Global Agenda: Bears in the cold

By PINCHAS LANDAU
December 21, 2006 21:10

The US economy is digging itself into a deeper and deeper hole.

3 minute read.



assorted greenbacks

money 88. (photo credit: )

In the face of ongoing rises in global equity markets it's getting ever harder to justify a bearish attitude. That is the best explanation for the steady dwindling in the number of bears, in the US and elsewhere. In fact, it's not just the markets that have driven the bears into hibernation. The overall performance of the global economy, and that of the US in particular, remains strong. True, the much-feared and often-predicted housing slump has finally materialized, but it seems - so far at least - to be less terrible, and certainly more manageable and with a lesser impact on the wider economy, than had been feared. The result is that the year-end forecasts are overwhelmingly positive, with the bulls able to pour scorn on the few remaining bears, in light of the latter's miserable record. However, there are still valid arguments in the bear camp. These rest on data that, so far from supporting the idea that an improvement has occurred and/or that all is well, actually point to ongoing deterioration and provide ample cause for concern. Let's start with the equity market, where the bulls are rampant. The problem here is that while prices are grinding steadily higher, in the US at least they represent valuations that are now at levels that assume earnings will continue to rise at the rates seen in recent years. On the basis of these record earnings, the price/earnings ratio of the S&P 500 is nearly 18, which is high by historical standards - but these record earnings reflect record-high corporate profit margins. If profit margins were at the level that prevailed as recently as the 1990s, the p/e ratio would be 25! Meanwhile, other measures of corporate value - such as price/book or price/revenue ratios - have not soared in the way the price/earnings ratio has. That's the equity story. The bond market, with its deeply inverted yield curve, clearly doesn't believe the growth story, but that discrepancy is becoming a normal part of the abnormal picture in the markets. But what about the wider picture? How come the slowdown in housing and, to a lesser extent, in manufacturing, hasn't had a greater impact on the rest of the economy? The answer, as ever, is that the American consumer is still out there buying everything in sight - or so we are led to believe by the recent data showing a strong gain in retail sales in November. The fact that Wal-mart and others said during and after November that it was a lousy month was quashed by this official government report, which took everyone by (very pleasant) surprise. What gives? Several problems emerge. One is that the statistical survey used for calculating the retail sales data just changed, which makes the report less reliable in the short-term. The other is that data on sales tax revenue from many states - surely the best measure of whether people are actually buying things - is signaling weakness. However, let's go with the flow and assume that people really are consuming as heavily as ever. How are they managing to do this when their main source of finance - drawing loans on their house - has plunged this year by some 30% overall, with the rate of decline intensifying with every quarter that passes (as the housing market weakens)? True, disposable incomes are rising thanks to slight wage rises, lower taxes and the recent fall in oil prices. But these increments do not offset the shortfall caused by reduced borrowing on home equity via mortgages. The only remaining possibility is savings and, yes, that's the answer. People are liquidating savings to maintain their spending. In the third quarter, for example, US households were sellers of Treasuries to the tune of $166 billion, and of $139 billion-worth of corporate bonds, as well as $750 billion of stocks, for a total of a cool $1.1 trillion, against which purchases of financial assets amounted to only $250 billion. This is negative saving big time. It certainly explains how spending is being maintained, but it doesn't bode well for the future. The bottom line is simple enough: The US economy is digging itself into a deeper and deeper hole. The spending binge is still in full throttle, but getting ragged round the edges and with its foundations crumbling. It's not what your broker will tell you, let alone what he or you want to hear. But the underlying trends haven't changed and they remain honey for bears. landaup@netvision.net.il


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