The new year has brought an onslaught of optimistic forecasts about the stock market and the economy. I suspect that much of this enthusiasm is the result of the return of stock market indices to “pre-Lehman levels” (with the S&P 500 above 1,250). The “Lehman benchmark” is based on conditions as they existed on September 12, 2008 – the date on which Lehman Brothers collapsed. The importance of the Lehman benchmark is primarily psychological — often a goal to be reached in this era of “less bad” economic conditions. The focus on the return of market and economic indicators to pre-Lehman levels is something I refer to as “pre-Lehmanism”. You can find examples of pre-Lehmanism in discussions of such diverse subjects as: the plastic molding press industry in Japan, copper consumption, home sales, bank dividends (hopeless) and economic growth. Sometimes, pre-Lehmanism will drive a discussion to prognostication based on the premise that since we have surpassed the Lehman benchmark, we could be on our way back to good times. Here’s a recent example from Bloomberg News:
“Lehman is the poster child for the demise of the banking industry,” said Michael Mullaney, who helps manage $9.5 billion at Fiduciary Trust Co. in Boston. “We’ve recovered from that. We’re comfortable with equities. If we do get a continuation of the strength in the economy and corporate earnings, we could get a reasonably good year for stocks in 2011.”
Despite all of this enthusiasm, some commentators are looking behind the rosy headlines to examine the substantive facts underlying the claims. Consider this recent discussion by Michael Panzner, publisher of Financial Armageddon and When Giants Fall:
Yes, there are some developments that look, superficially at least, like good news. But if you dig even a little bit deeper, it seems that more often than not nowadays there is less there than meets the eye.
The optimists have talked, for example, about the recovery in corporate profits, but they downplay the layoffs and cut-backs in investment that contributed to those gains. They note the recovery in the banking sector, but forget to mention all of the financial and political assistance those firms have received — and are still receiving. They highlight signs of stability in the housing market, but ignore lopsidedly bearish supply-and-demand fundamentals that are impossible to miss.
In an earlier posting, Michael Panzner questioned the enthusiasm about a report that 24 percent of employers participating in a survey expressed plans to boost hiring of full-time employees during 2011, compared to last year’s 20 percent of surveyed employers:
Call me a cynic (for the umpteenth time), but the fact that less that less than a quarter of employers plan to boost full-time hiring this year — a measly four percentage-point increase from last year — doesn’t sound especially “healthy” to me.
No matter how you slice it, the so-called recovery still seems to be largely a figment of the bulls’ imagination.
As for specific expectations about stock market performance during 2011, Jessie of Jesse’s Café Américain provided us with the outlook of someone on the trading floor of an exchange:
I had the opportunity to speak with a pit trader the other day, and he described the mood amongst traders as cautious. They see the stock market rising and cannot get in front of it, as the buying is too well backed. But the volumes are so thin and the action so phony that they cannot get comfortable on the long side either, so are buying insurance against a correction even while riding the rally higher.
This is a market setup for a flash crash.
Last May’s “flash crash” and the suspicious “late day rallies” on thin volume aren’t the only events causing individual investors to feel as though they’re being scammed. A recent essay by Charles Hugh Smith noted the consequences of driving “the little guy” out of the market:
Small investors (so-called retail investors) have been exiting the U.S. stock market for 34 straight weeks, pulling almost $100 billion out of the market. They are voting with their feet based on their situational awareness that the game is rigged, and that the rigging alone greatly increases the risks of another meltdown.
John Hussman of the Hussman Funds recently provided a technical analysis demonstrating that – at least for now – the risk/reward ratio is just not that favorable:
As of last week, the stock market remained characterized by an overvalued, overbought, overbullish, rising-yields condition that has historically produced poor average market returns, and consistently so across historical time frames. However, this condition is also associated with what I’ve called “unpleasant skew” – the most probable market movement is actually a small advance to marginal new highs, but the right tail is truncated and the left tail is fat, meaning that there is a lower than normal likelihood of large gains, and a much larger than normal potential for sharp and abrupt market losses.
The notoriously bearish Doug Kass is actually restrained with his pessimism for 2011, expecting the market to go “sideways” or “flat” (meaning no significant rise or fall). Nevertheless, Kass saw fit to express his displeasure over the degree of cheerleading that can be seen in the mass media:
The recent market advance has spurred an accumulation of optimism. S&P price targets are being lifted by many whose memories are short and who had blinders on as the equity market and economy entered the last downturn. Bullish sentiment, coincident with rising share prices, is approaching an extreme, and the chorus of bullish talking heads grows ever louder on CNBC and elsewhere.
Speculation has entered the market. The Iomegans of the late 1990s tech bubble have been replaced by the Shen Zhous, who worship at the altar of rare earths.
Not only are trends in the market being too easily extrapolated, the same might be true for the health of the domestic economy.
On New Year’s Eve, Kelly Evans of The Wall Street Journal wrote a great little article, summing-up the year-end data, which has fueled the market bullishness. Beyond that, Ms. Evans provided a caveat that would never cross the minds of most commentators:
Still, Wall Street’s exuberance should send shudders down any contrarian’s spine. To the extent the stock market anticipates growth, the economy will have to fire on all cylinders next year and then some. At least one cylinder, the housing market, still is sputtering. Upward pressure on food and gas prices also threatens to keep a lid on consumer confidence and rob from spending power even as the labor market continues its gradual and choppy recovery.
The coming year could turn out to be the reverse of 2010: decent economic growth, but a disappointing showing by the stock market. That’s the last thing most people expect right now, precisely why investors should be worried about it happening.
The new year may be off to a great start . . . but the stock market bears have not yet left the building. Ignore their warnings at your own peril.
EU-phoria Fades
The most recent “light at the end of the tunnel” for the European sovereign debt crisis was seen on Friday June 29. At a summit in Brussels, leaders of the European Union member nations agreed upon yet another “plan for a plan” to recapitalize failing banks – particularly in Spain. The Summit Statement, which briefly summarized the terms of the plan, explained that an agreement was reached to establish a supervisory entity which would oversee the European banking system and to allow recapitalization of troubled banks without adding to sovereign debt. By owning shares in the ailing banks, the European Stability Mechanism would no longer have a senior creditor status, in order to prevent investors from being scared away from buying sovereign bonds.
The bond markets were relieved to know that once again, taxpayers would be paying for the losses sustained by bondholders. The reaction was immediate. Spanish and Italian bond yields dropped faster than William Shatner’s pants when he passed through airport security. Spain’s ten-year bond yield dropped to 6.51 percent on June 29 from the previous day’s closing level of 6.87 percent. Italy’s ten-year bond yield sank to 5.79 percent from the previous closing level of 6.24 percent.
Global stock indices went parabolic after the news from Brussels on June 29. Nevertheless, many commentators expressed their skepticism about the latest plan. Economist John Hussman of the Hussman Funds discussed the shortcomings of the proposal in his Weekly Market Comment:
The criticism expressed by Charles Hugh Smith is particularly relevant because it addresses the latest move by the European Central Bank to lower its benchmark interest rate by 25 basis points (0.25%) to a record low of 0.75 percent. Smith’s essay, entitled “Sorry Bucko Europe Is Still in a Death Spiral” consisted of sixteen phases of the death spiral dynamic. Here are the final seven:
Of course, Mr. Smith is forgetting that the Martians could call upon those generous taxpayers from planet Zobion for a bailout . . .