Markman: Economic Worrywarts Have it Wrong

by Jon Markman | June 1, 2011 1:47 pm

June has been the worst month of the year for stocks in the past 15 years, wresting the crown of badness from September.

As we motor into the thick of a potential June swoon, here are the big questions that top economists on Wall Street believe investors are mulling: 

1. Will the economy rebound from its current soft patch?

2. Will equities tip over when quantitative easing ends in July?

3. Will sovereign credits swoon if Greece is forced to restructure its debt?

4. What will happen to oil prices if Qadaffi is pushed out of Libya?

5. How soon will Japan recover?

6. What will happen to commodity prices if China is successful at slowing its economy?

Of all these, the most important for U.S. investors is the first. And I may be totally wrong, but my expectation is that the worrywarts have this wrong. 

Much of the lull in U.S. manufacturing has come about as a result of some abnormal weather conditions in the winter and spring, plus the effects of the automobile manufacturing kink created by the Tokyo earthquake. Another large part of the problem has been a surge in gasoline prices that has been a drag on consumer spending.

These seem to be transitory issues of the type that are usually, in retrospect, called a “growth scare.” To be sure, data last week was some of the weakest in two years, with no signs of strength in manufacturing, the Philly Fed report, industrial production, and unemployment claims. Plus we saw that home prices are still falling, governments are cutting back on spending, and payroll taxes are about to kick back in.

But there are some bright spots that don’t get as much ink. For one, people may be surprised to discover that the expansion is self-sustaining, in part because super-low interest rates have combined with the Fed’s asset-buying program to create a lot of stimulus that is not seen on the surface.

Plus, there’s no denying that earnings season shows us that corporate profits are strong and balance sheets are in fantastic shape, particularly after companies have been able to issue a lot of incredibly cheap debt. Credit card delinquency rates are way down, emerging market demand is still growing, a technology boom is emerging, gasoline prices are coming down, and the grain and cotton price surge of last year has been erased.

Also, we can’t forget that President Obama and Fed Chief Bernanke are both dead-set on doing what they can to improve the economy going into the 2012 election cycle, which is why the third year of the presidential cycle tends to be so strong historically.

And finally you can’t ignore the impact of the Japanese tsunami and nuclear crisis. They threw the world’s third largest economy for a loop, as industrial production in that country plummeted by 15% in March. That disrupted supply chains worldwide, with U.S. car and truck manufacturing on track to decline by 10% in the second quarter and Indonesia authorities saying they expect vehicle production to drop 15% year over year in the second quarter.

But these troubles in Japan are not going to last forever. And already production data out of Tokyo is showing a marked improvement, with Tokyo saying it expects to be back to normal in June.

In sum, all that has to happen for U.S. economy to emerge better on the other side of this soft spot is for some luck to go our way rather than against us. And the decline in the price of gasoline will continue to help people afford consumer staples, boosting the earnings power of companies like McDonald’s (NYSE:MCD[1]) and Conagra (NYSE:CAG[2]) — stalwarts of the FT Consumer Staples (NYSE:FXG[3]) exchange-tradedfund.

I am told that ISI Group analysts are looking for three factors to set in place to ensure that the expansion is self-sustaining:

— Employment gains need to keep up their recent pace. (My data sources suggest there could be an upside surprise in May).

— Credit expansion needs to continue on its recent pace. I can see that bank loan data is edging higher, and in my conversations with colleagues and friends in commercial banking I am hearing anecdotally that loan committees are finally freeing up money for projects again. Commercial and industrial loan, in aggregate, have been up for six straight months, as is consumer debt. Bank loans must keep rising once quantitative easing ends for the credit expansion to work.

— House prices need to stabilize. This is not happening, to be sure, and is one of the biggest risks out there. The overhang from foreclosures is still staggering, though the good news is that home affordability has never been better. If young people here won’t buy houses, foreign buyers, taking advantage of the lower dollar, are sure to come in.

One of the two things investors care about the most is earnings growth, and that still appears to be on track. A survey of 9,000 analysts by Bloomberg this week found that the consensus believes S&P 500 profits may reach $105 a share in the next 12 months. 

If you put a 15x multiple on that, you get a potential target for the S&P 500 of 1575, which would be a touch above the 2007 high. The consensus has to be wrong, by definition, so let’s say the range is 1475 to 1675. I think we would be happy with either side of that, since the minimum is 12% higher than the current quote. Don’t think it can’t happen.

 
For more guidance like this, check out Markman’s daily trading service, Trader’s Advantage,[4] or his long-term investment service, Strategic Advantage[5].
 

 

Endnotes:

  1. MCD: http://studio-5.financialcontent.com/investplace/quote?Symbol=MCD
  2. CAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=CAG
  3. FXG: http://studio-5.financialcontent.com/investplace/quote?Symbol=FXG
  4. Trader’s Advantage,: http://www.jonmarkman.com/
  5. Strategic Advantage: http://www.markmancapital.net/

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