Mauldin: End of Recession?

In New from the Frontline, Mauldin dissects the posted stats and figures to illustrate why they are being spun off for more than what is really the case.

This is not to say that the news is bad or good. It requires deeper interpretation for its consequences. For example, Mauldin also notes that later this year or next, GDP will rise...when compared to previous quarters and years. One bad year will most likely likely follow with a good one because the comparative baseline year was so bad.

My analysis is below.

Recession's End Vs. Stock Market

In 2003, when the market finally turned up, we were already well out of recession. And the market had a very quick 12% or so drop while we were in recovery, while later we went on to a 90% run-up! Was the drop telling us anything, or do we explain it away?

"In the short run," St. Graham said, "the market is a voting machine. In the long run it is a weighing machine." The voting is based on current sentiment, but what the market weighs in the long run is earnings. The market tries to forecast future income streams. And it gets it wrong as often as it gets it right.

...

The CNBC host talked in breathless terms about the importance of the 50-day average moving above the 200-day average. It means nothing until it means something, and we won't know what that something is for some time.

Analysis:

Most analysis I have done from a macro level strongly suggests that the market needs to fall. This has not happened for four months. Even though traders have made some 40% in this time period, investors need to review earnings, ongoing losses in commercial real estate, and option ARM (adjustable rate mortgages). The unknown factors (helping the markets) still exist around policy and monetary policy, which is distorting the natural behavior of the markets.

About Unemployment:

• Should labor market conditions proceed along the path taken in the 1992 recovery, the unemployment rate could peak close to 11% in mid-2010 and remain above 9% through the end of 2011
  
• Projection indicates that the level of labor market slack would be higher by the end of 2009 than experienced at any other time in the post-World War II period, implying a longer and slower recovery path for the unemployment rate [incorporates involuntary part-time workers plus standard unemployment rate]
  
• When the economy rebounds, employers will tap into their existing workforces rather than hire new workers. This could substantially slow the recovery of the outflow rate and put upward pressure on future unemployment rates.

Analysis:
It is difficult not to read into "positive" economic news, but the focus must remain around the level of unemployment, progress of shift into new sectors, and economic changes/trends in the manufacturing sector.

How Income...and Savings...Both Rose

A large increase in "government social benefits" and a decline in personal taxes accounted for all the gain, and then some. The increase was the effect from the recent stimulus package, which is (for now) temporary, and not the result of a recovering economy. Hardly green shoots. It is just borrowed money from another (government) source.

Analysis:
Who's paying for this again? Oh yes. You are. You, the tax payer. It is easy to be skeptical on how much longer the stimulus package will be funded. Tax will not likely go up in the U.S. for another 3 years. This statement is based on the assumption is that the current government will want to be re-elected.


John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

A Rally Without Earnings-less Recovery is...

On TradingSystemGuru this week, Matt and his team returned from a nice vacation in Europe (I believe). He expressed his doubt about the stock market rally in the following points below:

• Average Price/Earnings ratio for the 8,011 US stocks of the VectorVest Composite Index (VVC) was 131.21
  

In the chart above, Matt notes that "the broad range of publicly trading companies is in uncharted territory and well above any previous rally or recovery high."

Source: http://tradesystemguru.com/content/blogcategory/34/68/

Canada may also be vulnerable to a sell-off:

Canadian stocks rallied 40% during a period in which earnings dropped more than 100%! When earnings get this bad, there is no point in looking at PEs – recently they went from +1000 to –1000 in the space of a week!

* So are US and Canadian stocks overprices now? You can judge for yourselves but either we have entered a new paradigm in which earnings don’t matter or the market is betting that earnings are about to take off like a thoroughbred on steroids.

About U.S. Debt:

Net foreign private flows were negative $58.4 billion [in April 2009], and net foreign official flows were $5.2 billion.

...

Foreign holdings of dollar-denominated short-term U.S. securities, including Treasury bills, and other custody liabilities decreased $39.4 billion and foreigners sold $44.5 billion of Treasury bills in April.

Why is this important? With a looming deficit north of $2 trillion, the US Treasury will have to sell approximately $200 billion in government bonds per month just to pay the bills, a level that is far higher than currently levels of investment in US capital assets. Unless the Treasury is able to attract new levels of foreign investment, there will be growing upward pressure on interest rates and rising rates are bad for housing and nearly every aspect of economic growth.

Notes from Frontline Thoughts: The New Normal

This week, Mauldin comments on the need for the economy to supply less, most especially in the consumer sector. His macroeconomic view is described as "the new normal."

The reason is clear: consumer spending will not increase, because savings rates have permanently and necessarily increased:

To expect a normal recovery cycle, whether it is corporate profits or lending or consumer spending or capital investment or (pick a category) is just not reasonable. This is a period that is fundamentally, in so many ways, different. And the recovery (and there will be one!) will also be of a different warp and woof throughout the entire world economy.

Three of the major points mentioned to support this argument are summarized below:

• First, we are at the end of a huge cycle of increasing private debt that ended in an overleveraged society.
  
• Secondly, my premise is that the recovery is going to take longer and be much less robust than any recovery since WWII. With unemployment likely to go over 10%, and with our new normal world not needing as much production of so many things, unemployment is going to stay stubbornly higher for longer than in any previous recovery.
• Thirdly, all this is going to affect corporate profits, especially for companies that depend on consumer spending. Those investors who expect corporate profits to rebound in 2010 are likely to be disappointed. (For the record, if you go to the S&P web site, analysts are projecting anywhere from a 40% to a 60% rebound in earnings for 2010 for the S&P 500. ...It is going to be tough to get much of a return from traditional buy-and-hold equity index investing for some time.
• Fourthly, this is a global problem and primarily one in the "developed" world. I think we will find that much of Europe will be in a worse state of affairs than the US.

What's next? Mauldin explains that:

In 2001, I wrote about what I called the Three Amigos that I watched to give us an indication of the direction of the economy. They were capacity utilization, high-yield bonds, and the (now-renamed) ISM numbers. Watching the direction they go gives us a good idea where the economy is headed.

1) Capacity Utilization is still declining
2) Junk bond yields are now at levels associated with a "recession." They were previously priced for what Mauldin calls "Armageddon"
3) ISM (Supply in the manufacturing sector of the economy) improved but it is still indicating that the economy is still bad.

Full original article may be found here: http://www.frontlinethoughts.com/pdf/mwo061909.pdf

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

To subscribe to John Mauldin's E-Letter please click here:
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Comments and Conclusions:
Not to place myself at the same level as a hedge fund manager, but Mauldin complains about the very things I complained about. The term "Green Shoots" is nothing more than hype created by Bernanke. Second, "less worse" does not mean getting better. These two ideas continue to support the market, but ultimately over time, the points brought up by Mauldin must be reflected in the stock market.

In the meantime, the stock market may have enough positive self-feeding positivity to rise. It is up to investors who have the primary goal of preserving capital not to mistake this as a bull market.