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Kass: Get Ready for the Fall

The Near-Term Global Economic Outlook Is Growing Cloudy

The fundamental global economic outlook is growing murky.

Far more important to me than technicals and sentiment is that the recent market advance has taken place despite continued ambiguity regarding the trajectory of global economic growth.

Since the June 1 low in the U.S., 52% of domestic economic data has been below expectations, 11% has been in line, and 37% has been above expectations.

On Friday, the ISI Group's company survey came in at the lowest level since December 2011, and importantly, its company survey diffusion index deteriorated to levels lower than the trough levels that were hit in the summers of 2010 and 2011.

The just-completed second quarter U.S. corporate profit picture represented a clear trend of decelerating growth in both earnings and sales.

While there have been some recent signs of economic stabilization (e.g., July retail sales, leading economic indicators, production), the initial August readings of manufacturing activity in New York and Philadelphia are not encouraging. Considering the seven-week rise in gasoline prices and the continued squeeze on corn prices and on other food prices perhaps a reversal from the better July readings is a reasonable expectation. As well, with inventory growth running well ahead of end market sales, a last half of the year de-stocking also seems plausible and represents another challenge to domestic growth.

Meanwhile, as I will discuss later in this series, the outlook for growth in China and the eurozone is weakening.

This leads me to believe that the recent market rally has been anything but fundamentally based and mostly everything to do with hopes for further global easing. (More on the myths of quantitative easing shortly in the next section.)

Jeremy Grantham's (co-founder of Grantham, Mayo, Van Otterloo & Co.) recent comments below closely embody and are aligned with my own fundamental views:

Most of the more optimistic calculations and estimates that I see are based on the assumption that we will do just that, that we are homo economicus (just as in investing): rational, smart, well informed, well-intentioned, and incorruptible. Well, it just ain't so. We are badly informed, passionately prefer good news, and easily evade unpleasant facts; our views are easily manipulated by vested interests; we are sometimes desperately inefficient; and we are apparently corruptible as heck....

The economic environment seems to be stuck in a rather unpleasant perpetual loop. Greece is always about to default; the latest bailout is always about to save the day and yet never seems to; China is always about to collapse but instead teases us by inching down; and I swear the Financial Times is beginning to recycle its reports! In the U.S., the fiscal cliff looms along with debt limits and the usual election uncertainties. The dysfunctional U.S. Congress continues for the time being in its intractable ways. The stock market rises and falls and rises and falls again. It is getting difficult to find anything new to say at client meetings. I, for one, wish that the world would get on with whatever is coming next.

One slight change, though, is that fantastic (almost unbelievable) profit margin and earnings gains have finally weakened a little. They, together with Bernanke's super low rates, have been the twin pillars of the market and not bad ones at all: here we are up 8% (make that 11% now) for the year in a thoroughly unsettling financial and economic world. With margins weakening, one of the twin pillars is looking shaky and price declines look more likely than before.

The Myths of Quantitative Easing

There seems to be an almost universal view in the business media and on the part of many investors that quantitative easing boosts all asset prices and has a positive wealth effect, improves the housing market and buoys economic growth, lowers interest rates, improves employment, and simultaneously fails to cause inflationary fears and pressures.

In fact, recent jawboning by the Fed and by European leaders and central bankers is seen as almost singularly responsible for the recent rally in stock prices.

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Chart of I:DJI
DOW 17,773.64 -57.12 -0.32%
S&P 500 2,065.30 -10.51 -0.51%
NASDAQ 4,775.3580 -29.9330 -0.62%

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