Wow! The bulls are definitely back in town. I want to provide some of my reasons for the strong market performance here lately. I will start with the consumer and provide my reasons why the consumer will not lead us into the next economic recovery. Then, I will focus on corporate profits and some selective components of GDP.
Consumer spending is about 70% of GDP. Therefore, I contend that no consumer spending, no substantial growth to GDP. Further, consumer spending cannot increase materially as unemployment heads to 10%+ (The employment growth for the current decade will clearly be negative by the end of this year.), wages are stagnant, in spite of the minimum wage going to $7.25, capacity utilization rests at the lowest level ever recorded (67%), and average hours worked hit a record low in June, as did the year over year change in aggregate weekly hours. In addition, since consumer credit hit a top of $2 trillion in January of 2009, only $60 billion has been reduced. No, the consumer deleveraging is not complete. And, credit card companies are aggressively cutting credit lines back significantly, in some cases to open balance amounts. These facts simply suggest that the consumer is not ready to aggressively lead this economy forward.
If these are indeed the sober facts, then why has the market acted so well? The answer is based on corporate cost cutting that has definitely enhanced the performance of corporate earnings during the current quarter. Let me explain it in the following way. The largest corporate expenditure is labor cost, and labor cuts have definitely boosted the corporate bottom lines. That is why Wall Street has responded in such a positive way. However, can the US economy recover and begin to grow based on labor cost cutting measures? What is good for corporate bottom lines is not good for employee wages, job growth, and, of course, consumer spending! Something has to give. What we have seen so far this quarter is that corporate earnings have come in above expectations (Market has loved it.), because of the cost cutting endeavors by corporate America. But, the revenues were below expectations. Corporate earnings increased solely on cost cutting measures, especially labor, not revenue growth. That is a real problem. Wall Street definitely is placing a lot of hope on revenue expanding during the second half of the year. I just don’t see it happening as long as the labor cuts continue, and the consumer continues to deleverage.
As just mentioned, I firmly believe the consumer will not be the catalyst for the next economic recovery phase, based on my aforementioned rationale. And, it is hard to see the catalyst being corporate America. I believe the true harbinger for “true” economic growth will only come from growth in capital expenditures and, of course, corporate labor numbers, which are currently dismal. Keep your eyes on those two measures. If those measures do not rebound quickly, I believe Wall Street is going to be in for a big awakening.
Another reason for the market gains is simply mathematics. In recent quarters, several critical components of GDP have declined at astounding negative annual rates (30% to 40%), such as housing, automobiles and business investment and inventories. Eventually, those huge negative numbers on a year over year basis will start to look a whole lot better. As an example, let’s say that housing on a year over year basis from June 2008 to June 2009 is down 40%. Next month (July), the housing numbers are still negative but on a year over year, they are down 10%. That change alone would have a positive impact to GDP growth. Notice that the move from -40% to 10% doesn’t constitute a boom, but merely slowing in the decline. Housing constitutes approximately 3% of GDP. In my example, that improvement, even still negative, would add about 1% to GDP.
Many analysts think housing may in fact bottom out in the third or fourth quarter of this year. Autos may already have passed their low point. Over the past year, inventories have been liquidated at an unprecedented rate. That, too, must come to an end. As inventory change turns from a large negative number into a less negative number. GDP will get another a big boost. Therefore, the numbers, year over year, are bound to look better.
Therefore, Wall Street recent gains have been based on better than expected corporate profits that are based solely on cost containment and reduction, not revenue growth, and year over year improvements in the statistics on housing, auto, and business inventory numbers. I, for one, do not believe that Wall Street has fully comprehended the possibility that these statistical improvements may turn out to be nothing more than a shooting star.
I will have the weekly exponential moving updates on the S&P 500 either later tonight or over the weekend. We are nearing a critical junction in relations to the 15- and 40-week EMA. One stock market model that I track had the market bottoming in April 2009, which, so far, the low was March, and topping in June 2011. To say the least, I really did anticipate that the S&P 500 would trade in the 800 to 850 levels before it would trade at 979. However, let’s keep in mind that the exponential moving average strategy moved us out of equities in January 2008 when the S&P 500 was at 1,401. At today’s close of 979 on the S&P 500, that is still down 30% from January 2008 level.
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