The Third Depression
I've discussed the potential for the coming 2Q earnings
season to disappoint as a primary reason for the recent weakness we've
seen in the stock market. The Wall Street Journal reported yesterday that
analysts have indeed been ratcheting down their earnings estimates for
the Second Quarter. Six of the top 10 sectors of the S&P 500 have had
earnings estimates lowered.
Basic materials companies have been hardest hit, with
current estimates now 13 percentage points below estimates from the
beginning of the month. Financial companies have seen the second biggest
fall in estimates, down more than 5 percentage points.
Overall, the companies of the S&P 500 are expected
to report $19.65 in per share earnings. S&P 500 earnings are expected
to peak in 4Q at $22 a share. Interestingly, 4Q estimates have not been
revised lower.
The S&P 500 is currently trading at 13 times next
year's earnings estimates. That is on the low side of historical norms.
Pay particular
attention to JP Morgan (NYSE:JPM). It reports
on Thursday, July 13. JP Morgan has said that its non-performing loans
are peaking right now. This is potentially significant because the bank
has been setting aside billions in loan loss reserves every quarter. And
that's been a drag on earnings.
Still, JP Morgan has managed to beat expectations in
each of the last four quarters. But earnings will really take off if JP
Morgan (and other banks) has to set aside less to offset bad loans. The
banks might even <gasp> start lending again.
Of course, 2Q
earnings are one thing on investors' minds. The tone of the recent G20
meeting is another that may be weighing on the stock market.
I discussed briefly yesterday that the leaders of the
world's biggest economies are wrestling with the issue of debt and
growth. It's also clear from the G20 meeting that European leaders are
more concerned with debt right now. And that may have some serious
consequences for the global economy.
Nobel-prize winning economist Paul Krugman wrote a
depressing op-ed piece in the New York Times yesterday titled The Third
Depression. In it, Krugman has taken a decidedly bearish tone. He
expects that global leaders are about to make the exact same mistake that
turned the stock market Crash of 1929 into the Great Depression.
Krugman says "…this third depression will be primarily a failure of
policy. Around the world - most recently at last weekend's deeply
discouraging G-20 meeting - governments are obsessing about inflation
when the real threat is deflation, preaching the need for belt-tightening
when the real problem is inadequate spending."
The issue for Krugman is fairly simple: unemployment. In
the U.S., unemployment is just below 10%.
In much of Europe, it's worse.
These are historically high levels, usually associated with economies
that are in crisis, not recovering.
The basic question is: will higher taxes, less spending
and increased regulation lead to hiring?
I think it's clear the answer is no. But without hiring,
without getting income into the hand of people who currently don't have
jobs, imbalances in the economy that are somewhat hidden right now will
come to the forefront.
Consider the numbers of people who are living in houses
that are in foreclosure, that are spending their mortgage money on
consumer goods and services. If economic recovery drags on, if
unemployment doesn't improve to the point that people afford homes again,
all the housing "shadow inventory" will become real inventory.
That means banks suddenly have more negative assets on
their books. It means the numbers of homeless people skyrockets. And
without an expanding jobs market, there is nowhere to turn. Hello, Third
Depression.
I will not
argue that the U.S.
economy, and many others around the world, need
structural change. The fact is, unemployment levels only reach what we
consider "full employment" during asset bubbles.
We saw unemployment at low levels during the DotCom
bubble, and we saw it during the housing bubble. To me, that says clearly
that our economy cannot sustain low unemployment levels. In other words,
millions of workers have been "marginalized" by globalization. The jobs
to employ them simply don't exist. And it's not just in the
U.S. It's all over the developed
world.
I don't have the answers on how to fix this. But I'm
skeptical that the advice to "take our medicine" is really the solution
we want. It took World War II to get the U.S.
out of the Great Depression. And Japan
is still stuck in its deflationary spiral.
At the same time, it's clear that we cannot simply spend
our way to recovery without any substantive economic restructuring. As
always, I'd like to hear your thoughts on this issue. Write me at
dailyprofit@wyattresearch.com
Now, I want to be clear that I am not forecasting
another depression for the U.S.
economy. My point here is to simply shed some light on
why stock prices have been volatile.
I usually maintain an optimistic outlook. I truly
believe that American ingenuity can solve virtually any problem. But
Americans need straight talk as to exactly what those problems are. And
unfortunately, straight talk isn't the kind of "pie in the sky" rhetoric
that gets people elected.
I've been meaning to give some acknowledgment to TradeMaster Daily Stock
Alerts' Jason Cimpl. He's been leading
his readers to some phenomenal gains. He recently purchased Netlist and
had it jump 50% in two days. And one stock he recommended last Thursday
was up +15% yesterday.
I expect Jason will be taking some gains off the table
today as the stock market looks like it's headed lower. If you'd like to
get in on Jason's next round of profitable short-term trades, you can
find out how HERE.
