“When the facts change, I change my mind. What do you do sir?” – John Maynard Keynes
If the market is doing something quite different than what you think it should be doing, it's time to reevaluate your thesis.
Great calls are not just about getting the direction right but also the timing. If you take a bearish or bullish view on the market, economy, or an individual stock and it moves contrary to your opinion, there are two questions an investor should ask: 1) am I wrong or 2) am I right and suffering the consequences of bad timing?
Currently, many believe that the economy and stock market are going to roll over due to presently high gasoline prices, but the evidence is simply not there. We have rising jobs, rising credit, rising housing activity, and growing consumer confidence.
Despite the significant amount of pessimism in the investment community, this market and economy are probably heading higher whether we like it or not.
No Energy Shock Yet as Consumers Keep Chugging Along
A major topic that I touched on last week was the impact of high gasoline prices on the economy. The takeaway from my analysis was that there's simply not enough evidence from seasonal trends, sentiment, and market breadth to conclude that consumers are near a tipping point given current energy prices.
I believe two main reasons for this are a brighter jobs backdrop and improving credit. During the 2008 energy shock the US economy was shedding jobs and consumer credit was approaching a peak. Last year, during the 2011 energy shock, the US economy was producing jobs and consumer credit was expanding but not at a brisk clip. Although we are facing high gasoline prices again, as seen in the tables below, this time around the US economy is producing jobs at an accelerated pace and consumer credit is expanding at the fastest clip in a decade.
As you can see, we are producing more jobs currently and witnessing greater credit growth than in the prior two cases, which helps to explain why the US economy is not faltering. But don’t just take my word for it, consider the following:
Gallup Poll: Consumers Say Tipping Point at .30 Gas
"Americans on average say gas prices of .30 to .35 per gallon are the tipping point that would make them cut back on spending in other areas or make significant changes in the way they live their lives."
Wendy’s (WEN) Earnings Call 3/1/12:
“We clearly sense that there has been an economic pickup in the country and that’s buoyed consumers’ attitudes out there. Obviously, we’re all watching gas prices carefully, but consumers seem to quite honestly have digested that quite nicely. So we’re pleased with the level of economic activity that we see.”
J.M. Smucker (SJM) Earnings Call 2/16/12:
"...when gas prices went to a gallon everybody stopped driving for a while until they got used to the fact that the new norm was .50 to and then they started driving again...I think this new inflation rate will be there for some time and the consumer will adjust."
Given the above, US consumers are not oblivious to rising fuel prices and are making adjustments to their spending habits as reflected by the composition of auto sales. The percentage of truck sales is falling as consumers prefer more fuel-friendly cars, but as the second chart below illustrates, as of February Americans are still buying more vehicles in total. If March data, which comes out early April, shows stalling similar to 2011, then we will likely be at or near a tipping point.
Source: Bloomberg
Source: Bloomberg
Flexibility & Humility Go Hand in Hand with Success
While I do not agree with many of the ideals espoused by the famous economist John Maynard Keynes, wisdom is wisdom regardless of the source and his quip to critics is timeless:
“When the facts change, I change my mind. What do you do sir?”
Last summer I surveyed many indicators I follow on a regular basis and they were downright horrible and suggested we were slipping into a recession. I argued as much in my article, “Economic Indicators Show Recession As Early As Next Month,” in which the one-month diffusion index for the Philadelphia Fed’s Coincident Index broke the critical 50 level in May and given its historical 4-5 month lead time before a recession begins I said we could be entering a recession by the fall. For the rest of the year my greatest concern was that, while the equity markets were staging an impressive bounce, credit markets were still deteriorating and were telling the message of a worsening economy and financial backdrop.
I began to change my tune as leading economic indicators were forecasting a manufacturing-led recovery heading into 2012 which I highlighted in my article, “A Window of Opportunity,” in which I thought we had an intermediate-term respite for the economy and stock market that could last for a few months before sputtering. I turned even more bullish in January when I saw major improvement in the credit markets which I highlighted in “Finally, Equity and Credit Markets in Harmony Again.”
When looking at the economic backdrop and internals of the stock market I was clearly wrong in calling for a recession in my articles late last year, but had adjusted my outlook accordingly rather than staying firmly in my bearish cave. I received a great deal of pushback from the bearish crowd and so I penned the article, “Stop Talking and Start Listening!” in which I suggested that “what the market IS doing is far more important than what you think the market SHOULD be doing."
When I survey economic report after economic report or various leading economic indicators, the message of the economy is overwhelmingly bullish and the probability of entering a recession is incredibly remote at this time. The Philadelphia Fed’s State Leading Indexes that provide a 6-month forecast are predicting expansion across the nation for the first half of 2012 as seen from the December report below.
Source: Philadelphia Fed
Confirming the message from the Philadelphia Fed is the U.S. Business Cycle Map from Moody’s Economy.com which shows the vast majority of states either recovering or expanding.
Source: Economy.com
The current reading of the RecessionAlert Weekly SuperIndex, which is based on 9 underlining well-known leading and coincident composites, calculates the probability of the US economy currently in recession at 0.21% and calculates the probability of the economy slipping into a recession in the next 3-4 months at mere 4.72%. Also, the RecessionAlert Headwinds Index gives a zero probability of recession occurring in the next six months.
Source: RecessionAlert
Source: RecessionAlert
Thus, the message from the Philadelphia Fed’s State Leading Index, Moody’s Economy.com US Business Cycle Map, and the data from RecessionAlert are all in collective harmony that there simply is not a recession on the horizon. Under that backdrop it is understandable that the US stock market remains resilient and is currently undergoing a much needed break to work off an overbought condition.
Using the Dow Jones Industrial Average as a proxy for the stock market paints a very healthy picture for equities. Here are some stats for the Dow that highlights how bullish the markets' backdrop currently is:
- More than 60% of the 30 stocks within the Dow are within 5% of a 52-week high and 80% are within 10% of a new 52-week high.
- Long Term Trend is Bullish
- 93% of the Dow members are above their long-term 200 day moving average
- 73% of the Dow members have monthly MACD buy signals
- Intermediate Term Trend is Bullish
- 90% of Dow stocks have their 50 day moving average above their 200 day moving average = “Golden Cross”
- Valuation:
- 80% of the Dow members price-to-earnings ratio (P/E) are below the Dow’s 1920-2012 median of 16.82.
Source: Bloomberg
With the economic and stock market backdrop presented above, it appears the bears are on the wrong side of the investment coin. There are plenty of potential events that could cause the economy to turn around like war with Iran, a surge in energy prices from present levels, another debt debate in the US like the summer in 2011, escalation in the European debt crisis, China hard landing, etc. While there will always be potential storm clouds to be aware of, right now the skies are clear and the stock market and economy will head higher whether we like it or not. If the facts change so will I, but I won’t be placed in either the perma bear or perma bull crowd as neither crowd has the right strategy in this period of record volatility where you can get a complete business cycle and have a bear and bull market all within the course of twelve short months. No sir, flexibility and the ability to change your views as the circumstances change are the strategy in this climate.
Inflationary pressures are beginning to build in the economy from higher commodity prices and rising import inflation thanks to a weakening USD, and these pressures are why I believe we will have our first major correction in the market by summer as I highlighted in my article, “Countdown to Market Peak Has Begun,” but I’ve only seen an increase in inflationary pressures that suggest the stock market and economy stall and pullback, but not enough to suggest a new bear market or recession. Incoming data will have to be monitored ahead to see if inflationary pressures get white hot to cause a bear market or recession. As of now they suggest we’ll see our first major pullback begin around summer, however, there are plenty of months between now and then for the stock market to put some more points on the scoreboard.
