Season of the Witch
- Joshua M Brown
- October 4th, 2011
Samhain was the original ancient name for Halloween, a harvest festival marking the end of summer and a transition to the darker days ahead. It was called Samhain (Summer's End) until the 800's AD when Pope Boniface IV renamed it 'All Hallow's Eve' to coincide with a Christian holiday. For 2000 years the Celtics were taught by their Druid priests that on October 31st the veil separating the World of the Living from the World of the Dead was at its very thinnest - transparent enough that the living could actually interact with the ghosts of their loved ones and the vengeful spirits of their departed enemies.
And as October 2011 begins, we find ourselves at the very nearest to the World of the Dead that we've been since the darkest days of the crash.
There is little separating us from the outright deflationary hell-cycle that monetary policy and optimism had staved off for so long. The Celtics dressed in costumes on Samhain in the hopes that the evil spirits they feared might not recognize them that night...given our current economic condition, I'm not sure that disguising in costumes would quite do the trick.
The veil between recovery and recession has never been thinner and all the old ghosts of the past have returned to haunt us once again, some of them almost exact replicas of their prior incarnations. Witness:
Rumors of hedge funds blowing up run rampant through the tape.
Bankruptcy talk for storied franchises like American Airlines and Eastman Kodak now litters the headline ticker.
Confidence is at all-time lows. We've not been this despondent about our leadership and forward-track in all of our recorded history as a society - the Civil War era and Great Depression included.
The certainty of higher taxes is also now taking hold, from the middle class on up. We know it's coming no matter who is elected, it's only a matter of timing and degree.
And the banks - the banks that are still with us after the shotgun mergers of 2008 - they are haunted still by exposure to loans and homes values and other banks and leverage and all of the old bogeymen that once forced investors to rip money away for fear of utter dissolution. Some of the most "systemic" banks in the market - Goldman ($GS), Citi ($C), Morgan Stanley ($MS), Bank of America ($BAC) - are once again trading at or below their crisis-level lows from 2009. This after trillions in interest-free money and a two-year period of do-whatever-you-need-to-get-better. Apparently they needed to get even more too-big and pay even heftier bonuses than ever before, not reduce risk or open up their balance sheets for serious scrutiny. They're going to pay for it now, flip on your quote screen.
But those are the devils we know...keep in mind that we have new ghosts this time around, perhaps even scarier ones to contend with in the coming months.
The BRIC miracle is has turned nightmare for investors who plowed in last fall. Emerging markets that are highly dependent on commodity prices, mining wealth or global manufacturing needs are finding little to cheer about in the spot prices or demand data - and their stock markets are reacting accordingly. Materials powerhouse countries have been hacked to pieces since the start of the year and on an accelerated basis since the wind-down of QE2 as we can see with a casual glance at the country-specific ETFs. Both Brazil ($EWZ) and Russia ($RSX) are down more than 30% year-to-date while the Australian market ($EWA) - another "commodities story" - is down a Koala-smashing 19% since January 1. On the demand side of the emerging markets story things aren't much better; India ($EPI) is down about 30% so far this year while China ($FXI) has become a New-Year-Low machine, off 27% and counting.
Not to belabor the China point too much, but it is important to understand that they reacted more forcefully to the threat of slowdown when in 2008 they did a stimulus equal to 20% of GDP. This massive spending thrust was about keeping the Olympic momentum going and they sure did succeed, serving as the lone engine of growth during the dark days when it looked as though the credit crash would never end. Beijing's central planners (along with the provincial bureaucracy which subsists on lending and development fees) overbuilt the country to the point that 46% of the Chinese economy is now in "fixed investment" - infrastructure and real estate spending. This compares to 12% for the United States. The Chinese are now facing the prospect of having to bail out a huge chunk of these projects that are looking more and more like they were bad investments, this at a time before the Chinese consumer is ready to step up and replace the waning dominance of the export economy that's gotten them this far. Lots of people say China is a "complicated story" but a few notable voices are now calling it relatively simple - it is the US just as the Roaring 20's are cresting. Boy, I hope they're wrong.
And of course Europe is the very spookiest of ghosts dancing 'round the harvest bonfire this season. Playing the role of the Ghost of Lehman this Halloween is the EU Fiscal Union and what's left of the ECB as a credible institution. In hindsight, it's a miracle that something like this was ever even attempted let alone allowed to persist for so long. Picture the self-satisfaction of the French, backed by the sweat-equity of the German efficiency empire, supporting an epic Mediterranean talent for deception and then topped off with a creme fraiche of Continental haughtiness - then you get to the heart of why this mess is so un-clean-up-able. The monetary-union-that-wasn't is a combination of all the worst traits of each of its member states, a 10-car pileup of cultural flaws just begging to be toppled so that the BMW at the bottom of the pack can drive away from the Peugeots and the Fiats with only minor scrapes and scratches.
The Chief Economists at Goldman Sachs are out this morning with their hatchets, they've chopped 2012 global growth estimates down to 3.8% this year and only 3.5% for 2012, predicting recession for Germany and France in the same report. In the meantime, Belgium's big bank, Dexia, is now on the ropes from Greek exposure, it is receiving the Good Bank/Bad Bank bailout treatment as you read this.
But even with the emerging markets coming apart at the seams and an historic level of disharmony in Europe - a continent that has been literally defined by its inability to get along - it is only when we turn our attention to the US that we feel the true sense of how inescapable a witching season has become.
Unemployment has not improved and has gone from being a cyclical issue to a structural one. The Fed's Chariman, who counts "full employment" as one of his organization's two primary mandates, has essentially thrown up his hands and winked at Congress. Congress is actually on the verge of slashing spending - certainly not passing the President's ridiculous "jobs bill" or signing off on any kind of new stimulus. In other words, the White House, Capitol and Federal Reserve Bank have all been sidelined by each other - I'd call it a "Mexican Standoff" but that would be an insult to the Mexicans, whose own economy is robust enough to have stalled the influx of their skilled labor into our beleaguered workforce for the first time in, well, forever. See "Better Lives for Mexicans Cut Allure of Going North."
And even if the politicians weren't handcuffed by their fear of each other and the coming elections, the people wouldn't care anyway. They are protesting in the streets and they are not leaving. There is no central aim of the Occupy Wall Street protest other than to express hatred and disgust for the banks and the politicians who've supported them. Wall Street protests are erupting across the nation, I think maybe it's for real this time.
Yesterday the Dow closed down 258 points to 10655, its lowest close since September 2010. Technically speaking, we've knocked on the crucial 1100 support line in the S&P 500 three times since August 8th and the fourth time was the charm, we are now through the lows and in a statistical bear market here in Recoveryland.
On the earnings front, the consensus is for $110 for the S&P 500 in 2012. Analysts have spent the last eight weeks trimming estimates but only by 2.6%...a joke when you consider that earnings typically fall by 25% to 40% in recession. The sell-side is cutting the crusts off of their estimate sandwich when they need to be slicing a third off of the loaf. This will come, grudgingly but inevitably, should GDP growth estimates continue to dwindle. Next Tuesday we'll hear from the super-cyclical Alcoa ($AA) to leads things off for the Q3 earnings season, is anyone feeling good about what they might say in terms of go-forward demand?
Some of you may be looking at the all the selling pressure and asking whether or not the stock market is even a good leading indicator for the economy to begin with. I'll say that it is a decent leading-to-coincident indicator if you know what you're looking for. The thing to keep in mind is that it's not the big one or two-day drops you have to worry about - the fast sell-offs in 1987 and 1998 were deep but the ended and took place in the context of economic expansion. For more on this concept, see: "Stock Market Crashes Do Not Predict Recessions". No, it is the rolling sell-offs that quietly persist against an apathetic backdrop for weeks that presage major economic trouble ahead, like the early 2001 and early 2008 - markets were down then but they were only on the threshold of the real pain that was to come.
The ECRI has just announced that the US is "tipping into a new recession. And there’s nothing that policy makers can do to head it off.” The ECRI only tepidly called the 2008 recession and certainly did not do so on a "leading basis" - in fact they spent the first three months of the last recession tiptoeing into it even though they ended up getting it right before most on Wall Street or in the media. But they typically have it right in the end even if they fail to live up to their claims of a lead-time.
Now there are those who look at the recent data and say that it is only a slowing of growth, not an actual economic contraction. "So what if year-over-year GDP declines below 2%," they'll say. My response is that they may be right - but they should be aware that every single instance of Y-O-Y GDP growth slipping beneath 2% since 1948 has led to a recession. Every single time we've slowed down to this extent in the last 60 years we've gone down to the zero line (11 instances) and into negative territory (10 instances). The ship is not so easily turned.
Faltering banks, confidence off the cliff, chronic joblessness, paralyzed politicians, slowing growth all over the world, crippling debt coming due at just the worst time...Can we really expect to whistle past this particular graveyard with all these malevolent spirits about? As we find ourselves face-to-face with the World of the Dead - closer than at any time since the last crisis - are we kidding ourselves that there is a painless resolution up ahead?
The market is saying no.
The action in front of us says it looks like recession has become all but inevitable as the entire globe slows down. It looks like a bank-related crisis is a foregone conclusion, either here or in Europe. It looks like we've not seen the worst in our stock prices.
It looks like the Season of the Witch.
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.