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Market still deluding itself that it can escape the inevitable dénouement

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September 14, 2010 – Comments (13)

John Mauldin's newest Outside the Box is a very good one: an article by Albert Edwards. There are several analysts, such as John Hussman and David Rosenberg, who are paying attention to leading macro inidicators. This is another good post in that vein.

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Market still deluding itself that it can escape the inevitable dénouement
By Albert Edwards

http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2010/09/13/market-still-deluding-itself-that-it-can-escape-the-inevitable-d-233-nouement.aspx

[excerpt]

The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious.

The notion that the equity market predicts anything has always struck me as ludicrous. In the 25 years I have been following the markets it seems clear to me that the equity market reacts to events rather than pre-empting them. We know from the Japanese Ice Age and indeed from the US 1930's experience, that in a post-bubble world the equity market merely follows the economic cycle. So to steal a march on the market, one should follow the leading indicators closely. These are variously pointing either to a hard landing or, at best, a decisive slowdown. In my view we are poised to slide back into another global recession: the data is slowing sharply but, just like Japan in its Ice Age, most still touchingly believe we are soft-landing. But before driving off a cliff to a hard (crash?) landing we might feel reassured when we pass a sign that reads Soft Landing and we can kid ourselves all is well.

I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can't remember where I read this, otherwise I would reference it). We have not quite reached this point. But with margins so high, any cyclical slowdown will crush productivity growth. Already in Q2, US productivity growth fell 1.8% - the steepest fall since Q3 2006.Hence, inevitably, unit labour costs have begun to rise QoQ. This trend will be exacerbated by recent more buoyant average hourly earnings seen in the last employment report. Whole economy profits are set for a 2007-like squeeze. And a sharp slide in analysts' optimism confirms we are right on the cusp of falling forward earnings (see chart below).



I love the delusion of the markets at this point in the cycle. It bemuses me why investors cannot see what is clear as the rather large nose on my face. Last Friday saw the equity market rally as August's 67k rise in private payrolls and an upwardly revised July rise of 107kbeat expectations. But did I miss something? When did we switch from looking at headline payrolls to private jobs? Does the fact that government is shedding jobs not matter? Admittedly temporary census workers do mess up the data, but hey, why not look at nonfarm payroll data ex census? Why not indeed? Because the last 4 months run of data looks notably weaker on payrolls ex census basis than looking only at the private payroll data (ie Aug 60k vs 67k, July 89k vs 107k, June 50k vs 61k and May 21k vs 51k). But these data, on either definition, look dreadful compared to the 265k rise in April and 160k in March (ex census definition). If someone as pathologically lazy as me can find the relevant BLS webpage after a quick call to the BLS (link), why can't the market? Because it is bad news, that's why.



August's rebound in the US manufacturing ISM was an even bigger surprise. This is a truly nonsensical piece of datum as it was totally at variance with the regional ISMs that come out in the weeks before. The ISM is made up of leading, coincident and lagging indicators. The leading indicators - new orders, unfilled orders and vender deliveries - all fell and point to further severe weakness in the headline measure ahead (see chart above). It was the coincident and lagging indicators such as production, inventories and employment that drove up the headline number. Some of the regional subcomponents (eg Philadelphia Fed workweek) are SCREAMING that recession is imminent

13 Comments – Post Your Own

#1) On September 14, 2010 at 7:59 AM, Gemini846 (50.98) wrote:

I have been exporing the idea that this leg up could actually take us up over 1180 (SPY), but we are certainly approaching resistance around 1128.

To me it seemed logical that we would be able to rally through the end of the year and perhaps a bit into 2011. However, I haven't seen enough evidence to move any long term money out of fixed income products.

If we are expecting another big leg down, is the real question when?

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#2) On September 14, 2010 at 10:05 AM, outoffocus (22.76) wrote:

Simple fact is theres alot of uncertainty out there. No asset class is safe, not even cash. This is big boon for gold.  Speaking of which, I think the shiny metal just hit a new all time high right along with silver.   Gold topped off at $1268 and silver at $20.34.

Also, Cramer said that SLW has been a bad investment. He touts SLV over SLW...LMAO!  On what planet?

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#3) On September 14, 2010 at 10:23 AM, binve (< 20) wrote:

Gemini846,

>> but we are certainly approaching resistance around 1128.

I am thinking that this will serve as very strong resistance

>>If we are expecting another big leg down, is the real question when?

If you are interested, here is my current thinking on the matter: http://marketthoughtsandanalysis.blogspot.com/2010/09/ponderings.html. Thanks!

outoffocus,

Totally agreed.

>> Speaking of which, I think the shiny metal just hit a new all time high right along with silver.   Gold topped off at $1268 and silver at $20.34.

Yes indeed my friend :)

>>Also, Cramer said that SLW has been a bad investment. He touts SLV over SLW...LMAO!  On what planet?

AWESOME!!! If I ever needed more conviction to stay in SLW (and I honestly don't) then there it is :) Thanks!..

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#4) On September 14, 2010 at 10:32 AM, outoffocus (22.76) wrote:

AWESOME!!! If I ever needed more conviction to stay in SLW (and I honestly don't) then there it is :) Thanks!..

Well i'll give you more conviction anyway.  SLW just hit $25!!  If this keeps going I'm going to have to buy Sinchi a bottle of champagne or 2.

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#5) On September 14, 2010 at 11:31 AM, binve (< 20) wrote:

outoffocus,

>>Well i'll give you more conviction anyway.  SLW just hit $25!!  If this keeps going I'm going to have to buy Sinchi a bottle of champagne or 2.

I second that!..

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#6) On September 14, 2010 at 11:48 AM, outoffocus (22.76) wrote:

I was so caught up in the excitement I almost forgot: *pops champagne*

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#7) On September 14, 2010 at 4:01 PM, rhallbick (99.62) wrote:

I read an interesting article recently noting the equity market typically does not begin to slump until just AFTER analysts begin to cut their 12m forward EPS estimates (for the life of me I can't remember where I read this, otherwise I would reference it).

He might have gotten this from David Rosenberg.  He's focused on that a lot lately.

RH 

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#8) On September 14, 2010 at 4:05 PM, binve (< 20) wrote:

rhallbick,

You are correct. I am also a fan/reader of Rosenberg (I read his Breakfast with Dave every morning) like I stated at the beginning of the post...

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#9) On September 14, 2010 at 4:53 PM, rhallbick (99.62) wrote:

I got a little behind on Breakfast with Dave recently and read about ten of them, one after the other.  It got me so depressed that I bought some bonds.

Mauldin is very good at funneling a variety of intelligent commentary/analysis your way. I appreciate his work quite a bit.

RH

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#10) On September 14, 2010 at 4:55 PM, DarthMaul09 (29.62) wrote:

To market time or not to market time, that is the question.

The answer may hinge on the extension of the Bush tax cuts.  If they are extended, then the correction may be delayed into 2011, but if it appears that the tax cuts will be allowed to expire, then there will likely be some selling to capture the capital gains this year.

Selling too soon leaves you with the problem of where to put the money.  Gold and silver are at their highs and bonds look like a trap, so maybe just holding cash is the least bad option.  I think that the US dollar index will fall below 80, so I don't believe that cash is a truly safe long-term investment, but that may be the price you pay for liquidity and the potential to buy equities at lower prices in the future.

Thanks for this blog to give me more to think about.

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#11) On September 14, 2010 at 5:09 PM, binve (< 20) wrote:

rhallbick,

>>I got a little behind on Breakfast with Dave recently and read about ten of them, one after the other.  It got me so depressed that I bought some bonds.

:) . It is actually nice to read an econmist / analyst who knows what he is talking about, doesn't sugar coat anything, but also doesn't talk about the end of the world. He is definitely among my favorites

>>Mauldin is very good at funneling a variety of intelligent commentary/analysis your way. I appreciate his work quite a bit.

Same here. Thanks!

DarthMaul09 ,

Thanks for the thoughts!..

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#12) On September 14, 2010 at 5:18 PM, leohaas (31.88) wrote:

"Selling too soon leaves you with the problem of where to put the money.  Gold and silver are at their highs..."

Disagree. If you buy into what binve is arguing, gold and silver will go up. And not just a little bit...

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#13) On September 14, 2010 at 9:49 PM, DarthMaul09 (29.62) wrote:

  leohaas

I do like the precious metals and mining stocks but I avoid buying them after they have begun to run up.  Some pundits are talking about $1300/oz gold, which means its probably not a good time to buy.  I would wait for a significant pull back, maybe to $1200 before making additional gold related buys.  I do have the expectation that gold will eventually break out above $1300, which is why I've held my investments in this sector.

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