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Economy by Will Swarts (Author Archive)
Economy Eases Back From the Brink for Now
(Page all of 2)
"While still fragile, sentiment has stepped back from the edge of the abyss — the potential of financial collapse and a hard-landing of the economy," wrote Liz Ann Sonders, chief market strategist at Charles Schwab, in a May 23 commentary. "The $168 billion stimulus package is likely playing its part in the short term, and the Fed's rate cuts will increasingly work their way through the economy. Even former Fed Chairman Alan Greenspan's characterization of the economy has improved from being in the 'throes of recession' in early April to an 'awfully pale recession' just last week."
Avoiding the worst isn't a triumph. Consider the 1.7% drop for the S&P 500 stock index in May as proof. Still, the prognosticators who pegged this recession as short and shallow are seeing some evidence to support their views, thanks to a mix of federal policy moves and continued strong global sales that have propped up U.S. company earnings.
Strategist Thomas J. Lee, at J.P Morgan, wrote May 12 that key data points, including an Institute for Supply Management Survey and a reduction in jobless claims, were healthy signs, relatively speaking.
"Our base case remains for the U.S. to exit the short recession sometime this summer, and recent economic data is slightly better than this, namely the stronger nonmanufacturing ISM reading and [lower] jobless claims suggest a stabilizing economy," he wrote. "Moreover, we believe investors will revisit the 'underperformers' as they anticipate a cyclical recovery, positive for financials and discretionary [sectors]."
That's not to say there's nothing ahead but blue skies and clear sailing. Ed Yardeni, president of Yardeni Research and a consistently upbeat voice amidst earlier fears of a severe recession, put himself in the middle of the predictions pack in a May 21 note, providing a laundry list of potential bad tidings.
"I guess I am smack in the middle of the consensus," he wrote. "So it's time to think about better and worse scenarios. It's not hard to imagine what could still go wrong. Oil prices might continue to soar. Consumers really do finally retrench. Home prices don't stop falling. Home and auto sales head still lower. Mark-to-market write-offs mount at the banks and so do bad loans as delinquencies soar on home, auto and credit-card debts. The stock market plummets. The Fed cuts the federal funds rate by another 100bps to 1.0%, but it doesn't do much to revive economic growth."
Spiking oil prices are high on the list, with crude still at $124 a barrel after topping $135 in late May. That's having a dampening effect on any cause for optimism and could accelerate a reversal of a rate-cut policy that helped pull the markets back from the edge, wrote Jeffrey Kleintop in a May 27 commentary for LPL Financial Services.
"The rise in price of oil has weakened demand for the physical commodity, but it has boosted demand for the financial commodity, since more investors are chasing the returns with oil prices tracking the path of the Nasdaq during the 1990s," he wrote. "Past bubbles have required Federal Reserve rate hikes to end them. The Fed is expected to begin to hike rates later this year. Until then it is possible oil continues to climb and weigh on stocks contributing to the volatile, range-bound performance likely in the coming months."
Also, Europe is starting to feel the pinch from across the pond, and that could surprise investors, warned Citigroup's Tobias Levkovich in a May 19 note.
"International strength has bolstered U.S. profits, but this seems likely to change," he wrote. "With Europe accounting for nearly half of American public companies' foreign sales, a European slowdown could meaningfully affect future profits and stock prices, especially given such trends do not seem to be built into expectations yet. Softer U.S. and European demand may be felt in developing economies as well."
Additionally, warns Pimco's Bill Gross, rising inflation is a much bigger issue than Americans realize, but its effects have been muted by making global comparisons, particularly to fast-growing emerging-market economies that obscure its impact.
"Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late '90s and the U.S. productivity 'miracle' may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal," Gross wrote in his June Investment Outlook. "I ask you: Does it make sense that we have a 3%-4% lower rate of inflation than the rest of the world?"
In the collapse of booms all over, from housing to credit, Merrill Lynch's chief investment strategist on May 13 urged an outlook from the Byrds, the '60s folk-rock outfit that scored a hit with "Turn, Turn, Turn," a song that noted: "To everything there is a season."
"There is a time to grow, and a time to shrink," Richard Bernstein suggested a bit less melodically. "We think that this might be the time for investors to shift their focus from expansion to consolidation. Since the end of the dot-com bubble, expansion has been the order of the day. Success in the financial sector has been largely driven by balance sheet expansion, for example, and the success of many of the 'hot' emerging markets has been based on the expansion of productive capacity."
Also See:
Richard Bernstein, Merrill Lynch
In past reports, we have discussed the need for massive consolidation in the financial sector. During 1989-90s severe credit contraction, roughly 25% of financial companies ceased to exist because of merger, acquisition, or bankruptcy. There has been minimal consolidation in the sector so far during this post-credit-bubble contraction. We expect a lot more to come. The consolidation theme extends far beyond the financial sector. Airlines, materials, technology, consumer staples, and retailing are only a few of the industries discussing consolidation strategies. Consolidation is even appearing in some of China's manufacturing sectors, and we think that the financial positions and balance sheets of U.S. households will be influenced by consolidation trend. (Merrill Lynch Research, May 13)
Bill Gross, Pimco
The correct measure of inflation matters in a number of areas, not the least of which are Social Security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. (Pimco Investment Outlook, June)
Ed Hyman, ISI Group
Over the past eight weeks there've been a remarkable number of policy responses, capped last week by the Fed's unexpected moves to help ease tight global credit markets. In addition, the Fed considered paying interest on reserves. There're probably more policy responses on the way. Odds of the economy going over the cliff are way down. (ISI Group Research, May 5)
Jeffrey Kleintop, LPL Financial Services
Now that the S&P 500 has narrowed the gap with the point at which it began the year to just a couple of percentage points, the historical pattern of stock market performance in a presidential election year suggests the upside price momentum may begin to fade leaving the S&P 500 range-bound until the election nears. It is possible that the timing of the break out may follow the Democratic National Convention in late August, however, it is far too early to be sure of any outcome — even that a consensus will emerge around the frontrunner by the start of September. It is worth noting that in every presidential election year since WWI, regardless of who the winner was the S&P 500 has posted a gain in the fourth quarter as the uncertainty surrounding the outcome of the election faded — with the only exception being 2000. (LPL Weekly Market Commentary, May 19)
Thomas J. Lee, J.P. Morgan
Consumer sentiment, which has been weakening steadily since 2007, finally reached levels that allow us to increase our [positive] conviction on the discretionary sector. Earlier this week, the Conference Board Consumer Confidence index came in at 57.2, a terrible reading only seen five times since the survey began in 1967. The survey affirms the gloomy mood of U.S. households on the heels of weakening home values, sputtering jobs markets and higher energy costs. Is it any wonder that economists, strategists, and investors are all calling for further downside in equities? After registering this low index reading (or worse), the S&P 500 produced impressive subsequent returns averaging 23% over the next 12 months. In fact, there has never been a single instance where the S&P 500 did not have a positive 6-month or 12-month return when Consumer Confidence registered 57.2 or lower. (J.P. Morgan Equity Research, May 29)
Tobias Levkovich, Citigroup
The investment community is likely to hear a different tone of business. Most industrial companies have enjoyed relatively good North American business trends, excluding the housing sector. Yet, this strength should show meaningful signs of strain during the next few months, given the normal lag of credit conditions leading corporate investment activity. Commercial and industrial loans pattern themselves after credit standards. With banks tightening up credit standards to typical recession levels, one should expect to see a sharp deceleration and ultimately decline in C&I loans with a commensurate impact on company revenues. While this may have been a bit delayed by companies drawing down all remaining credit lines, given a less than accommodative bond market, it seems implausible to suggest that the typical relationship will not resume. (Citigroup Research, May 27)
Liz Ann Sonders, Charles Schwab
Speculative phases have their limits. We know these momentum-driven phases can't last forever if only because speculators can't indefinitely inflate (or depress) the price of something. If speculation worked over the long term, then it would only require a sufficiently large amount of money to corner any market. Particularly encouraging currently is that the present commodity mania has coincided with similar momentum speculation in three other financial markets: the U.S. dollar, U.S. Treasury yields and U.S. corporate bond yields. We may be seeing simultaneous reversals in many of these momentum 'trades.' At the time of the engineered rescue of Bear Stearns (BSC), the market for investment-grade credit began to improve. (Charles Schwab Market Perspective, May 23)
Ed Yardeni, Yardeni Research
If [Goldman Sachs analyst] Arjun Murti is right about the outlook for the price of oil, I am going to be wrong about my outlook for a short and shallow recession. Yesterday, he forecast that the price of oil could jump to $150-$200 a barrel over the next 6-24 months. A super-super spike would most likely put a stake in the heart of global economic growth. A global economic downturn would be the most likely outcome, led by a longer and deeper recession in the U.S. Then again, in this scenario, the price of oil would probably fall rapidly and sharply back down to $100 a barrel, or even lower, as demand weakened. Wouldn't the drop in oil prices then revive economic growth? Normally, it would, but if the super-super spike occurs, the resulting longer and deeper recession could trigger the dreaded "negative feedback loop" from the credit crisis. (Yardeni Research Morning Briefing, May 7)
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