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Long time readers know that I don’t buy the claims of economic “recovery” in the slightest. Often times I see folks on CNBC asking, “when will things get back to how they were?” The simple answer is…
NEVER.
The US has entered a New Normal… a new economic climate… and it is one dominated by:
- Higher consumer savings
- Lower consumer spending
- Rising unemployment
- Lower corporate profits
- Increased Government spending/ transfer
- Reduced private sector growth
- Excess capacity
- Reduced production
- Excess bank reserves
- Reduced lending
This is, in a nutshell, a bleak economic picture. It is, however, reality. I know the media is now rife with folks predicting the end of the Recession. I even know “smart” analysts who are saying the same at independent research firms.
In terms of the REAL economic picture, these folks are completely misguided and wrong. The US is facing the worst economic contraction since the Great Depression. This is NOT a plain vanilla recession. And while stocks may (and I emphasize that word) have staged their major bottoms in March, the US economy has yet to remotely turn around.
Consider that:
- 34 million Americans are on food stamps
- 18% of incomes coming from an already broke government
- Seven million people will run out of unemployment insurance by Christmas (add their families and you have 13 million folks becoming destitute)
- Tax receipts are at their lowest levels since 1932
- 32 states have budget problems ($121 billion in total deficits) and the Federal Government is running a $2 trillion deficit
- Civil unrest growing: National Guard May Be Called to Alabama
- Industrial capacity for May ’09 was 68%: an ALL TIME low (roughly 1/3 of our plants and production facilities are doing nothing at all).
- Rail carload volume for 1H09 is down 19% from the already plunging level of 1H08.
- Even after laying off people and cutting costs, Quarter over Quarter Corporate Revenues and Profits fell 17% and 33% respectively in 2Q09.
Hard to get the word “recovery” out of the above. However, economics is a dark art, and in the hands of a deft accountant, you can dream up all kinds of nonsense, including a positive GDP… which we are likely to get in 3Q09.
However, with the Feds even openly acknowledging that their GDP findings are wrong (see the numerous revisions to the downside over the last year), this will be largely meaningless to anyone outside of the DC beltway.
On that note, the next time you see or hear anyone proclaiming that the recession is over, feel free to forward them the above list of data points and ask for their explanation as to how those items spell recovery.
As I’ve noted in previous essays, this stock market rally has come much too far, much too fast. All told the S&P 500 is up over 48% since the March lows. This is unprecedented in the post-WWII era.
As I’ve pointed out earlier, this rally is mirroring the post-‘29 Crash rally to perfection. In fact, we just hit the “peak” in terms of both gains and days. This does not bode well for stocks.
At current levels, the S&P 500 is pricing in a 40-50% growth in earnings for 2010 AND GDP growth of 4.5% for the 3Q09. I put the likelihood of both of these items at less than 1 in 100. Earnings may have beaten Wall Street estimates, but they did so by laying off workers en masse and cutting back on inventory.
REAL earnings (including credit write-downs), in contrast, have fallen off a cliff. And they’re not coming back any time soon. The reasoning is simple: the CONSUMER IS DEAD. Despite incredible stimulus efforts, consumer spending fell at a -1.2% annualized rate in June.
In simple terms, the government is finding it harder and harder to get growth out of debt: it now takes a record $5 and change in debt to stimulate $1 in GDP growth. Failing another Stimulus Plan (I’m not in favor of this), 3Q09 earnings will be a disaster. And even WITH another Stimulus, there is NO CHANCE of earnings rebounding 50% in the next six months.
Historically, as famed economist David Rosenberg notes, by the time the stock market rallies 48%, the following have occurred:
- Real GDP had expanded on average by 4.5%
- Employment had rebounded an average of 850k jobs
- Corporate profits had recovered 12%
- Bank lending had risen an average of 5%
This time around, NONE of those has occurred. This market has risen largely based on momentum NOT fundamentals. And it’s beginning to show serious signs of weakness.
First and foremost, the financial bell-weather, Goldman Sachs (dotted line), which has been leading stocks (S&P 500= solid line) on the upside, has broken down.
As you can see, GS peaked a few weeks ago and has since posted a significant decline of more than 5%. Meanwhile the S&P 500 has only just started to come unraveled.
Besides this, the Baltic Dry Index has failed to confirm the July rally in stocks. If you’re unfamiliar with the Baltic, it measures shipping rates around the world. When people are moving a lot of goods and ships are in high demand, the Baltic rises. In contrast, when things slow down and ships needed less, the Baltic drops.
And as you can see, the Baltic (dotted line) has been dropping steadily against stocks (solid line) since June, which indicates that claims of economic recovery and growth are just that: claims, NOT facts.
The S&P 500 has finally begun to acknowledge these realities and is tipping over. As my friend and colleague Brian Heyliger noted in yesterday’s essay, we could well drop to 930 in the next week or so.
If you’ve not yet gone short, don’t worry. Tomorrow’s (Thursday) performance gaming due to options expiration could very well offer you a good entry point.
You see, August’s options expire on Friday. Because of this, traders who are underwater on their positions will try to push the market higher in order to close out their positions for a gain. Historically the day before expiration (Thursday) sees the largest market jumps as traders pile in pushing the market higher.
In light of this, I would not at all be surprised if the S&P 500 rallies hard tomorrow. When and if it does, you should get a good entry point to establish some shorts. Once options expiration is over after Friday’s close, the fundamentals should take hold of the market again, pushing stocks lower.
Meanwhile, Gold is positioning itself for a major leg up.
No investment ever goes straight up or straight down. During the last bull market in gold, the precious metal rose 2,329% from a low of $35 in 1970 to a high of $850 in 1980. However, during that time, there was a period of 18 months in which gold fell nearly 50% (see the chart below).
As you can see, from mid-1971 to December 1974, gold rose 471%. It then fell 50%, from December ’74 to August ’76. After that, it began its next leg up, exploding 750% higher from August ’76 to January 1980.
Now, in its current bull market (2001 to March 2008), gold rose over 300% from $250 to a little over $1,000. And just like in the mid-70s, it began showing signs of weakness after its first big rally up to $1,014 in March ’08. At one point, it even fell to $700, a 30% retraction.
Granted, it wasn’t a full 50% retraction like the one that occurred from 1974-76. But we are experiencing a financial crisis. And gold is the most common catastrophe insurance.
If we were to go by the historic pattern of the gold market in the ‘70s, gold should experience upwards resistance for 19 months after its first peak today. Gold’s recent peak was $1,014 in March ’08 (roughly 17 months ago).
If this bull market parallels the last one, then gold should renew its upward momentum in a very serious way starting in October 2009. And this next leg up should be a major one (the biggest gains came during the second rally in gold’s bull market in the ‘70s).
The chart certainly forecasts a major move.
As you can see, gold has formed a long-term inverse head and shoulders formation (two smaller collapses book-ending a major collapse). Typically a head and shoulders predicts a massive collapse. However, when the head and shoulders is inverse, as is the case for gold today, this typically predicts a MAJOR leg up.
Indeed, any move above the “neckline” of 1,000 would forecast a MAJOR move up to $1,300 or so. Going by history, this is precisely the move we should expect: remember based on historical trends (the gold bull market of the ‘70s) gold should begin its second and largest leg up in September or October 2009.
Watch the gold chart closely over the next month or so. If gold makes a move above $980 perhaps add to your current positions. If it clears $1,000, hold on tight, cause the next leg up in this secular bull market has begun.
I’ve put together a FREE Special Report detailing an unusual means of playing the gold explosion. While most investors blindly pile into the gold ETF or buy gold bullion, this backdoor play allows you to buy the precious metal at an incredible $188 an ounce. If gold breaks above $1,000, the opportunity for triple digits gains is huge.
Swing by www.gainspainscapital.com/gold.html to pick up your FREE copy!!
Good Investing!
Graham Summers
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I’ve prepared a FREE Special Report detailing three investments that will soar when the Second Round of the Financial Crisis hits. I call it the Financial Crisis Round Two Survival Kit. Swing by www.gainspainscapital.com/roundtwo.html to pick up your free copy today.
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