Extraordinarily Large Band Aids and Leading Indicators
June 12, 2010
It has been a tumultuous month in financial markets, and in times like these it is helpful to get insights from experienced (and highly disciplined) value managers like john Hussman who provides a useful frame-work to evaluate the market and its possible direction.
While the overvalued conditions in the market have eased somewhat, the markets internals (which includes a variety of measures to gauge oversold or overbought conditions) continue to deteriorate and we are still "in the eye of the hurricane" and he remains cautious.
The markets seems to be now going through a process of factoring-in a lower likelihood of a v-shaped recovery which had fuelled the unprecedented rally over the last 18 months.
The disappointing jobs report from last Friday should not have been a surprise – the four week moving average of initial claims for unemployment is running at 468,500 which is normally consistent with monthly payroll job losses of 80,000.
Profit margins are now at historical high levels (to match levels in 2007) and analysts implicitly expect these to continue into next year which is likely to be a source for disappointment.
The fundamental problem with the market today is not greece , the euro or the jobs report – it is that we have more debt than which can be serviced and all we have attempted to do so far is put extraordinarily large "band-aids" to plug the gap temporarily rather than address the issue by restructuring the debt.
He continues to believe that the next shoe to drop is likely to be fresh credit strains in the U.S. driven by defaults on exotic adjustable mortgages.
The "recovery" over the last year has been driven by unsustainable levels of deficit financing – and excluding this effect, the growth rate over the last year (near zero!) has been at par with the worst performance over the last 50 years.
Bailing out reckless lenders comes with an implicit cost because real value gets diverted at the expense of numerous productive activities - by crowding out private investment and redistributing wealth to banks from savers (through a zero rate policy) -there is no "free lunch".
Their stance remains cautious and they are fully hedged against further market weakness. They plan to add to inflation hedges (which is a longer term concern) by buying tips and commodities only during periods of (likely significant) market weakness.
On Leading Indicators (Dave Rosenberg) :
"The pace of activity is on the precipice of slowing down sharply. Indeed, the smoothed ECRI leading index slipped during the week ending May 28th week for the fourth week in a row and now in eight of the past nine. it is now at its lowest level since June 12, 2009 — when the S&P 500 was sitting at 946 (interestingly enough from a technical standpoint, right near the 50% pull back level of the bear market rally from the march 2009 low to the April 2010 high). The ECRI is now just basis points shy of breaking below zero but a double-dip is going to become a real likelihood if the index breaks to and through the -10 threshold."
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