In 2011, most of the world's equity investors suffered. Although business conditions have continued to slow on most continents, the majority of world equity markets have turned the tide and started 2012 on a strong note. As typically happens, perception of the news brightens after markets rise. Earlier this week the excellent researchers at ISI offered a litany of "Positives Starting to Dominate." Notwithstanding the quality of their research, these points typify the bullish bias of the Wall Street establishment rather than portray an accurate rendering of underlying business fundamentals.
After each of ISI's "positives," I'll offer what I consider to be a more relevant counter-balance from the perspective of investors rather than short-term traders.
- Housing starting to recover. While some measures of decline are improving, prices continue to fall and huge numbers of foreclosures remain a fact of life. It will take years for the housing market to return to conditions that existed before the bubble.
- Labor market improving. This is a celebration of direction over level. At 8.3% unemployed, the labor market is only slightly better than its worst status since the Great Depression of the 1930s. The government's U6 measure, combining both unemployment and unintended underemployment is above 15%. Additionally, a large number outside those measures have given up hope of finding a job and have left the labor force entirely.
- Credit expansion unfolding. This is due more to the unprecedented creation of money from world central banks than from any greater willingness to lend by bankers, who are still licking their wounds from their mindless expansion of credit over the prior decade. Applause for credit expansion must also be questioned while we are still trying to recover from an unprecedented debt crisis.
- Low dollar. While a cheap dollar does improve profit potential for exporters, no country today wants too strong a currency, and currency wars with unpredictable negative consequences are a very real possibility. It's also hard to believe that the U.S. will long maintain its historic economic supremacy with a weak currency.
- Low rates. While low rates clearly benefit the housing market and businesses financing operations or expansion, low rates penalize savers and pension plans. Furthermore, with central bankers artificially lowering rates and keeping them down for years, unintended negative consequences could be numerous and severe.
- Pent-up demand. We hope there's pent-up demand, because consumers have bought far less in recent years than had become customary before the bubble burst. It is certainly possible that personal deleveraging is continuing, however, as people realize that they had run up unsustainable debt levels before economic conditions deteriorated. With unemployment still extremely high and the fear of unemployment a real concern for many, the willingness to spend may be markedly diminished in the years ahead.
- U.S. manufacturing renaissance. It has been encouraging to see manufacturing statistics and manufacturing employment improving over the past several months. After years of ceding our manufacturing dominance to the rest of the world, however, we need far more evidence to call this improvement a sustainable trend.
- U.S. energy sector booming. As with manufacturing, it's certainly welcome to see this industry improving. The durability of that improvement, however, will undoubtedly be determined by the success or failure of efforts to reignite world economic growth.
- Double-dip fears minimal so far this year. How strong a positive is it when we're celebrating the reduced potential for a serious negative? It's damning with faint praise at best. And with Europe falling into recession, this potential must refer only to the U.S.
- Inflation receding around the world. Receding inflation is testimony to weakening worldwide business conditions despite the huge monetary expansion being conducted by most major central banks. Ironically, our Federal Reserve is afraid of inflation receding too much, possibly leaving us with deflation, a condition Fed Chairman Bernanke has vowed to combat.
- Europe financial strains have eased. Really? Why are heads of state and central bankers meeting daily for weeks on end to ward off the dangers of sovereign default? The pledge of unlimited supplies of new money to endangered banks for almost any quality collateral has eased the liquidity crisis, certainly not the solvency crisis.
- Liquidity is building in the world economy. No question liquidity has improved. That's what happens when central banks hand out newly created money. And many corporations have improved their liquidity by lengthening the average maturity of their debt. It is perhaps instructive to remember that when you or I borrow from a bank, we may have more cash in our pocket, but we still have to pay it back, and we have to pay interest while the loan is outstanding. Improved liquidity may only buy time for entities with intractable solvency problems.
- There have been 83 stimulative policy initiatives announced around the world over the past 5 months. Why have governments and central banks done that? Because business conditions are so bad.
- The Fed has rates on hold at zero and is doing Operation Twist. See the prior comment.
- ECB is scheduled to further expand its balance sheet on February 29 by as much as 1 trillion euros. Ditto again. Moreover, do you suppose that bond buyers might start to worry about the value of the currency in which they are supposed to be repaid? Perhaps that concern helps to explain why the price of gold has exploded upward, a situation that central bankers and other proponents of fiat money hate to see.
- There are no particular problems at the moment such as Japan disasters, Thailand floods, supply-chain disruptions, gasoline price spikes, and debt ceiling crises. Thankfully, although seasonally adjusted gasoline prices are up by almost 30 cents over the past two months, and we know we will soon again be wrestling with our own need to reduce deficit spending. Unfortunately, natural disasters happen all the time, and when any nation, company or individual is excessively leveraged, risks of bad outcomes are far more likely. The world and its institutions have never before been so dangerously overleveraged.
Is the glass half full or half empty? It largely depends upon what one chooses to look at. Do the listed "positives" foretell steadily improving world economic business conditions? Can governments and central banks print their way to wealth and prosperity? If so, why not do it all the time? Notwithstanding the possibility of central bank largesse creating periodic bursts of enthusiasm, current economic and monetary dangers are severe and the future very uncertain.