How negative is the sentiment regarding the world economy? Well, last week a self proclaimed independent trader named Allesio Rastani was interviewed on the BBC and made some rather dire predictions about the global economy. Among other things Mr. Rastani averred that the “market is toast”, “the stock market is finished”, the European “bailouts won’t work”, investors should “get prepared” for a crash and oh by the way, “Goldman Sachs rules the world”. He added that as a trader, he “goes to bed every night dreaming of a new recession” because he knows he can make money from the coming crash. The video went viral on the internet via Twitter, blogs and You Tube (well over 1,000,000 views). Google “BBC trader” and you get over 30 million hits.
The problem is that Mr. Rastani isn’t a trader – indeed, appears to have no job at all – doesn’t own the flat he lives in – the mortgage is in his girlfriend’s name – and has less than $1500 to his name. He isn’t licensed by the Financial Services Authority (the British equivalent of the SEC) and has no work history in London’s financial district. As he described himself later, he is an “attention seeker” who likes to “talk a lot”. I predict he will be appearing on a “reality” television show soon. That he was so readily believed says a lot about how negative public sentiment has become.
I spend a large part of every week talking to investors, economists, traders (real ones) and other market observers. Right now, I can’t find even one that is positive about anything. They cite the same negatives, from Greek default to European banks to US banks to a China crash to emerging markets and of course, another US recession. They’ve got market indicators to back them up – Copper is crashing!. They’ve got proprietary economic indicators to back them up – the ECRI weekly leading indicators are falling! Positive indicators are dismissed as flawed in some way. Anyone expressing anything positive is ridiculed.
In a meeting earlier this week with a member of a consulting firm (who sells some very, very expensive research), I suggested that maybe some of this bad news had already been discounted by the market. He quickly and eagerly offered to “take the other side of that trade”. As we were leaving he brought me into his office to show me a report on the European bailout. He scanned down a list of figures and pointed out that Greece’s debt/GDP ratio would actually rise if the current bailout were completed as planned. He did this sotto voce, as if this were highly confidential information. I was too polite to mention that I too have access to this new-fangled internet thingy – where the report can be found on the IMF’s website. I may take him up on his offer to trade; if his research were worth the price he’s charging, he wouldn’t sell it for any price. He’d keep it to himself and put it to use in the market.
Maybe the world is heading for another financial crisis, another crash and another recession but if so, it might be the most anticipated event in the history of markets. I suppose sentiment could get more negative still and markets could fall further, but if you’re negative right now, you aren’t exactly outside the consensus. And that has rarely been a recipe for investing success.
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The economic data released last week contrasted sharply with the mood of the market which can best be described as frigging nuts. US stocks were basically flat on the week but only after another massive serving of volatility and a side of fear. Foreign markets did better but of course they’d already absorbed a bigger beating than their US cousins so a bounce isn’t surprising. Indeed, most emerging market and European stock markets were already – and remain – officially in bear market territory. Whether US stocks join them by declining over 20% depends on whether the nattering nabobs of negativity turn out to be right about the US economy. Based on the data – rather than the emotion of the moment – that is far from the open and shut case it first appears.
If the US economy is falling into recession it sure hasn’t shown up in the consumption data. Goldman reported a slight weakening in same store sales but still expects a year over year gain of 3-4% for September. Redbook also reported numbers slightly below trend but also reports year over year gains of over 4% although department store sales appear to be falling off a bit. The official personal spending report also showed a gain (+0.2%) but with inflation rising the same amount, real sales were flat compared to July. Considering the turmoil of August though, anything that didn’t involve negative numbers has to be considered a positive. Personal income did fall 0.1% in August though and that is cause for concern going forward. Several other analysts blamed the drop on the Verizon strike but that seems a bit far fetched to me. We won’t see significant gains in personal income until the job situation improves.
The investment side of the economy also refuses to conform to the bearish storyline. Durable goods orders were down 0.1% but that follows last month’s 4.1% surge. In addition, the big drops were in metals which are affected by falling commodity prices. Machinery, computers and electronics and electrical equipment were all higher. Within transportation, an 8.5% drop in autos was offset by a surge in aircraft orders. Most importantly for long term growth, non defense capital goods ex aircraft orders rose 1.1% while shipments were up 2.8%. Companies may not be hiring but they do seem to be investing in capital equipment. Contrary to President Obama’s fears of rising productivity, that is good news for long term growth.
The housing market data still showed a market struggling to recover but at least it appears things have stopped getting worse. New home sales dropped to 295k but they’ve been fluctuating around 300k for months now so it wasn’t a significant change. I also take it as good news that prices for new homes fell 8.7%. Nothing works like lower prices to solve an excess inventory problem. The Case Shiller home price index was flat for the third straight month so overall it appears prices are stabilizing. Pending home sales were also down slightly but much of the decline was in the northeast and was likely a function of Hurricane Irene. Mortgage applications rose for both purchase and refinancing.
The Chicago PMI showed a re-acceleration in September to 60.4. That bodes well for the national ISM report to be released Monday. The regional surveys mostly improved on the month with several showing moves back into positive territory. Nevertheless, my expectation is for a sub 50 reading on ISM as a catch up to the recent weakness in the regional numbers. Certainly the market is not expecting a good number so an upside surprise could have an outsize market impact.
2nd quarter GDP was revised higher to a 1.3% growth rate and corporate profits were also revised higher. These are interesting revisions but don’t tell us much about future growth. Jobless claims, on the other hand, do tend to be correlated with both the economy and the stock market so the drop back below 400k (to 391k) last week is very encouraging. There were rumbles about adjustment problems but the non seasonally adjusted numbers were also down significantly from last year so this looks like a clean number. Has the downtrend in claims resumed? I sure hope so; we’ll get a full employment situation report next week.
Overall, the data last week has to be classified as better than expected and not indicative of a recession. That could still change but unless this is deja vu all over again it is unlikely the data will just fall off a cliff like it did in 2008. I think a lot of people are using that as a template – that’s called recency bias, people – but what happened that year is not normal. Data generally deteriorates over a longer period of time than it did in 2008. While I will never underestimate the ability of government officials to scare the pants off the private sector, I think it would be hard for the public to be shocked by anything at this point short of seeing John Paulson approach a podium.
Our portfolios remain conservatively invested – the path of least resistance for markets is still down – but with sentiment so negative we are looking for entry points. From a technical standpoint 1100 on the S&P seems to be the support level of concern for most traders and a break below that would probably trigger some immediate selling. Commodities remain weak with even gold acting toppy recently. As long as the US dollar continues its recent strength that will probably continue and I remain bullish on the dollar. Oil continues its established downtrend and that is bullish for future growth. Treasuries continued their bull run but I’m not much interested at these levels. High yield offers a much more attractive risk/reward profile. For now, stay conservative but start looking for signs of a bottom.
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An excellent piece Joe.
Putting the current situation in perspective and making reasonable recommendations.
Thanks, Stephen.
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