What Could Possibly Go Right?
A buddy of mine who is an institutional stock broker e-mailed me yesterday that he hadn't shaved and he was so bearish he was sick of hearing himself talk about the stock market. He felt the same two months ago when I told him I was looking to buy stocks and he was right as were several of my other bearish Wall Street bretheren.
So I must confess to poor timing for the piece I wrote a couple of months ago called "Introducing the Less Worse Bull Market". At the time the stock market was poised just below the 200 day moving average, corporate bond spreads and the ABX indexes were improving....it was Spring. I was surprised that the market had not gotten hit harder during the Bear Stearns crisis and had merely retested it's prior low. I introduced the concept of a stock market that could start to do better on bad news becoming less bad than the general outlook had become. By that time the disaster scenarios that were being crafted on investment web site regarding the ultimate credit losses in this cycle had gotten absurd. I did note that the "Less Wrose" bull market might not happen until one more test of nerves had taken place - but I am not ready to say that it has taken place yet. As I admitted my timing in introducing a more positive scenario was pretty bad, the stock market started to tank within a week of my original piece as oil went ballistic. Here we are again with credit spreads blowing out, the market breaking having gotten shellacked and doom and gloom pervading. But let's back up for just a minute and get some perspective.
Last Spring a wrote a piece called Black Monday 20 Years Later, the gist of which was, things are too good, there are lots of risks percolating around (increased interest rates, a weak dollar, corporate profit growth slowing, inflation threatening) and people are engaging in top making kinds of transactions and behaviors. At that time few were worried.
Over the following weeks and months Noah and I wrote pieces that brought up the risks of commodity price inflation, the many unforeseen tentacles of the housing crisis/credit debacle, the bubbles in stock and property markets in India, Spain, China and the UK, the likely State budget shortfalls to be reckoned with and even the risk of policy changes by a new president. Today the sum of all these fears is being manifested "on the tape" that's trader speak for "The news is out in the headlines and therefore it is far too late to trade on it". Remember the Wall Street adage buy the rumor, sell the news, or in this case sell the fears that the Utopian bull market could end and buy when everyone knows about all the horrible problems we face.
So what could possibly be the bull case for the economy and markets?
First a couple of assertions, which you may or may not agree with, but I believe to be axiomatic. You cannot have a wage price spiral form when people are being thrown out of work. You will experience a decline in consumer spending as consumers are thrown out of work. You will experience a decline in fuel usage as prices rise.
Positives
The Chinese, Indians and other fast growth Asian economies have begun to cut fuel subsidies.
Growth rates in India and China are expected to slow markedly and stock market bubbles have popped.
Eurozone growth is slowing and while it will take longer for inflation to slow there due to their socialist ways and slower losses of employment, they will not need to hike rates much further.
The housing market is getting down to a base level of activity supported by only those who really need more space and have the money to afford it. The likelihood that demand will plummet from here is low and new supply continues to be slashed. Eventually inventory will start to be worked down.
Subprime debt defaults are not as bad as people are modeling, nor as bad as the "mark to markets".
Bank loan losses are well below where they were in the early 1990s, when there weren't just risks of bank failures but actual bank failures. Mark to markets will prove to have been overly pessimistic before any major banks fails....the government may actually get involved in monitoring bank cash flows and adjusted capital bases as opposed to marked to market capital bases, before huge fund raising are required.
My Bull Case:
World growth is slowing and will take the edge off the commodity driven inflation picture. The consumer will get weaker and unemployment will rise which will be a good thing, as those with jobs start to save more and the fed is able to hold rates steady or cut, rather than raise them. Note that this recession has begun with the slowest loss of jobs that has been seen in several cycles, my belief is that it's because the housing related jobs were already lost and many other jobs are sustainable without a major growth in the economy as very few domestic jobs were added by companies since 2000 and those that were added are fairly critical. The dollar will gain strength again as a safe haven as other countries start to get worried about their own economies and bubbles. The loss of housing buyers and increase in sellers that result from the US recession will pale in comparison to the decline in home buying interest and increase in home selling that has already happened and the housing market will enter a long period of sleep, but won't implode from here.
This could all be complete poyannish thinking and we are headed into a long and painful recession with inflation that will be the ultimate payback of all our profligacy and immorality. However, it didn't happen in 1987, it didn't happen in 1990, it didn't happen in 1998 and it didn't happen in 2000 and each time you could have made a dire case for markets and the economy. I remember a famous stock market strategist coming to my office talking to us about the huge threat of suitcase bombs and the apocalyptic outlook for the country and markets after 9/11.
I am not recommending that anyone invest money based on what I am saying. But as a long-term investor I learned through several cycles that when its really hard to imagine a horrific fall in the market, you should be exploring what events could cause one, and when you can't imagine how things could ever get better, you should start formulating what a bull case could look like.
Comments (6)
What I am watching is core import prices versus unit labor costs. What is interesting to me if I am tracking them right is that the former has been going up but haven't filtered through to core CPI yet. I am guessing that is b/c the U.S. consumer is so weak U.S. business can't pass it on. But if their profits keep declining (and tax receipts suggeest 2nd quarter profits will be negative again), eventually they will have to or risk going out of business. If those price increases stick, then wage inflation could happen. If they don't, then we are talking deflation. Also, not good.
But, global economies are slowing and so core import price increases may slow and if so may slow enuf so core CPI increases won't happen. But I don't think the avoidance of inflation will trigger a bull market. I am thinking the Fed and the U.S. gov't are getting so involved in making the U.S. economy work that we will end up like Japan after the 80's. Still no sign of a bull market there.
Posted by Query1 | July 14, 2008 1:02 PM
I think this is being overanalyzed... until there is a bottom in housing there will be continous downward pressure on equities. The difference between 1987, 1990, 1998 and 2000 is the tremendous amount of leverage in our banking system.
Too many people are trying to time the turnaround by evaluating the psychology or sentiment towards the markets. The psychology may not be far negative enough when we have had $400 billion in total write downs with an estimated $600 billion to go.
If the world slows down as a result of rising inflation and a weak US consumer, I could paint an even more disastorous picture for equities. Up to this point our economy has benefited from the rest of the world picking up the tab. Rising inflation could effect consumer spending worldwide.
Posted by vince | July 15, 2008 2:08 AM
Jeff, I love you man and respect your intelligence, but let me throw some two cents in here on some points you make for sake of argument:
J: World growth is slowing and will take the edge off the commodity driven inflation picture
N: Yes, but commodities will be driven by dollar weakness and I dont see that changing anytime soon. I do see demand destruction for oil going on, but when that hits the price of crude who the hell knows.
J: The consumer will get weaker and unemployment will rise which will be a good thing, as those with jobs start to save more and the fed is able to hold rates steady or cut, rather than raise them
N: I see consumer being tapped out, unemployment rising but I do not see this as a good thing. There is no wage inflation and jobs market is deteriorating so no way the fed raises rates anytime soon. Lets not forget 70% of our economy is consumer driven and the credit platform for spending combined with negative wealth effects with asset deflation will pressure consumer for years
J: Note that this recession has begun with the slowest loss of jobs that has been seen in several cycles, my belief is that it's because the housing related jobs were already lost and many other jobs are sustainable without a major growth in the economy as very few domestic jobs were added by companies since 2000 and those that were added are fairly critical.
N: True, but why compare to a tech driven boom that happened to be at same time as Y2K problem that saw tons of hirings and therefore, tons of job losses after the boom. Agree with your housing related jobs point.
J: The dollar will gain strength again as a safe haven as other countries start to get worried about their own economies and bubbles.
N: This in my opinion is one of the most important side effects to how our gov't/fed handles the current crisis that is here. With some right moves, at the same time as world growth is slowing, we could very well see a dollar bounce and a drop in commodities as a result. But will it happen? I certainly hope so, but I worry that it wont. A drop in commodities via a stronger dollar will bid up the stock market.
J: The loss of housing buyers and increase in sellers that result from the US recession will pale in comparison to the decline in home buying interest and increase in home selling that has already happened and the housing market will enter a long period of sleep, but won't implode from here.
N: Yes. The rate of deceleration will likely slow, as we near a bottoming in house price deflation. But with foreclosures in the pipeline, we might see another sig drop first, before the deceleration catches up. With mortg markets and bank system in the shape they are, and jobs market so soft and neg wealth effect, I just dont see how consumer can sig bid up house prices in near future.
MY BIG WORRY - Treasuries. What if foreigners lose faith in our treasuries, the dollar continues to weaken, commodity inflation surges, and our gov't makes the wrong decisions (like buying stock in FNM & FRE). If our debt is not funded by foreigners, or our dollar collapses or credit rating of US govt is questioned by markets due to wrong direction, yields for our treasuries could rise substantially.
Posted by UrbanDigs | July 15, 2008 8:05 AM
Folks...my apologies....Noah published this piece by mistake it was an unfinished and frankly not fully polished article I had sitting around in the system to be released at a later date. That said I still stand by the basic premise that as along-term investor it is time to start looking for positives. I have never made any money betting on the end of the world....I just don't see it happening this time either...In six months we will ook back and say, that was a close shave, but I don't think we will be ina depression. See Barron's front page piece on why the housing crisis will be ending soon. As for stocks they are getting quite cheap especially if you don't see interest rates rising much for a long time.
Posted by jeff | July 15, 2008 9:44 AM
Jeff,
You might want to take a look at the commentary at The Big Picture about that Barron's article.
Posted by brenda | July 15, 2008 11:36 AM
what, are we on FOX news? countries in the "eurozone" are not socialist, they are mostly social-democratic, parliamentary republics. and yes, there is a difference, not that anyone this side of the atlantic should care, but labeling the countries of europe as "socialist" is an easy way to bolster the notion of the superiority of unfettered capitalist growth in the US. too easy. the average quality of life in europe is much better than in the united states. buy a ticket, go there, see it...then comment.
Posted by MinNY | July 22, 2008 1:52 PM