Comstock Partners, Inc.February 16, 2012
Stock Market Is Expecting Too Much
At current levels the market is expecting a lot more than it's going to get. Investors are breathing a sigh of relief that the U.S. did not fall into a recession following the 2011 mid-year slowdown and that the likelihood of an agreement between the EU and Greece will, at least, avert a Greek default on March 20th. While that is true as far as it goes, the U.S. economy is still highly fragile, and the EU agreement is the least bad among a choice of lousy options.
Although the U.S. economy has not fallen back into recession, it is far from out of the woods. This has easily been the weakest recovery of the post-war period. Since the cyclical trough in 2009 the strongest quarter has witnessed annualized GDP growth of only 3.9%, an anemic number for an economy that one economist recently described as in "a self-sustained cycle of growth". By comparison, in the last 57 years there have been 51 quarters with growth of 5% or more----sometimes much more----all during economic expansions.
Moreover, even this weak recovery is facing significant headwinds in 2012 as a result of 1) a slowdown in global economic activity; 2) fiscal tightening; 3) a continued weak housing market; 4) the need for more household deleveraging; 5) high levels of uncertainty among households and business; 6)) an unsustainable decline in the consumer savings rate; and 7) possible financial market turmoil from the European sovereign debt crisis. We have written in detail on each of these factors in recent comments. In addition the economy has benefitted from some temporary factors such as the 4th quarter inventory restocking, the 100% depreciation provision on capital goods that ended on December 31st and the unusually warm and snowless winter that has distorted seasonal adjustments to economic data and made growth look stronger than is actually the case.
In addition the stock market can no longer count on the ever increasing corporate earnings outlook that has overcome a lot of the other drags from the U.S. and global economic picture. Only 63% of 4th quarter earnings results have beaten estimates, the lowest since the 3rd quarter of 2008. Only 43% exceeded revenue estimates, the lowest since the first quarter of 2010. Furthermore, consensus year-over-year earnings estimates for the 1st quarter of 2012 are now down to zero, and the trend of estimates is falling.
As for the probable deal to bail out Greece for a second time, all it does is avert a Greek default on March 20th when 14 billion Euros in bonds become due. A default would cause widespread havoc and cause Greece to leave the EU, leading to deep depression, unemployment and a wipeout of a substantial portion of the nation's savings along with political social upheaval. Having said this, the outlines of the prospective agreement is no panacea. While it would prevent imminent default, the required austerity measures would depress the economy, raise unemployment and probably increase the deficit as a result of declining tax revenues. Depression and deflation would be the likely outcome for years ahead.
In either case Europe is entering a deep recession, particularly in the so-called periphery countries, but also in the more prosperous northern tier. Banks are not providing credit, but are selling assets and exacerbating the downturn. This will impact exports from the rest of the world, including the U.S., China and emerging nations. Chinese exports and imports are already declining sharply while their housing and commercial real estate markets are slowing. This will spread to the emerging markets that are mainly producers of commodities. All in all, it appears that the global economy is slowing and is likely to provide a serious headwind to an already fragile U.S. economy.