Raul Elizalde - Friday, December 2 2011
Thanksgiving week was a tough one. According to newspaper articles, the stock market had the worst Thanksgiving week since 1932. Never mind that Thanksgiving only became a US federal holiday in 1941: by any measure, the market was unquestionably lousy.
That was then, and this is now. Merely a week later the US stock market is finishing the best week since March 2009, which itself was one of the best ever. This is by now a familiar tale: euphoria one week and despair the next, most of it due to the unpredictable turns of European policy. Most market participants have become hopelessly confused.
We will spare the reader from a detail account of all the ups and downs since early August. Suffice to say that the enormous volatility of the last few months is due not only to violent swings in confidence, but also to the desperation by market participants to be the first ones in –or out. The prevailing sentiment seems to be that if everything turns out to be fine, the market will explode to the upside; but if things turn out to be bad, the market will implode and there will be no time to get out. Is this true?
One thing seems undeniable: everyone is sprinting back and forth because nobody knows in what direction “fundamentals” are pointing. For all the rhetoric about staying the course, investing for the long term, looking for solid companies with a story of increasing dividends, etc. etc. the fact is that if the eurozone breaks up, China hard-lands, or the US falls into a new recessionary cycle, all that you-must-look-beyond-the-horizon advice won’t prevent huge portfolio losses that could take years to repair, just as it happened in 2008.
By the same token, we are not convinced that even if the “fundamentals” turn out to be good, the market will move up explosively and quickly plateau at a higher level, condemning those who didn’t dare to bet early to a future life of regret.
Notwithstanding the finger-on-the-trigger atmosphere of the moment, building up to a market that can sustain steady returns like the recent bull markets of 1982-2000 or 2003-2007 will take time. Large swaths of the economy – housing and the banking sectors, for example – have a long way to go. Setting sail in the middle of the squall could give you a head start, but it can also sink you. Waiting for fairer weather may be a more reasonable strategy, especially for those investors nearing retirement or who may no longer be in their asset-accumulation phase.
With this background, how should an investor interpret the latest US data? Corporate leverage is at its lowest in 25 years, corporate profits are at a record high, retail sales are strong, unemployment seems to be falling, and manufacturing data released this week shows a surprising pick-up in activity. US banks’ assets, if not stellar, at least seem sufficiently understood and provisioned against to preclude an unexpected banking crisis. Are these not the signs we were waiting for to know that things are finally stabilizing, that the time to plunge into risk assets has arrived?
According to the Institute of Supply Management, “the downturn in demand at Eurozone manufacturers deepened to the most severe since May 2009, while China and Japan saw new business drop at the fastest rates for 32 and 7 months respectively.” This is in contrast to the US, which reached a 7-month peak. (Graph: Financial Times)
All this is happening while Europe is falling inexorably into a new recession. Manufacturing data shows that factory output there has been steadily declining for months and is now contracting (see graph). Unemployment in the periphery is astronomical (close to 50% among the youth in Spain), and European banks are in such dire need of financing that six central banks – the US Fed along with the central banks of Europe, Switzerland, England, Canada and Japan – had to step in to provide desperately needed liquidity to prevent the system from seizing up. That the market thought this was good news was met with most analysts’ stupefaction.
So it all boils down to an image that a cartoonist could easily conceive. Above the precipice is the US, pulling on a rope labeled “world economy” which European countries, dangling above the void, are grasping with all their might while squabbling among themselves. Somewhere in between is China, which having been on the side of pulling is now sliding toward the edge of the cliff, dragged down by a surprising downturn in exports, manufacturing activity, and falling real estate values. A crucial detail in this cartoon is that the “world economy” rope is tied around one of Uncle Sam’s ankles, which eliminates the option of letting go. As much as one may want to bet on the US’ newly found strength, nobody yet knows whether it will be enough to pull everyone up and prevent a nasty fall.
That was then, and this is now. Merely a week later the US stock market is finishing the best week since March 2009, which itself was one of the best ever. This is by now a familiar tale: euphoria one week and despair the next, most of it due to the unpredictable turns of European policy. Most market participants have become hopelessly confused.
We will spare the reader from a detail account of all the ups and downs since early August. Suffice to say that the enormous volatility of the last few months is due not only to violent swings in confidence, but also to the desperation by market participants to be the first ones in –or out. The prevailing sentiment seems to be that if everything turns out to be fine, the market will explode to the upside; but if things turn out to be bad, the market will implode and there will be no time to get out. Is this true?
One thing seems undeniable: everyone is sprinting back and forth because nobody knows in what direction “fundamentals” are pointing. For all the rhetoric about staying the course, investing for the long term, looking for solid companies with a story of increasing dividends, etc. etc. the fact is that if the eurozone breaks up, China hard-lands, or the US falls into a new recessionary cycle, all that you-must-look-beyond-the-horizon advice won’t prevent huge portfolio losses that could take years to repair, just as it happened in 2008.
By the same token, we are not convinced that even if the “fundamentals” turn out to be good, the market will move up explosively and quickly plateau at a higher level, condemning those who didn’t dare to bet early to a future life of regret.
Notwithstanding the finger-on-the-trigger atmosphere of the moment, building up to a market that can sustain steady returns like the recent bull markets of 1982-2000 or 2003-2007 will take time. Large swaths of the economy – housing and the banking sectors, for example – have a long way to go. Setting sail in the middle of the squall could give you a head start, but it can also sink you. Waiting for fairer weather may be a more reasonable strategy, especially for those investors nearing retirement or who may no longer be in their asset-accumulation phase.
With this background, how should an investor interpret the latest US data? Corporate leverage is at its lowest in 25 years, corporate profits are at a record high, retail sales are strong, unemployment seems to be falling, and manufacturing data released this week shows a surprising pick-up in activity. US banks’ assets, if not stellar, at least seem sufficiently understood and provisioned against to preclude an unexpected banking crisis. Are these not the signs we were waiting for to know that things are finally stabilizing, that the time to plunge into risk assets has arrived?
A cooler analysis may make you wonder whether the US is in such great shape that it can help the entire world to emerge from the current woes. While the US is stepping on firmer ground, Europe is sinking deeper and deeper in what the Governor of the Bank of England just this week called “an exceptionally threatening environment” that threatens to “spiral” into a full-fledge crisis and unravel the eurozone. Never mind that the French President Nicolas Sarkozy just stated that a breakup of the eurozone would be the “demise of Europe”: some European businesses are starting to stress-test their processes to prepare for just that.
According to the Institute of Supply Management, “the downturn in demand at Eurozone manufacturers deepened to the most severe since May 2009, while China and Japan saw new business drop at the fastest rates for 32 and 7 months respectively.” This is in contrast to the US, which reached a 7-month peak. (Graph: Financial Times)All this is happening while Europe is falling inexorably into a new recession. Manufacturing data shows that factory output there has been steadily declining for months and is now contracting (see graph). Unemployment in the periphery is astronomical (close to 50% among the youth in Spain), and European banks are in such dire need of financing that six central banks – the US Fed along with the central banks of Europe, Switzerland, England, Canada and Japan – had to step in to provide desperately needed liquidity to prevent the system from seizing up. That the market thought this was good news was met with most analysts’ stupefaction.
So it all boils down to an image that a cartoonist could easily conceive. Above the precipice is the US, pulling on a rope labeled “world economy” which European countries, dangling above the void, are grasping with all their might while squabbling among themselves. Somewhere in between is China, which having been on the side of pulling is now sliding toward the edge of the cliff, dragged down by a surprising downturn in exports, manufacturing activity, and falling real estate values. A crucial detail in this cartoon is that the “world economy” rope is tied around one of Uncle Sam’s ankles, which eliminates the option of letting go. As much as one may want to bet on the US’ newly found strength, nobody yet knows whether it will be enough to pull everyone up and prevent a nasty fall.
Raul Elizalde | raul@pathfinancial.net
©2011 Path Financial LLC
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