FYI | Dec 18 2018
By Peter Switzer, Switzer Super Report
I wouldn’t be doing my job if I didn’t seriously evaluate this headline and story in Bloomberg over the weekend. It went like this: “Recession Signs Hard to Miss If Stock Message Is Taken Seriously!”
Iit’s not misplaced, as it works if the headline scares you about what might happen to your capital, and it works for me if I conclude that this is unnecessary, unsupported negativity conjured up by an attention-seeking journo who has succeeded with their possible goal.
Bloomberg’s Lu Wang has got our attention!
If you need a quick summary of the story, this excerpt sums it up: “Pools of gloom await anyone looking for a message in stocks. There’s the $3 trillion in value erased, the bloodbath in banks and the trouncing in transports. In wonkier circles, shrinking valuations and negative rolling returns have started to ring the recession bell. A relatively calm week in the Dow Jones Industrial Average just ended with a 495-point thud.”
Okay, let’s objectively assess these arguments for stock player fear and loathing.
The best revelation of this story was the fact that it was one of the world’s most famous economists, Paul Samuelson (whose textbook was my first ever), who said that stock markets have predicted “nine of the last five recessions”, but even in this jibe you have to accept equities got it right five times!
One argument advanced for believing that stocks are telling us something we can’t ignore is that a stock market weighs up a huge collection of individual investor views on the future. That’s true and I agree you should never ignore it, but we had a huge sell off in February, when the collective assessment was that inflation was going to be the next big threat. What happened to that? Well, we’re now worrying about a recession in the USA!
Keeping score and the S&P 500 is down 11.3% since September but there are well-known companies in bear territory — down over 20% — but that always happens in corrections. Locally, REITS have done well since the sell-off, while tech companies, such as Afterpay Touch, are down nearly 50% since their high $23!
To be fair, the Bloomberg story did reveal the following: “Make no mistake: the pros say the sell-off doesn’t mean much. Looking at the S&P 500’s downward trajectory over the last 12 months, David Kostin, Goldman Sachs’s chief U.S. equity strategist, reckons the market is pricing in zero economic growth. That’s too pessimistic, he said, as the firm sees a 2.5 percent expansion next year.”
And this coincides with my view that while we have to mark down the more optimistic US economic growth and company profit narrative for 2019, it could go from very good to good growth, albeit slower than expected. Remember, stock markets are controlled day to day by traders and speculators and their sentiment can turn on a dime.
Some complicated analysis based on the historical forward P/E advanced the argument that the market sees lower profits next year compared to analysts, but I think the basis of this call was a stretch and so did Anik Sen, global head of equities at PineBridge Investments.
“The market is wrong,” Anik said. “Clearly it has been a slowdown, but the slowdown can be very transitory in our view. At the end of day, there is enormous pent-up demand, whether it’s capex or technology spending. None of that has changed.”
Despite the scary headline, even Bloomberg’s survey of 89 economists has US growth next year at 2.6%, which is a long way from a recession! That said, Lu Wang does point out that academic work shows these economists’ surveys have missed a hell of a lot of recessions, one year out!
But this needs to be looked at a little more closely. Here’s what Lu Wang reported: “Meanwhile, a 2014 study by Prakash Loungani of the International Monetary Fund found that not one of 49 recessions suffered around the world in 2009 had been predicted by the consensus of economists a year earlier.”
That does not surprise me because everyone, including economists, were fooled by the incorrect assessment of the collateral debt obligations that were at the crux of credit crunch, the stock market crash and the related and ensuing Great Recession.
Raj Kumar Mittal, an academic at Guru Gobind Singh Indraprastha University, studied the role of credit ratings agencies or CRA’s in the credit crunch we call the GFC or global financial crisis and his conclusions show economists had a good excuse for not seeing the prime cause of the recession.
“The paper has examined how the financial market crisis was different from crises in the past and the role played by the credit rating agencies during the crisis. Credit Rating Agencies play a very vital role in assessing the creditworthiness of the issuer with respect to the instrument being rated,” he explained. “The CRAs were playing a dual role in not only structuring the CDOs and MBS — mortgage-backed security — but also assigning their ratings.
“The ratings, so assigned failed to accurately estimate the creditworthiness of the underlying collateral assets and this led to downgrades of the rating. Events during the financial crisis have revealed that the gaps in rating quality and rating standards have eroded market confidence.”
My core argument supporting my view that we’re in a market correction rather than a crash is that I don’t expect a recession in the US next year. A lot of economists think 2020 is likely, but others push it out to 2021 or 2022 with the Fed’s rate rises critical in determining the timing.
Megan Greene, chief economist at Manulife Asset Management, expects a recession after 2021 and points out that “the U.S. has slipped into recession during 10 out of the last 13 rate-hiking cycles.” (axios.com)
In contrast, Mark Yusko, founder of hedge fund Morgan Creek Capital, forecasts recession next year, and puts the odds at 100% — thanks to trade tensions, axios.com tells us. “The trade rhetoric is one of the dumbest things in the history of all administrations and it will cause a global recession,” Yusko insists.
Over the weekend, the Dow Jones index lost nearly 500 points on slower economic data out of China and the EU and when it comes to the former, the tariff tantrums USA v China have had a role to play. And they could even be not helping a European Union struggling with a recalcitrant bad budgeting Italy and a drawn out bumbling Brexit drama.
To be objective, and that’s what I try to do, I agree with the observation that the Trump trade war plus the Fed and rate rises plus Brexit plus a slower China and EU economies than was expected, all say we have to be cautious about global and US growth next year.
And all these have powered the recent stock market correction so far but next steps will be critical especially when it comes to the trade war and I can’t believe Donald Trump will let his calling out China on trade smash the stock market and push the economy into recession. Americans would never forgive him or themselves at the next poll in 2020 if their electoral experiment with the oddest US President in living memory lands them into a recession.
Donald knows that and while he says some dopey things, he’s no dope.
The Fed decides this week on its expected December interest rate hike and what it says, along with whatever Donald and his team say on trade will determine whether we see a Santa Claus rally in the final two weeks of the year. These are the two weeks which determine festive frolicking or fear for stock players around this time of the year, so I will watch these with great interest, hoping to see reason to believe a New Year rebound, or more of the same fear and loathing for stocks, is on the cards.
Right now I think Bloomberg has hyped up the headlines about recession and “pools of gloom” for stocks but the recent run of economic data has made me less confident about my optimism right now.
Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.
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