There’s too much optimism compared to actual data and recent trends, at least so far as I can see. Here are some examples.
The Financial Times has, behind a firewall, an article out today showing evidence of falling demand for petrochemicals in China that, the writer says, raises the question of whether China’s industrial slowdown is accelerating downward faster than expected. Then the article twice goes on to proffer market participants’ expectation that this is just a brief pause in growth; the pause that refreshes.
Both du Pont and Texas Instruments pre-announced weak earnings for the current quarter this week, but each stressed they are optimistic for a quick turnaround, citing low customer inventories. (But will inventories appear “too low” if new orders surprise to the downside?)
The Reuters/U-Michigan survey of consumer confidence reported a nice jump in future expectations but practically no change in current conditions. Many Fed manufacturing surveys have shown this as well lately.
The Bloomberg Consumer Comfort survey (formerly run by ABC and before that by ABC-WaPo) has shown worse estimates of personal economic circumstance for a longer period (3 months) than even in 2008-9. Gallup’s discretionary spending data is similar if one adjusts for price changes, and Gallup has shown for well over the past three years a strong continuous majority of respondents reporting the economy worsening.
Meanwhile, many observers report that corporate profit margins are at or near modern records, and different measures of Tobin’s q or its variants (replacement costs for corporate assets), or a somewhat similar measure that John Hussman reported on recently, suggest as well that the general stock market is substantially overvalued.
Meanwhile, it is impossible to discern whether Europe is first going to flirt with price deflation before all the money-printing that I expect leads to the usual result of price inflation following monetary inflation. But with imported oil into Europe, the U.S., and Asia remaining above $100/barrel, an ongoing tax on industry and spending is continuing that in the past has correlated with recession- and the longer and higher the oil price has stayed, the deeper/longer the recession.
Back in the U.S., two measures of earnings momentum are ominous. In the earnings season just passed, it was reported that there was a higher ratio of Q4 earnings downgrades to upgrades by reporting companies than since 1998. People may remember that the real economy actually peaked in the 1997-8 period known as the Asian contagion, ending with Russia going into hyperinflation and the collapse of LTCM. It was in part the system’s (read, the Fed’s) money-printing response to the LTCM mess that helped set off the amazing surge in stocks for the next 1-2 years, all of which was soon given back (and then some). Then, this past week saw a report that channels the 2001 recession:
Companies cutting forecasts outpace those raising estimates by the greatest ratio in 10 years, and some sectors, such as materials, have seen a dramatic fall in expectations for the soon-to-be ended fourth quarter, according to Thomson Reuters data.
It is a stark reminder that even as U.S. economic data has improved in recent weeks, the euro zone debt crisis and concerns about slowing growth in China still cast a long shadow.
Estimates for fourth-quarter S&P earnings growth have tumbled over the past two months as global macroeconomic headwinds prompted analysts to slash forecasts.
The S&P is now seen posting earnings growth of 10 percent in the fourth quarter, down from a forecast for 15 percent growth on October 3…
So when I read this, I see optimism: growth, problems elsewhere in the world but not the U.S.
To me, the simpler approach to take is that corporate earnings are being richly valued relative to the actual value of corporate assets, including net cash, and that these earnings are further being richly valued based on peak profit margins. Meanwhile, the populace keeps reporting, for the first time since records are available, that the cyclical rebound in industrial and other production has not been associated with any improvement at all in their financial situation- actually, they report a steady worsening. Said worsening is of course because wages and jobs have stagnated while living costs have risen, while the average value of household assets (financial and real property) have at best stagnated.
Furthermore, and unlike the period in the post-1932 era well past the end of WW II, stocks are not inherently viewed the way they used to be, which is inherently risky assets that, after all, require a leap of faith to own. Unlike lending to a corporation or municipality, which are contracts with indentures, the purchase of a common stock is a pure investment without even an implied promise from the company that it will seek to maximize the value of outsider shareholders’ shares; and most large companies today have minimal levels of insider ownership and minimal to no insider buying other than to exercise and promptly sell in-the-money stock options.
There’s no way to know, but I think it’s reasonable to look at the way Big Finance was acted with Other People’s Money and shy away from any belief that it’s different this time. For the last 111 years, the linked chart suggests that stocks will at some point fall below fair value. If so, a large drop in stock prices could soon follow the rapid deceleration in earnings growth especially should actual declines in profits be projected.
Thus it just may be that a general market complacency could be replaced sooner rather than later by something more like what most of the country already believes, which is that the Great Recession only ended in the securities markets but not in the real world. If it is occurring or occurs soon, a clear new cyclical downturn in the U.S. could therefore end up having a disproportionately greater effect on stock prices than on the real economy.