Will U.S. Avoid a Recession in 2012? (Part 4): Shilling
I have explained why I believe there may be a U.S. recession this year, spurred by renewed consumer retrenchment amid further declines in house prices, stagnant incomes and uncertain job prospects. So why are investors continuing to show such an appetite for equities?
Stocks have been volatile: Over the past month, the Standard & Poor’s 500 Index had three trading days when gains exceeded 1 percent and three when losses exceeded 1 percent. And major stock indexes dropped sharply in the early days of April. Yet, despite concerns about the strength of the U.S. economic recovery, the S&P 500 closed the first quarter above the 1,400-point mark for the first time in almost four years while the Dow Jones Industrial Average closed out its best first quarter since 1998 and the Nasdaq Composite Index topped the 3,000 level for the first time in more than 11 years.
So either I’m dead wrong, or investors are ignoring reality as they emphasize “risk-on” trades. Stocks have been strong, with the exception of defensive dividend payers, such as utilities, that investors have ignored. Until very recently, Treasury yields surged and prices plunged as investors switched to riskier securities.
The volatility is due to investors taking their cues not from the performance of the economy, as they traditionally have, but from the Federal Reserve.
The met March 13, and its statement, for the first time in several years, included some hints of optimism about the economy, which it said “has been expanding moderately”; labor markets, which “have improved further”; and household spending and business investment, which “have continued to advance.” Wall Street responded positively, with the Dow Jones Industrial Average and the S&P 500 both jumping by 1.7 percent or more that day.
Two weeks later, Chairman Ben S. Bernanke said further declines in unemployment would “more rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies.”
Investors interpreted that as suggesting the economy might falter enough to precipitate another round of quantitative easing, seemingly believing that the negative effect of a weak economy on corporate profits and dividends pales in comparison with the influence of the money received directly by sellers of securities to the central bank. Stocks took off after Bernanke’s remarks, with the Dow rising 1.2 percent and the S&P 500 advancing 1.4 percent.
In contrast, stocks tanked when the minutes of the Fed’s March meeting were released April 3 and showed that the central bank had no immediate inclination to institute another round of easing or other stimulus. Markets fell sharply that day, with the Dow falling 0.5 percent and the S&P dropping 1 percent.
It seems that, until recently, investors have been ignoring the big picture of the still-weak economic recovery and focusing instead on the Fed. That is partly what generated the robust first-quarter gains for stocks and other risky investments while Treasuries slumped. The sole focus, it appears, is on liquidity created by the Fed. If investors believe the central bank is about to dump more money into the system, stocks soar. If Bernanke hints that the liquidity tap is closed for now, stocks tank. This narrow focus suggests that investors aren’t happy with the fundamental state of the economy.
Apple Inc. offers another example of this narrow focus and the willful suspension of disbelief concerning the uncertain outlook for the economy and corporate profits. Of course, civilization would come to a grinding halt without Apple iPhones and iPads. But when the market capitalization of that one stock -- about $585 billion -- exceeds that of the entire retail sector -- about $550 billion -- is it conceivable that speculation may be afoot?
The zeal for Apple, whose share price is up more than 50 percent this year alone and is almost double its year-ago level, reminds me of the early 1970s and the era of the Nifty Fifty “one decision” stocks: Companies with such wonderful long-run growth prospects that investors could simply buy them and never worry about selling. That list narrowed as icons fell from grace, but the true believers never faltered. I remember becoming concerned when the interest focused on only four companies -- McDonald’s Corp., Polaroid Corp., Walt Disney Co. and Winnebago Industries Inc.
It struck me then that hamburger stands, cameras, amusement parks and motor homes were the limbs and outward flourishes -- and not the soul -- of the economy. If investors were avoiding just about everything else, they were implying that the economy was in trouble. This, along with a huge, but generally unrecognized, inventory buildup, led me to successfully forecast the 1973-1975 recession, until then the worst since the 1930s.
Is history about to repeat itself? Maybe, just maybe, reality is re-entering investors’ field of vision. The payroll employment increase for March -- 120,000, or about half the expected gain -- was announced April 6, when most markets were closed for Good Friday. There was futures trading, and stock futures plummeted and Treasury bonds soared. And that pattern persisted in subsequent days with Treasuries and the dollar leaping while stocks and commodities nosedived. In a pattern that is very similar to early 2011, investor optimism may be entering an agonizing reappraisal. The “risk-off” trades may be back, in line with my economic forecast.
Next week, I will reply to some of the comments and questions posted online regarding this series.
(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. Read Part 1, Part 2 and Part 3 of the series.)
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