How could the US market have risen from the September lows if we are in a recession? The answer is...
How could the US market have risen from the September lows if we are in a recession? The answer is that it had already discounted the recession and is now seeing signs pointing to recovery.
Through late August and beyond the terror of 11 September, the equity market discounted the first US slump since 1990. With a 30% fall in the broad S&P 500 to 21 September from its 2000 peak, the market had reached recession-like valuations compared to rock-bottom bond yields. Since then, the market is up 17%: what gives?
The key point is that, contrary to the bears, the US consumer is far from dead. Show them a deal and they will buy it, with car sales hitting record levels and Thanksgiving sales buoyant.
With rates at extremely attractive levels, homeowners have refinanced their mortgages in record amounts for a year, which, as in the UK, frees up extra cash for spending. Housing is the top asset for 95% of Americans and house prices have risen for a decade.
What about rising unemployment? Job losses continue to mount and unemployment could well hit 6%. But the 94% of people still with jobs are benefiting from lower rates, lower taxes and lower energy prices. When this happens, consumption powers ahead.
The flipside of those job losses is that companies are cutting overheads at a time when productivity is growing faster than in any prior recession. Inventory is being slashed at record rates. The US is setting up for a classic inventory upswing, as stocks are rapidly becoming too lean. Manufacturing surveys, like the NAPM, and factory orders are turning up: the latter jumped 12% in October alone.
After collapsing for a year, orders for technology goods have finally bottomed. While third-quarter earnings were poor, tech companies indicated that their order books were no longer falling apart. While corporate cashflow is not strong enough to count on any near-term boom, at least the floor on tech spending has been laid. The tech wreck reflected sky-high values with the sense that the bottom was falling out of the industry. Valuations are more reasonable and we have some sense of a base.
We are near a turn in the production and corporate profits cycle, with Q4 earnings likely to be the bottom. Longer-term, the consumer will stay solid because of the massive monetary stimulus, in place for over a year, which was extended and deepened by 11 September.
Even with modest inventory re-stocking, manufacturing should start to recover in early 2002. Corporate profits are geared to the cycle, and managers have aimed to maximise that leverage. Trimming payrolls, shedding inventory, curbing capital spending, and refinancing debt will all contribute.
The cycle is ready to turn and, as usual, the equity market has begun to snuff it out. No doubt markets will be volatile, with profits yet to rise and the Middle East always a wild card. From a long-run perspective, S&P earnings are 20% below trend. The current global monetary re-inflation sets the stage for a solid earnings recovery over the next couple of years.
Negative real interest rates.
Fiscal stimulus nearing $200bn.
High cash levels in mutual funds.
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