Juggling Dynamite

I have the good fortune of travelling with my work. Each trip I take an interest in gleaning what I can from local people on the state of their economy.
Over the past 18 months I was not surprised to hear pessimistic comments from Americans, particularly about their real estate markets. Over the past several months this pessimism seemed to spread to the UK, parts of Europe and recently Australia and New Zealand. But for the most part it seemed that people in my homeland of Canada were feeling still quite confident and optimistic about continued strength in real estate. Generally I think it fair to say that while Canadians have become increasingly aware of troubles in other parts of the world, we have so far enjoyed a sense of “not in our backyard” immunity.
Recently I noted a whispering afoot. It started at cocktail parties last summer with people speaking of a little “softness” in certain regions. Lately I've have heard some concern about a sluggish spring start in several areas. Yesterday someone sent me a link to Garth Turner's Greater Fool website on Canadian real estate. Today I found Mike Shedlock's article Canada's Housing Boom is Over an interesting read.
My sense is that although we Canadians have not been as over-levered as Americans with exotic mortgages this cycle, we are still now more over levered than ever before, with the most debt and the least savings in generations.
This means many Canadians now also have little buffer against an economic slowdown. In addition I have met many boomers who have over-invested in housing over the past few years with the assumption that they will downsize in the future and extract some capital to help augment their retirement funds.
My thinking is that as the boomers move to pare capital out of their housing, there will be less and less people willing to buy meg-mansion, energy-sucking, high maintenance properties. Food for thought, even in Canada.

A Merrill Lynch report from David Rosenberg yesterday entitled Recession Roadmap gave us an exceptional overview of the current global economic situation. The piece is comprised of over 90 historical charts on a host of key metrics. With very little text or spin, these pictures paint some valuable perspective. Everyone should take a look; even a quick scan offers an enlightening overview.
One of the more important take-aways is that the stock market has historically bottomed about 60-70% of the way through each economic downturn or recession (see chart 16 of the Rosenberg report). Since World War II the average recession has lasted 10 months. This means the stock market has typically bottomed well before the overall economy but not before some 6 to 7 months of economic contraction.
Presently our best estimate is that the current US contraction began in December 2007. If we were to get an average run-of-the-mill contraction this time it would last until October 2008. A 10 month contraction would suggest a stock market bottom this time in and around June or July 2008.
Optimists who are declaring January 2008 as the market bottom this cycle are doing so after only 1-2 months of contraction. If that is the case it would be a most incredible bottom indeed!
But the real shock will come if this downturn goes on longer than the average. If this economic downturn proves more like the 16 month-1973-74 variety, then this would suggest a stock market bottom some time in October-November 2008. In addition, stock market declines, during longer than average contraction periods, have historically been in the 45% range; much deeper than the average 28% decline of shorter contractions.
And what of Canada and our beloved commodities-based economy? Aren't we protected or shielded during US market downturns? Sadly, the answer has always been, no. Our stock market has historically corrected more than the US during each cycle down turn. Infact this has been the case even where the Canadian economy has managed to “decouple” from the US and not enter a classically defined recession. We should note that during the longer-version US bear markets of 73-74, or '00-'02, Canada never officially entered a recession and still our stock market lost about half of its value.
So we should be careful of holding blind-hope for an incredible bottom. It seems that lasting bottoms have never come quickly, but rather have ground investors down over time.

There has been a lot of pessimism about the economy over the past few weeks. Today was a big relief rally on news that some companies like JP Morgan and Intel had fared better than feared.
For those of us that had anticipated present problems before they became widely recognized, we can’t help but feel surprise now at how “unexpected” recent bad news is to many mainstream commentators.
That said stock markets have been thrashing wildly in violent fits and drops. Will markets break out to a fresh new bull from here? Obviously no honest person can say with certainty. Those of us that know markets well know that strange things can happen. But it is noteworthy that healthy market expansions do not exhibit this extreme volatility day to day, week to week. Healthy markets are not so bi-polar.
For the time being, we are watching our technical indicators with care as always. If there is a meaningful and sustained break through long-term support we will see it. But we are not there yet. Until then we are still in a bear market, the same bear market that we have avoided while it harmed others over the past 12 months.
Fortunately we are not desperate to pile back in to ride this wild market wherever it may take us. That is the beauty of having a management discipline while others flip-flop madly about.
Markets may rally on hope that the credit crunch worst is past. That may be correct. But I suspect that even if it is, more typical cyclical issues will inevitably stomp into focus:
Without question world economies are now fully into a contracting phase. It typically takes at least 3 quarters of disappointing earnings to put in a bear market bottom. So far we are through only one.
Analyst expectations have traditionally lagged earnings reality for exactly one year.
This is why analysts are so little help to those of us trying to avoid down market losses.
Notwithstanding large downward revisions, consensus earnings expectations over 2008 are still a high 10.8% growth. Presently stock prices are discounting a further earnings decline from here of -8% in the US and -24% in Europe. Even in the past 2 shallow recessions of 1991 and 2001 earnings fell -20% in the US and -40% in Europe. In longer contractions, earnings declines of 45-50% would be “normal”.
Buy or hold recommendations on stocks are now at 95% or the highest in 5 years.
In the past 6 recessions, US markets have lost an average of 28% peak to bottom over 9 months. Canadian markets have traditionally lost more thanks to over-exposure to cyclical sectors: financials and commodities. Relative to historical precedent, market losses to date have been remarkably shallow and short.
Crude-oil prices settled at a new record high for the third trading session in a row, closing at $114.93 on the New York Mercantile Exchange, an advance of 1%. Crude futures have risen 4.4% over the last four trading days and climbed 13% so far in April. Inflation caused by this will be a negative tax on us for some time.
Property prices continue in a free fall in many countries around the world. The US bubble has been mirrored in dropping prices now in Ireland, Spain, the Baltic States and parts of India. Some experts are warning against the potential for a wholesale collapse of the property market in some of these regions.
And last but certainly not least, we are only just started into the corporate bankruptcy fall-out from recent credit shocks. Growing numbers of companies are now struggling with rising defaults in a market where it is virtually impossible to get refinanced.