You could feel the gloom lift a bit on Wall Street and most other global stock markets last week. The S&P 500 rallied 6% and now rests nearly 14% off the intra-day nadir of early October. It was a good week but I don’t think investors should get too excited just yet. In fact, quick rallies like we’ve seen over the last two weeks are more typical of bear market rallies than the beginning of new bulls. The European debt situation is still far from resolved and the US economy, while not in recession, is far from healthy. And in both cases the future to some degree lies with the politicians. If that doesn’t give you pause, you’re braver than I.
In Europe, there have been numerous leaks about potential elements of a deal but nothing concrete yet. The situation is no closer to being resolved than it was last week. It is important to remember that this is a political problem, not an economic one. As a whole Europe is in ok fiscal condition – in some ways it might be better than the US – but finding a solution means getting all of Europe’s politicians on the same page. One would likely have more success herding cats. We should start to see more details about a potential deal emerge this week and while I’m hopeful, I can’t seem to shake the feeling that the ultimate solution will be found at the ECB’s print shop.
In the US, the economy continues to surprise on the upside but that’s more a matter of reduced expectations than great economic performance. Last week, a 1.1% gain in retail sales was much better than expected but there wasn’t much else in the way of forward looking data. The trade deficit was basically unchanged but all that really tells you is that we’re still importing a lot of oil. Import and export prices rose again with import prices up 13.4%, the seventh straight month of double digit year over year gains. Export prices rose a more modest 9.5%. Getting to a trade surplus through a devalued dollar isn’t as easy as the populist politicians seem to believe. Jobless claims posted another week above 400k and while not getting worse, also refuse to get better. The US economy isn’t in recession but neither is it healthy.
While a change in economic policy isn’t required to keep the US economy out of recession – markets are amazing at healing economies if left alone – it will surely require better policy for improved performance anytime soon. On that front, all eyes are on the Super Committee tasked with coming up with a grand bargain on the budget. About the only thing they’ve accomplished so far is to make the job of lobbyist even easier by concentrating power in a dozen lawmakers. They’ve only met a few times publicly but Lord only knows what is going on behind closed doors. With an election year rapidly approaching, it might not matter though. Both sides are more interested in jockeying for electoral advantage than cutting a deal for the good of the country. A big deal seems unlikely.
Our base case remains that the US economy will avoid recession but that growth will be limited until better policy emerges. We continue to analyze the data as it comes in and right now we can’t make a case for recession. Neither can we make a case for an acceleration of growth. As Doug Terry points out in his analysis this week, the US stock market is priced for no growth and while that might be a bit pessimistic, it probably isn’t by much. Better global growth would require a combination of a soft landing in China, a satisfactory resolution to the European debt situation and an outbreak of patriotic bipartisanship in DC. That’s quite a trifecta. If stocks return to their worst levels of the month, we might be more interested depending on how those variables are changing but the recent run up definitely reduces our urgency. Caution and patience would seem the most prudent course.
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