Back in April a piece was penned that looked at how oversold the market was on a statistical basis (“Possible vs. Probable”). The basis for the article was to look at the percent deviation of the S&P 500 from its 200 day moving average (200d MA) and how many standard deviations it was below the mean, comparing the current experience to prior bear market sell offs. The image below was shown displaying how the percent deviation from the 200d MA followed the typical bell-shaped curve and that the low seen in November of 2008 marked a major statistical extreme.
Seeing as how oversold we were back in April, an argument was made that the likelihood of a further correction away from the 200d MA was far less likely than a move back up to the 200d MA, with comments from the April article given below:
Looking at the current bear market, the S&P 500 was 39.6% below its 200d MA on November 20th of last year, which was a -4.17 standard deviation event, even more unlikely than the November 1929 low. A -4.17 standard deviation event should be seen only 0.0015% (0.000015) of the time, or to put it differently, observations above -4.17 standard deviations should be seen 99.9985% of the time. This means there was a 99.9985% probability of the next observation being above that number while only a 0.0015% probability of the next event being below -4.17 standard deviations. To put the number in the context of time, a -4.17 standard deviation event should be seen once only 66,666 days (once ever 265 years). The November lows that we just witnessed was more than a “100-year storm,” it was a “265 year storm!”
Now that we have indeed reached the 200d MA, where do we go from here? To help answer that question a comparison was made to the 1929/1930 sell off and recovery, which so far displays a fairly close resemblance to the current market. To highlight the analogy, the following chart was shown back in April.
S&P 500 (1929-1930)
Source: Bloomberg
While a top was not seen in May, the markets still show a similar path to the 1929-1930 analogy, which witnessed a second peak that was slightly below its 200d MA, and would call for a sell off here that would lead the market to roughly 20% below its 200d MA, which would correspond to a move to roughly 732 on the S&P 500.
Source: Bloomberg
The S&P 500 staged a five month rally that propelled the markets 46% off the November 1929 lows to the April 1930 highs, which pales in comparison to the market’s current performance. Since the March lows the S&P 500 has vaulted roughly 40% in just over two and a half months. As a correction was due in the 1930 experience, a correction or at least a consolidation appears the most likely outcome, though it may occur after quarter end rebalancing that advances the markets up a few percentage points.
We know that after the April 1930 top the S&P 500 then went on to decline 83% to the lows seen in the middle of 1932, with periodic rebounds that would attempt to rally back up to the 200d MA. Are we likely to see such a monster decline ahead? While I would wager that a correction lies in our near future, I am not so certain that we will see prices decline as drastically as they did post the 1929 crash, though in real terms a dramatic decline is certainly possible over the next few years. For example, while nominal prices advanced off the 1974 lows, real prices continued to fall until bottoming in 1982, giving a false sense of wealth creation in the later part of the 1970s.
Source: Robert J. Shiller
Making the call back in April for a market rebound back towards the 200d MA was the easy call to make based on how oversold the market was. Now that the market is overbought the future direction appears far more uncertain. At this stage in the economic cycle where the economy attempts to emerge from recession, one by one economic reports should begin to improve and thus give a mixed bag as some reports remain bearish while others begin to show an expanding economy. Eventually the predominance of economic reports shows an economy that is in the early to middle stages of an expansion. Will this be the case again?
Could this time be different?
The question is posed because we have two clear forces at work in the present situation. The economy is clearly coming back from the brink as it fell off a cliff last fall, with many economic numbers and credit spreads returning to pre-Lehman levels, the so called “less bad” or second derivative improvement. Moreover, the government stimulus passed earlier this year will slowly be pouring into the economy, lifting economic activity.
However, it is likely that we could continue to get mixed economic signals even after the current recession is over, with a significant possibility for a double dip recession. I believe we remain firmly entrenched within a secular bear market that is not likely to lose its grips for several years to come. There are secular trends and structural shifts currently underway and it would seem naïve to think that we will have anything that resembles a normal economic recovery compared to those over the last few decades.
One of the structural headwinds the US faces is employment. To the point, where are the jobs going to come from? The growth in employment this decade was absolutely anemic compared to the growth seen over the last five decades.
Source: BLS
Hat Tip: Brian Pretti, ContraryInvestor.com
While the unemployment rate gets much of the economic publicity, what is not as widely commented on is the level of those who can only find part time work, which is approaching 18 million U.S. citizens. While this number is alarming, it still does not match the scale relative to total employment seen in the early 1980s. What has exceeded the early 1980s level is the percent employed full time, which is on the verge of hitting all-time lows. It appears the only sector currently growing jobs is the government, which just witnessed its share of total employment rise to levels not seen since the early 1980s.
Source: BLS
Source: BLS
Source: BLS
Source: BLS
Clearly the amount of labor underutilization is substantial in the U.S., and I’m afraid the trend of outsourcing jobs seen earlier in this decade will continue, making the future recovery in jobs possibly even more anemic than the last expansion. For example, the recent CFO survey showed expected growth over the next twelve months for employment to contract 5.6%, while outsourced employment is expected to show positive growth at 0.3%. Campbell Harvey, founding director of the survey and international business professor at Duke’s Fuqua School of Business had the following comment in the May release (emphasis added).
“Presumably, government programs will offset some of these losses, but even the most optimistic government forecasts would reduce the losses by only two million. We’re facing the possibility of another four million lost jobs,” said Harvey.
While U.S. CFOs are expecting U.S. employment levels to decline by another 4 million jobs, they are also expecting positive growth in outsourced employment. So again the question is posed, where are the jobs going to come from if the new jobs created are being shipped overseas? Employment headwinds facing the economy are sizable as the pool of unemployed swells. The concern is, if throwing mountains of debt at the economy earlier this decade produced so little in terms of results, what makes us think throwing more at the economy will produce anything different? Is that not the very definition of insanity?
The current decade’s growth in employment produced such a meager marginal return relative to the debt taken on by the economy with the only true measureable increase seen was the propping of asset bubbles such as stocks and housing. The question becomes, are we approaching the zero hour? That is the hour where throwing another dollar of debt at the economy produces zero GDP dollars. It sure appears we are on that path as we just took out a new low in terms of financial productive capacity in the U.S. as we currently receive only 29 pennies in GDP for every dollar of total U.S. debt accumulated.
Source: Federal Reserve/BEA
Source: Federal Reserve/BEA
Source: Federal Reserve, BEA
Our economy is saddled with debt and throwing more at the economy will only get us so far. We simply cannot put off the pain forever and it appears the bond vigilantes are making that point known. There is only so much debt that the U.S. can dump on the markets and any excess supply of Treasuries are going to drive rates up as bond prices fall. The housing market is so fragile that any uptick in rates is immediately felt as refinance and purchase applications fall. From late January to late March the Mortgage Bankers Association (MBA) refinance and purchase indexes increased significantly as mortgage rates fell. The trend reversed as rates began to rise and refinance applications have fallen more than 50% with a decline also seen in purchase applications. What should also not be forgotten is that delinquency rates continue to rise from subprime to prime mortgages, with sizable financial losses from mortgages and mortgage-backed securities.
Source: Bloomberg
Source: Bloomberg
While the U.S. government embarks on record budget deficits, the U.S. consumer is taking a different approach as recession economics remain prevalent as a recent New York Times article points out, with excerpts provided below.
The Recession, Wal-Mart Style
So what are Wal-Mart, with 4,100 stores across the country, and other major retailers seeing?
Less browsing in the aisles, for one thing. Consumers now are “very disciplined in terms of making sure that they don’t go beyond what they have on their lists,” Kathryn A. Tesija, Target’s executive vice president of merchandising, told investors recently.
Food, of course, is high on those lists (discretionary items like clothes and furniture are not). But consumers are cracking their wallets only so far. Many are trading down to private label groceries. At Wal-Mart, sales of refrigerated pizza were up last month compared with a year ago. Lower grades of meat are outselling the higher-grade, pricier cuts. A recession protein hierarchy has emerged, with ground beef trumping steak, and chicken trumping beef. Some consumers are forgoing protein altogether, opting for pasta.
“We’re seeing a movement away from protein into carbohydrates,” Mr. Fleming said. “It stretches the dollar a lot further...”
Retailers say consumers are trying to make being cooped up as painless as possible. Mr. Fleming said that would explain why even in this economy, sales of flat-panel and high-definition televisions at Wal-Mart are strong. After all, the retailer’s 8, 32-inch RCA LCD television is more affordable than a vacation.
Home Depot’s Craig Menear, executive vice president for merchandising, told investors recently that vegetable and herb sales were thriving because “more customers are opting to grow their own vegetable gardens.”
Car maintenance and repair is also big. Sales of motor oil, filters and tires are among Wal-Mart’s top sellers. “Anything that helps their car last longer is doing well because they’re not buying new cars,” Mr. Fleming said.
Consumers are spending to keep themselves in good health too, for fear of having to miss work. Wal-Mart said sales of vitamins are robust. So are sales of over-the-counter medications. Sales of sleep aids, pain relievers and antacids have spiked.
The point of the above is to illustrate that the U.S. faces major headwinds to the economy and the economic growth that results after the conclusion of the current recession is likely to be anemic as consumers pair back on debt as witnessed by a negative year-over-year rate of change in consumer credit.
A Bumpy Road Going Forward
As Mark Twain said, “History does not repeat itself, but it does rhyme." We entered into a secular bear market back in 2000 and history tells us that secular bear markets last anywhere from 12-15 years in duration, with several cyclical bull and bear markets during the period. It is likely that we are transitioning into the second cyclical bull market of this decade, though one which will likely be shorter than the 2003-2007 bull market.
Interestingly enough, the path of the NASDAQ since its bubble peak in 2000 is tracing out a similar pattern to the one traced by the S&P 500 during the Great Depression and also the Japanese Nikkei 225 index after its bubble peaked in 1989. You can see these stock market bubble comparisons that lead to 15+ year secular bear markets in the image below, with cyclical bear (red boxes) and cyclical bull markets (green boxes) highlighted.
Source: Bloomberg
While the positive economic news of late is welcome news, we should never lose sight of the current reality that financial losses on residential and commercial real estate have not peaked, nor forget the long term reality of massive debt levels and a large void in terms of employment creation that lies ahead. We are likely in a new cyclical bull market, but one of unknown duration and sustainability given the current backdrop, which should help keep investors' enthusiasm grounded as they keep these thoughts in mind.
