San Juan Mountains

San Juan Mountains
San Juan Mountains: Grenadier Range

Friday, February 5, 2016

Unnecessary Pessimism Reigns Supreme In Stocks

As I write this the stock market is down more than eleven percent from the most recent high attained on July 20th of last year.  Normally I would not consider a run-of-the mill stock market correction worthy of a blog post but this one seems to stand out from the others due to the extreme level of pessimism associated with it.  This pessimism is tainting the economic eyeglasses of many people and causing them to say and do some very stupid things.  As I write this some economist at Citi has announced that the world economy is trapped in a "death spiral" that will lead to "a recession and a bear market."  A couple of weeks ago I read about how a noted economist and stock market forecaster was predicting an 80% drop in value for the domestic stock market this year.  Yet as all of these gloomy predictions and assertions are being made the folks making the forecasts are ignoring a tremendous amount of positive economic data.  Let me give you some examples.
  • In the Socialist Democracy of Amerika the Institute for Supply Management’s Non-Manufacturing Purchasing Managers’ Index (generally known as the PMI) dropped to 53.5 in January.  It was down from 55.8 in December.  In the UK, the Markit/CIPS Services PMI rose a little from December’s 55.5 to January's 55.6.  Any number above 50.0 for both indices is indicative of future growth.  The two indices were predicting somewhat slower economic growth in the SDA and somewhat faster economic growth in the UK.  How were those two data points received?  Bloomberg announced that, "Service industries expanded in January at the slowest pace in nearly two years, raising the risk that persistent weakness in manufacturing is starting to creep into the rest of the U.S. economy."  The Guardian interpreted the favorable data this way, "Samuel Tombs, the chief UK economist at Pantheon Macroeconomics, was not impressed with the latest numbers. 'January’s services report indicates that the UK’s economic recovery is a shadow of its former self.'"   When good news is called bad news you know the perspective of the interpreter is biased and distorted.
  • Among the many reasons cited for why the world economy is doomed to enter a "death spiral" is the low price of oil.  According to the Citi spokesman cited earlier, lower oil prices "would lead to Oilmageddon, a 'significant and synchronized' global recession and a proper modern-day equity bear market."  Jumping on the oil bandwagon, the Wall Street Journal reported, "With oil hovering at $30 a barrel and gasoline below $2 a gallon, the pleasure of lower fuel prices is turning painful for more of the U.S. economy. The problem isn't just the layoffs and the investment cutbacks in the oil patch, two effects that have been expected since crude oil began sliding back in 2014.  Worries about energy related bankruptcies and loan defaults also are helping to tighten financial conditions."   Now why should low oil prices cause a global recession?  The facts tell the opposite story.  Low oil prices are good for the world economy.  Here are the facts about energy:  1) the energy sector is only about 6.5% of the S & P market cap, 2) in the third quarter of 2015, energy contributed less than 5% of total S & P 500 earnings, 3) excluding energy, the S & P 500 earnings are still growing, 4) the four biggest banks exposure to energy ranges from 1.9% to 3.5% of total loans,  5) in 2014 oil and gas extraction comprised just 1.7% of GDP and, 6) oil and gas extraction accounts for just 0.1% of all SDA jobs. The only people hurting from the low price of oil are oil producers and related service companies.  For everyone else in the world low energy prices are an economic boom.
  • When it comes time to discuss the rate of economic growth around the world you would be forced to agree that we are soon to enter a death spiral if all you knew is what we are being told by the financial media.   How the media can look at the data and consistently come to the wrong conclusion mystifies me.  Do a Google search for "world economic conditions" and all you will read about is how growth is slowing or nonexistent.  All we are hearing about is the existence of some nefarious global slowdown that will harm us all in the near future.  You will find a chart, from the World Bank, showing the rate of economic growth around the world since 2006 here.  Notice that world economic growth from 2012-2014 has been right around 2.5%.  Early estimates of the rate of growth in 2015 are putting it at 2.5%.  Good estimates for the rate of growth in 2016 are around 2.8%.  Looking at another source of information, the world economy grew by 3.1 percent in 2015 and is projected to accelerate to expand by 3.4 percent in 2016 and 3.6 percent in 2017, according to the International Monetary Fund. So I ask you, where is the death spiral?  Economic growth around the world is holding steady or slowing increasing.  It is impossible to interpret the data in any other fashion but that is precisely what is happening anyway.
  • Last week I read a story about commercial and industrial loans that should have sent me running into the streets, screaming at everyone to run for our lives.  According to the article the rate of creation of new business loans declined by a small amount in January, giving us a clear signal that Great Recession II is just over the horizon.  I had to check this out for myself. Here is a Fed chart showing the total amount of commercial and industrial loans in the country through the middle of last year.  I fail to see how a small downtick in the total value of all outstanding loans in January indicates we are heading into a recession.  Neither should you.
                              https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=3mTs
                       
          Here is what it looks like when we enter a recession:

                             https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=2LD9
  • In one of the classic examples of self-referential reasoning, one of the most significant reasons we are expected to soon enter a recession is because the stock market is forecasting one.  Of course it is alleged that the stock market is forecasting a recession because the pundits have examined the data and concluded that it clearly points to an immanent recession.  But the data do not point to a recession.  The data indicate growth.  This only illustrates the old maxim that the stock market, and the day traders who move its price daily, has accurately predicted 15 of the last 3 recessions.  The present drop in the stock market is based upon presuppositional bias and pessimism, not economic reality. 
  • Another bizarre argument being presented in favor of the idea that the world is going into recession is that the strong dollar is inhibiting international trade, thus bringing about a worldwide recession.  How the relative strength of the various currencies of the world has anything to do with overall international trade and economic conditions is not explained.  It is true that relative differences in strength between the currencies of two countries can make the goods and services exchanged between them have different values but it does not follow that exchange rate differences inhibit trade.  Go here for my blog post discrediting that ridiculous idea.   The only thing that is true is that the dollar is strong, as this graph indicates:
                             https://research.stlouisfed.org/fred2/graph/fredgraph.jpg?hires=1&g=3jCG
  • All a strong dollar indicates is that the SDA is inflating its money supply less quickly than the rest of the countries of the world.  That is a good thing for the citizens of the SDA.  There is no indication that the strong dollar is inhibiting international trade.  Here is the total amount of world trade, reported in millions of US dollars, for 2010 through 2014.  2010: 15,150,000     2011: 18,077,000     2012: 18,123,000     2013: 18,412,000     2014: 18,580,000.  As you can see, it has grown every year.  Statistics for 2015 are not yet compiled although some of the preliminary observations indicate a slight decrease in overall trade. Most of that can no doubt be tied to recessions in some emerging markets nations (their economies are often connected to oil exports) and the economic problems with some European countries.  To asses the value of the argument that a strong, or strengthening, dollar inhibits overall world trade, let's examine the 1990s, when the dollar strengthened even more than it has in the last two years.  The best information I could find on this topic is found at this website.  Scroll down to the graph entitled "International Trade as a Share of GDP for a selection of Countries."  It is about halfway down the page.  Place your cursor on any of the ten countries starting in 1990 and watch how international trade expanded throughout the decade.  In theory, or at least according to today's wrongheaded theory, international trade cannot expand when the dollar strengthens.  History shows us the truth.  There is no connection between the strength of the dollar the the level of international trade.
I conclude that the present pessimism about the stock market is unfounded.  It follows that now is an excellent buying opportunity for stocks and stock mutual funds.  I would take advantage of that opportunity if I were you.

Update:  February 8, 2016

As I write this the stock market has opened down over two percent, despite the fact of Denver's victory in the Super Bore yesterday.  Some things make no sense at all.  The current market drop is being attributed to the fact that last Friday's jobs report showed growth in jobs as well as higher wages for workers.  What would normally be considered to be good news was corrupted and distorted into bad news by those who wouldn't know a strong economy if it jumped up and bit them in the face.  According to the naysayers the good news about the economy will result in the Fed raising interest rates which will have a negative impact upon the economy as we then would plunge into a recession.  Besides the bizarre counter-intuitive nature of that argument, it is also incorrect that rising interest rates are harmful to the economy or the stock market.  Go here for a post showing how utterly ridiculous that idea is.  The bottom line is that bad news is bad news and good news is bad news because the day traders who are moving the market are presuppositionally incapable of perceiving economic reality if it is positive in nature.  This will not go on forever.  Be patient and buy some more stocks if you have the money. 

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