Nouriel Roubini and the Future of the Stock Market

Most readers are probably familiar with Nouriel Roubini. Roubini was one of the few academic/establishment economists who predicted the credit crisis and the ongoing recession. Liberals especially embraced Roubini because he advocated for strong Keynesian measures to prevent the economy from going into freefall. He's emerged as one of the most influential economists in the world right now, right along with Paul Krugman. One fact that some of you might not know is that, under the Clinton presidency, Roubini was a senior adviser to Timothy Geithner(who is now Treasury Secretary under President Obama).

Roubini has warned his readers that the ongoing stock market rally has a strong possibility of fizzling out and ultimately being nothing more than a "dead cat bounce." Quite simply, the optimism in the market doesn't jive with the weak expectations for earnings growth. Today, Bloomberg has published an article presenting the viewpoint of some Roubini-skeptics. Apparently, a lot of investors genuinely believe we've entered a bull market and they cast doubt upon Roubini's warnings. In fact, according to Bloomberg, some investors might have missed out on "the biggest rally since the 1930s" because they followed Roubini's advice.

When it comes to the stock market's ongong rally, I agree with Roubini. There's a lot of exuberance around the stock market but it's definitely not based on the 2009 and 2010 projections for the U.S. economy, which are still mostly "doom and gloom." Despite all the talk about recovery and "green shoots," our political and financial leaders still haven't pointed to one industry or one economic sector that they expect to significantly grow and be able to drive a recovery over the next few years.

However, the part of the Bloomberg article that I found the most interesting was the following:

Roubini has “done a very good job on the economy,” Birinyi said in an interview Aug. 24. “Our approach is to try to understand the market and not try to do much more than that.”

Laszlo Birinyi is an investment manager (unlike Roubini, who is an analyst and a scholar at New York University) who also correctly predicted the economic collapse, in 2007 (Roubini warned his audience about troubles in the housing market as early as 2005). The article further states:

“Both of them just have a pretty deep understanding of the history of economic and business cycles,” said Eric Teal, who oversees $5 billion as chief investment officer at First Citizens Bank in Raleigh, North Carolina. “Roubini has just had more of an academic background, whereas Birinyi has been much more in the spotlight managing money and working in capital markets.”

I thought these excerpts were quite telling about so much.

What comes through is that investors perceive a divide between "the economy" and "the markets." To some degree, this explains why so many investors were blindsided by the recession. Investors were so focused on understanding the movements and dynamics of the market that they were unable to see the flawed and unsustainable foundations of the economy on which that market was based. Apparently some things dont change.

At the same time, these investors aren't completely wrong in the way they see things. What happens when a company experiencing distress lays off a significant percentage of its workforce? On the one hand, the American economy as a whole suffers because it adds to unemployment and lowers consumption. On the other hand, the economic situaton of that company might genuinely be better because it has reduced costs and has probably come closer to returning to profitability. When this happens on a mass scale, as is happening now, a kind of decoupling between the economy and the markets happens. The market comes to only represent a certain slice of the American economy. Much of the real economy is no longer reflected by the status of the market. The problem is that the media still tries to present the stock market as if it were an accurate measurement of the health of the real economy, which it isn't.

Finally, these comments show just how desperate investors are right now. A small rise in the Dow Jones Industrial Average would have been understandable considering the national economy did just avoid total meltdown. But a small rise isn't the case. The reality is that we're in the midst of one of the steepest rallies since the 1930s, as Bloomberg points out. There are very few safe havens for investors out there. So, when investors saw that the stock market was rallying they were willing to ignore the obvious signs of risk out there (including overt warnings from Roubini and others like him) and they jumped in with the hope of making at least some returns. The desperation of investors tells us more about the state of the economy than the various indices do, in my opinion. We can also see that, as long as there serious doubts about the economy, we can expect some serious volatility in the markets. As a recent commentary by me points out, the Great Depression bore witness to some of the biggest rallies in history.

So when we see something incredibly contradictory like what we see today: Roubini(who is probably the most influential economist in the United States) voicing major concerns over the future of the economy while the stock market rallies and institutional investors declare a bull market ... I think the only thing we can be sure about is that the recession is still far from over and some severely bumpy road (to say the least) still lies ahead.

Forecast Calls For Higher Taxes

Today, the Toronto Star tells us that:

OTTAWA–The International Monetary Fund says most countries will need to raise taxes to pay off the trillions of dollars they spent fighting the global recession.

IMF chief economist Olivier Blanchard says in an article to be published today that governments acted properly in ramping up spending to stop the worst slump since World War II.

Soon, he says, nearly all countries will have to raise taxes to pay the recovery bill.

I'm not sure why the IMF has to publish an article in order to inform the public of this fact. How else were governments expected to pay for these stimulus programs?

Blanchard, meanwhile, says with the recession virtually over, what is left are deep scars that will take years to heal.

He sees positive growth for most countries in the next few years, but says it will be sluggish.

“The recovery has started,” Blanchard says in the paper released by the Washington-based lender.

“The crisis has left deep scars, which will affect both supply and demand for many years to come.”

In many countries, the potential exists for economies never to return to where they stood before the recession hit, Blanchard states.

I disagree that the recovery has started. None of these officials can point to one sector of the economy that is actually experiencing significant growth, not even the government sector under their control. Nor can they rebut the myriad facts that point towards the economy worsening, not recovering. The only bright point is the ongoing stock market rally. However, the stock market is driven more by investor psychology than by economic fundamentals. For whats it worth, the stock market in China just officially entered a bear market.

A rebalancing among nations is also needed, the IMF says, with countries like the United States increasing imports and economies like China increasing exports.

I'm assuming this is a typo or I'm just reading it wrong. Rebalancing would involve the U.S. increasing exports and China increasing imports, but the chance of that happening is close to nil right now.

Fiscal deficits could feed "worries about U.S. government bonds and the dollar ... causing large capital flows from the United States," Blanchard added.

"Dollar depreciation may take place, but in a disorderly fashion, leading to another episode of instability and high uncertainty" that could derail recovery

No joke: President Obama just raised the 10-year budget deficit projection to $9 trillion from approximately $7 trillion. It's pretty obvious that taxes are going to have to be raised to cover this increasing deficit. As for the fate of the dollar, I covered that in a previous post.

Is the Recession Over in Europe?

The recession is over in Europe. That's what much of the American and European financial media is declaring. Unlike most industrialized nations in the world, Germany and France actually experienced economic growth during the last financial quarter. That fact, combined with the announcement last week by Eurostat that the Eurozone economies only declined by 0.1% quarter-to-quarter, has many feeling that the recession is on its way out and a recovery is here for Europe.

Are they right? Writer Ulrich Rippert of the World Socialist Web Site says 'no.'

I'll begin with this interesting tidbit:

At the same time there are voices warning of undue optimism about an economic recovery. In its latest edition, the weekly Die Zeit writes: “‘Recovery at last! Investment bankers establish upward trend,’ reads the New York Times. ‘Further progress in the business world,’ reports the Wall Street Journal. ‘Economists see signs of a recovery.’ ‘Powerful rise on the stock markets,’ report others... The headlines appear to come from August 2009. In fact, they are from the year 1931. They were published in the midst of the Great Depression in the US, i.e., in the blackest economic epoch of the 20th century.

This echoes something I've said before: prolonged recessions/Depressions bring about extreme market volatility. The Great Depression bore witness to some of the biggest stock rallies in history. A growth in stock prices, especially an extremely rapid one, does not necessarily indicate that the economy is actually in recovery. It might indicate such a thing, but it is not a given, yet the media is treating it as a given. The reality is that this kind of historical precedent (the experience of the Great Depression) is pretty much impossible to factor into the statistical models that today's investors, analysts and economists employ. Their field of vision is much more narrow. And that's the problem ... understanding the historic point in economic history we're at right now requires a panoramic lens, so to speak.

Rippert continues:

In these declarations there is a combination of self-delusion and calculation. The politicians and financial players have a vested interest in promoting a mood of euphoria to sustain the heady rally on global stock markets. However, there is little in the actual economic situation in Europe and internationally to justify such optimism.

The minimal economic growth reflected in the latest data should come as no surprise, given the manner in which governments across Europe have opened up their treasuries to bail out the banks. Hundreds of billions of euros in public funds have been placed at the disposal of the major financial institutions, without any demands being placed on the banks or a single one of the bankers responsible for the crisis being held accountable.

Not only have the banks dictated their own rescue packages to their respective governments, they have profited handsomely from the process. The billions turned over to the banks are being used as a pool for further speculation, while bailed-out banks impose high interest rates and fees on governments seeking loans to cover their ballooning debts.

The financial elite regards the crisis as an opportunity to dismantle, with the collaboration of the trade unions, all that remains of the social gains won in the course of decades of struggle by the working class.

Nothing surprising here. Europe mirrors the U.S. in a lot of regards. Its interesting to see a self-declared socialist web site criticize trade unions. In the U.S., I disagree that the trade unions are serving to "dismantle" the position of the working class. First off, most blue collar workers are no longer in unions to begin with. Secondly, the trade unions were actually the primary opponents of Governor Schwarzenegger's budget in California. With that being said, I would agree that the unions aren't really playing much of a big political role or offering up anything new in terms of where the economy should go. That's a big difference from the 1930s.

What is the underlying economic reality? Compared to one year ago, the German economy has declined by no less than 7 percent. In a few months, the German “cash for clunkers” scheme will expire, accelerating the decline of the country’s auto and auto-supply industry. The consequences for the German steel, engineering and chemical industries have already been felt.

Up to now, mass redundancies in Germany have been avoided by means of a reduced work-hours scheme, which has been renewed several times. When the 1.4 million employees on short-time work eventually join the ranks of the unemployed, the official unemployment level will rise to 5 million.

...

The constitutional “brake on debt” which was recently passed by the German parliament means that the first priority of any future government will be drastic budget cuts. The promises being made by all of the parties taking part in the national election campaign will be consigned to the waste bin as soon as the votes have been counted on September 27.

...

A glimpse of what is to come was provided by the so-called “Guttenberg Paper,” which was made public just a few days ago. The document, bearing the title “Proposals for a Sustainable Industrial Policy,” was commissioned by German Economics Minister Karl-Theodor zu Guttenberg and lists some of the savage measures which business lobbies are demanding in response to the crisis. Similar measures to those outlined in the “Guttenberg Paper” are already been prepared by the appropriate ministries, but there is an agreement amongst the various political parties that no one raise such themes in the course of the election campaign.

The Frankfurter Rundschau reports that the 52-page document calls for “tax relief for businesses,” “the reduction of supplementary wage costs,” and “increased flexibility in the labour market.” The document urges a weakening of job protection provisions, limits to sick pay and the scrapping of proposals for a guaranteed minimum wage.

Interesting. In short, the German state is basically expending all of its resources to hold up the economy. Even then, the economy is barely above water. It appears that Germany is already on track to experience what California is already facing today ... massive government budget cuts and an end to the various subsidies and measures by which the state propped up the economy. Last week I commented on what awaits places like California and Ireland where the government sector and state welfare policies have been drastically reduced ... and the picture ain't pretty.

I haven't really explored the World Socialist Web Site very much, but I thought this was a pretty good article. It certainly offered one of the best rebuttals to the claim that its all smooth sailing for the European economies from here. In actuality, we can see that they still face a lot of hardship.

Twitter and it's Parasites

Over at Reuters Blogs, Jon Cook has an article up entitled 'Is Bit.ly's Twitter advantage unfair?'

Bit.ly and Tr.im are URL-shortening services. As some of you may know, Twitter has a 140 character limit, so these websites exist to make URLs short enough to fit into 'tweets.'

The thrust of the article is that Tr.im finds Bit.ly's special relationship with Twitter (as its default URL-shortener, ooh la la) unfair, and is likely to go out of business because it can't compete.

Here is a quote:

Tr.im further stoked the Bit.ly-Twitter relationship debate, by adding that “Bit.ly has a monopoly position that cannot be challenged with reasonable investment or innovation unless Twitter offers choice. This is a basic reality of challenging monopolies. Bit.ly has deep personal connections and agreements with Twitter that we simply cannot compete with. And it is our humble opinion that this type of favoritism will become an issue for all Twitter developers.”

First of all, as many of the commenters on the Reuters Blog post pointed out, in most other industries this is simply called free competition. Enterprises are free to form preferential relationships with each other ... what exactly makes Tr.im think it deserves some special privelege ... and what makes Reuters' writer Jon Cook think this story is newsworthy?

Secondly, I find this whole issue to be representative of all that is troubling about the "new economy" led by the "creative classes."

I personally find Twitter to be incredibly overhyped. It doesn't really offer anything that existing web services didn't already offer. In fact, it artificially constrains messages to 140 characters for who knows what reason. I suppose it represents the incredibly short attention spans of today's media-crazed populace. Twitter's growth has been mostly driven by hype and social influence ... people try it out because all of the cool people are doing it, not because its actually useful. If you scan through Twitter you'll find that most "tweets" are often just plain junk, that or what are essentially private test messages put out in the open.

Here, however, we're not even talking about Twitter. We're talking about companies that act as parasites on Twitter. Both Tr.im and Bit.ly basically existed to serve the "market" for URL-shortening that Twitter created. The fact that one of these companies is complaining about a "monopoly" would be hilarious if it weren't so pathetic. Do these companies really think theres a viable market allowing for multiple competitors in URL-shortening for Twitter? Isn't Twitter going to eventually buy and incorporate one of these companies anyway? Truly, this is a tragedy of the greatest proportions, LOL.

And yet ... this is what our leaders tell us is the future of the American economy, or at least should be. This kind of "social entrepeneurship" ... this kind of "innovation" (and truly, where would society be without the marvelous innovation of Twitter and Bit.ly?). Even though there are billions of people around the world who need to be fed, clothed, given housing, given transportation, etc. any kind of industrial or physical economy is "dead" in the eyes of many of America's political and economic leaders. Instead, the future many of our leaders would prefer is one where we design new ways to waste time (and to make that time-wasting process more efficient). I seriously wonder whether the people investing millions of dollars of capital into these pointless tech companies and the political leaders heralding them as the greatest thing since sliced bread have ever actually visited and spent time on these sites.

Well, enough ranting for me ... If you agree with me, spread the word about my blog. If you don't, express your differences in the comments.

Addendum: Spoke Too Soon on China/Australia

In my previous post, I pointed out the dependence of the Australian economy on exports to China. There, I said that as long as the Chinese government's stimulus program didn't change Australia would likely fare fairly well during the rest of this recession.

It seems as if I spoke far too soon.

I was just surfing through Reuters when I stumbled upon this news article:

BEIJING (Reuters) - The Chinese government is attempting to pass the baton of growth from state-funded infrastructure investment to the private housing sector, a risky but necessary move to sustain the economic recovery.

Construction cranes sprouting in big cities, busy furniture shops and soaring property sales all show that the transition is going smoothly so far, though officials are wary that house prices may rise too high, too quickly.

The rest of the article is about the Chinese government's fears about the housing market heating up too fast. No further comment is offered on how state-funded infrastructure investment is being reduced, if in fact it is. I don't know the intricacies of the Chinese economy enough to be able to comment on how this will effect Chinese raw materials imports from Australia. Nonetheless, this seems to complicate the situation and what I stated in my previous post.

Australian Economic Forecast

The Australian economy doesn't get much attention in the American press. Today, however, I found an interesting article from Forbes on the future of the Australian economy.

The good news is that the Australian economy is nowhere near as over-leveraged as the American and British economies are.

Australian activity has remained surprisingly strong during the global crisis. Monetary and fiscal policy were aggressively switched to stimulus at an early stage. Australian banks were never exposed to the same degree of risky lending as their counterparts in the United States and the United Kingdom. The strong fiscal position enjoyed by the government enabled it to extend guarantees to various parts of the financial system at relatively low cost.

The bad news?

Over the past two years China's share of Australia's merchandise exports has risen from 15-20%.

and

The sharp fall in Chinese exports has not resulted in lower demand for Australian resources, as China's fiscal stimulus has focused on infrastructure, for which Australia is a supplier of raw materials. Although export prices are down from 2008 peaks, total Australian merchandise export volumes have risen in the nine months to June.

So Australia is heavily dependent on the Chinese market for raw goods. Lately, the media has been printing all kinds of troubling news concerning the Chinese economy ... everything from the macro effects of slumping American consumption to the decline in the real estate markets of Shanghai and Beijing. However, China is importing raw goods that are to be used in infrastructure construction. As long as the Chinese government keeps up its fiscal stimulus program and keeps it oriented towards infrastructure construction, the Australian economy should be, more or less, fine.

So, for now, I think the Australian economy will face some pain, but, not quite on the level that the U.S. and U.K. are facing. Of course, if the entire global financial system melts down, this all goes out the window. That's a big "if" of course.

Quick Update: Swine Flu in Japan

A few days ago I made a post about the effects of the swine flu on the Indian economy.

Today, the Japanese Health Minister has declared that the swine flu has reached pandemic levels in Japan after a third death in the nation from the virus.

At the moment, it doesn't appear as if the virus is having the same major effects on the economy that it had in Mumbai and other parts of India. That doesn't mean that it won't in the near future, however. The Health Ministry might be accurate and the virus could spread at pandemic levels. Or, the Health Ministry might be blowing smoke and being extra cautious. Even then, the media attention has the capability of transforming this into something larger and keeping people away from public places (and thereby from consumption).

In one of my previous posts, I commented on how stock markets are often driven more by psychology than by economic fundamentals. If history serves as a guide, then I would not be surprised in the least if this news affects Japanese investors and drives prices down, if only temporarily. Recently, negative economic news out of China and Japan hurt stock prices in the United States and Europe. That presents a pretty negative prospect, but that's reality in this global economy.

Keep in mind, I'm not predicting a decline in stock prices. Like I said in a previous post, I don't focus on the stock market, I prefer to try and gauge how the so-called "real economy" is doing. I'm merely pointing out that this swine flu is something to keep an eye on, since it definitely has the prospect of affecting economies.

Deflation or Inflation?

Nathan A. Martin writes the Economic Edge blog. Martin is the author of the 'Flight to Financial Freedom' book and is certainly a guy who knows what hes talking about when it comes to finance and the economy.

I bring his blog up for a reason. During this recession, the alternative and independent media has focused in on the idea that the outcome of this recession will be inflation, if not out-and-out hyperinflation like the Weimar Republic of Germany faced earlier this century. Much of this sentiment originates from the so-called Austrian School of economics. Dr. Ron Paul is one notable politician who has warned about the hazards of hyperinflation (and who I respect quite strongly).

Mr. Martin is also quite pessimistic about the future of the American, and world, economy, judging by his blog posts. However, he argues that, rather than inflation, the U.S. is about to enter a deflationary cycle. I don't really feel capable of answering this question, of predicting whether we'll face inflation or deflation, but I found his argument to be enlightening and educational nonetheless and really quite compelling. So I strongly urge you to visit his website and read his post, which you can find *here*.

Here is an excerpt from his post:

No, I’m not being over-dramatic. It is time to buckle the heck up. The resonant disconnect between reality and the pumping that is going on in the media and among supposed “experts” is at an all time historic, never been here before, Economic Mass Psychosis, HIGH.

To Quote John Kenneth Galbraith, “The majority is always wrong.” Right now the majority believe we are exiting the crisis. They are just plain old fashioned WRONG – again.

To prove my point, I’m going to show you the week in charts courtesy of the St. Louis Fed. This week, however, I’m issuing a WARNING. The evidence in these charts points to the beginning of a DEFLATIONARY SPIRAL. The PPI data comes out next week and will be a key piece of evidence in this regard. The results of a deflationary spiral will be UGLY if entered. You will see another round of deleveraging to go with locked credit markets. Equities will get hammered and the real cleansing of the economy will accelerate. This process will be PAINFUL but necessary to end the malinvestment. It will be the phase where more businesses who were hanging on HOPING for recovery will simply run out of cashflow to maintain operations. The same thing is necessary to cleanse a way over-bloated government and military.

The fallout will affect everyone. These charts are HISTORIC, they are NOT indicative of a short recession. As you view these charts, pay attention to the negative trends and look at them from a historic perspective. Many market callers are looking for immediate inflation due to the money pumping. I challenge them to point out inflation anywhere in these charts besides the money aggregates, which, by the way, are not growing at the rate they were. Those who look solely at the money aggregates are not seeing the destruction of credit which is very real and has hobbled the consumer. Never ending growth was a fantasy and is over for the time being, there is simply too much debt/credit in the system.

*Please* go over and read the rest of his post right now for the rest.

Response to Agnes Crane on Reuters

Writer Agnes Crane has written an article for Reuters Blogs entitled 'Don't be fooled by global stock stumble.' Her basic argument? Don't lose confidence in U.S. stocks because of today's (8/17/09) stock market drop.

I want to emphasize that I am definitely not a stock market "guru." I personally feel that the stock market doesn't accurately represent the real American economy. To begin with, the stock market does not encompass the entire American economy - small-businesses often drive American economic growth and expansion much more than publicly-owned corporations. Secondly, the stock-market is driven much more by psychology than by economic fundamentals. The various bubbles that have popped or are in the process of popping during this recession were created because individuals ignored the fundamentals of the economy and latched onto blindly optimistic sentiment that grossly overvalued just about everything in our economy. Psychology changes on a whim, but the fundamentals stay basic.

Still, I do follow news concerning the stock market because it does have some relationship with the real economy. I just try and keep a critical mind that attempts to discern between reality and falsehood. With that in mind, I want to respond to Crane's commentary here.

She writes:

Don’t blame global stock markets for being skittish. It is August, after all, a month that has spelled trouble in the past two years.

Recall that, a year ago, Fannie Mae and Freddie Mac started wobbling at the precipice while AIG, desperate for cash, began paying junk-like yields in the corporate bond market. A month later, all hell broke loose.

In August 2007, a shutdown in short-term lending markets forced global policy makers to rush in with a flood of liquidity to keep the lifeblood of the financial system from clotting.

So it’s only natural that, this year, sellers are trigger-happy at the slightest whiff of trouble.

Once again, the argument is entirely psychological. According to her, all that is wrong is that investors are psychologically uneasy because of the significance of August (and presumably, her commentary will serve to destroy this notion and keep you psychologically optimistic and ready to invest in stocks). Is this argument true? Personally, I find it laughable. Lets try to imagine this scenario for a moment ... an investor is watching his money grows as the stock market rallies, suddenly he looks at his calendar and sees its August ... uh-oh, bad things have happened the past two Augusts ... I guess its time to pull all of his money out! Sound realistic? Last week Reuters reported that major "insider" investors were pulling out of stocks. Do we really imagine that big-time investors with lots of experience and lots of money invested in the market are going to pull-out based on what month it is?!

Problems surfaced in the United States last week, when a double-whammy of soft retail sales followed by a drop in consumer sentiment reignited worries that for all the good cheer about an emerging recovery, the exhausted American shopper is still unfit to carry the economy.

These concerns carried over into Monday trading in Asia, where they mingled with homegrown worries. In China, a drop-off in direct foreign investment helped fuel a nearly 6 percent decline in the Shanghai stock index and concerns about the Japanese economy helped trim more than 3 percent from the Nikkei.

U.S. stock indices have followed suit, with the S&P 500 off 2.43 percent and the Dow Jones Industrial Average off 2 percent.

Hmm ... wait, I thought it was all just skittishness on the part of investors? So, Crane admits here that the economy has serious problems that cast major doubt on the viability of the current rally. Should you be worried, like a lot of those "insider" investors are?

Monday was an ugly day, but investors should try to rein in their anxiety about what it means for such big-picture questions as what shape the economic recovery will take. That’s because a battle between bulls and bears, which typically emerges at economic turning points, has taken hold of financial markets — meaning today’s worries about the global economy are likely to morph into tomorrow’s worries about too much stimulus creating dangerous asset bubbles.

It’s a constant tension and one that will continue to push and pull financial markets for some time to come.

Her answer is no. What shes basically saying is that we're in a time of great volatility. Keep in mind that the Great Depression was a period of great volatility as well. The Great Depression saw some impressive stock rallies, which all turned out to be illusory by the way. The author has no way of ascertaining that this is a "turning point" except through hindsight, so it is merely supposition, or wishful thinking, on her part.

“The markets have very selectively reacted to economic data,” says Stephen Stanley, chief economist at RBS. Little more than a week ago, for example, the S&P 500 hit a 10-month high after the U.S. reported “only” 247,000 workers were dropped from payrolls in July.

When do the markets not selectively react to data? The entire housing bubble was caused by "selective reaction." Furthermore, the July unemployment numbers have been challenged for being artificially-low by various sources. I won't go into it now, but if you want to know more about how the U.S. calculates unemployment from payroll sources, I point you to ShadowStats.com's page on the matter.

Given the big run up in risky assets like stocks and corporate debt since March, and last week’s data, it’s not surprising that investors are now worried that the rosier outlooks failed to take into account the growing fixation of the U.S. consumer on savings.

Take price-earnings ratios. Bespoke Investment Group noted last week that the P/E ratio of companies in the S&P 500 climbed to its highest peak since 2004, as earnings failed to keep pace with the optimism that fueled a 50 percent jump in the S&P 500 stock index since March. For earnings to catch up, the consumer will have to shake off worries about high unemployment rates and pitch in with good old-fashioned shopping. So far, that’s looking like a stretch.

So, chalk up the stock declines to correcting what had become overbought conditions and get ready for more choppiness ahead.

This is the messy reality of turning points, not necessarily the foreshadowing of something truly ugly to come. Even if it is August.

I don't have much to add here. The author asks the reader to not be worried and assures us that this is merely a "turning point" towards better times ... yet provides us with nothing but troubling economics forecasts. Where is the positive news to convince the reader to stay invested? It is definitely not present in this article. The author seems to think that by merely explaining the reasons why investors have lost confidence in the market rally that somehow negates those reasons.

Overall, I found this to be a very poorly argued commentary piece and I'm quite disappointed in Reuters. Financial journalism isn't very good these days. More often than not, you're better off reading independent and alternative news sources for actual truth.

Is the Stock Market Rally Over?

Here are a few reports from Reuters on the current state of the stock market. Here, Reuters reports that:

NEW YORK (Reuters) - Stocks suffered their worst loss in seven weeks on Monday as weak data from Japan and a disappointing outlook from retailer Lowe's Cos (LOW.N) dampened hopes about the economy's growth.

Japan's gross domestic product showed its economy pulled out of recession in the second quarter, but at a slower pace than expected, prompting a sell-off in major Asian markets that spilled over into Europe and North America.

....

The results amplified worries about weak consumer spending following last week's poor data on U.S. consumer sentiment and retail sales.

The health care sector managed to outperform most other economic sectors. Is the stock market rally of the past few months over? Will we see the Dow Jones Industrial Average go below 9,000 points again? Only time will tell. Its pretty clear that the primary reason for the decline is the fact that consumption seems to be on a consistent decline and shows no sign of recovering. The retail sector is struggling especially hard.

Here is another story from Reuters, published last week, that is of interest to anyone invested in the stock market:

NEW YORK (Reuters) - A massive rally in U.S. stocks since March has reawakened bullish spirits, but insiders are jumping out of the market in a sign the run up is getting stretched.

Company executives are selling stock at a rate not seen in two years after a near 50 percent rise in the S&P 500 from a March 9 low. That suggests directors and managers may think stock prices are nearing the top end of their range in the current economic climate.

...

For brokerage Jefferies & Co., a significant increase in insider selling transactions as well as a decrease in short interest across most sectors of the S&P 500 demonstrates the weathering of the bear market rally.

...

Since early March investors have piled back into the stock market in the hope of an economic recovery, bank sector stabilization and expectations many more will follow them.

...

"Insiders historically have a strong correlation on a macro level to buying and selling, said Silverman, who is based in Princeton, New Jersey. "There's a lot of negative signs right now coming from insiders."

It seems like investors should definitely consider the implications of these news stories. While the media and some financial institutions publicly declare that the recession is on its way out and a recovery is here, some major insiders are dumping stock. Who is going to be left holding the bag if the stock market takes a dive again?

Here is one final report, also from Reuters:

Of late there has been an influx of money, but it's not necessarily good news. Recent experience shows that the biggest influx of money comes at the peak, according to Birinyi Associates.

"It's somewhat of a reverse indicator," said Jeff Rubin, market strategist at Birinyi in Westport, Connecticut. "You do want money going in, but you don't want this tremendous shift."

While it hasn't been a tidal wave, money is returning to stocks, according to data from the Investment Company Institute. For the week ended August 5, equity funds saw an estimated inflow of $5.5 billion, compared with an inflow of $3.4 billion the previous week.

In the short term, such flows can bolster heady gains, but larger bouts of optimism are often a sign markets are about to turn.

So there you have it. Quite a negative picture from Reuters on the future of the stock market, at least in the short-term. It seems as if we may have reached another turning point in this prolonged recession the world is experiencing.

Government Sector in Big Trouble

Over the past few years, three of the economic sectors with the most growth were health care, education and government. Of course, health care and education are often intimately tied in with the government. A lot of people strongly believed that these sectors were "recession-proof" and safe places to develop a career. It appears they might be wrong. Very wrong.

A few days ago the Washington Post published this story:

As states across the country grapple with the worst economy in decades, most have cut services, forced workers to take unpaid days off, shut offices several days a month and scrambled to find new sources of revenue.

The good news is that much of the pain this year has been cushioned by billions of dollars of federal stimulus money, which has allowed states and localities to avoid laying off teachers, prison guards, police officers and firefighters.

The bad news is that for the next fiscal year, beginning in July, the picture looks even bleaker. Revenue is expected to remain depressed, even if the national economy improves. There will be only half as much federal stimulus aid available, and many states have already used up their emergency reserves.

The bold emphasis was added by me. California is the prototypical example of this. The budget recently passed is slated to cut a lot of state jobs. As the recession deepens in 2010, we can probably expect further cuts. That means higher unemployment. The cuts to government services will also surely have a negative effect on consumption.

In California, a great number of teachers have been laid off by the new budget. That means both the "government" and "education" sectors, which were supposedly "recession proof," are going to take a massive hit in 2010. As this article indicates, this isn't just a California problem, we're going to see this kind of thing across the U.S.

Here's a report out of Europe, from Ambrose Evans-Pritchard. I'm not usually a big fan of Mr. Evans-Pritchard but I definitely stand up and take notice when he titles one of his articles 'Fiscal ruin of the Western world beckons.' Quite alarming.

Concerning Ireland:

A further 17,000 state jobs must go (equal to 1.25m in the US), though unemployment is already 12pc and heading for 16pc next year.

Education must be cut 8pc. Scores of rural schools must close, and 6,900 teachers must go. "The attacks outlined in this report would represent an education disaster and light a short fuse on a social timebomb", said the Teachers Union of Ireland.

He continues:

But the deeper truth is that Britain, Spain, France, Germany, Italy, the US, and Japan are in varying states of fiscal ruin, and those tipping into demographic decline (unlike young Ireland) have an underlying cancer that is even more deadly. The West cannot support its gold-plated state structures from an aging workforce and depleted tax base.

He warns:

While I agree with Nomura's Richard Koo that the US, Britain, and Europe risk a deflationary slump along the lines of Japan's Lost Decade (two decades really), I am ever more wary of his calls for Keynesian spending a l'outrance.

Such policies have crippled Japan. A string of make-work stimulus plans - famously building bridges to nowhere in Hokkaido - has ensured that the day of reckoning will be worse, when it comes. The IMF says Japan's gross public debt will reach 240pc of GDP by 2014 - beyond the point of recovery for a nation with a contracting workforce. Sooner or later, Japan's bond market will blow up.

No-brainer here. We should already be suspect of spending as a strategy towards solving a debt-crisis, but pointless spending that does nothing to create a more productive future is obviously futile and probably makes the problem worse.

Go over there and check out his article. It will surely make you think, even if you don't agree with his prescriptions.

Ultimately, this is setting up to be a major blow to the American and European economies, especially in 2010. The mainstream media isn't talking about this very much though, choosing to focus on hyping up a supposed "jobless recovery" and encouraging spending, although it doesn't appear to be working very well.

Quick Link: Suburb Developers Take A Hit

Over at the Financial Armageddon blog, the author has put up an interesting post about the fate of suburb developers during this recession. The results shouldn't be surprising for anyone who has followed this recession, but it makes for an entertaining read nonetheless. One quick quote from the end of the article he references in the blog post:

Hedlund says his forecasts for 2010 include the possibility that the year could be worse than 2009.

"In the meantime, communities may have trouble maintaining the infrastructure on unused land," he added. "Eventually, many lots will have to be bulldozed."

By the way, I don't agree with everything the author of Financial Armageddon writes, far from it. A lot of what he writes concerning the finer points of finance is also over my head. Nonetheless, you'll usually find something interesting over there.

Job Growth (?)

I want to draw your attention to this article from the New York Times. And specifically to this graphic. The Times writes that:

FOR the first time since the Depression, the American economy has added virtually no jobs in the private sector over a 10-year period. The total number of jobs has grown a bit, but that is only because of government hiring.

The accompanying charts show the job performance from July 1999, when the economy was booming and companies were complaining about how hard it was to find workers, through July of this year, when the economy was mired in the deepest and longest recession since World War II. For the decade, there was a net gain of 121,000 private sector jobs, according to the survey of employers conducted each month by the Bureau of Labor Statistics. In an economy with 109 million such jobs, that indicated an annual growth rate for the 10 years of 0.01 percent.

This reveals more about the state of the real economy than any stock index or analyst opinion does. Without jobs there are no consumers, and without consumers there is, in effect, no American economy. Now, of course, there are jobs out there. But with unemployment reaching towards 10% nationally and closing in on 20% in some particular areas, its clear that finding a job is a much harder venture than it was a few years ago.

One comment in the article which I found interesting was:

Hard as it may be to believe, the consumer economy of the United States actually lost retail jobs over the decade, at a rate of 0.2 percent. There were fewer people working in food stores. But the category of general merchandise stores — like Wal-Mart and Costco — showed an impressive gain of 1 percent a year, even though the category also includes department stores like Macy’s, where the number of jobs has fallen.

So even retail, one of the supposed bright spots of the economy, suffered in this decade.

If you look at the graphic, you'll see that the two economic sub-sectors which exhibited the greatest growth were 'Management & technical consulting' as well as 'Home health care.' I'd like to go more in-depth into each of these industries later. Needless to say, I'm skeptical that they will be drivers of economic growth.

In recent memory, one of the primary reasons that management consultants have been hired by corporations is to and fire and downsize. With smaller operating budgets during this recession, I wouldn't be surprised if the use of management consulting declines overall.

Secondly, when it comes to home health care nothing is a 'given.' I keep hearing people trot out facts about the aging boomer population and how they'll need home health care in the near future. Yes, there will be a lot of elderly people in the United States. There are many elderly people around the world, however, and not all of them receive commercialized care (or government care, for that matter). Most are taken care of by their families. If there is no money to pay for commercial home health care, it doesn't matter how many old people you have. Lets just take a look at a few factors:
1. The incredible wealth-destruction that many retirement accounts have been subject to during this recession.
2. The incredible debt load future generations will carry.
3. The dismal jobs situation in the United States.
With these three conditions in mind, how can we be so sure that health care will continue to grow at such a rapid rate and be a job-creator? In my opinion, we can't.

Thus, I see the New York Times job report as being all-around dismal.

Swine flu and the economy

An article from the Times of India:

MUMBAI: Maharashtra's economy, which only recently started emerging from the shadow of the global meltdown, has been delivered a double whammy with the spread of swine flu and what officials are calling the worst-ever drought to have hit more than two dozen districts.

How is swine flu affecting the economy in India?

While educational institutes and theatres and multiplexes have been closed in the Mumbai-Pune belt, authorities in other districts, too, are facing pressure to shut down all institutions in a pre-emptive attempt to check the spread of the virus.

"The closure in Mumbai and other districts will definitely have an adverse impact on the economy. Major and minor transactions in the entire region have almost stopped. In fact, after the closure of schools was declared, there was sudden drop in attendance in government and private offices too. The epidemic has had a cascading effect on the entire state,'' the NCP minister said.

The so-called "swine flu" took an interesting route through the media. There was a lot of hype and panic over it in the media when it first emerged. However, the American media has a 2-second attention span so the story disappeared as quickly as it emerged. However, in the period after it disappeared from the national media, or was at least moved from the front page, swine flu has emerged as an actual health threat. As of today, Wikipedia is citing some 2,000+ global deaths and 200,000+ laboratory confirmed cases. That's laboratory confirmed. The real number is likely higher.

As the above article states, the response in India has been to shut down schools and other public institutions. Some places of commerce have also been shut down to inhibit transmission of the disease. Of course, when news like this is made public it makes people less inclined to patronize the commercial establishments that actually are open.

Of course, some of you will also know that the Mexican tourist economy was devastated by the swine flu pandemic.

Will the US face something like this? Of course no one really knows, yet. It certainly is possible. A casual Googling reveals that many American schools certainly are preparing for the possible emergence of cases of swine flu amongst their student body when the school year begins. The United States already leads the tally in terms of numbers of confirmed deaths from the disease. If school closures do happen in the U.S., it will be interesting to note what kind of attention a story like that attracts from the national media. If it does get much play in the mainstream media, I would not be surprised to see a further hit to the retail and hospitality sectors of the economy as people stay home instead of vacationing or visiting shopping centers. This is something to watch for as the school year begins again in the next few months.

"Cash for Clunkers" Losing Steam

Today, Reuters informs us that:

Red hot auto sales under the U.S. government's "cash for clunkers" incentive began to cool as dealer inventories tightened and showroom traffic showed signs of leveling off from its frantic pace of a week ago.

One industry analysis released on Tuesday forecast a steady decline in "clunker" related business even though the Obama administration and Congress added $2 billion to the program in recent days with hopes of matching the success of its first weeks. Sales during that period topped 250,000 and rebates exceeded $1 billion at least, according to government and industry figures.

I have several criticisms of the "Cash for Clunkers" program.

1. Why the auto industry? Practically every sector of the economy in the United States is hurting. Some are hurting very bad. Why did the government choose to subsidize auto sales? Especially considering it has already been quite generous, to say the least, to General Motors and Chrysler. Why not help, say, non-auto-related manufacturing? The auto sector is hurting but there is no indication that it will permanently leave the United States. In contrast, there are some other manufacturing sub-sectors that are more at risk of completely disappearing from the U.S.

2. This program is encouraging consumers to take on additional debt. Of course, if consumers were to devote all of their income to solely working off debt the U.S. economy would likely grind to a standstill. But, still, how smart is it for the government to be haphazardly encouraging consumers to assume additional debt in the midst of a debt-fueled recession?

3. The "clunkers" must be less than 25 years old. So we're not talking about scrap heaps. Anecdotal evidence suggests that many of these cars are still in good, working order. When traded-in, these "clunkers" will all be sent to the junkyard. In short, the government is destroying working assets that still have some value to them. Why? The argument is that these cars have low fuel efficiency and therefore have lost a lot of value in this recession. There are many poor people (and many young people) in this country who could use a cheaply-priced car. Maybe they only need a car to make short trips, or to get them to work, or to go to the supermarket, and the low fuel-efficiency doesn't matter to them. Instead, the government is trying to "protect" consumers and the auto re-sale market from price declines. What gives the government the right to interfere with the economy to that extent? As I see it ... valuable assets are being destroyed, a few consumers get to take on a new government-subsidized debt load, auto corporations (and thus the government, when it comes to General Motors) get a big payday and, worst of all, the economy is prevented from re-purposing valuable assets towards a more efficient use.

Anyway, I thought I would air out my grievances with the program but that's not the real story here. The real story is that even though the federal government is out-and-out subsidizing car sales, the program is already weakening and car sales are already declining from when the program first began. That says a lot about the current state of the American consumer. Not even a few thousand dollars towards your down payment courtesy of Uncle Sam is convincing people to buy cars. Can we imagine what would have happened if this program had been put in place in say, 2005 or 2006?

Feel free to read more in-depth about the Cash for Clunkers program (official name: Car Allowance Rebate System) on Wikipedia.

Analyst Expectations and Reality

Recently the mainstream media has been full of supposedly good news for the economy. If you've been following the news lately, you probably know what I'm talking about ... it seems like every week we hear of more corporations that are managing to beat analyst expectations in regards to quarterly earnings or profits.

Not familiar with what I'm talking about? A quick Google search of recently published news stories returns the following ... an article from MarketWatch reporting that Applied Materials Inc. beat analyst expectations for quarterly earnings and sales ... an article from the Wall Street Journal reporting that Anheuser-Busch InBev beat analyst expectations for second quarter earnings ... an article from the Epoch Times reporting that Macy's also beat analyst expectations for second quarter earnings ... etc. These examples are just to give you a taste of what I'm talking about. They are all from the past several days. Look for yourself and you'll find many, many more.

It's pretty clear that the media has put a huge spotlight on analyst expectations. I'd like to put my own spotlight on this trend.

The first question I'd like to ask is: why is the media focusing so hard on analyst expectations? There are various reasons that I suspect.

1. A lot of people are very thirsty for any kind of positive economic news. If you read any of these articles you'll see that conditions for most of these corporations are pretty dreary. Most are actually seeing declining sales and earnings. About the only positive thing to report is that they beat analyst expectations.

2. Many of these media organizations are clearly suffering in this downturn as well. A recovery would greatly benefit them. So its in their interest to promote as much positive economic news as possible, possibly in an effort to shift public opinion and promote more economic confidence (regardless of whether it is warranted or not).

3. Many of these media organizations want to paint a positive picture regarding the financial situation of these corporations because they have ties to them. For example, remember the story about Macy's I linked to up top? The retail sector is one of the biggest advertisers in just about every form of media.

4. Its the predominant thinking on Wall Street and these media groups don't want to rock the boat. Call it inertia, if you will.

The second queston I'm asking is: why do we care that a company beat analyst expectations?

What a lot of these news stories are essentially saying is: this company is taking a complete nosedive in every respect BUT it beat the estimates set by a third-party.

What is left out of this type of reporting is:

Who are these analysts? What firms do they work for? What ties do they and their firms have to these corporations? to Wall Street institutions in general?

What were their expectations based on in the first place? What changed for this company that made it beat expectations? Does beating expectations mean that the company's financial situation is actually bettering or was the analyst merely far off the mark?

None of these questions are ever really asked because the point isn't to give you an accurate picture of the health of a company. The point is to offer you a quick soundbite that sounds positive and upbeat and restores confidence. At least thats how I see it right now.

I also want to say that I'm not insinuating that there is any kind of collusion between analysts and corporations. However, I encourage you to remember the role credit-rating agencies played in overestimating the value and security of subprime mortgage-based securities. If you aren't familiar with what I'm talking about, I strongly encourage you to look into it. On top of that, we all know that corporations have tons of way of creatively fudging their books. With that in mind, how can any responsible financial journalist *not* be asking these questions? How can we be sure that these analyst expectations actually represent valuable standards by which to judge the health of a company or of the economy as a whole? Yet, I don't see any of these questions being asked in the mainstream media. I do, however, see the mainstream media using these supposedly positive reports as a basis on which to begin promoting stocks as a great investment again.

The moral of the story? Look deeper. Think critically. Ask the right questions. Don't believe the hype.

Hopefully we will start seeing some better reporting soon, but I'm not holding my breath ...

July 2009 housing statistics

I'd like to begin with a straightforward post about the housing market. The importance of the housing market to the overall economy is obvious.

Reuters provides us with an image of how the housing market fared in July of 2009.

Foreclosure activity jumped 7 percent in July from June and 32 percent from a year earlier as one in every 355 households with a loan got a foreclosure filing, RealtyTrac said on Thursday.

This is, more or less, unsurprising. It is more evidence that a turnaround in the housing market is nowhere on the horizon yet. Most of these foreclosed properties will take quite a while to make their way onto the market due to the backlog that lenders are facing.

Obama's housing rescue is gaining traction in altering terms of loans for struggling borrowers, but slowly.

Earlier this month the U.S. Treasury Department detailed the progress of the top servicers in modifying loans and prodded them to step up efforts to stem foreclosures.

I thought this was an interesting comment on the part of Reuters. They're referring to this. I'll let them speak for themselves:

Eleven of the largest 25 mortgage service companies are helping less than 5 percent of eligible borrowers, while the most effective servicers are helping as many as one in four eligible borrowers, according to Treasury data.

"It's safe to say we're disappointed in the performance of some of the servicers," said Michael Barr, Treasury assistant secretary for financial institutions. "We expect them to do more."

Bank of America, the biggest U.S. bank by assets, is aiding just 4 percent of eligible borrowers, while No. 4 bank Wells Fargo is reaching only 6 percent, the Treasury said.

This isn't the complete story, of course. Some smaller banks are modifying loans at rates higher than 20%. However, I thought it was an interesting bit of spin. In the context of the July housing article, the government's loan modification program is presented as a positive factor in favor of the housing market. If we dig deeper, however, we see that the program is quite troubled and, in its current state at least, unlikely to make much of an impact in stemming the wave of foreclosures.

Anyway, back to the article on July's housing numbers ....

California, Florida, Arizona, Nevada accounted for almost 57 percent of total U.S. foreclosure activity in July.

Illinois had the fifth-highest total filings, spiking nearly 35 percent from June, in an example of how moratoriums often delay rather than cure an inevitable loan failure.

This is pretty troubling. California alone makes up a huge percentage of economic activity in the U.S. Of course, I'll be the first to state that it'll be nice to see California's housing prices come back in line with reality. However, that kind of correction could come at a pretty steep cost. We'll likely see more destruction of equity and wealth in California as prices continue to decline and in turn we'll see less investment and capital available. Despite what some may think, that *will* have repercussions throughout the rest of the United States.

Meanwhile, things are, well, horrible in Nevada.

Nevada had the highest state foreclosure rate for the 31st straight month, with one in every 56 properties getting a filing, or more than six times the national average.

Tourism, hospitality and, of course, gambling have already taken a huge hit. Now we're seeing that 1 out of every 56 properties in Nevada has gotten a foreclosure filing. Anecdotal evidence, as well as simple population statistics, make it clear that most of those filings are probably in the Las Vegas region. I can't say I envy those of you in Las Vegas right now. Of course, real estate development in Las Vegas is as much commercial as it is residential. Various economists and commentators have already pointed to the commercial real estate market as the next major pillar of the economy to face major problems so we should pay close attention to Las Vegas as a test case of where the national economy might be headed. Times sure are looking tough in Nevada right now.