The Market Bears come out to play
It’s spring time again. As nature has intended it, the bears are coming out of hibernation to forage for food after a long winter of inactivity. Such is also the case on Wall Street. The roughly +30% rally in the market from October 2011 lows to April 2, 2012 put the bears into their seasonal slumber. The fifth consecutive negative trading session puts the market in a much needed 5% correction mode. Granted the market’s stellar winter rally came on the back of auspicious, improving, but not outstanding economic data. With some bumps along the way to recovery, the market could be expected to sell off slightly in a healthy fashion as investors take some profits off the table as they await further clarity of the economic picture. But this week’s deluge of bear cases for US recession are certainly overblown at this early stage in the year. So investors today find themselves at a pivotal crossroads in the market.
Some pundits like A. Gary Shilling are forecasting a double dip recession should his prediction of another 20% drop in housing prices come to fruition. Shilling bases his claim on the fact that falling housing prices will bring down consumer spending and hugely impact economic growth as a result.
Doug Kass of Seabreeze Partners also sees an unfavorable economic outlook based on major economic headwinds:
“While a muddle-through backdrop of only 1.5% to 2.0% real GDP and modest (+5%) profit growth remains my baseline expectation, the market’s risk/reward remains unfavorable.”
- market participants are incorrectly assessing the trajectory of domestic economic growth (it is slowing, not accelerating);
- the political backdrop is not market- or business-friendly, with the growing likelihood that Obama will regain the presidency and that the Republican Party will likely control the House and Senate (gridlock and failure to address our fiscal deficit holds risks to the capital markets);
- a monetary cliff is approaching at June’s end (“The Liquidity Rally Is Over”);
- a fiscal cliff is a threat at year-end;
- there remains risk of further debt contagion in Europe (as risks in Italy and Spain have resurfaced); and
- a meaningful reallocation out of bonds into stocks is no longer likely.
Gluskin-Sheff’s David Rosenberg points to six roadblocks waiting ahead of the market.
- Liquidity – sees Fed backing off from QE expansion
- US economy – jobs, and 70% economic data coming in below expectations in March
- Rapid slowing in corporate earnings – Q4 YOY S&P 500 operating earnings slip into single-digits with only 62% of companies beating estimates. Expectations lower for Q1
- European concerns – poor Spanish bond auction and French elections do not bode well. Poor macro picture writ large
- Poor technicals picture – a decline in the number of stocks making fresh 52-week highs is on the decline
- Valuation support is less positive than it was six months ago – on CAPE basis the market is 40% overvalued at 22x from long-run average of 16x.
While valid in their assessment of the current economic data, what at the three experts fail to account for is the new paradigm in financial markets that has the Fed and central planners at the helm. Free markets no longer, central policymakers have endless ammunition to manipulate markets these days. The Federal Reserve has the will and the tools to deploy the needed liquidity to prop up the market and fulfill its third mandate. Our market outlook, thus, breaks from traditional paradigms and specifically follows the psychology of the Fed and its intention to salvage the capitalist game from collapse by preventing the market from sinking into the abyss. Despite choppy waters ahead, the market will continue to climb higher over the wall of worry as it subconsciously relies on the omnipresent Bernanke Put.
And while the bears continue to pick at the blossoming berries of spring, their exuberant mood will shift to grumpiness as they are left wanting in the wake of the Fed’s tactical maneuvers that will take the market higher till election time.