Portrait of a Maturing Secular Bear Market

| July 2, 2011

In his latest weekly newsletter, John Mauldin reviewed the fundamental big picture as the US economic recovery struggles to continue after two years of massive government stimuli. We have reprinted an excerpt from his commentary below.

The economy should be in Muddle Through range (around 2% growth), absent any shocks. For instance, today we had the June ISM number, which was stronger than most analysts expected, at 55.3. There was a lot of whispering that it could dip below 50. Some of the internal components were a little soft, though. New Orders were barely above 50. And Backlogs fell below 50. Exports fell to the lowest level in two years (more on that below). Of the 18 industries surveyed, only 12 reported growth.

But Muddle Through is not going to allow us to really cut into the unemployment problem. We need at least 3% and most economists think we need to see 3.5% to result in some real strong jobs numbers for several months in a row. That just doesn’t seem to be in the cards. Richard Yamarone at Bloomberg is calling for a recession by the end of the year, and he sent me a rather vivid PowerPoint of his latest thoughts. Let me share a few of those slides with you. The following chart shows what I mean by Muddle Through not being enough to really cut into unemployment. As GDP seems to be slowing rather than picking up, the correlation between employment and growth is not encouraging. And if you look at the NFIB (National Federation of Independent Businesses) data, small businesses are not really back in the hiring game, and that is where the action needs to happen. We will see a new survey next week, but I doubt we will see a major jump in expectations.
About two years ago I wrote a rather lengthy piece about why unemployment would be a problem until at least the middle of the decade. When you lose 8 million jobs, with about 2-3 million of those jobs permanently gone, it is tough to dig out of the hole. We can’t look to housing construction to be the driving force that it once was for another 3-4 years, and commercial construction is falling.

I was talking to a friend yesterday who is a director on two local bank boards. He pointed out that while the government wants banks to lend, the regulators (the Fed) are basically saying they can do development loans without very large equity components. They want 50% loan-to-value of very-reduced valuations. Let’s look at two charts from Rich. One shows commercial construction and the other shows regional and strip mall vacancies. Construction spending for May 2011 fell 0.6% below its revised level in April, and is 7.1% below its May 2010 level. This is not the stuff that makes real estate moguls want to part with their cash. Nor does it bode well for construction jobs.
OK, only two more charts from Rich (Over My Shoulder subscribers can see the whole thing. More on that below.) The first is the smoothed ECRI (Economic Cycle Research Institute) index over the last 20 years. We can see it turning over. The ECRI weekly leading index decreased to 126.4 for the week ending June 24, from an unrevised 127. The smoothed, annualized growth rate fell to 2% from an unrevised 2.9%. The ECRI WLI has been consistently losing momentum in recent months, adding to concerns about the sustainability of the recovery.
The ECRI itself points out that their index is simply signaling a weakening economy but does not signal a recession. And you can see that there have been similar downturns in the past without a recession or even a recovery. But the recent trend is disconcerting and must be watched.

And the last chart is one I had not seen before, and is interesting. Rich notes that if year-over-year GDP growth dips below 2%, a recession always follows. It is now at 2.3%.

Growth is clearly decelerating. Look at the growth numbers from the St. Louis Fed website for the last six quarters: 2009-10-01 13019.012 2010-01-01 13138.832 2010-04-01 13194.862 2010-07-01 13278.515 2010-10-01 13380.651 2011-01-01 13444.301

It will be very interesting to see, at the end of the month, what the numbers are for the second quarter. Another quarter like the first quarter and we should either be close to or actually dip below 2%.

This type of economic turmoil and uncertainty is typical at this stage of a secular bear market. Stocks themselves will likely continue to lurch higher and lower for several years at a time until the underlying structural problems are resolved, as they did during the previous two secular bears that commenced in 1929 and 1968, respectively.

The secular bear market from 2000 is now 11 years old and shows no signs of terminating in the near future. Since our Secular Trend Score (STS) issued a sell signal in late 1999, stocks have behaved exactly as expected, moving effectively sideways in nominal terms.

At a current duration of 28 months, the latest cyclical uptrend from March 2009 could terminate at any time and it will likely be followed by a violent downtrend that is equally extreme in character. As always, it is impossible to predict when the forthcoming cyclical inflection point will develop with any useful degree of statistical confidence. However, the judicious application of chart analysis will facilitate the identification of the long-term reversal as it occurs.

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Category: Commentary, Market Update


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