Comstock Partners, Inc.June 28, 2012
The Global Slowdown Will Accelerate
Slowing growth as well as deficit and debt problems in the Eurozone, U.S., China and the emerging nations increases the odds of a deflationary global recession and a renewed down leg in the ongoing secular bear market.
The Eurozone crisis is worsening as economic growth is being hit by front-loaded austerity measures that are exacerbating budget deficits and reducing tax revenues. The southern-tier nations, particularly Spain and Italy, cannot get credit as interest rate spreads have widened to unsustainable levels. Funds have been flowing out of the disadvantaged nations and appear on the verge of a full-fledged run if financial aid in some form is not provided in the very short term.
As we write, the EU is meeting in emergency session to take up measures to shore up the finances of Spain and Italy with the hope that they can buy enough time to start planning on longer-term solutions. For the last two years the EU has enacted one emergency bailout after another only to have to come back and try again within a short period of time. Most likely, they will come up with another short-term plan this time as well, although how much time it will buy is questionable.
The U.S economy has been slowing in the last two or three months. Either downside surprises or actual declines have been reported in key economic indicators relating to consumer spending, new orders, production and employment. A number of major companies have either revised down their second quarter earnings estimates or reduced their guidance for the second half. As a result, second quarter earnings estimates for the S&P 500 have been declining and full-year estimates probably will drop as well. When we further consider the dysfunction in Congress, the "fiscal cliff", the prospective end of operation twist, the elections and the prospect of renewed fighting over the debt ceiling, the threats to an already fragile recovery are high.
The Chinese economy is slowing, perhaps by more than the official numbers show. The NY Times has reported that many local and provincial officials have been falsifying numbers to hide the true extent of the problems. China's economic model is heavily dependent on capital investments and exports, while internal consumer spending remains a relatively small part of GDP. Although Chinese officials recognize the need to increase consumer spending as a percentage of GDP, that is a long-term solution. In the meantime, exports to Europe, China's top customer, are falling now and cannot be offset, except by ordering the building of more plants that will produce goods for which there is no current market. All in all, it seems that it will be difficult to avoid a hard landing.
The slowdown in Europe, the U.S. and China is also impacting the economies of the emerging nations, which are heavily dependent on exports. Declining growth is also driving down commodity prices. Despite all of the talk of decoupling, it seems apparent that the economies of all nations are linked and that there is little prospect of an oasis of prosperity in an increasingly dependent world.
Unfortunately, the monetary and fiscal authorities are out of ammunition. With short-term rates near zero and the 10-year bond yielding 1.6%, there is not much more the Fed can do. At the same time fiscal stimulus is restrained by debt and deficits that are too high relative to GDP.In our view, the current situation is reminiscent of the dot-com top in early 2000 and the subprime top in late 2007, when investors remained in denial that the economy was highly vulnerable. We believe that the April 2nd peak in the S&P 500 marked the top of the uptrend from the March 2009 lows, and that a major market decline is ahead