Global Contagion Looming?
The much ballyhooed second half arrived a few weeks ago but someone forgot to tell the promised recovery. Not only is the recovery not in sight, but quite a few factors have aligned to suggest that the bear market in stocks is not over and that the market is precipitously balanced just above what could be its next major leg downward.
On 18 July, Fedhead Alan Greenspan announced what readers of The Sovereign Strategist have anticipated for quite some time: that the recovery is not here and economically, things don't look particularly swell. In his own words:
The period of sub-par economic performance, however, is not yet over and we are not yet free of the risk that economic weakness will be greater than currently anticipated and require further policy response.
In June, industrial production fell for the 9th straight month, hinting quite strongly that "the recession that is not a recession" may in fact be a recession. To paraphrase Anivan Banerji of the Economic Cycle Research Institute, it's the worst non-recession ever.
There's been a lot of talk about how the consumer is still spending and that car sales suggest that the economy is not hurting as bad as it looks. Tell that to General Motors which announced on Tuesday that second quarter earnings plummeted 74%.
Emerson Electric recently announced that its 43-year record of rising profits came to an end this year. Jack Welch of GE recently stated that this is the worst industrial recession he's seen in 20 years.
And more danger signs from Standard & Poors who announced that default rates on corporate debt will reach a 10-year high this year. It seems that quite a few businesses are having a hard time repaying their loans during this slowdown.
As though the U.S. news hasn't been enough to cause concern, the global outlook is growing truly precarious. Emerging markets got slammed last week as the threat of an Argentinean default rose to the forefront. Singapore is clearly in recession and that spells leaner times for all the Asian Tigers. Japan continues to flirt with recession, is almost surely in one, and proposed reforms, if instituted, could send that economy over the cliff.
Germany is having a rough go of it as well as that economy appears to be flirting with recession too. And let's not forget about Turkey. While the mainstream media's infinitesimally small attention span has forced the spotlight onto other matters, Turkey's economic problems have not gone away and continue to provide substantial risk for the region.
In the midst of so much uncertainty and global economic weakness, there is now a very real threat of "contagion". One severe event could spark sort of an economic domino effect of concern and reaction that could cripple the global economy. I'm not predicting such an event, only outlining the precarious nature of the current situation. There are so many loose threads hanging around the world and pulling any one of them could very possibly unravel our economic sweater.
The International Monetary Fund recently stated that international markets are seriously threatened by further declines in the U.S. stock market and that a "sharp repricing" in the U.S. market is a "key risk" for the world economy. Chalk that up as another possible trigger for the contagion I speak of. And given that the stock market has given us no indication that it wants to go higher, perhaps the threat is greater than we'd prefer to think.
Again I'm not predicting an economic crisis. And there is some wisdom to the adage "it's always darkest just before dawn." We know that markets bottom when things look their worst. Nonetheless, it's clear that there are some major storm clouds developing.
The gold market is also sending some interesting confirmations. Fundamentally, there might not be a whole lot of obvious reasons for gold stocks to be holding strong. During economic weakness, who's going to buy boatloads of jewelry? The high-tech industry is in bad shape, so we shouldn't look at that sector to create huge demand. If the industrial and consumer demand bases are weak, what could be propping up gold stocks? I suspect its reputation as a crisis hedge is a primary factor. Perhaps I'm not the only person concerned about the possibilities for an economic crisis. Perhaps the "smart money" has been hedging its concerns with quality gold producers like Agnico-Eagle, which remains firmly higher even while the price of gold drifts.
Of course, the word "crisis" might be a bit strong. But let's say at a minimum that the convergence of these economic threats does not create a scenario under which the U.S. economy is likely to thrive.
Here's another factor that concerns me. So far, the consumer has been acting relatively carefree, continuing to spend as though the 90s bull market and expansion were still running in full force. I suspect much of that has been due to expectations that the current slowdown is a temporary one. I suspect it's due to the curious trait of human psychology that has us believe that when times are good, the good times will last forever and that when times are bad, the misery will never cease.
I suspect that the U.S. consumer, after being conditioned by an 18-year bull market, high employment and good wages, is ignoring the reality of our current condition. According to psychologists, the first emotional stage following news of a death is denial. Well, the good times died a while ago, but U.S. consumers appear to be unhealthily locked into this first stage of grief. The U.S. consumer is unwilling to consider the possibility that the party has ended.
But here we are into second half and contrary to the prognostications of the spin doctors, talking heads and Fedsters, a recovery doesn't appear imminent any time soon. I think there is a very real possibility that if things don't turn up very soon, consumer confidence, sentiment, and psychology will turn sharply. If the U.S. consumer, the only factor keeping this economy above water, grows a wee bit concerned and begins to act with some fiscal restraint, the economy could sink rapidly.
According to the Fed's #2 man, Roger Ferguson, if consumers were to start acting responsibly, "it would put the economy at risk of unacceptably low growth. Now this statement was made back in March when folks were still talking about how the slowdown was just a minor blip, an aberration, and how milk and honey would start flowing through the land anytime now. Five months later, we're already in "unacceptably low growth" and the consumer is still spending. Responsible fiscal action would easily shift "unacceptably low growth" into "negative growth" which is Fedspeak for "pretty darn crappy times."
The long and short of it is that the U.S. economy is teetering somewhere between hope and a prayer, high above an economic chasm deeper than the officials and spin doctors would have us believe. We don't have to plunge. Sometimes hopes and prayers pan out handsomely. But the risk is great. And under that kind of risk, it simply doesn't make sense to be heavily invested in an overpriced stock market that is still firmly entrenched in a major downtrend.
Mark M. Rostenko, a veteran floor trader of Chicago's commodity exchanges, is the editor of The Sovereign Strategist investment newsletter. His views have been featured in Barron's, the Wall Street Journal, the Miami Herald and many other publications. Among his recent forecasts were calling the stock market's March short-term bottom one day after it was in place and identifying 1317 as a critical turning point for the subsequent S&P 500 rally. The S&P 500 topped out at 1316 a few weeks later.
Mark M. Rostenko
July 20, 2001
Mark M. Rostenko is a veteran of Chicago's commodities pits and the editor of
The Sovereign Strategist investment newsletter.
To request a free sample issue of The Sovereign Strategist, please visit www.sovereignstrategist.com
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