Bear market is far from over
By Comstock Partners
What is currently happening in the market and the economy was predictable and is following the sequence we have long expected. Households accumulated enormous debts in the past decade, leading to the credit crisis and recession of 2007-2009. The government stepped in with massive monetary ease and fiscal expansion that produced only a weak recovery and a vast increase in government debt. The market erroneously assumed that the recovery would follow the pattern of typical post-war expansions and rallied strongly from the early 2009 bottom to the recent highs.
A similar pattern developed in Europe where sovereign debt of the weaker EU members has become a serious problem that EU leaders have been unable to solve. Now we are undergoing the aftershocks of the crisis.
As we have repeatedly stated, crisis recoveries are characterized by short sub-par recoveries and numerous recessions as household debt burdens dampen consumer spending for long periods. We did see the short sub-par recovery and now it seems to be ending at a time when the Fed has already used its best weapons and fiscal policy is due to become more restrictive. First half GDP was revised down sharply. Housing has continued to weaken. Consumer spending has been sluggish. Initial jobless claims for the latest period jumped back over 400,000. The ECRI leading index has declined to 127.9 from its April peal of 131.1.
Even more shocking was the plunge in the August Philly Fed Index to minus 30.7 from 3.2 in July. The drop was the weakest since October 2008. In addition the August University of Michigan Consumer Confidence Index dropped to 54.9, lower than any level during the recession and the lowest in 31 years. These are the types of readings seen only in recessions. Although the Fed only recently lowered its economic outlook for the second half of this year and 2012 these projections already seem outdated. Today the New York Fed lowered its outlook while numerous brokerage firms and banks have belatedly been scrambling to cut their forecasts as well.
If anything the situation looks even worse in Europe. Germany reported second quarter GDP growth of 0.1% and growth in France was zero. Moreover European banks with exposure to PIIG debt have been turning to the ECB for emergency loans. Today the ECB reported that one bank (not named) has borrowed 500 million Euros a day for seven days.
The remaining areas of the world cannot stop global GDP growth from shrinking. Japan is in a recession. China is still tightening to dampen inflation. China as well as the other emerging nations are export-driven economies that depend heavily on American and European consumers.
We therefore believe that the market has now entered a major downtrend. It is a mistake to dismiss the slide we’ve seen to date as mindless and devoid of fundamentals as many strategists maintain. These are not just scary headlines—-they are scary fundamentals. As usual there will undoubtedly be some more sharp rallies that will be interpreted as new bull markets. In our view, however, the bear market has only begun and has a long way to go.
Lets split the stock markets from the economy, and from the global economy. Global recessions are very rare, only occurring when there is a global crisis such as a significant oil crisis like 1973 or the global financial crisis.
So until we have another financial crisis I think that the world economy will cope. That said a severe financial crisis is imminent. The efforts of central banks and governments have just papered over the cracks in the banking system. So a global recession is coming but it will centred in heavily indebted countries as the recession increases the debt burdens to breaking point.
As for individual countries the countries that will be most effected will be the US and Europe. Ultimately those debts will need to be written off and only once that has been done will the economy be in a position to recover. In some respects the US will probably suffer most because they simply lack the political will to stimulate the economy. Europe will suffer just as much because of the constraints of the euro. Once the periphery start to exit the euro will they get to a position to recover. The core nations will then have to deal with those loans created by the banks.
As for companies and stock markets, they will be in a secular bear market for years. The one sector to avoid is finance. Longer term that faces regulation of one form or another. Property investment will also be troublesome. With a weak economy and leverage they are a leveraged play on the economy. Also they are running on PE ratios that are simply unsustainable. The stock markets have a long way to fall.
Second leg down in the global deflationary depression, exacerbated by erroneous economics and bad policy.
Exactly all that our politicians and bankers have done is to temporarily inflate the economy to avoid all the signs of the depression. Now that will end and the Depression will be upon us.
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