Today's Market Observation  05.28.2009  Mon  Tue  Wed  Thu  Fri  Park Archive

Hopes for the Second Half

BY DANIELLE PARK | May 28, 2009

Harsh as this global downturn has been, some have held great hope for an economic rebound in the second half of 2009. As we now enter the second half it has become increasingly clear that while the rate of decline in some areas appears to be slowing, the evidence of a rebound in consumption and spending are so far not apparent.

This week the consumer confidence survey indicated that recently Americans were feeling more hopeful about their future prospects. But, so far at least, hope for the future has not translated into increased spending.

We have pointed out many times that technology is one of the key sectors to receive orders early in a recovery and as a result technology companies tend to be early cycle performers leading out of a market bottom. One of the bell weather tech companies is Hewlett Packard. This month HP announced that its Q2 earnings in the second quarter had fallen by 17%. More significantly however HP also announced that it was postponing its previously scheduled June shareholder meeting until September. Apparently they do not have enough visibility of the second half just yet. This is just one of the companies that have been hesitating of late to forecast the rest of 2009. Perhaps this is why the Tech laden NASDAQ Index has been hitting up against some over head resistance this month.

NASDAQ 100 Index

The significance of the second half (2H) rebound thesis to a myriad of government and corporate forecasts and assumptions cannot be overlooked. Indeed the stock market rally from the March 9 lows has been partly fuelled by the 2H-rebound thesis (and also by governments pumping unprecedented capital into the financial system causing increased speculation against the US dollar).

In February our firm was expressing optimism about a snap-back rally from near 12-year lows. We have since enjoyed a dramatic rally since early March. The trouble is that animal spirits driving this rally seem likely to have gone too far too fast. If second half data is soon to disappoint, today’s still fragile investor sentiment may well be in for yet another anxious spell. And although we remain longer-term optimistic, in the near term---over the next few months—we are finding our indicators once again cautiously neutral to bearish.

At month end many of the main indices are once again coming up against their longer-term resistance, and on faltering volume. It is rudimentary, but a bull market should see increasing volume. So far volume has declined steadily through the past several weeks of this advance.

S&P 500

Thanks to herculean government intervention: rates are pushing up

Another trend that seems mounting against nearer term economic recovery is the growing 10-year Treasury yield shown below. This recovery wants interest rates to stay down. But as governments issue debt to fund staggering deficits, their fiscal policy is undermining their efforts at directing monetary policy. The 10-year Treasury yield has now jumped 61% since December 2008.

US 10 year Treasury note yield

The falling US dollar produces exasperating consequences for the economic recovery. One of the more significant impacts of the falling dollar is spiking oil prices. This seems counter-intuitive, but while demand has vaporized, the price of crude has jumped 80% in less than 6 months. Meanwhile the supply of oil and U$ dollars continues to gush.

Rising interest rates and rising oil prices are large impediments to the renewed demand the world so desperately seeks to start.

On the upside, as US yields rise, the benchmark currency will eventually become more attractive again to foreigners. This is likely to be especially true when the next patch of risk aversion breaks out in world markets. Perhaps we should hope for panic to resume?

But doesn’t the market always rebound before the economy?

Market participants tend to talk about the stock market as "always" bottoming before the economy. These bullish arguments presently forecast the economic bottom to trough this fall and therefore argue that March 2009 was "the" stock market bottom this cycle, neatly 6 months in advance of the economy. This theory may prove correct in the end. Only the clarity of retrospect will tell us for sure.

But a risk now is that the "rule of thumb" about markets bottoming before the economy may not hold true this time. The most recent exception was the last downturn where the “economic trough” was November 2001 (now clearly defined in retrospect) and yet the stock market did not make a lasting bottom until February 2003 (15 months later). Part of the reason for this lag of the market bottom after the economy last time, was that the jobless, anemic economic recovery disappointed those conditioned to expect a vigorous "V". Far from a robust bounce, in 2001-2004 we saw a timid, tepid start. It took a few years before over-juiced credit finally ignited mass speculation and the appearance of stronger growth.

The probability of a sluggish recovery this time is surely higher than after the tech wreck in 2000. This time we have a multi-asset, multi-country, financial crisis. This time the savings rate is coming back in earnest, as a shell-shocked consumer comprehends the importance of a saving buffer rather than just access to a line of credit.

This time people already have too much credit; few want more. This time the masses already own multiple-real estate or too much house, they wish to downsize not lever up. This time the economic recovery is more likely to be slow and plodding, blurred by rising unemployment and more modest (perhaps wiser) consumers.

There is a risk that those that have been piling back into the stock market the past couple of months may not be prepared for the long, hard, slog back to economic health. We suspect this is a marathon, not a sprint. Reducing over-capacity, building up savings and equity are the foundations of our future sustainable growth, but none of this is as easy as throwing more credit around.

These will be healthy developments in the longer term—they make us longer-term more optimistic--, but in the next year or so, masses weaned on quick growth and easy money may not be mentally prepared for a slower and plodding course.

It seems that a defensive investment posture is still appropriate.

Danielle Park

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Danielle Park Portfolio Manager, Venable Park Investment Counsel Inc.
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