Wednesday, December 21, 2011

Take a Walk on the Dark Side of Macro Expectations With Andrew Smithers

From the Capital Spectator:
Take A Walk On The Dark Side Of Macro Expectations
In the great debate about whether there’s another recession heading our way, economist Andrew Smithers, head of Smithers & Co. and author of Wall Street Revalued, weighs in with a persuasive argument that the year ahead will be no stranger to risk and so it’s premature to dismiss the idea that a new downturn is lurking. A persuasive argument isn’t always the same as fate, but regardless of your macro outlook it’s helpful to consider an array of opinions if only to stress test your own convictions. The world is awash in forecasts, of course, but Smithers’ take strikes me as valuable for framing the linkages in markets, politics, and the economy. It’s a thankless task, of course, but someone’s got to do it and he does a commendable job in a new research note sent to clients today.

The foundation for Smithers’ concern is his claim that "the US stock market is seriously overpriced and profits are almost certain to fall over the next few years as a necessary condition for fiscal retrenchment." The calculation is based on two metrics that Smithers favors: the so-called q ratio and the CAPE metric (you can find some background information on these measures here.)

Smithers goes on to warn that the rate of decline in corporate profits will be closely linked with "the speed at which budget deficits are reined in" for the U.S. Good luck with that. If the latest round of political dysfunction in Washington regarding the payroll tax is any indication, corralling the deficit challenge looks set for a long and winding road and an uncertain outcome.
Even more byzantine complication awaits, Smithers continues:
Thereafter the path of US fiscal policy will depend on the outcome of the 2012 elections. These involve massive uncertainties: (i) the policies, if any, on which the election will be fought, (ii) the result of the voting, (iii) the policies that the parties will espouse after the election and (iv) the policies that will be agreed between the new Administration and the new Congress.
Add that risk to the eurozone mess and "there is clearly a significant risk that the developed world will fall back into recession and that there will be a sharp fall in world stock markets," Smithers writes. But all's not lost, he adds, anticipating that 2012 will bring slow growth rather than an outright contraction....MORE