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What could wreck expectations for a second-half economic recovery?
- Continued higher oil and gasoline prices that force consumers to cut spending elsewhere. With the summer driving season just about to start, I find it hard to see gas prices giving consumers much of a break before the fall. Rising gas prices also put a damper on consumer spirits, and a consumer worried about the future spends less in the present.
- Higher inflation that scares the Federal Reserve into stopping its interest-rate cuts before delivering the additional 0.5-percentage-point in rate reductions that Wall Street expects by June. Another 0.5 point in cuts would bring the Federal Reserve's target interest rate to 1.75%.
- Evidence that housing prices will keep declining past the end of 2008. Only 21% of the economists in The Wall Street Journal's poll predict housing prices will bottom in 2008; 67% pick 2009 for a bottom, and 12% are looking at 2010. I don't think Wall Street shares that pessimism. The rally in financial stocks in the first quarter of 2008 rests on a belief that the worst is over for mortgage-backed securities. If the drop in housing prices continues into 2009, however, some banks and nonbanks will announce new write-downs that aren't built into Wall Street expectations.
- More write-downs of debt from the banks outside the mortgage market. Credit card, auto loan and commercial loan defaults are climbing as the economy weakens. Just because write-downs of mortgage-backed assets are over -- if they are -- doesn't mean that Wall Street is out of the woods. In the first quarter, bank earnings took a hit as financial institutions raised reserves to handle problems in consumer and commercial loan portfolios. You can see how optimistic Wall Street is about an end to write-downs by looking at estimated earnings in the financial sector of the S&P 500. Projections now call for a drop in earnings of 38% for financial stocks in the second quarter as companies complete their write-offs. That swings to a 24% gain in third-quarter earnings as write-offs vanish.
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- A slowdown in global growth, just becoming visible now, gains momentum. I'm not talking about growth in economies such as China and India falling to zero or anything like it, but these economies do seem to be slowing. Growth in the case of India is now projected to fall to 7% in fiscal 2009, which ends next March, from 9.6% in fiscal 2007 and 8.7% in fiscal 2008. In China, economic growth has slowed from 11.2% in the fourth quarter of 2007 to 10.6% in the first quarter of 2008. The World Bank now projects 9.6% growth for all of 2008 and 9% growth for 2009. Most countries would kill for growth like that, but for China and India, it represents a slowdown with big consequences. In India, for example, an economy growing at 7% wouldn't create enough jobs for a rapidly growing work force.
- Rising U.S. unemployment takes a bigger-than-expected bite out of retail spending. The economists surveyed by The Wall Street Journal expect unemployment to climb to 5.6% by the end of 2008 from 5.1% now. Retail sales grew at an annual rate of just 0.1% in March, so it wouldn't take much to turn this number negative. And there's nothing that spooks Wall Street like a negative number on consumer spending.
We won't see any meaningful numbers to tell us how fast or slow second-half growth will be until the fall. So, until then, Wall Street will be forced to get by on rumor, wild extrapolations from unreliable data points and big emotional swings from giddiness to despair. None of that is the foundation upon which a bear-market-reversing rally is built.
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Jubak: Trouble in ChinaStocks in Shanghai are in the grip of the bear, with prices down 50% from their high. New rules haven’t calmed investors worried about a big jump in the supply of shares.
I'd be happy to see the market stuck in its current rut for the next few months. I'd bet that individual sectors such as oil and natural gas or metals stocks would do reasonably well in that period, even if the market as a whole went nowhere. And I've got Jubak's Picks positioned with good exposure to those sectors. That's why I've got the portfolio about 60% invested with an overweighting toward those sectors.
I'd be unhappy to see stocks start to sink simply because Wall Street decides that it can't live with this much uncertainty and starts repeatedly hitting the sell button, sending just about everything downward, so it can sleep better during the hot nights of summer.
I'd be unhappy. But I wouldn't exactly be surprised. Which is why I'm about 40% in cash.
Continued: Developments on past columns
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