A friend sent me the following chart. The arrows, shading etc. are his. Note that he has a few questions. If you can answer the second question you could make some money.
Photo: Bruce Krasting
The green shaded area was clearly a head-fake by the market. This was (in part) a reaction to the Greenspan comment that the economy had “hit an invisible wall”. Alan was right. Many indicators and a fair number of soothsayers (myself included) saw the signals and concluded that a double dip (or at least a significant slowdown) was in the cards. As far as the markets go that call was dead wrong. The view was that employment would continue to worsen. That of course was spot on. Wrong for the right reason. Yuck.
The yellow line covers the time that QE2 first became official. It took the Fed another two months to actually implement the policy after the September comments by Ben. But there was very little doubt on the outcome right from the get-go. Yes there were speeches and planted news stories that suggested there was some debate. That was all show pony, there was never any doubt about the outcome.
Stocks have loved it. Why not? The Greenspan Put worked great for a while. QE is even better. The Bernanke Put is ‘In the Money‘. The thinking is you can’t lose. A very dangerous state of mind. The bond reaction was: buy on the rumour and sell (hard) on the news.
Looking at the chart since September you have to ask the question; “Is this real or is this another head-fake?” It’s hard to fight the lines that point up since September and not conclude that the market is telling you a sustainable recovery is being formed. I read a fair bit and can say that an awful lot of pundits are looking at this and concluding that the worst is behind us and that reasonably solid growth is on tap for 2011. The next read on the Leading Indicators will no doubt show an uptick, the principal reason being that the yield curve has steepened.
I am going to stick my neck out and say it is a head-fake. It is not clear sailing in front of us. Some things that I think “fight” the conclusion that stocks, bonds and pundits are drawing:
-Sustaining the Bush tax cuts is not a stimulus. No one’s check is going to be bigger as a result. This is more of an absence of a negative versus a positive.
-The $115b, 2% reduction in Social Security taxes is a stimulus. But not much of one. It comes to $15 a week for the average worker. Helpful, but I don’t see it changing things too much. The reduced deductions are largely offset by the elimination of the Make Work Pay program. Net net no big deal.
-The dollar is too strong to think that our economy is going to grow much. 2011 will bring us higher trade and current account deficits.
-2011 will be a year of non-stop muni “crisis” talk. What this really means is that the states, counties, cities, towns and villages will all be cutting expenses. They have to. They (for the most part) have to balance their budgets. Big cut backs in muni spending will drag on GDP.
-BABs is dead. This is going to make a difference in how big ticket projects are financed. Large construction projects of hospitals, schools, roads and the like are going have to be scaled back.
-Energy prices are rising. In 2011 we will see this in both electricity and gas. That $15 a week savings from SS is going right out the window and into a gas tank.
-The cost of food and insurance is about at least 10% YoY. Don’t look at those CPI numbers. Look at your bills. Real disposable income is going down, not up.
-We will spend most of 2011 with unemployment NORTH of 10%. Give me a break, how can we expect much growth with that as a backdrop? Sure the checks are still going out. But this is the third year that we have been at post depression highs on UE. We also know that the UE numbers are bogus. The number of people who are out of the system altogether or are working part time just keeps getting bigger.
-ARRA, the 09 stimulus, is essentially finished. Another absence of a positive.
-We will have ZIRP. A plus. But how much of one? Loan demand is not responding to ZIRP. Most large companies are sitting on bundles of cash. ZIRP actually hurts them.
-Mortgage rates are not getting cheaper. Long-term bonds for corporates have backed up a bunch.
-We have six months of QE2 left. The last month will see only small amounts bought by the Fed. Therefore in approximately 75 days we will be sliding downhill on this program. I’m not sure what it means or what will be the outcome. I know it will add to a sense of instability as something very significant will be passing into uncertainty. Put differently, we have 53 trading days left to half-life. Not much time at all.
-Don’t’ count on the EU lifting US GDP in 11. Not going to happen. China is a question mark. I say that they cool in the coming year by more than the current thinking.
-Wild Card. There are always surprises. Rarely are they good.
What are the odds that we see a head-fake? A surprise outcome where numbers and events force a significant rethink of the now prevailing 3+ % growth in 2011 story? I would say those odds are not too high. Does 30% probability for a hard landing sound right? It’s very hard to handicap. One thing about this; if we do see the head-fake it is going to put a big dent in markets that are now trading very rich.
If the first few weeks in January give us another run up in equities and yet cheaper bonds it might be worth buying some out of the money puts/calls. The money spent may be a throwaway. But if in fact what we are seeing is a big misread on the economy and a distortion by QE2 then we are going to see the bottom levels on the chart again. Something like that happens and there are big multiples on the money spent on the bet.
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