It was another ugly week in the equity markets, with most of the damage done on Friday, January 15th. The S&P closed the week down 2.2% on top of its 6.0% fall on the first 5 trading days of the year. According to Wall Street Economist David Rosenberg, of 51 global stock indexes, 19 are in “bear-market” mode (20%+ decline from prior peak) and 25 are in “corrective” phases (10%+ decline). In this market, investors are dismissing all of the good news (e.g., JPMorganChase significantly beat Wall Street estimates, but the stock price fell) and focusing on bad news.
There are lots of worries:
- That economies, worldwide, are decelerating;
- That China will have a hard landing;
- That U.S. growth will be so low or negative that corporate profits will fall;
- That the falling price of oil will cause a recession;
- That the Fed has made a policy mistake and that they will continue on that errant path.
Let’s take these in order.
Worldwide, economic growth is still projected to be 3.0%. That is down from 3.3% a month ago, but it is not a disaster. On the bright side, Europe’s data has all been quite positive of late. And the concerns over China are overdone. Their transition from an infrastructure dominated economy to a consumer led one has slowed their rate of growth, but it is still growing at a rate in excess of 6%. Ask GM – they had their best sales year ever in China. Apple too. It is important to understand that, unlike the U.S., where middle class people have 401ks and IRAs invested in equities, that is not common in China. Most consumers there don’t have a stake in the equity markets. As a result, there is little correlation between their stock market and their real economy.
US growth (or recession) is another concern. As we have discussed in other blogs, manufacturing represents 12% of the economy, and oil about 2%-3%. Let’s call that 15%. If 70% of GDP, which represents the consumer, grows at a low rate of 2%, then manufacturing and oil must contract by more than 9% for GDP to grow at 0%. That contraction has to be 14% if consumption grows at 3% as it did in 2015. Given that the ISM Manufacturing Index is still above 48, such a contraction appears to have low odds. Look at the following data:
- U.S. auto sales – 2015 was a record year for sales (17.5 million units);
- Home sales on an uptrend – there is an uptrend in housing starts; inventories are tight; and millennials have jobs and are entering the home buying markets;
- Labor markets are strong – even if you don’t believe the 292,000 jobs the government reported on January 8th, ADP, the largest payroll processor in the U.S. (they should have a large enough sample to be reliable) reported a 257,000 job growth for December; in fact, the last 3 months of job growth in 2015 were the strongest 3 months of the year;
- Consumer credit is rising indicating that consumers are confident; in addition, voluntary quits have now reached heights not seen since before the recession, indicating that workers are confident that they can find (or have already found) another job (probably at higher pay).\;
- The Leading Economic Indicators are calling for expansion, not contraction, and there has never been a recession without a significant deterioration here.
We have to question the idea that falling oil prices can cause a recession. The experience of the last 5 decades tells us that recessions may occur if oil prices rise rapidly, usually due to artificial supply restrictions by OPEC (1973, 1980, 1990), not when they fall. All of the periods of falling oil prices have spurred the U.S. economy. The fact is, falling oil prices benefit all consumers and most businesses. Why should this time be different?
The market thinks the Fed made a policy mistake when they raised the Fed Funds rate in December. And they simply can’t digest the Fed’s projected 4 rate increases in 2016. Since December, long-term rates have fallen indicating that the markets don’t believe the Fed would dare raise rates again with current market sentiment. In addition, with oil prices off sharply, the Fed’s forecast that “inflation will rise, over the medium term, to its 2 percent objective” is now a questionable assumption, and will likely keep them from raising rates again until the price of oil stabilizes and/or starts to rise. Let’s not assume the FOMC members are fools.
Volatility is likely to continue for the next few weeks. Keep in mind that in ’87, ’94, ’98, ’02, and ’11, we had significant market corrections, but no recession. And in each of those cases, the markets rebounded to new highs over the next year. If this, indeed, is only a correction, it very well could eventually become a buying opportunity for those bold enough to take advantage, have an appropriate longer term view, and have the wherewithal to stomach what appears to be market irrationality.