It invariably happens that after the linkfest goes up, I discover a killer article that would have been perfect. This piece from the L.A. Times’ Tom Petruno is just such a column.
Petruno identifies three potential issues the markets may have to surpass in the next few quarters: Consumer Spending, Corporate Earnings, and the Declining Dollar.
Here’s a quick look at the big three threats:
• U.S. consumer spending dives. Perhaps the surest ticket to a bear market in stocks would be for Americans to close their wallets — either because they’re spent out or because they’re nervous about their finances or their job outlook.
This is so obvious that it might well be overlooked as a risk. Investors have no recent experience with a consumer-led recession. The last one was 17 years ago, in 1990. The 2001 recession, by contrast, was led by a plunge in business outlays.
• Corporate earnings shrink. Wall Street is fully expecting a slowdown in profit growth this year with a weaker domestic economy. But an outright decline in earnings might be a shock investors couldn’t handle.
Bad news: The margin of safety is dwindling. Total operating earnings of the Standard & Poor’s 500 companies are expected to rise a mere 4.3% this quarter from a year earlier, according to analyst estimates tracked by Thomson Financial. That would be less than half the pace of the fourth quarter and the slowest growth in nearly five years.
• The dollar’s value tanks. The U.S. economy has been built on foreign money over the last two decades. Massive inflows of capital from overseas have been needed to cover the nation’s trade and budget deficits. Other countries’ saving underwrites our spending.
What would happen if foreigners lost their appetite for U.S. assets? Granted, that question has been asked so many times since 1990 that Wall Street is downright bored with it. Which means that a dollar crisis would be exactly the kind of thing to catch most investors by surprise. A fast slide in the buck could be a sign that the allure of U.S. investments is fading with foreigners.
That’s the overview; the whole column is definitely worth a read . . .
Graphic courtesy of LATimes
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Sources:
Hazards ahead as a new quarter starts
Investors seem to have gotten over the mortgage scare, but more challenges loom.
Tom Petruno:
L.A. Times, Market Beat
March 25 2007
http://www.latimes.com/business/la-fi-petruno25mar25,1,624538,full.column?
hello from germany
this might be a little ot but i think the latest from hussman is a must read (on the fed wording last week)
Clear Statements and Rose Colored Glasses
http://www.hussmanfunds.com/wmc/wmc070326.htm
The article left out the single biggest threat to the market, which is a jump in reported inflation and/or inflation breakevens.
This is not the same as a weaker dollar against other major currencies; indeed, a weaker dollar would probably ultimately be a good thing for US equities, as it would substantially increase the dollar value of corporate profits accrued abroad, and/or make US exports even more competitive. Just ask Boeing how “bad” a weak dollar has been for them!
It looks as though we may hit the Trifecta: the MEW-go-round has been closed for repairs, leading indicators are on a downturn, and the IMF is calling for a drastic dollar devaluation.
I wish Hussman had an RSS feed. It’s always a comment on The Big Picture that alerts me to a new article.
Who will benefit and who will lose from further dollar depreciation?
The loser: an average American whose wealth (life savings) would depreciate at the same rate.
The winner: the rest of the world (they are actually recommending this non-sense) so buying oil and commodities would be cheaper for them
As the result, an average American will have to deal with high inflation and subsidize oil and commodities for the rest of the world.
Yeh, great idea IMF! Let us inflate corporate earnings by cutting interest rates and further depreciating the dollar. Let us solve all global imbalances at the expense of hard working Americans. Let us further depreciate the dollar so TV talking heads can pound on the table and tell us about “the best story never told”.
Yeh, great idea IMF!
IMF to urge further depreciation in dollar: paper
http://www.reuters.com/article/hotStocksNews/idUKL2423658320070324?rpc=77
V L
If your consumption basket is denominated in dollars, how exactly do you lose if the dollar goes down? The passthrough of currency strength/weakness has been negligible for some time now.
And how does the rest of the world, which enjoys a $60 billion/month trade surplus with the US, benefit if the dollar goes down?
Regarding Hussman–He posts each Monday, so I always look for his article.
I would add an number 4: I think that derivative instruments are going to cause a nasty surprise. I was fretting about it this weekend, and low and behold, my frets were answered! FT had an article that you can find (sorry, subsription) here–http://www.ft.com/cms/s/92f9a7d6-db2d-11db-ba4d-000b5df10621.html
To honor subscriptions/copywrights, I’ve only posted the headline and first paragraph. I’d be pleased to e-mail the article from the site to any who request.
————————————-
Risks of derivatives ‘not fully evaluated’
By Saskia Scholtes andRichard Beales in New York
Published: March 26 2007 03:00 | Last updated: March 26 2007 03:00
Fewer than half of global financial institutions account sufficiently for complex financial and commodity exposures in assessing the riskiness of their holdings, according to a survey by Deloitte.
Macro Man,
“If your consumption basket is denominated in dollars, how exactly do you lose if the dollar goes down?”
Through high inflation (decreasing dollar buying power) You would need to pay $5 for a gallon of milk instead of paying $3 dollars (a farmer pays more for wheat to feed a cow). You would need to pay a million dollars for an average home instead of paying 0.5 million, etc (for example, a home buyer would compete with foreigners buying US real estate for speculation because it would be cheap for them converting their currency into USD)
For example, the dollar has depreciated by 40% since 2001. Have incomes appreciated by 40% since 2001? NO! (Corporate profits, executive salaries, Wall Street bonuses; but not the salaries on working Americans)
“And how does the rest of the world, which enjoys a $60 billion/month trade surplus with the US, benefit if the dollar goes down?”
It is not the rest of the world, it is mostly Asia. Moreover, if the dollar depreciates further, the $60 billion/month trade deficit will widen (the dollar depreciated by 40% since 2001 led to wider trade deficits, not smaller). We would have to pay more dollars for everything we import (including oil and commodities). The nonsense that it will improve our exports is silly because our economy is mostly based on consumption 70% and we have to import everything to feed this consumption. (American industrial sector is shrinking). The dollar would have to depreciate by thousands percents before you would see any reduction in trade deficits.
I agree with Macroman that a dollar devaluation won’t be a straigt down phenomena. We’ve already seen some benefit in the mfg export numbers over the past year.
I think VL would explain his consumption basket this way. If 50% of your consumption is of oversea’s products, then their prices will rise as your currency falls. At this point, the big question is China. When and at what rate will China start reducing their exposure to the dollar? Can they control the rate of decline in the dollar if they are bearish on the dollar? It appears to me that every attempt they have made to reduce their dollar consumption has been quickly reversed due to the near panic it has caused.
The dollar has appreciated by 40% against the euro…and the US trade balance with Euro land is improving. The dollar has only declined by 7% against the RMB, it has appreciated against the Mex peso, and it hasn’t moved against the currencies of the Gulf Coast countries. It is very slightly weaker against the yen.
The milk example cited above is spurious, as wheat is grown domestically rather than imported. Indeed, US imports are only about 16% of GDP, so it would be a rare consumer indeed that sees 50% of his consumption basket comprised of imports. Last time I checked, neither shelter nor utilities were imported from China.
US export growth has outstripped import growth (both including and ex petroleum) for some time now, and the trade deficit (both ex and including oil) is also well off its widest level.
However, I concede that these facts are unlikely to mean anything in the face of such a powerful force as faith.
The stock market seems to believe that the Fed will be dumping more booze into the punch bowl before the last hangover wears off.
Macroman,
The 50% figure wasn’t meant to be taken seriously. I didn’t see V.L.’s post on milk before mine went up. You highly discount energy’s impact. You aren’t the only one, and you are in respectable company. Energy, the item I believe we can agree would be most impacted by dollar devaluation, is what concerns me because energy costs are widely distributed. For the large portion of the country that lives paycheck to paycheck, any additional dollar in energy is a dollar they don’t spend elsewhere.
As usual, the following disclaimers to the release apply:
1) The 3.9% headline number has a margin for error of +/-17.4%. Seriously.
2) Builders are now routinely including incentives – everything from free televisions to upgrades, vacations, even cars; and these incentives are not subtracted from the reported sales price.
3) New Homes Sales are reported upon signing of a contract, and do not include cancellations, so given the high cancellation rates being reported by builders, the sales declines are probably understated.
All the dollar talk has to be kept in perspective. Look at a longer term chart of the buck, and you’ll see that it has come back to the levels it was at before the hype/lies/and BS of the 90’s. We are entering a long term trading range band, imho…and we’re near the sweet spot of that range.
Barry…how about a refresher from you on where you see equities heading from here…3 mos, 6 mos, and year end?
Thanks in advance.
Macro Man,
“The milk example cited above is spurious, as wheat is grown domestically rather than imported.”
Even though wheat is grown domestically; nevertheless, it is subject to global prices. I am not sure if you know that wheat is a commodity (same as oil).
I am indeed aware that wheat is a commodity. I am also aware that wheat, like oil, has demonstrated virtually zero correlation with the dollar over long period of time.
Rsq of Nymex crude to DXY, 1997-2007: 0.016.
Rsq of Nymex crude to DXY, 1987-1997: 0.008
Rsq of wheat to DXY, 1997-2007: 0.006
Rsq of wheat to DXY, 1987-1997: 0.011
Rsq of wheat of DEM, 1977-1987: 0.066
Rsq of wheat to DEM, 1972-1977: 0.11
Maybe if you put on red slippers, click your heels three times, say ‘there’s no place like home’ and wish REALLY hard, your wishes will come true.
Or, you could look up the facts. Your choice.
Yah, BR. But consumer spending is still growing even if at a slower pace. The housing ATM has been gone for two years now, since the housing correction is two years old. I think the higher energy prices are impacting it most of all these days.
Another thing fueling the economy is government deficit spending. If that falls and if taxes go up, then I think we’d see some major corrective action in the markets. But no worries. The Congress doesn’t seem to be planning on spending cuts anytime soon, and at least here in CA, state deficit spending (via bieeeeellions in bonds) is alive and well.
Macro Man,
“I am indeed aware that wheat is a commodity. I am also aware that wheat, like oil, has demonstrated virtually zero correlation with the dollar over long period of time.”
Try again, only this time use the correct interval and the correct currency group. Use the interval when the dollar was DEPRECIATING, instead of combining two reciprocal intervals and using obsolete Deutsche Mark.
Over the past four years (2003-2006), the correlation between the dollar and oil prices has been approximately 80%. (actually negative ~0.8 correlation coefficient, the variables moved in opposite directions; as the dollar depreciated, oil prices increased). In addition, similar negative correlation coefficients were between the dollar and other commodities.
Close your eyes and wish “REALLY hard” that your cherry picked intervals and distorted data will come true, or you can use the recent interval when the dollar was depreciating.
Love how everyone just knows the fed will cut. People like Cramer and his buddies are like little kids tugging on BB’s skirt, getting the thick lips going and pleading for what they want……
Thing is the fed WILL cut and by doing so add yet another ball to the many they are trying to keep in the air. Got a feeling the dollar could take a whack this time and inflation….?
One thing I like about this blog is that is seems to be three months to a year ahead of where the MSM is leading the crowd.
The main stream media is only talking about the sub-prime mess now. It was front and centre on this blog at least a year ago. Another example is the Cramer controversy. The MSM is just picking up the scent now yet it was featured here months ago.
I fully believe that this topic today will be picked up and noticed by the MSM sometimes this summer. That makes this blog a very valuable service indeed
I do not think we have been through the lead up to a possible recession where nominal house prices were actually falling (according to the Case-Shiller Index y-o-y changes are now negative). In the past nominal house prices may have stagnated while real prices fell as a result of continued CPI inlfation. This is probably not being factored into forecasts of consumer confidence and spending.
Macro Man,
“The milk example cited above is spurious, as wheat is grown domestically rather than imported.”
It is just for you Macro Man.
Milk Prices Expected to Rise 9 Percent
http://biz.yahoo.com/ap/070330/farm_scene.html?.v=5