Betting on the Economy
From a big picture perspective, there are really only two things that you need to worry about these days: Europe and the U.S. economy. Sure, there are lots of little side stories here and there, but if you had just come back from a long vacation, these are the only two things that you would want to focus on. I know, I know, this is really simple stuff. So, before you hit the delete button, let me get straight to the point. You see, if you are a buyer of stocks at current levels (and you don’t plan on selling them in the next 25 minutes), I’m of the mind that you are making a bet that the U.S. economy is not going to go into recession.
The bottom line is this… If Europe doesn’t collapse (which I assume is your baseline assumption if you are buying anything but gold and Treasuries these days) then the key to the market’s direction is the state of the U.S. economy. And the way I interpret the data, if the U.S. economy winds up avoiding another recession, we can argue that the nearly -18% correction is probably “good enough” to discount a slowdown in economic activity. However, if GDP should manage to turn negative for two consecutive quarters, there might be some more downside work to do.
Thanks to the analysts at Ned Davis Research, we know that there have been 27 bear markets since 1900. And of those 27 grizzly periods, a recession in U.S. economy accompanied 14 of them. The problem is this. The average decline seen during the bear markets that were not accompanied by a recession was a little more than -25%, whereas the bears that had recessions saw declines in excess of -33%.
So, if Europe doesn’t implode and the economy here at home can avoid a recession, the good news is that we’ve likely borne the brunt of the decline in stock prices. And with nearly every group on the planet suddenly looking to buy European debt in order to lend a hand, a bet on this scenario means it is okay to put money to work down here in the stock market.
However, if the U.S. economy doesn’t start moving in the right direction, there might be some additional pain to endure. As of yesterday’s close, the S&P 500 is now 14% lower than the high water mark seen on April 29th. Thus, if history rhymes in some reasonable fashion, the S&P could fall another 22% or so from here.
But here’s the fun part. The stock market doesn’t follow the economy, it tends to discount the future (hence the joke that the stock market has predicted 9 of the last 6 recessions). Therefore, some will argue that the direction of the market over the next three months is going to tell us a lot about what the economy is likely to do.
For my money though, I’ll bet that the stock market indices continue to be pushed and pulled in both directions by each and every piece of data that hits the wires. And given that the economists now put the odds of recession at about even these days; traders will be paying particular attention to the key economic data. Thus, investors will want to stay in tune with the data and the market’s reaction to any and all economic news in the coming months.
As for the very near-term, the big picture is being interrupted by the Greek tragedy going on across the pond. Today we’ll hear the results of the on-again, off-again conference call with Greece in which Nicolas Sarkozy and Angela Merkel are likely to offer up an inspiring rendition of “Stand by your man.” The call and the market reaction ought to also be worthy of note. Stay tuned and by all means, feel free to place your bets.
Turning to this morning… Although Moody’s downgraded two big French banks this morning, the world appears to be rallying around Greece and the Eurozone with the IMF saying central bank resources are practically infinite, China talking about more investment in the Eurozone and the BRICS also expressing an interest in buying European debt. In addition, the EU’s President has renewed hopes for a joint Eurozone bond. In response, European markets are up more than 2% across the board.
On the Economic front… The Labor Department reported the Producer Price Index (an indication of inflation at the wholesale level) for August was unchanged, which was above the consensus estimate for a gain of -0.1%.
When you strip out food and energy, the so-called Core PPI came in at +0.1%, which was below the consensus for +0.2% and July’s +0.2%.
Next up, the Commerce Department reported that Retail Sales were unchanged in the month of August, which was below the consensus for +0.1%. When you strip out the sales of autos, sales were up +0.1%, which was below the consensus for a reading of +0.2% and below last month’s revised +0.3%.
David Moenning
Editor: The Daily Decision
