NEW YORK (TheStreet) — Doug Kass of Seabreeze Partners is known for his accurate stock market calls and keen insights into the economy, which he shares with RealMoney Pro readers in his daily trading diary.
Among the posts this past week was an entry about the global economic recovery.
The Global Economic Recovery Is Foundering
Originally published on Friday, Feb. 14 at 7:59 a.m. EDT.From my “15 Surprises for 2014″:
“Surprise No. 1: Slowing global economic growth and fears of stagflation emerge.
“At the core of this year’s surprise list is that the U.S. economy disappoints (with domestic real GDP growing at +1.75% or less, half the expected rate offered by the consensus) relative to consensus expectations. Many (e.g., Harvard’s Martin Feldstein) are worried about the economy overheating, but global growth also fails to meet forecasts (and is only +2.5% against consensus forecasts of +3.6%+).
“The case for slowing growth is not necessarily quartered and dependent on rising interest rates. Rather, central to my surprise is a “spent-up not pent-up” consumer whose fragility may be exposed and an uptick in economic inequality as trickle-down policy grows increasingly ineffective.
“The recent rise in unemployment claims, higher gas prices, slowing population growth, the higher costs of health care, slowing retail sales and a pause in domestic automobile and housing activity likely presage that slowing growth is in store for 2014.
“U.S. real GDP growth is under 2%, and worldwide growth is under 3%, making the difference between anemic growth and recession increasingly one of semantics. (Note: The U.S. stock market has a forward P/E ratio of nearly 17 with a 2% real GDP growth rate, while China has a forward P/E ratio of about 7.5x with a 7% real GDP growth rate.)
“The Fed’s tapering will be put on hold in response to slowing growth, and some within the Fed, including Whirlybird Janet Yellen, argue for increased levels of quantitative easing. Half the Fed members are reluctant to add “more cowbell,” however, so there is no additional QE and the new Fed Chair’s more aggressive monetary policy views are repudiated.
“Pressure is placed on both parties in Washington, D.C., to introduce more radical and aggressive fiscal policies in order to stimulate domestic economic growth by year-end.
“Major droughts in the U.S., Brazil and Russia have a knock-off impact on much higher commodity and food prices, experiencing a greater-than-5% rise in 2014 (negatively impacting the consumer’s purchasing power).
“The drought brings on stagflation concerns. Other supply disruptions fuel some cost-push commodity price inflation even though economic growth is weak relative to expectations.
“The risk of an exogenous shock expands, and further downgrades of global growth could put the U.S. and Europe in a deflationary headlock, finding both regions in a light liquidity trap.
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“Even though interest rates grind a bit higher in early 2014, the rise is mild, and the yield on the 10-year U.S. note spends most of the year between 2.5% and 3.0%.
“Surprisingly (with a stable rate picture), the housing market is further disrupted. Mortgage rate and home price sensitivity are underestimated, as double-digit home price increases in 2013 dwarf modest rises in incomes. As a result, affordability suffers, and real buyers are priced out of the market. Traffic and orders drop off as the year proceeds. The accumulation of homes to rent by new-era buyers (hedge funds, private equity, etc.) precipitates further weakness in the U.S. housing market — indigestion in the rental markets develops, as there is an inability to absorb the units. By the second half of 2014, year-over-year home prices turn mildly negative.
“A new homebuyer tax credit is considered in late 2014 in order to stimulate residential real estate markets.
“Refinancings evaporate, serving to put pressure on household cash flow and personal consumption expenditures. The unemployment rate remains sticky (hanging around 7%), and consumer confidence falls.
“The expected recovery in capital spending fails to materialize in 2014.
“Companies slow down their share repurchase programs (which buoyed EPS last year), balking at higher stock prices and recognizing that the economics of debt offerings to fund repurchases are less compelling from an ROI standpoint than they were in 2013.”
My biggest surprise for this year is panning out: The global economic recovery is foundering.
The economy is the lifeblood of corporate profit growth, so it is not surprising that the most hotly debated topic in the investment community is what the pace of worldwide global economic growth will be in 2014.
Many have interpreted the recent soft data as being weather-related. This group believes that the weak jobs number, in particular, should be dismissed and that the domestic economic growth rate will quickly return to 3% once the weather distortions have been passed.
Others view the strength in the November and December economic releases as a big fake-out, believing that overall economic activity is slowing.
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I side with the view that 2014 will be a disappointing year for economic activity, even adjusting for the adverse impact of weather. I believe the reality of slowing growth will expose the structural headwinds that will produce a period ahead of subpar growth that is not anywhere near “escape velocity” — the solution to which is no longer ever-easier money.
Here are some signposts:
Jobless claims are rising, underscoring the uneven progress in the labor market.
Retail sales are weakening.
Away from the Northeast sector, which is crippled by foul weather, housing traffic and orders have been stagnating for months.
Capital spending remains moribund
Forward sales guidance, upon the release of fourth-quarter results, has been weaker than what the consensus has expected.
The projection of U.S. real gross domestic product for the first half of this year rose 4% in the third quarter and 3% in the fourth. However, that projection has steadily eroded under the weight of poor weather and with the loss of the benefit from inventory accumulation and replenishment. Most Wall Street economists are now looking for a sub-2% rate of growth in the first quarter.
Abroad, the European Union is only slowly emerging from recession. Japan’s Abenomics is getting roughed up — the Nikkei 225 was 220 points lower last night, has lost 3% in the last two days and is down 12% year to date. China’s economic growth rate is suspect.
“Growth slowing” is the message delivered by today’s bond yields. The 10-year U.S. note yield stands at 2.73%, and with the 30-year yield at 3.69%, the fixed-income markets might be sending a more definitive sign of slowing economic activity than is the U.S. stock market.
Often, the More Popular the Trade, the Harder it Might Be Hit
For now, the equity market has been embraced and markets are ignoring the signposts of slowing growth.
But, as I have cautioned, risk in markets happen fast. Just look to Japan.
A bullish observation could have been made at year-end 2013 for the never-ending rise in the Japanese market. But the overwhelming consensus of optimism only five weeks ago has abruptly changed as the Nikkei has gone from hero to goat.
The clock is ticking. Economic statistics in the U.S. better put up or shut up in the weeks and months ahead.
As I wrote earlier this week, while Mr. Market’s upward price momentum has been unshaken in recent days, the reward-risk scenario has deteriorated for stocks and is now back to unattractive readings.
Out of respect for the market’s momentum, this week I have been atypically cautious in expanding my short exposure, which is now only at 10% net short.
However, I plan to raise my short exposure on any further market strength as the upside potential for the market fades and the downside risk expands.At the time of original publication, Kass was short SPY.