Stock Market Observer 2011-06-13
"Ain't no cure for the Summertime Blues!"
I never really understood the concept of summertime blues. Summer has always been a joyful time for me - a break from the "Ho Hum" of the rest of the year, warm weather and long days usually full of sunshine. How could that make you blue?
But the summertime blues hit the stock markets more often than not. That is why we often hear the phrase, "Sell in May and go away." Statistically, summer month returns in the stock market are below the norms for the rest of the year, though nowhere near the disasters of September or October.
Is that what's happening here? Sell in May and go away?
In my last Market Observer (March 03, 2011) I suggested that the correction of February (at the same time as the Japanese quake, tsunami and nuclear incident) was not "It." It was not safe for the citizens of Amityville to go back into the water.
"I will also stick to my original suggestion to not wait until you see the storm clouds before you check out your emergency rations and insurance policies. There is time to address these issues, but less and less every day."
Fortunately we ended up getting that time - in spades. The market continued it's rebound in April, hitting a peak in May. Since then it has been all down hill. Unfortunately, most people decided that since disaster had been averted in February they didn't have to stock up on the supplies and emergency rations.
Fundamental Yuch
"Fundamental Yuch" is a technical term used to describe the goopy stuff stuck in the very core of our economic engine - the sludge left from years of abuse which will eventually seize the motor but for now keeps the "low engine oil light" from going on.
Nothing has changed since our observations at the beginning of this quarter (see Economic Observer, April 04, 2011). We still haven't made a decision on the choice between having it all now and paying dearly for it later or having less now (maybe substantially less) but not having those burdens in the future.
Actually, that isn't quite accurate. What our country's leaders have decided is to go for "option A" (have it all now and pay dearly for it later), but the possibility to change course to "option B" is still available. The economic engine hasn't seized ... yet ... so there is still time to pay for the mechanic to take the engine apart, clean everything and put it all back together - an expensive procedure but not requiring a lot of new parts (read: "even more expensive procedure").
Basic Data
We've seen lots of economic reports the past few weeks that have come out well below analyst expectations. While we were expecting GDP growth of 3.0% or higher a couple months ago, now the "experts" think the number may come in closer to 2.5%. I wouldn't be surprised if it came in even lower than that. This is not a recession, but it will continue to feel like one with 9% unemployment.
Other data this past year has been under-whelming, but the markets have chosen to ignore that information choosing instead to climb higher. Don't get me wrong. We ARE in a recovery, but an extremely anemic one.
Middle East
Fighting and protests continue in the Middle East. Libya, Bahrain and Yemen are still flashpoints that will dip in and out of the headlines. They could become world-class serious issues or continue to simmer along for many more months. The one thing that is assured is that these issues will not go away EVEN if the current crop of despotic leaders are overthrown and replaced.
The pot will continue to get stirred by this region creating a sense of instability among world leaders.
Japan
Japan continues to try to work their way out of the natural disaster that became a nuclear one earlier this year. Then again, they're also working their way out of a 20 year deflation spiral, complete with a monstrous deficit that makes the U.S. debt picture look like a child borrowing a dollar from his Mommy to buy a candy bar.
China
More and more reports are coming out of China about price inflation on consumer goods. They also are at the peak of a real estate bubble of massive proportions. Then again, everything in China is of massive proportions. You have all seen (I hope) the videos of giant ghost town cities in China - built recently to stimulate the economy but completely empty. Such inefficiencies cannot be sustained and will have a serious effect on economic partners.
Europe
The European debate about Greek debt is a micro-climate of overall problems in the world economy. The ECB and German banks don't want to admit that Greece can't pay back those loans. They keep hoping if they kick the can down the road that the problem will go away. It won't. It will just get bigger.
Eventually Greece will default. They will likely have another name for it, but a default is a default no matter what word you use to describe it. When Greece defaults, the ECB will be in worse shape than Lehman was before it failed.
The irony here is that the efforts to stop a small problem from becoming a bigger problem (Greece defaulting) have only created an even bigger problem (the ECB going bankrupt). If that happens, the repercussions in the market will be extremely severe and global.
Liquidity
There has been a shift over the past several months as central bankers in Europe have begun raising rates. Ben Bernanke hasn't joined that crowd yet but Quantitative Easing part 2 ends this month. Just as the market started going up last August in anticipation of QE2 starting in October, the markets have been soft the past two months in anticipation of it's ending this month.
The ONE THING that Bernanke's QE2 has been successful with has been in raising stock market prices (as well as commodity prices). As that extra liquidity rushes out of the system, those asset prices are very likely to deflate.
This is probably the biggest factor working against the market right now.
Staying on Record
Nothing has changed in general in the markets. The only thing is we're a little further down the road. The Fundamental Yuch is still there and slowly getting yuchier (if that is a word). Things will seize. I don't know when, but it is in your best interests to be prepared.
--- The markets WILL go through a correction - we just don't know when (my crystal ball does not come with a clock). Is this the start of it? I can't say although I suspect not yet. Please don't come back at me in six months if I'm wrong and say I told you that everything was fine. Everything is not fine and the danger level is rising.
--- Look for continued increases in instability throughout world markets. There will be volatility with little direction at first (we're starting to see that) but eventually it will lead to a sizable (and likely quick) correction with very little warning. "Everything will be fine ... until it isn't."
--- Even if things don't go to hell in a hand-basket in the next six months, you owe it to yourself to be familiar with your protective systems. What would you do IF something bad were to happen to the economy? Are you leaving yourself with as many options as possible going forward? Are you putting on your seatbelt every time you get in the proverbial car?
In my last market observer I noted that the status quo could continue for a while longer. At the time we had more liquidity sloshing around in the system. With the end of QE2 and European banks tightening, that situation becomes increasingly unstable. We could be OK for up to another year. I don't think so, but it is possible. Markets can remain irrational for a lot longer than anybody might think. But just understand this:
The longer we ignore the fundamental problems, the bigger and more painful will be the correction when it finally comes.