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The imagined recession disappears

And POOF, just like that, the imagined recession disappeared! The equity market rallied from its Feb. 11 low (S&P 500 1829.08, down 10.5 percent for the year) to 1893.40 (March 3) and rising as I write. Amazingly, the markets are now only down about 2.0 percent for the year. This bounce is a relief. And with positive economic data of late (242,000 new jobs in February), the odds of that imagined recession have now receded in the minds of Wall Street players. Nevertheless, there are still real and illusory headwinds in the financial markets. The major stories revolve around China and the threatened impacts of low oil prices on banks and the financial system.

China

The issue in China is not growth or recession, but involves corporate debt levels and whether or not a debt crisis there triggers a currency devaluation. Just for comparison, corporate debt in China is 160 percent of their GDP, and it rose at a 25 percent pace last year. In the U.S., in contrast, corporate debt is only 70 percent of GDP.

If the corporate debt bubble bursts in China, the central bank will have little choice but to devalue the currency and print money to try to prop up the financial system. If this transpires, there would be a currency devaluation in other Asian countries which would likely lead to deflation and recession, at least in that part of the world. During the week of Feb. 22, Wall Street breathed a sigh of relief, at least temporarily, when, at the G-20, Beijing officials stated that no further yuan devaluation would occur. Believe them at your own risk! This is a real issue.

Oil

The other significant headwind for the equity market remains the price of oil. The market low on Feb. 11 coincided with the low in the price of oil ($26.21/bbl). Since then, talk by OPEC and other large oil producers about capping or reducing supply has sent the price back above $30 ($34.56 as of March 3).

Equity market issues are now revolving around the banking sector. The banks are a very important cog in the equity markets, as they are a proxy for the economy’s health. As the oil price fell in early February, the large banks, JPMorgan Chase (JPM) in particular, announced a $500 million addition to its loan loss reserve. The bank also announced that they would place an additional $1.5 billion in their reserve if the price of oil fell to $26/bbl and stayed there for any length of time. The markets viewed this announcement as confirmation of its suspicions that the banks were hiding something and the fear of another financial meltdown swirled (never mind the fact that $500 million is only slightly more than 2 percent of JPM’s 2015 earnings or that $1.5 billion is less than 7 percent.) Slightly lower earnings, in the unlikely event that oil retests $26/bbl and holds there, simply does not translate into a financial system meltdown. Nevertheless, as a result of this “scare,” the KBW Nasdaq Bank Index fell 23 percent from year’s end to Feb. 11. It has since recovered some of those losses, down about 11 percent as of March 3. Because of the importance of the financials to the economy, the market as a whole cannot advance without uplift from this sector.

Realistically, another financial crisis in the U.S. is very unlikely, as bank balance sheets are much stronger than they were in ’08, and loans to the energy sector are not large enough to cause such issues. A recession in the U.S. is possible (but unlikely) due to the “negative feedback loop,” where negativity causes businesses to scrap expansion and hiring plans. So far, we’ve only seen this in the weakening of one of the consumer sentiment indexes (namely, The Conference Board’s Consumer Confidence Index) in February. But it hasn’t yet translated into business plans as evidenced by the February employment report. And it appears that such recession fears have receded.

Strong U.S. consumer

The U.S. consumer (70 percent of GDP) is healthy. Household balance sheets are stronger than they have been in 50 years. Wages are finally growing, jobs continue to be created, gasoline prices are at levels not seen in years, mortgage rates are low, and the price of homes — the largest asset on U.S. household balance sheets — is rising. Q4 earnings of consumer-oriented companies have generally surprised to the upside (except Wal-Mart). But perhaps the best single indicator of consumer health is the weekly report of initial jobless claims. This is one of The Conference Board’s 10 leading indicators. It remains at historically low levels, and tells us that businesses are not letting their employees go.

Conclusions

  1. We need to keep a close eye on China’s corporate debt issues, as these could ignite worldwide deflation.
  2. The worries about the financial sector are overdone; the recent uplift in oil prices have quelled Wall Street’s recession fears, at least temporarily; and financial stocks have recouped about half of their year-to-date losses in just the past week.
  3. The fact that Saudi Arabia, OPEC, and Russia are talking about production cuts is a positive sign for Wall Street’s worries.
  4. There is no pending recession in the U.S., the consumer remains healthy, and there are signs that even manufacturing has bottomed.

Robert Barone (Ph.D., Economics, Georgetown University), an advisor representative of Concert Wealth Management, Inc., is a Principal of Universal Value Advisors (UVA), Reno, NV, a business entity. Advisory services are offered through Concert Wealth Management, Inc., a Registered Investment Advisor. Dr. Barone is available to discuss client investment needs. All accounts welcomed. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources that Universal Value Advisors believes to be accurate and credible but makes no guarantee to their complete accuracy. A more detailed description of Concert Wealth Management, Inc., its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

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