財經觀察 1979 --- Is the Economy at an Inflection Point?

Is the Economy at an Inflection Point? by Dan Tierno

Now don’t get me wrong…I like a rising tide in stocks better than anybody. A decimated 401k recovers, folks smile again, the flowers bloom and birds sing…let the sunshine in.

The abyss from which we are emerging has been combed over ad nauseum. If a reminder is needed…

There has been growing concern about the recent rally and exactly what it is predicting for the broader market and economy as a whole. An article in the WSJ proves a bit disturbing to me. Check out the headline - Banks Getting TARP Cash Aren’t Paying it Forward

No real shocker to me. But taken at a macro view…think about the ramifications here. The average consumer/family most likely has a credit line (the average family has an outstanding credit balance of $8000). Surely those statistics are skewed, but the fact remains that enough Americans carry enough debt to make enough of an impact, bar none. So let's say our hypothetical man in his hypothetical job (let’s call him Joe, and let's say he is a Plumber) has just been laid off due to the fact that a large construction project in his area has been put on hold. So unemployment benefits kick in allowing him to manage while seeking employment. Suddenly, the credit crisis hits. As a result the economy and the markets take one of the most intense nosedives in history.

So what is the near term result? Banks re-assess their models of credit worthiness thanks in no small part to support of the banking system by the public sector. Lending standards become much tighter. Credit lines are curtailed, and interest rates gap higher on both “high risk” and “good” borrowers.

Now let us take up Joe’s situation. He has been out of work for a substantial time period, and it is a well known fact that in economic recessions job growth lags. In fact, throughout the initial upswing unemployment peaks as economic slack is soaked. In Joe’s situation chances are, oh let’s say at around a 17% real unemployment rate plus a 1 in 8 chance he has a 5 digit debt balance, he is most likely experiencing credit pressure. So Joe cuts back, paying debt and consuming less. All the while, his interest rates rise, his credit contracts, and the cycle intensifies.

This type of negative consumer feedback loop is not abating…in fact given the trends in unemployment and consumption it may just be hitting its stride. The credit card culture is now broken, and the resultant economic rebound will be shallow. Pent up demand will be weak as long as the consumer is obsessed with saving and paying down debt. Therefore, inventories will continue to remain lean, which will ripple throughout the entire fabric of the economy. Sure to follow are waves of defaults on credit card borrowers as well as the impending commercial real estate crisis (lack of occupancies + inability to roll debt over = lost rent revenue). Look no further to support this conclusion than earnings season. Loan-loss provisions are increasing Q/Q, not decreasing.

From a stock market standpoint, what does it all mean? We are up nearly 30% in 6 weeks in what many are deeming the prediction by the markets of the eventual economic recovery. When sentiment will turn negative again is anybody’s guess (looks as if the battleship may be turning)…the markets can remain irrational far longer than one can remain solvent (John Maynard Keynes, the owner of that quote, really was on to something). I can guarantee you this…this market is on very shaky ground relative to the macro environment. When it is realized that losing 650k jobs a month is not a moderating slowdown, as well as the fact that a very mild recovery is in the wings due to reduced leverage (thank you Credit Crisis)…the bull run will lose its substance. This market will retest its low in its own good time. Right around the time you feel like throwing all caution to the wind and find yourself racing to get in for fear of missing the up move is exactly when it will be high time to go short.

As of April 7, 2009 the 12 month forward earnings multiple for the S&P 500 is 14x - a decent valuation given historic P/E trends of about 15x forward earnings from 1920 to 2000.

Earnings For the S&P 500

If you consider the revision of S&P 500 profit estimates for this year from $75 to $59, with all likelihood of further downward revisions, any move higher in the market given the macro environment must be viewed with skepticism with respect to valuation. In addition, our friends at Bespoke Investment Group have a link to some nifty charts detailing a myriad of sectors, and the extent to which stocks in those sectors are overbought or oversold. So in effect there are 2 forces working against upside here - short term overbought conditions and a hazy macro outlook at best, intense crisis aftershock at worst.

Disclosure: As of this writing author has no market position