I Can Relax Now

I was a bit worried. A couple of months ago I predicted the second dip in this recession would come this fall. Then June happened. Markets were down substantially, worries arose about sovereigns in Europe, housing was facing head winds and so forth and so on. I feared that I predicted the second leg down as too late in the year. Then came July.

July has reinvigorated the markets. Don't ask me why but they are invigorated. Actually, go ahead and ask me why. It is relatively simple. There is a massive amount of money on the sidelines waiting to come into the markets, especially in institutions, like pension funds, mutual funds and the like. They need very little excuse to dive into the pool and they have raised their equity allocations several percent over the past couple of months, which is many billions of dollars flooding into equities. And so the July spike was, in retrospect, not that surprising. So we look to the fall . . .

I still stand by my dire fall prediction. Most stimulus is ending or has already ended here and in other countries, the political will to incur the cost of more stimulus is gone (here and in other countries), housing is still problematic, manufacturing is still problematic - and so forth and so on. I am really not seeing any significant bright spots in the data. Look at this link from Calculated Risk in case you disagree, it is not pretty:

http://www.calculatedriskblog.com/2010/07/2nd-half-slowdown-update.html

I suspect now that the S&P has crossed its 200 day moving average the spark is still there to carry us through August. It is traditionally a low volume month so I do not expect anything serious to happen, but watch out come September and/or October. I have been wrong many times but this is a prediction I feel a bit more confident about and I cannot fully explain why. Fundamentals have sucked wind for a long time so pointing to them does not explain it all. It is mostly the lost steam of government stimulus in conjunction with people coming into the new (old) reality, also referred to as back to normal by some commentators.

The point being quite simply that for a good decade or two we have lived rather substantially beyond our means, especially here in the U.S., but also in the UK and EU and other countries. We have been a consumpti0n machine, be it real estate, electronics, clothes or whatever, we have consumed it like there is no tomorrow. We have not said no to ourselves or our kids. Commercial retail space has exploded to where the U.S. has roughly 50% more than any other country. Real estate prices went through the roof due to speculation and anyone who could fog a mirror being able to finance a purchase. There was no end to our consumption orgy - that is until the recession of 2008.

Now lending standards are overly conservative (both for individuals and companies) , 95% of all mortgages end up with a GSE, consumers are starting to save despite a dismal job market, and the only good news for the economy this past year has come from government stimulus, which is ending. Let me add that foreclosures are on the rise and ARMs are resetting at an alarming pace this fall and next year. With over a hundred banks put down by the FDIC this year, it is clear the mortgage stats are not that great. In short, I am not popping any corks just yet.

I personally think this is leading to a new lower level of economic activity. A sustainable level of economic activity to which the markets have still not fully adjusted. And that is what I think will happen this fall. As government stimulus fades away and the fog clears, people will see where we are and what lies ahead more clearly. That, to me, is a good thing. Time to get real folks and the sooner the better. It will be painful but I am not sure there is any other better alternative.

Disclosures: None