Comstock Partners, Inc.June 07, 2012
Stock Market On Life Support
The stock market continues to be on life-support, depending on the actions of the Fed and other central banks to arouse it from its lethargy. While Bernanke's statement and testimony before Congress today was somewhat disappointing to those hoping fervently for a hint that QE3 was just around the corner, the hope is still alive. At the same time the market was cheered by the mere statement that Europe was "considering a plan" to help Spain and by a surprise ¼% drop in the benchmark Chinese interest rate. All of this just indicates how weak the economy is without continual booster shots from the central bank.
The ongoing softening of the economy was reinforced by the second consecutive disappointing payroll employment report following a couple of months of mostly below-expectations releases. This is no surprise to us, as the lack of aggregate demand due to the deflationary debt deleveraging that is only in its early stages continues to weigh upon the economy. Consumer spending has held up only by the reduction of the savings rate down to 3.6%, a level that is unsustainable. Wages and salaries are barely rising while government transfer payments are coming down.
With no big demand increase in sight there is no reason for businesses to hire additional workers or to boost capital spending. Add in the uncertainty of Washington gridlock, the well-publicized "fiscal cliff", the severe sovereign debt problems in Europe and the slowdown in the previously rapidly-growing "BRIC" nations, and we have all the ingredients of an economy in great danger of falling into another recession. In our view we are in a lengthy period of high risk and the potential for nasty shocks.
The European banking system is in a precarious position while the European Union, the individual nations and the ECB each wait for the other to lead. The result is a lack of leadership with new proposals being bandied about every day with little action. For more than two years now all we have heard about are plans to come up with a plan. Current proposals on the table are a banking union, deposit insurance, bank recapitalization, Eurozone-wide supervision and regulation, EU fiscal unity and Eurobonds. The problem is that these are medium- to-long-term solutions requiring either lengthy negotiations or unanimous approval by each nation. The market may not give them that much time. Even as we write, a number of observers are worried about an imminent run on the banks, a concern that cannot be dismissed lightly.
Adding to the global malaise, the economies of the "BRICS" (Brazil, Russia, India and China) are all slowing down. Europe is the major importer of Chinese goods, and any recession in the EU has a direct negative effect on China, which is about to undergo a generational change in leadership later in the year. With Chinese consumers still accounting for a relatively small percentage of the economy, a move to ease by the central bank is only likely to result in either the building of more idle capacity or the production of goods that cannot be exported and that nobody will buy. We think that it will be difficult for China to avoid a hard landing.
With all of these problems, it is only the hope of Fed and foreign central bank intervention that is keeping the market from capitulating. The action is highly reminiscent of early 2000 and late 2007 when the market took a long time to form a top as investors remained in a state of denial. The uptrend that started in October was broken when the market dropped through 1357 and then 1340. In our view the downtrend has a long way to go before bottoming.