Economy Still Hasn't Turned Corner, Experts Say

JULY PROVED A muggy month for our pundits. Predictions got mauled, models were upended by oil-price spikes and faltering financials, investors went south and recession worries lingered.

But even as the S&P 500 dipped, rallied, dipped again and started to claw back to recovery by the end of the month, a few of our forecasters said glimmers of a bottom were starting to twinkle through the tumult. Not that it was an easy call.

"Let's not sugarcoat this equity market," J.P. Morgan strategist Thomas Lee wrote July 11, "It is terrifying." Earlier, on July 7, he pointed out massive levels of short interest in the market, and by midmonth, stocks spiked in a brief rally led by financial stocks and goosed by massive short covering.

But the effects faded, and Merrill Lynch's Richard Bernstein wrote on July 14 that the sector still had plenty of trouble. The increasingly strong governmental intervention into the sector, including restrictions on short selling in 19 companies and a bailout plan for beleaguered mortgage financers Fannie Mae (FNM) and Freddie Mac (FRE), underscored his point, made in a July 14 note.

"We feel the time to overweight financials will be when there is an admission that the problems are systemic, and a formal government entity is put in place to facilitate broad financial sector consolidation by moving assets from weak balance sheets to strong ones," Bernstein wrote.

Even as the government bucket brigades frantically toiled to fix financials, the effects of soaring oil prices muddied the market waters, and those effects helped trigger a global slowdown tinged with rising inflation. Ed Yardeni, president of Yardeni Research, observed July 28 that views on rising oil prices have been radically revised.

"All economies are coupled to the price of oil," he wrote. "Until this year's spike, rising oil prices seemed to reflect growing prosperity around the world, so it was sort of a 'prosperity equalization tax.' More recently, it has become more like an onerous consumption tax."

Although oil had receded from its record $147 a barrel high, reached July 11, it continues to pressure the U.S. economy as well. Ed Hyman, head of the ISI Group, wrote July 21 that his recession alert for the group's 2009 forecast hadn't abated, despite the drop in oil prices.

"Oil's $16 [a barrel] decline last week was a step in the right direction, but not enough. We probably need $100 oil to take the heat off," he wrote.

Despite the apparent remoteness of that call, ISI's surveys also pointed out some data that were at least mildly reassuring. A string of unemployment tracking numbers indicated that the four-week average of unemployment claims was 383,000 as of July 24, below its estimate of 400,000 — figures consistent with 1% GDP growth.

That's no cure-all, but some prognosticators said that at least the idea of a bottom was starting to gain a bit of traction; though reaching it wouldn't be a pretty process.

Liz Ann Sonders, chief equity strategist at Charles Schwab, wrote July 18 that investors, particularly in financials, might have pushed the sector as much as they could, barring more shocks to the system.

"Remember, it's not just fundamentals that drive stocks and markets but the relationship between fundamentals and expectations," she wrote. "At market lows, the expectations bar has usually been set sufficiently low for fundamentals to hurdle them, even if those fundamentals remain weak in absolute terms."

That's going to require more than trusting the market, wrote Pimco bond guru Bill Gross in his August commentary. He said the mortgage crisis had curdled the workings of the credit markets, and falling home prices threatened to make it an almost intractable problem without extraordinary measures.

"If they go down even more, and stay down, well then Washington — Wall Street — and ultimately, Main Street — we have a problem," he wrote. "That is why [Secretary of the Treasury] Hank Paulson and in turn [Securities and Exchange Commission Chairman] Christopher Cox are waving their independent but coordinated wands in an effort to 1) prevent a market run on the price of bank and investment bank stocks until there is enough time to reflate the U.S. housing market, and 2) ultimately recapitalize our primary mortgage lenders — FNMA and Freddie Mac."

Somewhere in the cross-currents and choppy waters, Citigroup chief strategist Tobias Levkovich found some cause for optimism. His July 28 note warned that it's the kind that arrives neatly packaged and solves everything all at once. Earnings expectations will be slashed to reflect harsh economic realities, and investors will react, causing more pain before a recovery.

"As estimates get trimmed, stock prices wobble, and we expect more churn in the markets to reflect the required changes to unlikely 2009 earnings assumptions. This process will further dishearten investors who have been seeking some positive reinforcement," he wrote. "There may be a few more months of pain to undergo, which may leave many investors unwilling to keep coming back to the trough. To some extent, that kind of contempt for equities is the needed component that has been lacking as everyone seeks evidence of a market bottom."

Also See:
Spelling Out Risks With a W and 4 E's
Economy Eases Back From the Brink for Now
April Brings Shower of Uncertainty From Experts

As described above, the United States faces some significant and unique challenges. However, because of the high level of international trade and financial-system integration around the globe, numerous commonalities also exist. It's our view that the United States has simply led the globe in an economic slowdown, which contributed to the sharp declines in the U.S. dollar earlier in the year. But we see mounting signs of slowing around the world. If they come to fruition, the global slowdown could lead to continued stabilization or even a rally in the dollar, as economic sentiment between different economies moves into closer alignment. (Charles Schwab Market Perspective, July 18)