About 85 percent of S&P 500 companies that have reported results since July 12 beat analysts’ per- share earnings forecasts, Bloomberg data show, while 69 percent have topped revenue forecasts. Sales have risen 9.2 percent for S&P 500 companies that have reported earnings so far.
Also, several leading indicators have also shown extraordinary strength. Shipping, Trucking, United Parcel Service (UPS), Intel and the Railways to mention a few. Perhaps better yet, US Home Prices seem to be on the rise too. From an article today on Bloomberg, dated 27th July, 2010 and titled "Home Prices in 20 U.S. Cities Rose More Than Forecast" we read:
Home prices in 20 U.S. cities rose more than forecast in May from a year earlier as a government tax credit temporarily underpinned sales.
The S&P/Case-Shiller index of property values increased 4.6 percent from May 2009, the biggest year-over-year gain since August 2006, the group said today in New York.
And finally, if all that good news hasn't been good enough, from another article in the New York Times dated 26th June, and titled "Retailers Pay More to Get Cargo (No Guarantee)" we read:
Fighting for freight, retailers are outbidding each other to score scarce cargo space on ships, paying two to three times last year’s freight rates — in some cases, the highest rates in five years. And still, many are getting merchandise weeks late.
Could this really be true? After all, just a few weeks ago, on 27th, June 2010, to be exact, Princeton University's Prof. Paul Krugman, winner of the 2008 Nobel Prize in Economics, wrote an Op-Ed article in the New York Times titled "The Third Depression", in which he had these extremely dark words of warning:
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.
Was he wrong?
I think the real question is: Will he be wrong? After all, he prefaced his words with some others that I should have mentioned first:
Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.
So the real question is, not just where we're at, but what the extent of the damage done to the world economy has been and whether it is pernicious enough to drag the recovery down. That's the million dollar, or perhaps trillion dollar question that we have to grapple with.
My first instinct is that at least for the US, a lot depends on the Housing and Jobs data that comes out in the next couple of months. I wouldn't place too much weight on the recent rise in Home Prices - they might just be a residual effect after the tax credit. Moreover, just out today is the Conference Board's Confidence Index, and a 27th July, 2010 Bloomberg headline blares, "Consumer Confidence in U.S. Fell in July to a Five-Month Low" with the following lines inside:
Confidence among U.S. consumers declined in July to a five-month low, a sign the lack of jobs will limit the economy’s recovery.
The Conference Board’s confidence index fell to 50.4 from a revised 54.3 in June, figures from the New York-based private research group showed today. The gauge was forecast to drop to 51, according the median estimate in a Bloomberg News survey.
Sentiment may be slow to improve until companies start adding to payrolls at a faster rate, and the Federal Reserve projects unemployment will take time to decline. Today’s figures showed income expectations at their lowest point in more than a year, posing a risk for consumer spending that accounts for 70 percent of the economy.
Looking across at Europe, a lot will depend on how much they tighten - I'm sure their tendency will be to err on the side of growth and see if inflation begins to raise its head. In the case of China, my guess is that how they deal with their Real Estate and Local Bank Lending crisis will determine the immediate future. But none of these adjustments promises to be easy.
Consider the following lines in a Financial Times article dated 26th July, 2010 and titled "Chinese banks face state loans turmoil":
China’s banks are facing serious default risks on more than one-fifth of the Rmb7,700bn ($1,135bn) they have lent to local governments across the country, according to senior Chinese officials.
...Chinese banks lent a record Rmb9,600bn last year – more than double the new loans issued in 2008. But stern warnings by regulators for the banks to slow down lending appear to be having an effect on the economy.
Headline growth in China slowed to 10.3 per cent in the second quarter from 11.9 per cent in the first quarter, and loans to property developers dropped 62 per cent from the first quarter to Rmb121.6bn in the second quarter, according to figures from the central bank.
But analysts say the apparent success of the clampdown on lending disguises a worrying new trend that involves banks co-operating with lightly regulated trust companies to keep loans off their books.
As for Europe, the Bank Stress Tests excluded Sovereign Defaults and Assets held to maturity but given the Stock Market rally that began just before they were announced, the market seemed to overlook the flaws.
But there is one other worrying signal out there. The difference lies in how the market is viewing the near term versus the Economy six months from now. From an article in the Financial Times dated 22nd July, 2010 and titled "Volatility gauges suggest trouble is brewing", we read:
“Near-term uncertainty, through year-end, is falling steadily as monetary policy in most countries is squarely on hold, US bank reform is out of the way and funding pressures on non-core euro governments are softening,” said analysts at JPMorgan in a research note. “But farther out, uncertainty is not fading. Investors are starting to consider more seriously the risk that Europe and the US follow Japan into a debilitating deflation.”
The Vix became known as Wall Street’s “fear gauge” after surging to record highs at the peak of the financial crisis and amid dramatic stock market tumbles in 2008. In recent weeks, however, it has been falling, partly because concerns over the eurozone debt crisis are fading. But investors who rely on headline Vix, which measures 30-day S&P 500 index option volatility, are not getting the full picture of the potential outlook for the market.
More than six months ahead, investors are signalling severe caution, with the gap between current and future measures of equity volatility widening to a record. This also signals illiquidity in these parts of the derivatives markets – there are few traders wanting to bet future volatility will fall – causing prices to surge.
And that is precisely my concern too. The outlook that Mr. Bernanke phrased as "unusually uncertain," is very likely a reference to this hazy picture facing us some months down the line.
The thing to do then is to keep an especially close watch on several leading indicators. Some I mentioned earlier, but other good ones include The Conference Board's leading indicators, the Baltic Dry Index that indicates the health of International Shipping traffic, the Ceridian-UCLA trucking Index that measures Diesel fuel at Truck Stops across the US and the German Business Confidence Index.
All in all though, my best guess is that there's almost certain to be greater volatility ahead.
Rajnesh Domalpalli