Juggling Dynamite

Market participants tend to talk about the stock market as “always” bottoming before the economy. Such bullish arguments presently forecast the economic bottom to trough this fall and therefore argue that March 2009 was “the” stock market bottom this cycle, neatly 6 months in advance of the economy. This theory may prove correct in the end. Only the clarity of retrospect will tell us for sure a few years down the road.
But a risk now is that the “rule of thumb” about markets bottoming before the economy may not hold true this time. The most recent exception was the last downturn where the economic trough was November 2001 (now clearly defined in retrospect) and yet the stock market did not make a lasting bottom until February 2003 (15 months later). Part of the reason for this lag of the market bottom after the economy last time, was that the jobless, anaemic economic recovery disappointed those conditioned to expect a vigorous “V”. Far from a robust bounce, in 2001-2004 we saw a timid, tepid start. It took a few years before over-juiced credit finally ignited mass speculation and the appearance of stronger growth.
The probability of a sluggish recovery this time is surely higher than after the tech wreck in 2000. This time we have a multi-asset, multi-country, financial crisis wreck. This time the savings rate is coming back in earnest as a shell-shocked consumer comprehends the importance of a savings buffer rather than just access to a line of credit.
This time people already have too much credit, they don't want more. This time the masses already own multiple-real estate or too much house, they wish to downsize not lever into more. This time the economic recovery is more likely to be slow and plodding, blurred in the outset by durable unemployment and wiser, more modest consumers.
There is a risk that those that have been piling back into the stock market the past couple of months, may not be prepared for the long, hard, slog back to economic health. I suspect this is a marathon, not a sprint. Reducing over-capacity, building up savings and equity are the foundations of our future sustainable growth, but none of this is as easy as throwing more credit around.
These will be healthy developments in the longer term—they make me longer-term more optimistic–, but in the next year or two, masses weaned on quick growth and easy money may not be mentally prepared for this course. Regular income more than capital gains may be the “trick’ for a while.
This recent Bloomberg interview with Roubini makes some valuable points on what the “new normal” growth may look like over the coming recovery.

Day three is now underway in this correction. Corrections are important to reign in animal spirits. Some faulty logic has been widely espoused along the following themes:
-a hope that less bad economic data means “green shoots” as in the economy will be back to healthy growth rates soon. Not quite.
-a hope that rising commodity and oil prices means manufacturing and industrial demand is on the rebound. Not yet. China and other countries with cash have been stock piling for anticipated demand later. See World Bank says China recovery hopes premature.
The world has also been showing an aversion to the US dollar again the past couple of months. This aversion has pumped up the value of U$ priced commodities like oil, gold and copper. But these price hikes don’t signify a rebound in demand or organic growth, just the same old hedging and speculative investment that we saw spike and then crash markets in 2008. Remember that commodities and energy are late cycle leaders. Price spikes there do not lead a sustained economic expansion—just the opposite. Price spikes in these sectors serve to thwart the new economic expansion everyone so desperately wants. The unfortunate consequence is then increased costs (inflation) with stagnant consumption demand.
-a hope that mortgage refi applications signify a consumer back in hot to shop mode. Not for quite a while. See Shift to thrift
We note that selling volume continues to overwhelm buying volume in the stock market. Wise money suspects the market has overpaid the past 2 months. This is where an appreciation of basic math comes in handy: the Shanghai stock market fell more than 70% 2007-2009. Year to date it is now up 46% in a few short months. Sounds great? only if you aren't good with numbers. A loss of 70% needs more than 230% to recoup capital values. 46% is a something but really just a drop in the bucket of the next cyclical expansion. Genuine expansion gains come in legs over many months. This past 2 months has been one excited leg, but ultimately too long means too vulnerable, too unrealistic.
If the market is able to test some important downside targets over the next few months and hold, that would be some green shoots worth noting. I continue to believe that March 2009 may well have been “the” low this cycle, but only the next few months will tell the tale. And this far above March 9 levels, downside risk is now front and center again.

It is a common human story; when cash flow is strong and leverage is expanding, most people spend lots on stuff. Then when a downturn hits, few are ready with sufficient liquidity to weather the storm. This clip reminds us that no matter how wealthy people may appear, the same rules apply for them as for others of more humble means. The lesson at all income levels is the same: spend less, save more.