Sunday, February 28, 2016

Byron Wein: There Won't Be A Bear Market

Our model (best guess) says no recession but is iffy on a 20% drawdown in equities. The S&P 500's undercutting of the August lows in both January and February gives one pause. Plus there's that Feb. gap that didn't get filled.

On the other hand, Wein is a very smart guy who's been at the market a very long time, i.e. Blackstone doesn't keep him around for his dashing good looks.
That all-time high on the S&P was 2134.72 so a 20% haircut is 1707.77.

From Barron's Wall Street's Best Minds column:

The Blackstone strategist writes that stocks will benefit from oversold conditions. But he’s no raging bull.
While I began this year with a cautious view of the financial markets, I did not expect the swift market declines that we have all experienced. At one point, the Standard & Poor’s 500 was down 10% year-to-date. The recent weakness is clearly supported by some serious economic problems which I will explore. My conclusion, however, is that we will not endure either a bear market or a recession this year, and I will try to defend that position in the course of this essay. 

In the current investment environment, it is easy to give up hope. Stock markets around the world have fallen sharply since the beginning of the year because of many factors. Monetary accommodations by central banks almost everywhere have done little to boost economies or arrest the plunge in equities. Investors are so anxious to hide from risk assets that they have pushed yields in developed markets down to extremely low levels or even negative rates. Designed to encourage consumer spending and bank lending, negative rates have some positive effect in the short term, but the long-term benefits are not clear. While the data on the performance of U.S. and European economies indicate that modest growth is continuing, the fear is that turbulence in the financial markets will cause businesses and individuals to curb their spending and a global recession will begin later this year. The fact that manufacturing is already in a recession in key areas raises the question of whether other sectors of the world’s economies are strong enough to keep even slow growth alive.

Perhaps it all started with China. While official numbers reported suggest strong growth is continuing, almost every observer believes that a slowdown of some significance is taking place there. The negative view is supported by data on exports, imports of raw materials, electricity consumption, retail sales and capital spending. 

The good news is that the Chinese economy is rebalancing. Growth was too dependent on capital expenditures for state-owned enterprises and infrastructure. Debt incurred to fund those projects had increased to unsustainable levels and there was concern that the banks held many non-performing loans. The economy could not continue to move forward on that basis; consumer spending had to overtake capital spending as it has in most western economies.

This process is underway, but during the transition period and perhaps beyond, growth will slow. An expectation that the second largest economy in the world will continue to grow at seven percent is unrealistic; four to five percent is more realistic. China’s growth is critical. When it was growing at seven percent, it accounted for 25% of the increase in world GDP. China is still creating more than ten million jobs annually, bringing people out of the agricultural countryside and into challenging but more financially rewarding urban settings. Its current leader, Xi Jinping, is determined to purge corruption from the leadership ranks. The Chinese population is supportive of the current regime and that is an important positive. If the fiscal and monetary stimulus program falls short, a devaluation of the currency may be used to stimulate exports. Many, including myself, expect that to happen later this year, but lately the authorities have been using China’s considerable foreign currency reserves to prop up the yuan. This effort caused the yuan to rally sharply in February and, as a result, China’s $3 trillion plus in reserves is being drawn down $100 billion a month.

The decline in the price of oil may be the major factor causing the current financial market volatility. Initially, lower oil prices were viewed as an economic positive. Consumers would have more money to spend, retail sales would improve and real growth in developed economies that import oil would increase. As it turned out, only half of the money saved at the pump was spent elsewhere; consumers paid down debt with, or banked, the other half. The more worrisome aspect of the decline in the price of oil was its impact on capital spending and the credit markets. The rig count dropped by 70% and the bonds of marginal exploration and development companies collapsed. This raised questions about the financial condition of some of the major lenders to the energy industry, causing financial stocks everywhere to suffer declines. In Germany, Deutsche Bank stepped in to buy $5.4 billion of its bonds to prove its financial condition was “rock solid.” Still, investors expected some of the major established energy companies to cut their dividends....MORE