lunes, 7 de marzo de 2011

lunes, marzo 07, 2011

Are Booming Economies Good for the Markets?

By John Mauldin

March 5, 2011
People only accept change in necessity and see necessity only in crisis.
—Jean Monnet

The economy is doing better, and we will survey some of the highlights. But does this mean the stock market is headed higher? A chart from Louis Gave got me to thinking, and I shot off a few thoughts and questions to Ed Easterling and Vitaliy Katsenelson. What ensued was a livelybattle” of charts and thoughts and more questions, so this week I let you look over my shoulder at our conversation. This letter will print longer than normal, as there are a lot of charts. I think you will find it very thought-provoking, if only a little cautionary.


And we start with a look at a survey about what Americans think of the current fiscal deficit and the ways to remedy it.
At the end of the letter I give you a link to a speech by my friend Pat Cox, which is one of the best speeches and PowerPoints I have seen in a long time. It will only remain up for another ten days, per agreement with his publisher, so you really do want to find some time to listen. And I remind you about my conference in La Jolla April 28-30, with its gonzo all-star lineup, which I modestly think makes it the best investment conference anywhere. It is rapidly filling up. Don’t procrastinate. And I have some TV and radio times for next week as well. Now, let’s jump in to today’s letter.
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The Delusion of Crowds and the Endgame

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My good friend Dennis Gartman pointed me to a recent survey of “likely voters” done by the Tarrance Group. The results were disturbing to me, and show how truly ill-informed the American electorate is. This does not bode well. You can see the survey at http://www.politico.com/static/PPM191_poll.html , but let me highlight a few key points.


“There are widespread misperceptions about the state of the federal budget. A majority of voters incorrectly believes the federal government spends more on defense/foreign aid than it does on Medicare and Social Security (63%). Also, a similar majority (60%) incorrectly believes problems with the federal budget can be fixed by just eliminating waste, fraud and abuse.


Voters do not casually agree with these untruths at least 40% strongly agree. Further, less than half (44%) believe Medicare and Social Security costs are a major source of problems for the federal budget (49% disagree).


“The waste in government is a strong concern to votersagain 60% believe fixing the waste will solve the nation’s budget problems, and voters say that a mean of 42% of each federal dollar is wasted.”


I was on the speaking platform yesterday with David Walker, the former Comptroller General of the United States and head of the Government Accountability Office (GAO) from 1998 to 2008, and we once again got to spend a good deal of time afterwards talking about the fiscal crisis as we were waiting for our respective spots on a PBS interview talk show hosted by Dennis McCuistion. Walker and I share a mutual concern that if “We the Peopledo not come to an agreement on the fiscal deficit of the US government, the country could be plunged into a crisis of Greek proportions. But he feels (and I agree) that part of the real problem is that people do not understand the true nature of the problem. The survey underscores his point. We have a deficit of $1.6 trillion, and Congress is debating over $61 billion in spending cuts, as if the Republic would founder with those cuts.


That is in large part the message of my new book, Endgame: The End of the Debt SuperCycle and How It Changes Everything. To avoid a crisis that would devastate this country, putting us into a decade-long recession (or worse), we must bring the deficit back (to at least!) below nominal GDP. That means a trillion dollars plus in spending cuts and/or tax increases.
I agree there is room for some serious reduction in waste, etc. The GAO just came out with a paper highlighting scores of redundant government programs. But reducing waste and redundant government programs won’t get us there. Not even close.


There are going to have to be a lot of “sacred cowsled to the altar. The weeping, wailing, and gnashing of teeth as subsidies, tax preferences, deductions, and other government benefits are eliminated or curtailed will be loud and long. The simple fact is that the federal government is now too large for our current income tax base as it is structured, and we have made promises that cannot be kept without a major change in the tax structure. Long-time readers know that I do not like taxes.


I stutter when I even try to say the word. But the national conversation we must have as adults is, how much Medicare do we want and how are we going to pay for it? If We The People decide we want Medicare at close to the level we have today, even reformed and optimized, it is likely going to require some form of value-added tax (VAT). Even rescinding the Bush tax cuts on the rich won’t get us close. But we need to recognize there are growth costs (and thus joblosses) that come with higher taxes. If we are going to have a VAT, we need a true top-to-bottom reform of the tax system.


Whatever we decide, we must get the fiscal house in order before the bond market forces us to, because waiting until there is a true crisis will leave us with only very bad choices. Now our choices are merely very difficult. This is going to require either true compromise, which today seems sadly lacking, or political courage that is all too rare, to avoid the very bad choices and long-term destruction that a crisis will force upon us.


I truly hope it leads to a more informed national conversation, not just here in the States but throughout the world, as we all must come to terms with a world that now has a debt-to-GDP ratio of over 300%. We simply must if our children are to enjoy a better economic life than we have been privileged to have (so far). Waiting until the crisis actually hits us (and it will, if we do not act!) is a guaranteed life- and investment-altering event. It will not be fun. Think Greece or Ireland.
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Let the Good Times Roll

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The economic data that came out this week was mostly strong. The ISM survey numbers, both manufacturing and service, were quite robust. The new unemployment claims were as low as we have seen in years. Today’s employment number was 192,000, which is good, although it should be averaged with a weather-affected January, which brings us back to a number that is growing only slightly more than the population. But we have had four months in a row where the revisions have been upward. That is a good trend.

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Same-store sales were solid. Factory orders were also in very good territory. The unemployment rate fell by 0.1%, this time without help from people dropping out of the workforce, although the total employment rate (jobs per population) was down.
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Still, the bears in the crowd can point to very disappointing income growth, and there are spots in the jobs picture that are unsettling. More than one commentary I read pointed out the fact that the following chart from data maven Greg Weldon ( www.weldononline.com) shows. The unemployment rate for certain sectors of the economy is not good at all. Single mothers are still above 13%. Plus, the average duration of US unemployment is still rising and is at an all-time high:
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The average duration of US unemployment is at an all-time high:
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Still, the economy is doing as well as it has in a long time, and the trends are more or less improving.

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Are Booming Economies Good for the Markets?

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As I noted above, I was reading the daily missive from GaveKal, one of my normally more bullish reads, and I found the following:


“The important question instead is whether booming growth is always good for equity markets. And on that, the data is frankly mixed. Indeed, while strong growth usually leads to higher earnings (good news), it also typically leads to a tighter liquidity environment as a) companies need money to finance larger inventories and capital spending, b) inflationary pressures may impact margins and c) central banks usually respond by draining excess cash away from the system.
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Of course, today, one could argue that the strong growth need not be a concern as a) companies are sitting on record amounts of cash and are still seeing their financing costs drop and b) Western central banks have yet to start tightening monetary policies. So the liquidity environment has yet to really tighten up.


“Still, we thought we would look at periods when the OECD LI stood 2% above their long term trendidentified as the areas shaded in blue on the chart overleaf. Interestingly, as the performance of the World MSCI (black line) shows, periods of strong economic growth do not always equate to tremendous stock market performance over the following six months. Equity markets struggle all the more if, while growth is booming, oil prices suddenly surge (red bars on the chart); a relationship which makes sense given that a high price of oil further drains excess liquidity from financial markets and typically generates large misallocations of capital (moving money from the pockets of Western consumer to those of Ahmadinejad, Chavez and Gaddafi is not really a good long-term use of capital). In fact, as the chart illustrates, the most dangerous periods for equity markets are typically periods of strong economic activity combined with rapidly rising oil prices.
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The team at GaveKal rightly noted the problems of a doubling in the price of oil and the shocks to the stock markets and world economy that would result. Good friend David Rosenberg puts those facts into this commentary, along with a graph:


“There have been only five times in the past 70 years when this has happened within a two-year time frame: January 1974, November 1979, September 1990, June 2000, and August 2005. And now, December 2010. . . . Of the five instances cited above, all but one involved a recession for the U.S. economy and that was in 2005 during the height of the credit and housing boom, which acted as a huge offset. But oil prices did keep rising and managed to outlast the euphoria in credit and residential real estate, so the recession may have been delayed at the peak of the ‘growth rate in the oil price, but it was not derailed, as history shows.”
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So, I posed the following question to Ed Easterling of Crestmont Research (latest book, Probable Outcomes) and Vitaliy Katsenelson (The Little Book of Sideways Markets). They love this type of stuff.


As Ed notes, the stock market is not correlated with economic growth. In fact, as the next charts and tables show, secular bear markets even have higher nominal GDP growth than secular bulls.
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Next he points out that 34% of the years since 1950 with economic growth have experienced declining earnings per share (EPS) growth!

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Back to 2007?

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Vitaliy wrote back:


“Here [in the charts below] is PMI vs. Dow 1966-1982 and 2000-today. Also, what worries me is that corporate profit margins are approaching pre-2007-crisis highs (see the third chart). A small slowdown in the economy, or just stagnation, will send profit margins down. Hopefully this helps. Also, as you normalize PEs for high profit margins (i.e., look at 10-year trailing PEs), the market is trading 30%+ above average PEsecular bull markets just don’t start at these types of valuations. In addition, the market did not spend enough time at below-average PE for this move to be the new secular bull market (in the 1966-1982 sideways market, PE was below-average half the time).





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(Ed has his own way of normalizing earnings ( www.crestmontresearch.com). He has developed a
methodology – one that is fundamentals-based – that produces similar results to that of a ten-year average, or something like Shiller’s work, yet also provides forward-looking insights. In brief, it uses the close and fundamental (not coincidental) relationship between earnings per share (“E”) and gross domestic product (GDP) to adjust for the business cycle. The baseline E for each period is essentially based on mid-point values for E across the business cycle peak and trough periods of actual earnings reports are adjusted back to the underlying trend line to reduce the intra-cycle distortions.)


If you use his form of normalized earnings, and use the earnings projections from the S&P website, you find us back in the nosebleed territory of 2007, which is both Vitaliy’s and my worry. Stocks are once again priced for perfection, but I worry that we live in an imperfect world. The markets are assuming a normal business cycle, but as I strongly suggest in Endgame (shameless plug), we are not in a normal business cycle. It is the dĆ©nouement – the end of the debt supercycle, which distorts the normal financial physics that markets have come to rely upon. When markets get this distorted, whether to the upside or the downside, a correction of some sort is around the corner.
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As both GaveKal and Rosenberg note, a doubling in the oil price is not good for markets. And if we actually do begin to work on the deficit to the tune of $150 billion or so a year in cuts and tax increases, while it may be necessary for the survival of the economy, it will also be a headwind for economic growth and earnings.
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There is no free lunch. Again, not dealing with the deficit is a “game over event. There are no choices that do not have some pain involved.


As I wrote a few weeks ago, we are entering a period where recessions are likely to be more frequent and markets more volatile. These are not times for normal buy-and-hold strategies.
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Don’t Miss This Speech

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Pat Cox is one of my real go-toguys when it comes to finding life- and economy-changing new technologies. He writes Breakthrough Technology Alert, which is one of my true must-reads and a solid source for investment ideas. I am a huge fan.

He did a speech in Vancouver last year that simply blew me away, and the PowerPoint was awesome. I finally got his publisher to let me post it for a few weeksat least until March 15. You really should take the time to hear how the ideas of Schumpeter and others feed into opportunities today. The presentation is at http://www.johnmauldin.com/outsidethebox/special/complimentary-investment-presentation-by-patrick-cox/
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John MauldinJohn
@FrontlineThoughts.com 
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Copyright 2011 John Mauldin. All Rights Reserved

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