Economic Growth Forecasts Lowered; SOGEN Says Profit
Downturn to Cause U.S. Recession
by The Curmudgeon
incredible investor complacency, low stock market volatility, overly bullish
investor sentiment, speculative excesses everywhere (e.g. virtual currency),
and an aging/ correction-free bull market, we have a global economy that
continues to tread water or deteriorate.
The CURMUDGEON has repeatedly stated that most of the non-financial
economy has been struggling, while Wall Street fat cats and selected social
media/Internet super-stars are raking in the dough. Meanwhile, global equity markets trend higher
with no fundamental underpinnings. The
great disconnect continues to widen, even as growth forecasts are cut.
article, we provide updated economic growth forecasts, examine the trend in
profits vs. stock prices, and highlight the key messages from a new Societe Generale (SOGEN
investment bank) report that suggests a U.S. recession will occur in 2014.
Victor and I
have previously stated that the odds for an economic contraction have increased
in 2014 due to: higher taxes, excess government regulation on business,
Dodd-Frank's tighter lending standards, and the very costly, problem packed ACA
(ObamaCare) rollout. The SOGEN report
offers much more support for a U.S. recession.
Forecasts and Reports:
1. A mid-November
Bloomberg survey of 73 economists forecast a median U.S. GDP estimate of
1.7% this year, improving to 2.6% in 2014.
Bloomberg also reported
that confidence among U.S. consumers unexpectedly declined in November to a
seven-month low as Americans grew more pessimistic about the labor-market
just has not performed very well this year and has been disappointing relative
to what most people were hoping for and expecting through the course of the
year,” said Stephen Stanley, chief economist at Pierpont Securities LLC in
Stamford, Connecticut. “It’s one thing when you have one or two years into the
recovery and things aren’t progressing in the job market, but here we are
four-plus years in.”
2. On November
25th, Reuters reported
economists trimmed their forecasts for U.S. economic growth in the final
quarter of the year and the first three months of 2014, but predicted a
slightly higher rate of job growth over the next four quarters. Analysts see the economy growing at an annual
rate of 1.8 percent in the current quarter, down from a previous estimate of
3. On November 19th, the OECD stated that world economic output would expand 2.7% this year ("the lowest number since the crisis of 2009") and 3.6% in 2014. Those figures are down from the group's May forecast of 3.1% growth this year and 4% next year. In OECD countries, economic growth is predicted to be only 1.2% this year- half of the world's growth- improving to 2.3% in 2014. OECD's forecast for U.S. growth was cut to 1.7% this year from May's 1.8%. The unemployment outlook is bleaker with an 8% average in the OECD region and 12% unemployment in the Euro area. Long term, structural unemployment is considerably worse, according to the OECD spokesman. Readers are encouraged to watch and listen to the very informative yet sobering OECD video here.
Greenspan told Bloomberg he's only predicting 2% U.S. growth next year. The
"maestro" said the economy is being held back in part by the banking
system, as some of the largest banks are not operating efficiently. “We’re supporting banking institutions who are not only very large, but not very efficient and they
are using the scarce savings of the society, which is critical for economic
growth,” he said. He declined to identify which banks had become inefficient.
Profits are Nothing to Write Home About:
U.S. company profits were up only 4.7% Year over Year (Y-o-Y), but that was
almost entirely due to cost cutting and accounting gimmicks. For example, H.P. outperformed diminished
Wall Street expectations for its 3rd quarter profits and HP stock rose strongly
this past week. But revenue was lower in
five of its six business segments, while demand for key products like personal
computers collapsed. Specifically, 4th
Quarter net revenue was $29.1 billion, down 3% from the prior-year period
and down 1% when adjusted for the effects of currency. Is that something to brag about?
After tax corporate profits as a percentage of GDP are at an all-time high (see graph below), without much (if any) top line growth. How long can that continue?
European stock markets have done very well this year (e.g. the DAX -Germany's stock market index- is up 22% YTD). But that's not because of increasing corporate profits. 3rd Quarter profits in Europe were down 5.1% Y-o-Y!
And the future
doesn't look any better on "the other side of the pond." ECB
data released on November 28th showed loans to the private sector shrank by
2.1 % in October from the same month a year ago, equaling the biggest fall
on record! "Even though the ECB
just cut its refi rate, the pressure to do more will
build, especially on the back of faltering credit supply," said Peter Vanden Houte, economist at ING. That certainly doesn't augur well for future
European economic growth or profits, which depend on credit expansion-not
Albert Edwards Stunning Report:
In his latest note to clients, SOGEN's long term bearish strategist Albert Edwards hints that a recession in the U.S. is coming sooner, rather than later. "U.S. equity participants continue to enjoy the intoxicating effects of the elixir of QE. This blow-off phase can go on for quite a while longer...."
investors enjoying this equity cyclical bull market, I continue to firmly believe
we are locked in a structural valuation bear market. We know from both the
U.S.'s own history and Japan's lost decade that these secular bear markets take
many economic cycles to fully play out. In the Ice Age, with equity and bond
yields inversely correlated, recessions are the catalyst that brings each round
of de-rating to lower lows. But a recession seems a distant prospect in the
minds of most investors. Yet one key precursor for a recession has now
fallen into place. Slowing productivity growth means that unit labour costs are now running well ahead of output price
inflation (see chart below). This means a margin and profits downturn is now
about to unfold. That typically is a key precursor of recession."
continues, "I have never ever seen the sell-side predict a recession.
There are a number of reasons for that, but key among them is the personal
career risk of calling a recession and being wrong. Both the sell-side and the
buy-side tend to do much better when the economy and the markets are doing
well, so who wants to be a party pooper. That is the nature of the beast....
many feel the current US S&P forward PE of 15x is
fair value as it is just below the average PE of the past 25 years. But 15x can only be considered cheap in the shadow of the Nasdaq
bubble. But to those who work in the markets now, it still does not feel
expensive, whereas any long-term analysis suggests it is."
that corporate profits should be watched closely, not for their direct impact
on equity valuations, but their impact on the economic cycle. They are a key
driver of the economic cycle. He states,
"Growth in profits determines the growth of investment, inventories and
employment....Over the years I have tended to focus on U.S. pre-tax domestic
non-financial profits as a best lead indicator for US-based company
business spending. Profits typically lead
Edwards focuses on the business investment, because it is one of the most volatile elements of GDP (see left-hand chart below). Swings in business investment almost always determine recessions he claims (see right-hand chart below).
believe a recession will not occur unless the Fed triggers one by monetary
tightening. Edwards response: "That is of course
nonsense. A credit bubble can burst without any monetary tightening and
similarly the profit cycle can turn down due to a variety of factors."
concludes, "The margin squeeze that is unfolding as unit labour costs climb above company selling price inflation
leaves the U.S. economy extremely vulnerable to a downturn in the investment
cycle. Business output inflation is measuring a wider basket of goods and
services than the Fed's favoured measure of
inflation- the core personal consumption expenditure (PCE) deflator....Low
pricing power is leaving the US economy more vulnerable than many suppose.
In my view, a full-blown profits and investment downturn is most likely
to be triggered by Asian and EM (Emerging Market) devaluations releasing
surplus capacity onto the West and crushing pricing power even further....Watch
the profit cycle closely. We ignore it at our peril."
CNBC notes that
other investment banks have also released bearish stock market outlooks for
next year. In early November, Nomura strategist Bob Janjuah
said in a client note that he expects a 25-50 percent sell-off over the last
three quarters of 2014 in global stock markets. Steen Jakobsen,
chief economist at Saxo Bank has explained on several
occasions to CNBC in recent weeks that bullish investors are "chasing the
tail" of the recent equity rally, indicating that now is not the time to
be risky. All that plus an enlightening
and refreshing discussion of Mr. Edwards report can be viewed here.
sentiment for U.S. stocks is at 1987 lows.
It follows that if any unknown event occurs, the large amount of bulls
will sell to very few bears covering shorts, and to those few waiting for a
correction to buy stocks.
bullish move can continue for a while longer, the key point is that it might
end very badly with huge gap downs in stock prices. In October 1987, after Treasury Secretary
James Baker threatened Germany with U.S. dollar devaluation, there was a race
to sell stocks when the opening bell rang.
A retired friend put in an order to sell 500 shares of Polaroid at the
market. The stock was quoted at $26.25, but his order was filled at $18.00 -
down 31.4%. Hedge fund manager George
Soros sold his firm's long position in S&P futures (on the CME) and wound
up suing Shearson due to a similar type of bad execution.
Those that are
long stocks should understand that you are betting on the Fed and the U.S.
federal government to protect your "investments." The economic fundamentals are not going to
help at a 20 trailing P/E (and an even higher Shiller P/E of 25.52). The U.S. stock market is in "weak
hands," which is dramatically illustrated by record high margin debt and
very low relative volume numbers. When
you consider the increased role of HFT's (that have largely replaced the
specialists as market makers), the odds of a very sharp market decline increase
Any type of
geopolitical event could shock the equity markets into a complete
collapse. For example,
China selling U.S. debt if the U.S. invades their airspace or interferes in
their affairs? Or Israel invades
Iran to take out their nuclear plants? Or Saudi supports pricing oil in a
basket of currencies rather than the U.S. dollar? Any such bad news could cause the global
equity markets to return money to its rightful owners... Those
who are prudent to understand the risks of the moment. |
Caveat Emptor and good luck!
Till next time........................
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1979) to profit in the ever changing and arcane world of markets, economies and government policies. As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.