Ceteris paribus, US equity markets are cheap.

Using trailing earnings (see Q2 Earnings Recap) and 3.6% inflation, fair PE of 16.6x by the Rule of 20 should bring the S&P 500 Index to 1507, 27% higher!

In the good old days, that is less than 12 months ago (Market Valuation), the math would be sufficient to jump into equities. Forget the various economic scenarios, the “on the one hand, on the other hand”, and this and that. Compelling valuation is compelling valuation.


In case your latin is rusted, “ceteris paribus” means “everything else being equal, constant”.

Unfortunately, nihil paribus. Read on.


Odds of a recession are rising throughout the developed economies. The folks at ISI, arguably among the best economists around, are now forecasting global GDP growth at 2.0% in Q2 2012 (consensus is 3.0%), while acknowledging that their dire forecast has downside risk given the rising fiscal drags.

Developed economies are forecast to grow by 0.6% in Q2 2012. US GDP growth is seen at 2.2%, with the same caveat due to the increasing fiscal drag. Recession odds in the US are now 40% for ISI, up from 30% in early August. They see the UK and the Eurozone in recession next year (-0.5%) and Japan at 0%.

Emerging markets GDP is estimated at 4.5%, down from 5.3% currently. China is forecast to keep growing but at a slow 8.0-8.5%, assuming inflation peaks out soon.

The recession odds for the US are substantially higher than at this time last year when the Fed launched QE2. Can we reasonably think that it can be avoided?


The Chicago Fed Index, which incorporates 85 economic indicators, is offering some hope.


However, the recently revised Q2 US GDP is +1.5% YoY. As the chart from Bloomberg’s Steve Yamarone shows, when real GDP YoY growth slips below +2.0%, a recession generally follows.

Ben Bernanke’s Jackson Hole speech reminded politicians that they are on the front line and that they need to act. The Fed is only there to support. It remains that most governments around the world are in a tightening mode… The big hope, for many, is that much of the recent poor economic data is due to the US debt ceiling circus and the US downgrade by S&P.

Wishful thinking in my view, much like the Japan tragedies and the rise in oil prices provided a false feeling of a “temporary” soft patch last spring. I dismissed that notion in my June 6 post THE ECONOMIC AFTERLIFE, demonstrating that we were in fact transiting towards something that was nowhere near a more cheerful economic life.


Most PMIs recently turned negative as this WSJ chart shows:


Careful readings of each survey results since last May were revealing that the foundations were eroding rapidly. New orders turned weak in May just about across the world. They generally turned negative in June with confirmation from the July US PMI which fell below 50 for the first time since June 2009. Similarly, the Eurozone July PMI abruptly fell to 50.4 with very weak new orders spreading throughout the continent:

Manufacturing new orders in the Eurozone declined for the second month running, and to the greatest extent for just over two years. Almost all of the nations covered saw a drop in new work received, with only a marginal increase in the Netherlands bucking this trend.

The decline in total new orders partly reflected a lower intake of new export work, as new export orders fell for the first time in two years. The steepest reduction was in Germany (…)

The July Global Manufacturing PMI fell to 50.6 as

levels of incoming new business declined slightly for the first time in over two years.


The August Eurozone Composite PMI had this observation:

Weaker growth of services new business (the smallest rise since September 2009) was accompanied by the fastest drop in manufacturing new orders since June 2009 (and the third successive monthly decline). Manufacturers reported that new export orders had fallen for the second month running, with the rate of decline also the fastest since June 2009.

On August 23rd, the Richmond Fed survey moved further into negative territory.

Looking ahead, manufacturers’ optimism regarding future business prospects dropped considerably in August. An increasing number of firms anticipated slower growth across the board for all future activity indicators.

ISI now estimates that the US manufacturing PMI will fall to 47.5 in August from 50.9 in July.

China PMIs have also been weakening since the spring, also accompanied by weakening trends in new order inputs.

Obviously, global final demand is seriously declining.


Speaking of final demand, US real retail sales remain substantially below their 2007 peak and have been flattening lately. In fact, ex-gasoline real retail sales per capita remain 11% below their January 2006 peak, standing at the same level where they were 13 years ago! (see Doug Short’s chart below)

FRED Graph

Click to View

Real retail sales are just as weak and depressed in Europe:


Until we see an upturn in real consumer demand, recession risks will remain elevated, to use Fed speak. We are into the back-to-school season and sales appear soft, a bad omen for the all important year-end sales.


But, can we rationally expect consumers to come to the rescue of ailing world economies?

  • Employment trends remain weak. That will be exacerbated by increasing fiscal drags in Europe and the US.
  • US inflation has yet to peak out.
  • US gasoline prices have not declined with WTI prices which remain 15% higher than a year ago. Yet, sharply lower oil prices could significantly contribute to increased consumer spending as we head into the the fall and winter.

  • The debate on the US debt ceiling has alerted Americans to their fiscal challenges, but also to the alarming level of ideological brinkmanship and narrow mindedness among politicians. Nothing conducive to dissaving, quite the opposite.
  • House prices remain weak.
  • The ECB has raised interest rates twice last spring. I doubt that they will quickly acknowledge their mistake and cut rates amid the current debt crisis.
  • Equity markets have declined some 15%, eroding the confidence and purchasing power of wealthier people. The S&P 500 Index is within 100 points of entering a bear market.
  • Interest rates are so low that interest income has dropped to the point where many retirees must meaningfully reduce their standards of living.

The US employment problem is well known but misunderstood as we will see below. Slow job growth has been compounded by stagnating real wages. Since 2002, real wages have grown at a 0.3% annual rate. They have actually declined 0.6% since January 2009. Median pay raises were flat in 2011 and are expected up 3% in 2012, still below the inflation rate currently at 3.6%. The number of Americans on the USDA food stamps program has jumped 66% since October 2007 to reach 45 million people, 15% of the US population up from 9% in 2007!



As Doug Short’s chart reveals, real disposable income has stagnated during the last 4.5 years.

Click to View

Clearly, absent governmental support, the consumer is in no position to boost the economy, even more so given his own financial condition and weak housing prices.


  • Employment by all levels of US governments peaked in April 2009, right on cue with the launch of massive fiscal stimulus (!). Since then, government employment has declined 2.8% or 647,000 employees (24k average per month), more than offsetting private employment gains of 456,000 (+0.4%) during the same period. So far in 2011, private employment is up 1,148,000 and government employment -218,000 (31k average per month).
  • Political wisdom and leadership is totally absent.
  • Monetary authorities may well be prepared to act but their tools are limited in scope and in power. Moreover, the Fed’s economic assessment has been quite poor in recent years. Their September meeting has been extended to 2 days. Will that help? Hopefully, the additional day will enable FOMC members to bond more homogeneously. Ben, the US and the whole world sure need a united Fed (see THE BERNANKE PUT? DON’T BET ON IT!).

US governments and private employers shed a total of 8.66 million jobs in 2008-2009. They have since reemployed 1.87 million workers (22%) but 88% of these re-employed people work in only five of the BLS’ fourteen major classifications. And yet, these 5 groups have recovered a mere 28% of their 2007-09 losses.


Governments, Finance, Construction and Information account for nearly 30% of total jobs in the US. Governments have been firing more than 31,000 employees per month in 2011 while the other 3 groups have only stopped declining.

Private American corporations are currently employing 6% fewer employees than at the end of 2007. Yet, real GDP is up 0.5% and after tax corporate profits are up 61% per the national accounts, +10% for S&P 500 Index companies.

The Liscio Report last May:

(…) seven quarters into the recovery, profits are up 54%, and employee compensation, not quite 5%. (That’s total compensation, not average wages.) The ratio is about 12-to-1—four times the historical average. In the previous expansion, the ratio was 10-to-1. In no previous recovery did it exceed 4-to-1. Whatever you think of the justice of this arrangement, it doesn’t seem either economically or politically sustainable. Would-be budget cutters should think carefully about the distributional effects of what they’re contemplating.


Nonfarm business productivity has gained 7.8% since 2007. So while corporate profit margins are close to their all-time high, labor’s share of corporate income is at a 65 year low (no prior data).



To summarize, corporate America is highly profitable and financially very sound while the country is economically stalled and financially strangled. Governments at all levels are struggling and firing people to restore their finances while corporations remain excessively budget prudent and pile up cash. Their big productivity gains are not shared with labor at a time when the economy truly needs higher consumer spending to keep corporations busy. Yet the same corporations which, with their management, strongly benefitted from the global bailout of 2008-09, are asking politicians to find ways and means to restart the economic engine.

Meanwhile, Congress and the Senate, each controlled by ideologically blinded extremists, are effectively stalling the recovery process. The President, for his part, is too weak to put forward a credible plan that he could sell directly to the people.

Cutting personal taxes in the US is like pushing on a string since 50% of Americans currently pay no federal taxes. Raising taxes to cut the budget deficit would clearly aggravate the problem, unless it only impacts the truly wealthy.

The reality is that employment and real income need to rise, quickly.

Private employers are adding 165,000 jobs per month in 2011 but state and local governments are shedding nearly 30,000 employees each month. Finance and construction are frozen by the continuing housing mess. Any stimulus program that does not specifically and effectively address state and local budget deficits and finance and construction industries is unlikely to boost the employment engine.

Real wages are another problem. New job programs should target higher paying jobs and incentivize corporations to share their increased wealth with their employees.

Shorter term, the upside is with lower inflation, particularly food and oil prices. A meaningful slowdown in inflation would quickly restore real discretionary purchasing power, just in time for year-end consumption. Why aren’t gas prices falling in line with oil prices? The last time WTI was at its current $85, pump prices were in the $3.00 range, 17% below current levels. It’s not because demand is so strong…

All said, even though equity markets are cheap the sad thing is that the economic outlook is quite poor with little visibility, economic, fiscal, monetary or political. Given that better prospects are highly dependent on quick and effective government actions, high caution remains warranted given what monetary authorities and politicians have shown us during the last 2 years.

Forty percent odds of a recession, rising fiscal drags, little obvious ways out, no political leadership, apparent dissensions at the Fed, a stubborn ECB, potentially rising social tensions because of the large income inequalities between corporations and labor and between rich and poor. Careful out there, ceteris definitely not paribus!

In closing, John Liscio’s chart and comments in his May 2011 report are worth reflecting upon:

People may differ on the fairness of this situation. But you do have to wonder how sustainable it is. Can an economy dependent on high levels of mass consumption—and one whose political stability may also depend on the same— continue to carry on if there’s no outlet in easy credit? Or will it require structural changes of the sort almost no one is thinking or talking about?


Cogito ergo sum, cogito ergo doleo.

Caveat emptor. Cogita ante salis.

Cura, ut valeas!



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