07-23-2012 Market Commentary

By Eddie Katz Gluskin Sheff - The American consumer is clearly in hunkering down mode. Even with lower gasoline prices and a tentative recovery in the housing market, the weight of over-indebtedness, weakening job market conditions, a muddled policy outlook and an increasingly jittery equity market is clearly weighing on both sentiment and actual spending. Retail sales fell 0.5% in June, far below the expectations for a 0.2% increase and down three months in a row and with downward revisions to boot. Going back into the history books, retail sales declining for three months in a row has only happened a grand total of 2% of the time. What we saw in the April-June period was a one-in-50 event. And each time it has happened, except once, the economy was in recession (so the folks at ECRI may be onto something). Moreover, the only time the economy was not already in a recession with a three-in-a-row sales decline was in the October-December 2000 period amidst the tech wreckage. So let's just say that 100% of the time in the past, when retail sales were down three consecutive months, the economy was either in recession or on the precipice thereof. The “retail control” figure (which feeds right into GDP) has been down or flat in each of the past three months and again this has only occurred in recessionary phases. Forewarned is forearmed. Merrill Lynch - Why are the recent data so weak? In our view, it is mainly a matter of confidence. The last several years have featured a number of false dawns. Each time the US economy looks better for a while, economists boost their numbers and start taking about “take off speed,” only to see growth falter. Similarly in Europe, each time a new rescue plan is announced there is a period of optimism in the markets, only to see the crisis pop up again. This long string of false dawns is slowly eroding away confidence in the recovery. Looking ahead, we see mainly downside risks to our well-below consensus forecast. If our Q2 GDP tracking model is correct, growth in the first half of this year—including weather-boosted Q1 and weather-payback Q2—averaged just 1.5%. The weak finish to Q2 means a negative “base effect” for Q3—specifically, data surprises in the last several weeks lowers the tracking for Q3 GDP growth by about 0.3 pp. The consensus has been drifting lower, but it still expects growth to pick up to 2.2% in Q3 and Q4. It is hard to see what would underpin such acceleration. The housing market is picking up modestly, but it is adding only a tenth or two to GDP growth and with a huge shadow inventory of foreclosed properties, a significant acceleration in new construction and prices seems unlikely. The mining sector is an ongoing source of strength, but it accounts for less than 2% of the economy and again the incremental contribution to GDP growth is a tenth or two. Elsewhere, the news is bad. Fiscal policy continues to slowly tighten at both the federal and state and local levels. The European crisis shows no sign of fading and, in the usual lagged fashion, should have increasing rather than decreasing collateral impacts on growth outside Europe. Last but not least, the risks of the fiscal cliff have just started to work their way into corporate psychology. We are frankly a bit puzzled by the persistent optimism in consensus and official forecasts. Barron's - The economic news here at home is at best a very mixed bag, with more recent particulars flirting with the outright negative. For weeks now we've been dutifully whistling past the graveyard as that menacing fiscal cliff draws nearer by the day, and so, alas, does the hair-raising possibility of plunging over it. But even as the recovery weakens and its already labored gait slows further, the market pushes higher, undeterred by shortage of breadth and by a heavy sprinkling of losses among rank-and-file stocks. One obvious reason for its quixotic behavior is the growing belief Mr. Bernanke will wave his magic wand and bring forth QE3, giving the faltering economy a proper lift. Ah, were it so easy. The problem with such much-to-be desired remedial action is that the effect of this stimulus appears to diminish with every repetition. And, despite Ben's calm reassurance offered once more last week to the foolish fiddlers on Capitol Hill that he will act when necessity calls for action, the suspicion mounts that the Fed may have just about used up its store of monetary tricks to rouse the recovery from its somnolence. Another more demonstrable virtue that investors have latched on to by way of justification for their urge to buy is the sterling performance of corporate earnings and the expectation that it will endure come what may. No argument that profits have held up remarkably well. But anticipation, whetted by analysts' projections for this year and next that earnings will continue to do so, ignores the sorry truth that margins are no longer so easy to fatten up by cutting staff, since there's not all that much staff left to cut. And, in any case, those bullish estimates make scant allowance for a stalled economy, let alone something much worse if, indeed, come Jan. 1, everything except lawmakers' perks and paychecks are slashed to bits and pieces. Friday's flaccid market may have been merely traders lightening up before the weekend. But it also might have been the result of the Street sobering up in the aftermath of its odd, brief buying binge. If so, to state the obvious (something we excel at), investors had best gird themselves for an uncomfortable summer. Conclusion – We're sticking to our guns regarding last week's call for a correction as last week's 0.4% gain on low volume didn't signify much in the way of progress. Earnings have been decent thanks to cost cuts, but there has been little in the way of revenue growth. From our lens, the market continues to be supported by hope for QE3. We would be happy to be proven wrong, but there are still hurdles to be jumped between now and the end of the summer. In the meantime, (for those in and near retirement in particular) we continue to ring the emergency bell for safe income, which is quickly becoming the greatest issue facing this nation. When government bonds of Netherlands, Finland and Germany are being purchased at a negative yield (meaning you are paying these governments to hold your money) because they are the only perceived safe havens in Europe, we have a hard time believing that the U.S. won't follow the same path considering it is the safest haven on planet Earth. Low rates may have historically led to a strong equity market as they were a precursor for a stimulative growth environment, but the truth is that in this post-financial crisis, low rates only indicate that U.S. GDP growth is weak. Without pulling any punches, if this environment continues, retiring by 65 will be a thing of the past for the sheer fact that retirees will be forced to rely more and more off of principal versus income. Of course, for those individuals currently with pensions and social security, there should always be a steady income flow, however, we would highlight two points. First, if you think social security is in good shape, please respond to us with the name and number of your pharmacist. Second, regarding defined benefit plans, Stephanie Pomboy states in Barron's this week, “the numbers of underfunding of U.S. plans are startling: an estimated $400 billion on the corporate side and a whopping $4 trillion of state and local governments.” Needless to say, just because you have a guarantee, it doesn't mean your guarantee is forever…just ask the retired civil servants of Stockton and San Bernardino. Everyone needs a contingency plan and we're not here as shills for canned food, guns and gold. Take care of your income needs first by matching assets to liabilities (much like a pension plan is required) and only then should you start venturing out on the risk spectrum to find other means of generating returns that will exceed inflation by a reasonable rate. For what it's worth, the California Public Employees' Retirement System (Calpers) has determined that 7.5% is the return needed to meet its future obligations. Unfortunately, size doesn't matter because even the nation's biggest public pension fund at $233 billion, Calpers returned a puny 1% for the year ended June 30th.