Guest post by Hussman Funds.
In the day-to-day focus on the “fiscal cliff,” our own concern about a U.S. recession already in progress, and the inevitable flare-up of European banking and sovereign debt strains, it’s easy to overlook the primary reason that we are defensive here: stocks are overvalued, and market conditions have moved in a two-step sequence from overvalued, overbought, overbullish, rising yield conditions (and an army of other hostile indicator syndromes) to a breakdown in market internals and trend-following measures. Once in place, that sequence has generally produced very negative outcomes, on average. In that context, even impressive surges in advances versus declines (as we saw last week) have not mitigated those outcomes, on average, unless they occur after stocks have declined precipitously from their highs. Our estimates of prospective stock market return/risk, on a blended horizon from 2-weeks to 18-months, remains among the most negative that we’ve observed in a century of market data.
On the valuation front, Wall Street has been lulled into complacency by record profit margins born of extreme fiscal deficits and depressed savings rates. Profits as a share of GDP are presently about 70% of their historical norm, and profit margins have historically been highly sensitive to cyclical fluctuations. So the seemingly benign ratio of “price to forward operating earnings” is benign only because those forward operating earnings are far out of line with what could reasonably expected on a sustained long-term basis.
It’s helpful to examine valuations that are based on “fundamentals” that don’t fluctuate strongly in response to temporary ups and downs of the business cycle. The chart below compares historical price/dividend, price/revenue, price/book and Shiller P/E (S&P 500 divided by the 10-year average of inflation-adjusted earnings) to their respective historical norms prior to the late-1990’s market bubble – a reading of 1.0 means that valuations are at their pre-bubble norm.
Guest post by Hussman Funds.
In the Mary Mapes Dodge book titled Hans Brinker, there is a fictional story within the story of a little Dutch boy who, on his way to school, notices a hole in the dyke. Having nothing else to fix the leak, he plugs the hole with his finger and stays there through the night until workers come to repair it. We are now into the fourth year of efforts to print trillions of little Dutch boys out of dollars and euros in order to stop a tide from crashing through a fundamentally damaged dyke. All of this has bought time, but no workers have arrived, and no real repairs have been done.
The holes seem only loosely related: non-performing mortgages, widespread unemployment, massive U.S. budget deficits, a “fiscal cliff” sideshow, inadequate European bank capital, European currency strains, a surge of non-performing loans in China, and unexpected economic softness in Asia and global trade more generally. All of this gives the impression that these problems can simply be addressed one-by-one. The truth is that they are all intimately related to a single central issue, which is the utter unwillingness of politicians around the globe to accept and proceed with the inevitable restructuring of bad debt, and their preference to defend the bondholders of a fundamentally rotted financial system.
A few links via El Pais.
French government ministers have reacted angrily to the front cover of the latest issue of the Economist magazine’s latest front cover – which features a bundle of French baguettes with a lighted fuse, under the headline “The time-bomb at the heart of Europe“. The special report warned that the dire state of the French economy – with its high unemployment, lack of competitiveness, dying industry and high public spending – could be the next biggest threat to the eurozone, dwarfing the problems of Greece or Spain.
The magazine warned François Hollande’s reforms did not go far enough to address the country’s economic woes and if these were not resolved, France could jeopardise the future of the euro. (The Telegraph).
Find the French video below.
Spain has a few choices in order to start dealing with the pain the country is experiencing. None of the choices look very attractive, but something must be done in order to start fixing the economy. Mr Rajoy, what u gonna do? Via the think tank Carnegie Europe
In the great debate over the economy we sometimes forget the simple arithmetic of economic rebalancing. This arithmetic, like it or not, severely limits the options open to Spain.
For many years, thanks partly to bad policies in Spain but mainly to aggressive attempts by Germany to achieve growth by forcing a trade surplus onto its European neighbors, Spain, and many other countries in Europe, ran enormous trade deficits. It is easy and popular to blame the greed of the Spanish and the stupidity of the government for the mess in which Spain has found itself, but the policies Germany put into place in the late 1990s guaranteed that Germany, a country that had run massive trade deficits in the 1990s, would run equally massive trade surpluses in the subsequent decade.
People are obsessed with the Euromess and the Fiscal Cliff. What about Japan? A few reflections via Caixin Online.
Every time I come to Japan to attend a conference, I am reminded of what a depression looks like in the 21st century. This time is no different: shops are not busy, restaurant owners wait anxiously outside for customers and are usually disappointed, empty taxi cabs roam the streets. Two decades after its property bubble began to deflate, Japan remains mired in deflation and contraction.
The economic statistics tell the horror story best. Japan’s nominal GDP in 2011 was 9 percent lower than in 2007 and 2.5 percent lower than in 1992! In 1992, the national debt was only 20 percent of GDP. It is now 230 percent. Essentially, 200 percent of GDP in fiscal stimulus hasn’t turned the economy around.
The depression dynamic begins with declining incomes. People then spend less to cope. Shops and restaurants become emptier. The weak demand depresses business profitability and investment. The former depresses the stock market, and the latter labor income. Both pressure people to spend even less.
Few people pay attention to Japan’s problems nowadays. Financial markets pay a lot of attention to the United States’ economic problems. But its nominal GDP rose 7 percent between 2007 and 2011 and is likely to rise another 4 percent in 2012. Japan could at best achieve zero growth in nominal GDP in 2012. The performance gap between the United States and Japan is 20 percent in nominal GDP since 2007. America’s national debt has doubled since 2007 and reached 100 percent of GDP in 2012. Its trend isn’t sustainable either. But Japan’s debt problem is more advanced in depth. Its debt crisis should occur before the United States’.
Guest post by Peter Tchir.
Go Ahead, Make My Day
Greece has negotiated like the Clint Eastwood that spoke to an empty chair for 10 minutes. It is time to bring out the Dirty Harry. Point a magnum at the Troika and tell the “go ahead, make my day’!
Greece has been asking for money in some form or another for almost 3 years now. It begs and pleads. It is forced to do things to its people. Then it is back to begging and pleading. It is time to stop. The negotiations have been stupid. Not once has Greece come up with a credible alternative to more Troika money.
The Troika actually benefits as much, or more from supporting Greece and everyone would be better off if Greece was given real breathing room for a change. Since the Troika either doesn’t see it, or refuses to believe it, it is time to make the Troika see the error of the ways.
Defaulting Takes Planning
Defaulting, properly, is as much a process as anything else. You need to plan. You need to line up post default financing. You need a credible story of why investors should come to you post default. Sovereign defaults are particularly tricky since there are few rules to begin with, and enforcing those rules is tricky.
Biderman on the Fiscal Cliff issue.
There are two parts to the fiscal cliff equation. Government spending on services and taxes. Unfortunately almost all the discussion about how to fix the long term problem has been about taxes.
Focusing on taxes to raise revenues to provide government services requires making a key assumption that governments can effectively provide services. But what if the real problem is that the US government by its nature is incapable of providing cost effective services? I say that government spending on services are not only cost ineffective but probably harmful to the overall economy.
Why is no one else saying that government spending is ineffective and harmful? I can even demonstrate that government control of health care has been 70% ineffective.
General strikes in Spain and Portugal will spearhead a “European Day of Action and Solidarity” called by unions in the region.
Unions in Greece and Italy also planned work stoppages and demonstrations against austerity policies, which labour leaders blame for prolonging and worsening the continent’s economic crisis.
For Spain, the eurozone’s fourth-largest economy where one in four workers is unemployed in a deep recession, it is the second general strike in eight months in protest against draconian budget cuts.
Spain’s main CCOO and UGT unions have urged people to rally under slogans such as “They are taking away our future!”, deploying pickets during the night at airports, bus and railway stations.
Activists alerted social networks of an evening rally outside the parliament in Madrid. (Full article here)