| |
Recent Market Commentary:
|
|
|
|
The stock market rally has now reached a point where it is forecasting a V-shaped recovery that is not likely to happen.
The recent catalyst for all of this optimism is a bullish interpretation of current economic activity, some apparent stabilization in the housing market and various companies beating earnings estimates. Also not to be overlooked is the perceived strength of the Chinese economy that is affecting global growth and the upward move in some basic commodities. We think that all of these points are being exaggerated while the fear of missing the train leaving the station is resulting in a speculative surge that is likely to leave the majority disappointed.
The Federal Reserve Board issued its periodic Beige Book yesterday, and while they support the general view that the economy is declning at a slower pace, they still view activity as weak. The Fed stated that "the economy continued to be weak...the pace of decline has moderated or...has begun to stabilize, albeit at a low level...Most districts reported sluggish retail activity." Only three of 12 districts reported some improvement in manufacturing activity. "residential real estate stayed soft in most districts...Commercial real estate weakened further...in two-thirds of the districts and remained slow in the others...Most districts indicated that the labor markets were extremely soft...and cited the use of various methods of reducing compensation in addition to, or instead of, freezing or cutting wages...Nearly all districts reporting on transportation services observed continued weakness." Seven of the 12 districts reported a tightening of credit standards and two others stated that tougher standards remained in place.
The Beige Book is not a statistical summary, but a report from the 12 districts on what is going on in their area. It certainly does not read like the bullish headlines we've been seeing, and , in fact, paints a weak picture of the economy across the board including retail sales, housing, commercial real estate, transportation, labor, manufacturing and credit.
As for the housing market, although we've seen some signs of stabilization at extremely low levels, the picture is nowhere near as bright as the screaming headlines in some major newspapers. New home sales for June were actually down when seasonally adjusted. Moreover the number of new homes sold in June was the worst since June 1982. You'd never know that from reading the newspapers or watching financial TV. Furthermore, income and employment, the main drivers of housing demand, are still too weak to support a meaningfull housing recovery. When we add in falling prices, excess inventories, more foreclosures and another surge of resets ahead, the housing picture is not too pretty.
Another factor that is being hyped is the bullishness over 2nd quarter earnings reports. Sure, earnings are beating expectations, but that's because they were deliberately set so low in the first place. While earnings are beating the most recent estimates they are actually still below the forecasts made in February. In addition we have previously commented upon the weakness of revenues in the earlier second quarter reports. This has continued in the current round of reporting. Wall Street was really excited over this week's earnings reports by Motorola, Goodyear and Dow, overlooking the fact revenues were down a whopping 32% at Motorola, 25% at Goodyear and 31% at Dow. This cost-cutting may be good for the individual firm, and it is what they should be doing, but the spending cuts necessary to get the results certainly damages the economy at large.
Another factor often cited is the perceived strong recovery in the Chinese economy that is supporting global growth and putting upward pressure on a number of basic commodities. Now we don't claim to have any expert knowledge about the Chinese economy, but some simple arithmatic makes us kind of suspicious. Exports, which account for about 35% of their economy, were down 20%, yet the GDP was up 8%. That means that the non-export sector (65%) had to be up by some huge percentage to make the GDP number. If their statistics are accurate (and we don't know that) then something else is going on. Loans in the first half of this year were reported to be up $1 trillion, compared to $600 billion in all of 2008, and most of this is apparently going into fixed investments. The question is: what are they going to do with all of these investments? To the extent that it is going into new plants, it will result in a huge increase in capacity at a time the export market remains very weak and domestic consumers account for a relatively small proportion of the economy. The new plants will remain mostly idle or will produce goods that nobody will buy. Either way, it certainly seems like a highly unsustainable way to grow. In addition it seems that commodity prices are at grave risk when the Chinese have to pull back on their spending.
All in all it seems to us that the market is far ahead of itself and that the outlook is not likely to validate the big rise in stocks, unless we get the improbable V-type recovery. Anything is possible, but we think that scenario has an extremely slim chance of working out.
|
