Monday, 28 May 2018

Not the summer of love

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With risks of a U.S. recession mounting, it is shaping up to be a hairy summer for investors.

James Saft, Reuters Columnist

The recent run of U.S. economic data has been disappointing, with weak employment and manufacturing numbers. The Economic Cycle Research Institute’s four-week moving average of its key gauge has now been negative for eight straight weeks, and consumer spending is down for the third month in a row. Moreover, and more crucially, government spending reductions pose a threat, both this year and next.

Secondly, the United States, at the very least, will have to contend with deflationary waves from Europe for the foreseeable future.

Even if the ECB steps in to rescue Spain — or whoever ails next — it seems very likely that Europe will act as a drag as well as a source of risk and uncertainty.

Finally, we might be in the first earnings season since 2009 in which earnings at S&P 500 companies actually sink. The run has been disappointing thus far, with Apple showing that perhaps not enough people need new phones every six to nine months, and Zynga Inc demonstrating the limits of a business strategy based on virtual soil and make-believe manure.

“The disappointing slew of revenue results in the ongoing Q2 U.S. reporting round is entirely consistent with the economy having dipped into recession,” Societe Generale strategist Albert Edward wrote in a note to clients.

Third-quarter earnings of Standard & Poor’s 500 companies are now expected to dip 0.1% from a year ago, a sharp downward revision from the July 1 forecast of 3.1% growth, Thomson Reuters data showed on Thursday.

“Analysts are now hammering downward their full-year revenue projections. But even before the earnings reporting season got started, it was already clear that something was amiss on the U.S. corporate top-line as nominal business sales growth totally stalled in the three months to May on an economy-wide basis.”

While margins on some readings appear to be holding up, in a disparity between margins and the top line it is usually wise to trust in revenues as the more reliable guide. Margins, after all, can be hoisted higher by many means but cash flows never lie.

Balanced against these risks is, in essence, one institution: the Federal Reserve.

Investors’ prime hope is that the Fed will swoop in with quantitative easing or some other form of relief should the economy, and markets, show real signs of stress. A story by The Wall Street Journal’s Jon Hilsenrath, seen to have a line into Fed thinking, raised the possibility that some action may come out of the Fed’s meeting next week.

Long way to Jackson Hole

But there are several fundamental problems with an investment strategy predicated on help from the Fed.

First off, there is every chance that nothing, or very little, comes out of next week’s meeting. While there is some hope that there might be tinkering with the rate of interest banks are paid on reserves or perhaps a small bond buying program targeted at the housing market, the outlook for a really big piece of stimulus at this point is not good.

If so, that means we have to wait until the Jackson Hole economic conference, hosted by the Kansas City Fed at the end of August, for hope of delivery.

That is quite possible – the Fed in recent years has used this forum as a place at which to deliver new programs. Still, it is a long way to Jackson Hole, and in the meantime, there are plenty of possible sources of shocks and volatility.

There is also, of course, the possibility that the Fed duly delivers and after an inevitable rally, stocks fade rapidly once again.

We have had four years of extraordinary monetary policy and the big winners so far have been bondholders. Neither the economy or the stock market has been able to maintain traction in that time.

Like the repeated rescues by the European Central Bank, the shelf life of Fed-induced euphoria seems to get shorter every time. A market that believes that 1) the U.S. is heading into recession and 2) the Fed will not be very effective is one on the way down.

“The first rule of summer is not to trade; the second is if you have to trade, not to do much; the third is if you have to do a lot, then only buy safe stuff,” Bob Savage, a long-time market veteran and CEO of research clearinghouse wrote to clients.

Summer 2012 might prove to be a good time to do very little other than keep your head down and enjoy the Olympics.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at

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