Stories have come out over the last two weeks about how the markets are providing a great buying opportunity for investors. In each of the last two years, the markets sold off in May and June on fears of a recession only to come roaring back in the fall when the recession did not show up.
This year though the underlying fundamentals are much different in a number of respects.
First, there is the massive amount of debt being created which feeds into the problem. Just look at the LTRO program which was created with too much fanfare last year. It helped for a few months but when the banks ran out of collateral to obtain cheap LTRO loans the support ended and yields began to rise again.
Now the EU is waiting for a German court to rule on the constitutionality of the ESM with a ruling expected to come in September. A positive verdict would empower the ESM to enter into operation but the problem is the failure of the ESFS and LTRO programs. Neither program was a success nor is it likely that the ESM, despite the best efforts of Brussels, will end up failing as well.
Second, economic growth around the world has slowed to a crawl with Europe already in a recession, China slowing appreciably, and growth estimates in the US slowing to 1.5%.
A growth rate of 1.5% means that not enough jobs will be created to absorb the new workers coming into the job market. Those existing workers who are having difficulties finding suitable employment will end up taking jobs in which they earn less money, have less disposable income available and live a more modest lifestyle.
Third, the US did not face a fiscal cliff at the end of the year. The expiration of tax cuts, automatic implementation of spending cuts, and looming debt ceiling crisis gives rise to economic uncertainty. This feeds down to businesses that cannot make decisions to invest capital and have consequently put off decisions to hire additional workers. The decision to slow hiring has put a crimp on spending as the growth rate for retail sales has fallen over the past few months into negative territory.
The amount of debt being thrown at the problems is having less and less of an overall effect on the market. One has to wonder if we have already reached a Japan moment where the addition of debt is making no impact on economic growth and in fact has become detrimental to economic growth.
In order for growth to pick up in the second half of the year we are going to have to see a clearing of the economic landscape unlike what we are seeing now. For the past two years the global economy was strong enough to absorb the aftershocks. In each instance the global economy has bounced back with less and less strength.
The solutions being presented of throwing debt at the problem has not solved the problem but rather created more problems as there is no exit strategy.
Looking back at the rally last year, which did not start because of stronger economic growth, it started due to the announcement of the LTRO program and the Federal Reserve implementing a massive swap program to bail out European banks.
The next time someone says that this year will be the same from previous years where the market sold off in the May and June timeframe only to rebound into the end of the year ask them about the three points mentioned above and how in the face of everything we are going to kick start economic growth. Last year the S&P 500 (SPY) and NASDAQ (QQQ) ended up flat after 11 months of sideways trading with the entire gain for the year coming in the final month. Then again, maybe things will be the same as last year with 11 months of sideways volatile trading and the total return for the year in the final month. In that case, it is not a pleasant thought.