We had a fairly decent monthly employment print this Friday which followed some decent ISM numbers. Based on these survey’s, an argument can be made that the FED has averted (at least prolonged) a near certain recession. Not everybody is convinced, I know I’m not. Aushtan from ECRI is sticking to his call (see “What I’m watching section”) too. I guess the FED doesn’t think so either; otherwise rates wouldn’t be at zero percent while they continue to pump $3B every single day into this economy. If the U.S is not in or near recession, we know that half of the OECD is. This is a very significant statistic that clearly shows that the world economy continues to slow.
So I don’t know if the US has avoided a recession, it’s possible that we’ve avoided at least a deep recession. Perhaps the FED has managed to kick the can down the road one more time. Whatever the statistics show, we’re told that net worth has never been higher. That’s strange, because Americans don’t feel richer. Real incomes have continuously declines while corporations continue to excel. Corporations continue to off-shore and retrench employees (through natural attrition) while they withhold passing on any of their profits in the form of increases in income. That’s why real incomes have fallen for virtually a decade now, while net margins at corporations continue to rise to record levels.
Even as corporations find creative ways to increase earnings, the equity markets gains continue to outpace gains in earnings. As more and more speculative liquidity begins to lift risk assets, we begin to see an ever greater valuation gap appear. With record net margins, corporations will have to find earnings growth through new sales and revenue, not margin expansion. That’s going to be hard because long term unemployment is a structural problem and personal incomes keep falling, meaning that sales growth will remain under pressure.
The equity market is now extremely vulnerable to any macroeconomic shock. This is because earnings are currently at record margins, equities are highly valued in historical terms, and they have shown difficultly in growing revenue organically. The world economy is already placing a drag on earnings, so a downturn in the US economy would suddenly make equities appear to be grossly overvalued, even by the most optimistic valuation models. But right now, the market is ignoring those risks and is in fact pricing an acceleration in earnings growth.
Equity market sentiment has now turned very festive as this cyclical bull market just marked its 4th birthday. It’s been an impressive 130% 4 year rally (100% retracement of the 2007/08 decline). Emotions are running high and the equity market can do no wrong again. Calls for a new American bull market are front page news on a daily basis. I would have thought it was possibly a new bull market too, if only the world economy had structurally reformed and the massive debt overhang (on all levels) allowed to correct. But I’m afraid that as not happened and I firmly maintain that this remains a cyclical bull market with a large secular bear market. The lessor of the two (cyclical bull) can be artificially extended and prolonged, but only the foolish can believe that a secular bear market will be denied.