U.S. Economy Better Days Ahead?

By: Puru_Saxena

BIG PICTURE – Over the past month, US economic data has surpassed analysts’ expectations and this positive surprise has triggered a rally on Wall Street. 

You may recall that only a few months ago, the investment community was worried about Europe and many were questioning the survival of the single currency.  During that period, investors were dumping all sorts of risky assets and capital was flowing towards the world’s reserve currency and the most liquid government bond market.  Back then, European leaders were desperately trying to find a solution to the debt crisis and policymakers were engaged in what seemed to be never ending talks! 

Then, a few weeks ago, the European Central Bank extended massive loans to troubled European banks and that seemed to calm the market.  Based on this development, risky assets found some support and the downtrend was neutralised.  Although the European Central Bank’s secret bail-out is not a real solution to the European crisis, at least it has managed to temporarily remove the risk of a serious banking crisis.  Perhaps this is why investors have decided to bid up the prices of stocks, high yield bonds and commodities.

More recently, the Federal Reserve announced that it will keep interest-rates at near zero for at least another 3 years!  This surprise news also excited the market and once again, risky assets were bid up by investors.  Unsurprisingly, the world’s reserve currency weakened on this policy action and it appears as though the world’s fever chart has topped out for now.  Figure 1 shows that the US Dollar Index peaked a couple of weeks ago and it has now broken below its support level (blue line on the chart).

Figure 1: World’s fever is declining!

Source: www.stockcharts.com

Look.  This is an extremely challenging investment climate because the deflationary forces of private sector debt contraction are colliding with the policymakers’ inflationary efforts. During this recessionary, low-growth environment, asset prices have a natural tendency to deflate.  However, this deflation is being countered by unprecedented monetary and fiscal policies.  Thus, asset prices are gyrating wildly and there is no clear long-term outlook.

Turning to the current situation, it is worth noting that the investment environment has improved significantly when compared to the last quarter.  For example, the world’s reserve currency seems to have topped out, credit spreads are narrowing (Figure 2), the 3-month LIBOR has declined marginally and money is coming out of ‘safe haven’ assets. 

Figure 2: The credit market is less fearful

Source: www.thechartstore.com

Elsewhere, it is notable that the Euro is rebounding sharply, commodity prices are rallying and global stock markets are consolidating their recent gains.  Thus, at least for now, it appears as though the expansionary monetary policy is emerging victorious and the bears may have to hibernate over the following weeks.

Turning to the real economy, it is notable that recent US data has been better than expected.  For instance, housing starts and permits have ticked up, orders for durable goods are holding strong and even the ECRI’s Weekly Index Growth Rate has improved (Figure 3).

Figure 3: Improvement in ECRI’s forward looking indicator

Source: www.fullermoney.com

You may recall that the ECRI has been forecasting a US recession for several weeks now, and one cannot argue with its stellar track record.  Nonetheless, with the recent uptick in its Weekly Leading Index Growth Rate, we are beginning to wonder whether the ECRI has been wrong about the severity of this economic downturn.  Unfortunately, we are not economists and do not know whether the world’s largest economy has managed to avoid a recession.  However, judging by the recent price action in the various financial markets, it looks as though investors have decided that 2012 will not be a recession year.   

Recession or not; one thing is certain and that is the fact that the US is in an election year and historically, this has been a good time for Wall Street.   It is interesting to observe that out of the last 21 election years (since 1928), there have been only 3 instances where the S&P500 Index produced a negative return.  Now, this does not guarantee that this year will be good for Wall Street, but the odds are certainly stacked in favour of such an outcome.               

After all, Mr. Obama will do everything in his power to get re-elected.  Therefore, it is conceivable that he may announce additional measures to ‘stimulate’ the economy.  In our view, Washington may unleash a new program to help distressed homeowners (good for votes) and this could certainly ignite festive spirits on Wall Street. 

Whether you like it or not, global stock markets are gaining momentum and the trend is up for now.  Currently, a number of stock markets in Asia, Latin America and Europe are trading above the 200-day moving average and even Wall Street has managed to climb above that critical level. 

Figure 4 shows the weekly chart of the S&P500 Index.  As you can see, the S&P500 Index has climbed above its prior high and it has also broken above overhead resistance (blue line on the chart).  More importantly, its 200-day (40-week) moving average has stopped declining and this is a favourable development. 

Figure 4: S&P500 Index – above prior high

Source: www.stockcharts.com

In summary, given the recent policy intervention, the probability favours the continuation of the uptrend in risky assets.  Obviously, we cannot forecast the duration of this uptrend but we do know that as long as prices stay above the 200-day moving average, the path of least resistance will be up.

For our equity portfolio, we have already identified several growth stocks which we have recently bought and for our fund portfolio, we have re-allocated capital to our preferred investment themes (China, India, developing Asia, Latin America, energy and precious metals).  It is our contention that unless a major credit event occurs in Europe, risky assets will continue to benefit from the ultra-expansionary policies being adopted by most of the world’s central banks.

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets.  In addition to the monthly report, subscribers also receive “Weekly Updates” covering the recent market action. Money Matters is available by subscription from www.purusaxena.com. 

Puru Saxena

Website – www.purusaxena.com

Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients.  He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.

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