I will focus here on the outlook for economic growth.
There will be opportunities in forthcoming letters to set out my views more clearly, but in brief I believe that we have mistaken a stutter in economic growth for the end of the cycle. In summer 2008, it was the view of many respectable market commentators (if my memory serves me correctly, notably Gavekal) that the slowdown in growth was simply a mid-cycle pause, and that the real estate-induced slowdown in US growth was a positive thing because of its anti-inflationary consequences and would in fact serve to extend the life of the expansion; this idea proved to be sadly mistaken. In summer 2011, there is an emerging consensus that the recent string of growth disappointments should be taken very seriously indeed and in fact represents the resumption of the depression that never really went away (since payroll growth was very disappointing). I suspect that this idea, too, will again prove mistaken.
I remarked in May on the rarity of the pre-2008 environment for growth internationally. It has been unprecedented to see all important regions in the world integrated into a single global economy and all experiencing strong synchronized growth. I expect the future to see much more divergence between regions and sectors.
Since 2009 we have seen strong growth in the emerging world (and in regions that export to them) accompanied by weak growth in the non-commodity-producing, non-exporting developed world. In part this is because the emerging world has bid away resources from the developed world via the high price of gasoline and food. When there is a financial market dislocation in outright terms, the hoo hah often tends to conceal a more profound transition in leadership beneath the surface. I think this is the case today – so although I think global growth is basing, I think its composition from here will be tilted more towards the US, Eurozone and UK and away from Canada, Australia, Latin America, Russia etc. One should await technical confirmation, but this is my bias. Job growth has been held back by the weakness of non high-end consumption and by regime uncertainty – lower gasoline prices and the nascent shift in the political tide can potentially help to shift these factors and if the present horrible mood can improve, one could see a sharp move lower in unemployment to catch up with the picture in initial jobless claims.
Should we rush to buy risky assets today and sell fixed income? No - I think that would be premature. Seasonality for risk assets is weak from now until early-mid October, and fixed income tends to do very well in September. But in the bigger picture one should focus on finding opportunities to get long over the next 6 months, and I suspect that long the broad dollar will be a higher quality trade than being outright short risk assets. One should also be very cautious about piling into defensive stocks, as currently seems to be the fashion amongst retail investors. (See recent front cover of Investors Chronicle - which, whilst ostensibly about momentum as a strategy, ending up by suggesting investors purchase defensive stocks at present levels).
Contrarian analysis is helpful in arriving at a potential variant perception, but a robust conclusion depends on a balanced assessment of evidence for and against the thesis. I have done this work and here choose to note the following (which are not intended to be exhaustive – please contact me if you would like me to clarify or defend my overall thesis or any of the observations supporting it):-
1. The Citibank index of Economic Surprises in the US (CESIUSD) topped at 97.50 6th March 2011, and yields topped . The index collapsed into a low of -117.20 on 3rd June 2011 and, despite the widely-publicized concerns over European sovereign funding, over the European banking system, and over the outlook for the US credit rating, has climbed since then. It broke out of the daily cloud 23rd August 2011, and the lagging span has just now confirmed the breakout of the cloud.
2. The year-on-year change in real personal consumer expenditure has historically been a good way to identify major turning points in the business cycle. This remains near cycle highs in solidly positive territory, and ticked up in July to 2.3% yoy from 2.0% in June.
3. The growth rate for the ECRI Weekly Leading Index for the US remains subdued, far below the Oct 2009 peak. But for now we have held the summer 2010 lows, and we have technical signs of exhaustion of the recent pullback.
4. The Citibank Index of Economic Surprises in the Eurozone (CESIEUR) topped at 130.2 on 28th May 2010, and has since then pulled back sharply – notably strongly in August – to a low of -104.20 on 26th August 2011. Although the index remains at its cycle low, it is holding the basing level of August 2008-March 2009. From a Demark technical perspective we have on a weekly chart five waves down complete, and a 13 combo signal indicating exhaustion of the recent down move.
5. The Citibank Index of Economic Surprises in the UK (CESIGBP) topped at 112.50 in May 2010 and has since pulled back sharply to new recovery lows, and close to the all-time low of -81.1 on 28th April 2006. We are very oversold and in a region from which historically surprises have tended to come in a positive direction.
6. Sentiment from the American Association of Individual Investors (Net Bulls) reached the -23.25 oversold region in June and in August that is possibly consistent with selling exhaustion (although buying opportunities in summer 2010 and March 2009 did see much worse levels).
7. Bullish Treasury sentiment reached 98% bulls on the DSI survey measure, an extreme only previously reached at the end of December 2008, at which point sentiment reached 99% bulls amidst predictions and market pricing across assets of a new Great Depression.
8. September is the best month for fixed income seasonal, but the cycle tends on average to be positive for bonds until early December.
9. Conference Board Consumer Confidence registered a monthly buy signal in Feb 2009 at 25.30. It qualified for the end of wave 1 higher in February 2011 at the level of 72.00 and then needed to pull back in a corrective wave 2 in order to complete a basing structure consistent with a sustained recovery in confidence. Since February 2011 we have achieved this with a sharp pullback of almost 62% to a level of 44.50 in August amidst a very depressing public mood (ideal for a wave 2). The buy signal from February 2009 remains intact.
Research work by Ned Davis shows us that on long time horizons, investments in the US equity market undertaken when consumer confidence is depressed tend to do very much better than average. The recent trough in Feb 2009 was the lowest seen in the history of the sample (going back to 1967), and we remain today at levels below that of all previous recession years except 1974/75. So this is a longer-term very bullish sign.
10. Michigan Consumer Sentiment registered five waves down complete with a confluence of price reaching the wave target at the low in 2008, and the increase until Jan 2011 registered as a wave 1 up, with the decrease since then registering as a wave 2 pullback. We were at 55.7 in August, with the all-time low in Nov 2008 at 55.3 Holding the low would be constructive.
11. Conference Board Consumer Expectations remains in wave 5 down, with outstanding projections of 45.5 and 40.4 (vs current level of 51.90). We are likely to have a buy signal by November 2011.
12. Presidential approval ratings are at new record lows. 44% approval for his job overall; 37% approval for his handling of the economy; 54% think Obama is ‘facing a longer-term setback from which he’s unlikely to recover’ (vs 39% at the beginning of the year); 19% think the country is heading in the right direction these days. Disapproval of Congress is at a record 82% disapproval. Whilst there may be idiosyncratic factors at work, these ratings tend to be a good reflection of the overall public mood. A very negative rating suggests a very negative mood, implying high eventual prospective returns on risk assets bought under such conditions.
13. Since 2008 there has been a great deal of agonizing over the depressed male participation rate (offset in the overall numbers by a rising female participation rate) even though this is a trend that has been in motion since the 1950s. Trends tend to catch the public imagination just as they are overdue for a reversal, and I suspect this case is no exception. We have 5 waves down complete, having reached the Dwave target and both monthly and quarterly buy signals.
In the Chicago Tribune of January 1894, the following article by H. Allaway appeared under the headline “Better Times Ahead “ (an article that proved to be prescient given the ‘Great Depression’ of 1873 ended within the year, giving rise to a long boom that was to bring the US to ascendancy).
“It is related that in the old days of the Commune in Paris a panic-stricken investor turned up in the office of M. de Rothschild and exclaimed:
“You advise me to buy securities now. You are my enemy. The streets of Paris run with blood.”
And Rothschild’s answer was this: “My dear friend, if the streets of Paris were not running with blood do you think you would be able to buy at the present prices?”