, we could see the S&P 500 make an attempt at the 2007 highs of 1,500-1,550.
· Given the conflicting forces of weakening economic growth and central bank liquidity, we continue to believe a barbell approach is best in sector positioning, as it provides a mix of cyclicality and defence in U.S. portfolios. We recommend an overweight in the information technology, consumer staples, and health care sectors. We are adding telecommunications to our underweight sectors, which currently include the financials and consumer discretionary.
Read on, or download from the slidedeck below:
US Equity Strategy Q3 12 – Ryan Lewenza – TD Waterhouse
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The Fourth Quarter Begins (Tchir)
Tuesday, October 2nd, 2012
by Peter Tchir, TF Market Advisors
A Confused Start to the Day, Month, Quarter
S&P futures have already traded in an almost 1% range today. Weakness in Asia overnight, caused in part by weak data, was reversed on the European open, in part on weak data.
You can’t make this stuff up, but the battle between weak data, mediocre earnings, downbeat guidance, and the forces of various forms of QE and stimulus continues.
Spain, no real plans to fix the banks
I found the bank stress tests to be worse than underwhelming. They appear to have been “goal seeked” with everything done to come out with an “acceptable” answer, rather than the “correct” answer. Since I don’t believe the economies can experience a significant turnaround without strong banks, the attempt to pretend undercapitalized banks are adequately capitalized is a clear signal Spain is intent on heading down the Greek path.
France, the guilty kid in the corner hoping not to be noticed
While we wonder whether Rajoy will ask for a bailout and wonder what terms he will be offered, we can also start wondering what France is up to. France has been noticeably quiet, avoiding the spotlight. Maybe France has been hoping no one will turn their attention on France, because the situation may be that they have more in common with Spain and Italy than Germany?
It is a little off the radar screen, and hasn’t reached even the buzz stage, but there is a murmur out there about growing problems in France. Clearly any loss in faith in French debt is either the kiss of death for the Euro or full on debt monetization that would make even Bernanke blush.
QE3, like water filling a dam
So much talk about where the QE3 money will wind up. How much can QE push up asset prices? I think in the near term, the effect is limited, but will result in one heck of a rally at some point.
In an ideal world, the money would flow from the Fed’s hose and flood across asset classes. A chain reaction of ever increasing risk taking would take asset prices up across the board, gradually.
I don’t think that is what we will get. The Fed has just turned on the hose, and first it has to fill the dam, which, once it burst will create a wave of buying, but in an uncontrolled fashion.
The dam needs to be filled because many investors put on aggressive positions ahead of the Fed announcement. So a portion of the initial Fed money goes to the “winners” who can use it to dial back risk to a more normal level.
Then, the agencies themselves, Fannie and Freddie, are decreasing their on balance sheet holdings, so some portion of the initial wave of purchases just tops this up.
Then there is the treasury itself. With the government racking up a massive deficit, there is no shortage of supply of new bonds. Maybe treasuries are less risky than mortgages, but some Fed money will find its way to treasuries to meet that supply.
A few imbalances need to be corrected before all of the Fed buying becomes incremental rather than replacement.
At the same time, the risk-on/risk-off trade can drive flows in the short term. If Europe enters another weak phase, which I expect, then markets will go into risk-off mode again. Investors won’t be tempted to put newly created money to work in stocks, they will buy t-bills. We have seen over and over again for the past 5 years, that liquidity by itself doesn’t create demand for risky assets. If investors have no faith in a risky asset, they won’t buy it, regardless of how much liquidity is pumped in.
That will be when the dam fills. The Fed pumps liquidity into the system that just collects. Then, when the risk-on mode becomes in favor, the amount of pent up demand will be astronomical because not only will we have the regular supply/demand of normal markets, but now all this money that was created will also join the chase for returns.
That is how I see QE playing out.
Institutions think retail likes fixed income more than retail
One of the growing disconnects I see is the number of institutional investors who see continued aggressive buying of fixed income by retail as a reason to own fixed income versus the amount of retail flows. Retail doesn’t hate fixed income, but after years of catching up, they are getting closer to normalized allocations to fixed income. Their portfolios are becoming balanced, but that does mean they are running out of new allocations to fixed income. I see the disconnect of many institutions loading up on bonds in complete faith that retail will be there to buy them as a real risk to the bond market. Shares outstanding on the big ETF’s have been stable for the past week or so. Given the Fed’s QE announcement, there was a compelling reason to see growth, since we didn’t, you have to assume that either the love affair is over or that the investors are tapped out. I lean more towards the latter with a touch of the former.
Earnings
Why bother? People should bother, and ultimately will bother, and maybe that will be the catalyst to spark a bigger move – likely down, but for now we are back to a Central Bank, Central Plan, Spanish Bailout, driven market. Even the Fiscal Cliff has trouble getting attention as an issue, with so much noise about government programs.
I remain bearish here. It is a bet against central bank action and the effectiveness of that action.
Copyright © TF Market Advisors
Tags: Bonds, Us Treasuries
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James Grant: QEternity, Zero Rates, and Massive MBS Buying are Dangerous Policy
Tuesday, October 2nd, 2012
A rare interview with an influential Financial Thought Leader and financial historian. James Grant, founder and editor of Grant’s Interest Rate Observer, will discuss why the Federal Reserve’s policies of zero interest rates and massive purchases of U.S. Treasury and mortgage-backed bonds are dangerous to the economy and damaging to savers.
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The Best And Worst Performers In Q3 And September
Tuesday, October 2nd, 2012
Some surprising winners and losers in the past month and quarter.
September:
Q3:
Source: DB
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An Ominous Pattern is Reaching its Peak in the Dow
Tuesday, October 2nd, 2012
by Don Vialoux, EquityClock.com
Upcoming US Events for Today:
- Motor Vehicle Sales for September will be released throughout the day.
Upcoming International Events for Today:
- The Reserve Bank of Australia Rate Decision will be released at 12:30am EST. The market expects a decline to 3.25% from 3.50% previous.
- Euro-Zone Producer Price Index for August will be released at 5:00am EST. The market expects a year-over-year gain of 2.5% versus 1.8% previous.
- China Non-Manufacturing PMI for September will be released at 9:00pm EST.
The Markets
Markets opened the start of the fourth quarter with a sense of euphoria as equities surged within the first few hours of trade following better than expected economic data pertaining to manufacturing. The ISM Manufacturing Index for September recorded a surprising uptick to 51.5, above analysts estimates of 49.7. Levels above 50 indicate expansion, a characteristic that has not been prevalent in recent manufacturing reports. The strength within equities was rather short-lived, however, as Ben Bernanke spoke on the merits of current monetary policy. The Dow and S&P 500 ended marginally higher while the Tech heavy Nasdaq ended marginally lower as shares of Apple continue to show signs of profit-taking. Apple has struggled at its 20-day moving average for the past few days and momentum indicators are trending lower, hinting of further declines to comes. The period of seasonal strength for Apple, and the Technology sector in general, begins within a week or two from the start of October. Apple holds the largest individual security weight within the S&P 500, so weakness in this stock has a reasonable probability of hindering positive results in this large cap benchmark.
Looking at a 15 minute chart of the S&P 500 for the past two and a half weeks, a triangle pattern can be derived, which Monday’s trading activity respected precisely. Trendline resistance is presently just above 1455 while support falls just above 1440. A break beyond either level will likely provide confirmation of a bullish or bearish path as we progress further into October.
On a longer-term scale, a more ominous pattern is reaching a peak. A weekly chart of the Dow Jones Industrial Average over the past few years shows a massive rising wedge formation, which has severe bearish implications should the price action break below the lower limit of this pattern. Given the easy money policy in the US and other parts of the world, a certain amount of skepticism of the bearish implications is warranted. However, the merit of this pattern is supported by a negative momentum divergence over the same period. As the market was charting a series of higher-highs from the March 2009 bottom, MACD has shown consecutive lower significant highs, failing to confirm the positive price action. Rallies are not generating the momentum that was seen one, two, or three years ago as doubt keeps investors to the sidelines. Certainty of economic fundamentals remains culprit, a scenario that seemingly has no immediate end in sight with issues such as the fiscal cliff, presidential election, and weakening growth failing to provide future clarity. The pattern is interesting to observe, but may not warrant altering intermediate-term trade decisions until a definitive breakdown is realized.
Sentiment on Monday, according to the put-call ratio, was bullish at 0.87.
S&P 500 Index
Chart Courtesy of StockCharts.com
TSE Composite
Chart Courtesy of StockCharts.com
Horizons Seasonal Rotation ETF (TSX:HAC)
- Closing Market Value: $12.66 (up 0.08%)
- Closing NAV/Unit: $12.67 (up 0.12%)
Performance*
| 2012 Year-to-Date | Since Inception (Nov 19, 2009) | |
| HAC.TO | 4.03% | 26.7% |
* performance calculated on Closing NAV/Unit as provided by custodian
Click Here to learn more about the proprietary, seasonal rotation investment strategy developed by research analysts Don Vialoux, Brooke Thackray, and Jon Vialoux.
Copyright © EquityClock.com
The ECB – EUR22 Trillion Is Missing
Tuesday, October 2nd, 2012
Via Mark J. Grant, author of Out of the Box,
The ECB: The Missing Assets/Liabilities
“To treat your facts with imagination is one thing, but to imagine your facts is another.”
-John Burroughs
Yesterday I published the assets/liabilities of the European Central Bank as provided by them. I provided some analysis that I thought was relevant as I also asked all of you to look at the numbers yourself. To be quite open; I was stunned by the data they provided and shocked by the implications. I had not seen the data in any other source or commented about by anyone and the subject, while admittedly complex, and perhaps made more complex by design, is a huge wake-up call for anyone investing in Europe.
The ECB lists, as of the end of the 1st quarter of 2012, 16.304 trillion Euros ($ 21.032 trillion) in assets and 17.334 trillion Euros ($22.631 trillion) in liabilities. It is right there in black and white as I showed in the ECB provided data that I presented yesterday. However when you get to their consolidated balance sheet you find the numbers they bandy about in public to be a ledger of 3.240 trillion Euros ($4.00 trillion) and you catch your breath and pause. Utilizing normal American accounting practices this variance would be impossible and yet here it is; staring us all right in the face.
“Europe has put a ‘stop payment’ on our reality check!”
-The Wizard
I can report that I did hear from a number of large institutions yesterday that also looked at the numbers themselves and were stunned. Conversations were held, questions were asked and I think an accurate summation of the conversations was that everyone was in some state or another of astonishment. The numbers were not my numbers after all and while many good issues were raised in terms of how to properly analyze the data that was presented there was a clear sense that we were being duped by the European Central Bank and played for suckers.
“Reality is the leading cause of stress amongst those in touch with it.”
-Jane Wagner
Forget that the liabilities are greater than the assets and forget that that both have increased rather appreciably in the last several years and just concentrate on the size of the numbers presented and then ask the central questions; who is responsible for these assets and liabilities and where are they counted? We know that they are not counted at the ECB as they are not a part of their consolidated balance sheet. You may ask how this is possible and I re-print, once again, the applicable note from the ECB:
“Recognition of assets and liabilities
An asset or liability is only recognized in the Balance Sheet when it is probable that any associated future economic benefit will flow to or from the ECB, substantially all of the associated risks and rewards have been transferred to the ECB, and the cost or value of the asset or the amount of the obligation can be measured reliably.”
So there is the rationale, like it or not, but then where are these assets/liabilities counted? We are talking about $21.032 trillion in assets here and $22.631 trillion in liabilities which are larger numbers that all of the GDP of Europe. We can surmise that the ECB does not count these loans, securitizations and collateral as they belong to a given nation or a bank guaranteed by the nation or the securitization is guaranteed by some country but the rub is the country doesn’t count them either. When a European nation reports out its debt to GDP ratio I knew that they did not count contingent liabilities and I knew that government backed bank bonds were not included and I knew that regional debt guaranteed by the government was not included but this, and the sheer size of it, had lain underneath everyone’s radar.
Think of it; twenty-two trillion dollars worth of assets and liabilities and accounted for nowhere. No need to worry anymore about Target2; a mere tuppence at one trillion dollars, a decimal point. Just exactly what these assets and liabilities might be is anyone’s guess. Just which nations generated them is also anyone’s guess as no data or explanation is provided. Just what any country’s real debt to GDP ratio might be if these assets/liabilities were included in the equation is also anyone’s guess but I think it is safe to assume that the numbers would be off the charts; far off the charts.
“Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.”
-Sigmund Freud
You know, these are not blue fairies or gnomes or elves that have gone missing. These are twenty-two trillion dollars ($22 trillion) of loans and securitizations and mortgages that are found and accountable for by no one. These are real assets and real liabilities that have been turned into cash by the ECB and it causes me to wonder just how accurate the Money Supply numbers are for Europe with this amount of cash being pumped into the system. I also wonder what anyone’s real balance sheet looks like and I wonder what kinds of losses are being incurred and by whom. To be quite forthright, and in my opinion, this seems to me not just the rigging of the game or the gaming of the system but something far past that; something out beyond the realm of the credible and of real world experiences.
This is what we are investing in when we buy European bonds? This is where we are putting our client’s money? I don’t know; they may have gone mad but I have not.
Have you?
“An error does not become truth by reason of multiplied propagation, nor does truth become error because nobody sees it.”
-Mahatma Gandhi
Copyright © Mark Grant
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“Me, Lord Marlboro, and the Dow?!” (Saut)
Tuesday, October 2nd, 2012
“Me, Lord Marlboro, and the Dow?!”
by Jeffrey Saut, Chief Investment Strategist, Raymond James
October 1, 2012
Reminding us of the current equity market is an anecdote about the Sport of Kings that took place in London:
An American race horse owner, while parading his entry in the paddock just before the event, fed the horse what appeared to be a white tablet. Noticed and challenged by an English track official, Lord Marlboro, the American was informed that his horse would have to be disqualified. Protesting vehemently that he only gave the horse a sugar cube, the owner popped one into his mouth and offered Lord Marlboro a cube as proof. The English official tasted and swallowed the cube. He agreed with the owner that it was a harmless sugar cube and waived the disqualification. Just before the race horse was to enter the gate, the American signaled his jockey, instructing him to keep his horse clear of trouble near the start and try for the lead early since his horse was sure to win. “In fact,” he told the jockey, “Only two have a chance to beat our horse.” “What two?” asked the jockey? The American owner replied . . . “Me and Lord Marlboro!”
… Anonymous
I recalled the “Me and Lord Marlboro” quip over the weekend as I prepared to journey to Keeneland Race Track this week to speak at a Raymond James function. For those that do not know about Keeneland, it is a thoroughbred horse racing facility and sales complex located in Lexington, Kentucky. It is also known for its reference library on the sport, which contains more than 10,000 volumes, an extensive videocassette collection, and a substantial assemblage of photo negatives and newspaper clippings about horse racing.
This “Me and Lord Marlboro” reference is not an unimportant observation since the stock market was fed a “sugar cube” a few weeks ago by the Federal Reserve in the form of QEternity! That “sugar cube” fostered a vault in the equity markets that left ALL of the sectors I follow, as well as the NYSE McClellan Oscillator, well overbought in the short-term. As stated at the time, there are two ways such an overbought condition can be corrected. First, the equity markets can trade sideways, in a tight trading range, while the overbought condition is corrected. Or secondly, markets can pull back to a support zone to alleviate the overbought situation. In the current case that would be 1400 – 1422 for the S&P 500 (SPX/1440.67). Last week, the tight trading range option was violated as the SPX declined to 1430.53, which was just slightly above my 1400 – 1422 support zone. The QE3 market surge came on top of an already strong rally that began on June 4th. The nearly four-month old rally of about 16% has left 90% of portfolio managers (PMs) underperforming the SPX. As year-end approaches, this underinvested crowd is now staring at not only performance risk, but bonus risk, and ultimately job risk. Indeed, just pull up a chart of the SPX and think about all of the underinvested participants that are NOT keeping up with the “Dow Jones” as they approach year-end performance report cards. Manifestly, it seems like everybody is unhappy. To use the quote I referenced a few weeks ago from Merrill Lynch’s legendary strategist Bob Ferrell:
Money managers are unhappy because 70% of them are lagging the S&P 500 and see the end of another quarter approaching. Economists are unhappy because they do not know what to believe: this month’s forecast of a strong economy, or last month’s forecast of a weak economy. Technicians are unhappy because the market refuses to correct, and gets more and more extended. Foreigners are unhappy because due to their underinvested status in the U.S., they have missed the biggest double play (a big currency move plus a big stock market move) in decades. The public is unhappy because they just plain missed out on the party after being scared into cash after the crash. It almost seems ungrateful for so many to be unhappy about a market that has done so well. … Unhappy people would prefer the market to correct to allow them to buy and feel happy, which is just the reason for a further rise. Frustrating the majority is the market’s primary goal.
Adding to the angst has been the D-J Transportation Average (TRAN/4892.62), which has decoupled from the D-J Industrial Average (INDU/13437.13). Verily, since the June 4th low the Industrials are up roughly 11% while the Trannies are flat. This decoupling has become even more noticeable recently, causing many pundits to suggest there is a big decline coming for the Industrials. Last week Mark Hulbert, in his MarketWatch column, elaborated:
“The transports, as virtually everyone who is even slightly paying attention already knows, are seriously lagging the Dow industrials. It is widely assumed that this bodes ill for the stock market. But I am not so sure. A careful market analysis of the last three decades suggests that the Dow Jones Transportation Average is not the leading indicator that so many think it is.”
Now many argue that the Transports are a leading indicator because if companies are doing well the Transports will benefit from higher volumes to carry those goods to market. Others will opine that our economy is more service-based, and not as manufacturing-driven as it used to be, so the Transports don’t count. As an avid believer in Dow Theory, I am always watching the Trannies. Yet, the recent weakness, at least to me, is not yet concerning. I have commented that I think much of the weakness is attributable to the railroad stocks, which have been affected by the weather. First, it was the drought that hampered grain shipments; and then it was Hurricane Isaac. The “rails” have roughly 23% of their revenues tied to coal and grain shipments, so ex-Coal and Grain volumes are up around 2% quarter to date. The airlines have also come under pressure as fuel prices have risen. Regrettably, it is going to take a little longer before we see if the Transports’ weakness is a one-off thing, or a more meaningful event.
Interestingly, Mark Hulbert concludes:
“But here was where the real shocker came in: The correlations that I did discover for the Dow transports were inverse. In other words, the stock market over the last three-plus decades tended to perform better following periods in which the transports were weak rather than strong.”
Of course, this Industrials and Trannies discussion leads to thoughts about to Dow Theory. Therefore, it would not surprise me to see the Transports break below their June 4th closing low of 4847.73 while the Dow stays above its June 4th closing low of 12101.46. That would represent a downside non-confirmation and should result in a re-rally for the equity markets. For the record, to render a Dow Theory “sell signal,” at least by my method, would require both averages to close below their respective June 4th closing lows.
The call for this week: Mark Twain once remarked, “October, this is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.” However, if the typical presidential election year trading pattern continues to play, after a pause/pullback stocks should trade higher (see chart on page 3). And, this week is full of economic reports that could cause a pause/pullback. This week we get the global manufacturing data and the U.S. jobs data. The wildcard, however, is Spain. The bulls are hoping that last week’s Spanish budget proposals will pave the way for a bailout request by Mariano Rajoy’s government. If so, it would be a step in clearing some of the uncertainty in the euro zone. Whatever the news, I don’t think stocks pull back much from here.
Copyright © Raymond James
War on Gravity
Tuesday, October 2nd, 2012
by Ilene, Market Shadows
War On Gravity
Read full newsletter: MarketShadows 9/30/12
As we noted last week, the global economy is slowing down, while the stock market continues to perform well. This week, we explore this disconnect in greater detail.
David Rosenberg describes six key variables that affect the stock market. These variables are: liquidity, fund flows, technicals, valuation, sentiment, and fundamentals. (Here Is How Much QEternity Has Already Been Priced In) The relative influence of these factors changes over time.
Liquidity: Quantitative easing (QE) has been supporting the stock market. The latest, QE-Infinity (or QE3), results in a new $40 billion/month cash injection into the Primary Dealers (PDs) accounts.
David’s research indicates that every $40 billion of QE added to the Fed’s balance sheet adds about 20 points to the S&P 500.
The chart below shows one way to quantify the Fed’s money-printing ways on the stock market:
Describing the chart, Phoenix Capital Research wrote, “the New York Fed itself has openly admitted that were it to remove the market moves that occurred around Fed FOMC meetings [the times when the Fed announced new programs or hinted at doing so], the S&P 500 would be at 600 today…” (Draghi’s Bazooka Fired Blanks)
The chart suggests that market participants were front-running the news. But had the increase in stocks been driven solely by anticipation, stocks should have later sold off. They didn’t. The higher prices were sustainable because liquidity was added to the financial system through the PDs–beneficiaries of the Fed’s QE programs.
In a ZIRP (Zero Interest Rate Policy) environment, with the Fed printing money and the Dollar losing value, “risk on” trades became increasingly appealing and money moved into stocks and commodities. The PDs also took advantage of more complicated investment strategies. According to Michael Hudson, the $800 billion QE2 was used by the banks to speculate on currency and interest rate arbitrage. They borrowed money at 0.25%, lent it to the BRIC countries at much higher rates, and then pocketed the interest rate arbitrage. Contrary to story line, the banks did NOT put this money into the economy. “The reality is that ever since QE1 and QE2, every time there’s a loan, the banks reduce their loans to businesses, they reduce their mortgage loans, there’s less mortgage refinancing, and in fact, the banks use the money to gamble, mainly abroad in foreign currency and interest rate arbitrage…” (QE3 = Jobs for Wall St.)
Fund Flows: Mutual funds and hedge funds have been underperforming the S&P 500. These funds have to buy the market to appear like they’re keeping up with the S&P benchmark.
Technicals: Technical analyses have been bullish. (Market Shadows includes commentary by Allan Trends, Springheel Jack and Lee Adler – they have been bullish recently.)
Valuation: Forward P/E ratios have been at the high end of the range for the past 20 months at 14x. The Shiller cyclically adjusted multiple is 25% above historical norms.
Sentiment: The shorter timeframe for the AAII Investment Survey is neutral, but longer term is bullish. David Rosenberg opined, “The bull camp is getting crowded — problematic from a contrary standpoint.”
Fundamentals: The world’s major economies are in slowdown mode. A question being raised in the financial blogosphere is whether the US is in or about to enter a recession. And if so, what is the likely effect on the stock market?
It might be expected that a recession would profoundly influence stock prices because, logically, lower economic growth is correlated with less spending, lower earnings, missed expectations, and lower stock prices. But such fundamentals are just one of many influences on the stock market. Lately, they have not been strong influences at all.
In The S&P 500 and Recessions, Doug Short examined whether recessions have led to declines in the stock market, and/or whether declines in the stock market have foreshadowed recessions. Doug’s chart below shows the market-recession correlation since the mid-1950s, with the daily closes of the S&P 500 overlaying periods of recessions (grey).
The S&P often peaked before a recession began and bottomed before it ended. Four of the nine recessions since 1957 saw the index higher at the end of the recession than at the start.
Describing the chart Doug wrote, “Since the inception of the S&P 500 in 1957, there have been 9 recessions and 9 bear markets (20% or greater declines). However, three bears were not associated with recessions, and three recessions happened without a bear market, although the 1990-1991 recession had the ultimate “near” bear with its 19.9%…
“Market indexes and recessions are two very different data series. The closing price of the S&P 500 is a real-time snapshot of equities. In sharp contrast, recession boundaries are determined many months, sometimes a year or more, after the fact, for both the starts and ends (peaks and troughs). The NBER makes its call after lengthy deliberations over economic data that has been subjected to extensive revisions.
“Economists often make generalizations about business cycles that suggest a substantial commonality among them. But that’s true only at a 20,000 foot level (and on a partially cloudy day). Recessions are dramatically different from one another if viewed within their individual economic and market contexts. Exogenous events can play a role…
“The US economic recovery since the official trough in June 2009 has been much weaker than hoped, and there are many financial pundits who agree with ECRI’s latest assertion that a new recession is underway, a view which, I would counter, is not supported by the Big Four economic indicators.”
The normal business cycle results in periodic recessions, but the character of these recessions can vary widely. The relationship between the stock market and recessions can also vary widely.
Economists and commentators disagree about whether the US is in a recession. Recessions are not declared officially until after substantial evidence accumulates over time. Current signs that the US is in the early phases might be recognized, in retrospect, but that isn’t very helpful in answering the question NOW.
Mish Shedlock argued that a recession in the US began in June: “I am very comfortable with pegging of the start of the recession in June and I expect more downward revisions in GDP and employment are on the way.”…
“Unexpected weakness and downward revisions are hallmarks of the beginnings of recessions. And so it is with durable goods. Economists had forecast a gain, instead there was a 1.6% drop. Moreover July was revised lower as well.
“Bloomberg reports Orders for U.S. Goods Excluding Transportation Unexpectedly Drop: ‘There was broad-based weakness,’ said Tom Porcelli, chief U.S. economist at RBC Capital Markets… ‘What this now means is that capital expenditures are now going to probably fall for the first time since the recovery started. It remains a terribly challenging backdrop in the U.S.’…” (Durable Goods Orders Ex-Transportation “Unexpectedly” Drop, Down Third Month, July Revised Lower; GDP +1.3% Second Quarter; June Recession Call Looking More Likely)
[See also: Case for US and Global Recession Right Here, Right Now; Recognizing the Limits of Madness. ECRI's Lakshman Achuthan Says US in Recession Now; That Makes Three of Us]
Writers at Zero Hedge are also in the Recession Now camp: “QE1, QE2, Operation Twist 1, Operation Twist 2, a Fed balance sheet that is now expected to be $5 trillion in 2 years, and all we get is a lousy manufacturing economy that according to the Chicago PMI just dipped into contraction, or for all intents and purposes, recession, printing its first sub-50 print, 49.7 specifically,… But not all hope is lost: at least prices paid soared for the third consecutive month… Cue not just recession, but stagflationary recession… Time to start pricing in QE X to be followed 24 hours later by QE X+1. The central bank cartel is starting to lose control.”
Whether we are in, on the brink of, an inevitable excursion into recessionary times, the US economy is weak, as are the other major world economies. The race is on to print money and devalue currencies, and this supports more risky assets such as stocks and commodities. This is the current theme of the markets and why the economy and stocks are not moving together. Fundamentals have taken a back seat to Liquidity, and this trend is likely to last into the near future.
DECOUPLED
Wolf Richter reflected on the real economy and contrasted it with the recent gains in the stock market:
“A veritable chorus of large US corporations has chopped their forecasts down a few sizes, citing the China slowdown, wobbly demand from emerging markets, the ongoing fiasco in Europe, or weakness in the US…
“But you wouldn’t know it from the stock markets, which are supposed to predict future turns in the economy better than any other measure, based on the collective wisdom of innumerable astute market participants—or rather computers, algos, and fat fingers. The S&P 500, for example, is up 22% over the last 12 months. A phenomenal run…
“That the CEO Economic Outlook Index evokes the dark days of double-digit unemployment is not a particularly good sign. It crowns a pile of slashed forecasts from bellwether companies. The old-fashioned among us would expect stock markets to have anticipated that corporate downdraft. But that hasn’t happened.
“If QE, QE2, QE3, the bubbly expectations of QE4, and of course QEx have accomplished anything [read... ‘Forceful and Timely Action’ to Nowhere], it is the miraculous decoupling of the stock markets from reality. Gravity can be turned off, apparently, in this new QE world of ours where no one has gone before. But then, gravity has the nasty habit of reasserting itself at the worst possible moment.” (The Miraculous Decoupling Of Reality, For Now.)
So when will gravity reassert itself? We don’t know but will be watching for signs of falling debris as the foundation of our house of cards starts to waver.
Also in this week’s MarketShadows Newsletter:
Springheel Jack’s TA
Allan’s Trends – Shorting the Nasdaq
Virtual Portfolio – House-cleaning
Weakening world economies – an odyssey from debt to tribulation
Tags: David Rosenberg, Gluskin Sheff, Rosenberg, Rosie
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