By Jon D. Markman
Stocks rebounded late last week with about as much sincerity as a six-year-old eating broccoli. And the modest advance may have distracted the public from an erosion of faith in the early-year rally on the part of big fund managers.
Despite a resolution of the Greek debt swap and an improvement in U.S. payrolls, the perception of risk actually increased, as measured by an increase in the price of credit default swaps on U.S. banks, according to data assembled by CheckRisk, a U.K. research firm.
Institutional investors were happy to see more people employed and the Greece fiasco calmed, but fears intensified that employment growth remains anemic by postwar standards and that the European sovereign debt drama is simply transitioning to a new chapter, not ending.
Global economic data is darkening, the way they see it, with risks tilted toward deceleration. It was shocking for some to see China's trade deficit widen the most since 1989 as exports grew 18.4% (vs. the +33.4% consensus) while imports grew 39.6%. The data suggests China is struggling to fill its factories with goods to sell recession-crippled customers in Europe.
Moreover, the potential for oil prices to persist at their present high levels is ratcheting up the risk meters. Israel may well launch a pre-emptive strike on Iran to prevent further nuclear weapon development this year, a move that would send crude oil future prices over $165 per barrel even if the U.S. opens its strategic reserves and Saudi Arabia promises to produce more. A NATO attack on Syria to prevent sectarian slaughter, while welcome, would also disturb the oil market.
Brent crude is already at $125 a barrel, while West Texas Intermediate is at $106. Prices this high are not in economists' or investment analysts' models this year, so if they persist even at these levels GDP and earnings estimates will have to come down.
Bottom line: Since stocks are not overbought following the recent dip, they can stabilize now even as risk perceptions tighten. But it would not take much to send them back over the edge.
Now, I know we all like to look on the bright side -- I do, anyway -- but let's take a quick look at exactly why markets were spooked in the first place early last week.
-- There has suddenly been a rush in Congress to pass legislation that could push the United States into a trade war with China with bipartisan support.
-- Lakshman Achuthan of the Economic Cycle Research Institute told clients last week that his firm's long leading indicators show "pronounced, persistent and pervasive" signs that the U.S. economy has lost traction and threatens to slide back into recession.
-- Fed chief Ben Bernanke sold Congress last week that the U.S. faces a "massive fiscal cliff" at the end of 2012 as tax cuts expire, the government cuts $110 billion under sequestration rules and new Medicare taxes begin.
-- Many economists see the potential for 1.5% to 2% GDP growth this year, but that's just barely a heartbeat. It's essentially a stall speed from which the U.S. economy typically tips into recession. It was a lot like this at the start of 2011, but at least back then corporate profits were rising instead of peaking.
-- Europe is choking on a lack of corporate and consumer credit. The European Central Bank's three-year lending facility, known as LTRO, averted a sovereign debt collapse in Spain and Italy via an injection of 550 billion euros into banks, but it has not revived lending. Banks have used the money to buy government bonds and park them and the remainder of their funds back at the ECB. It's prudent to save for a rainy day, but the point is that in the meantime the amount of money in circulation in southern Europe is collapsing.
-- Over in China, meanwhile, home sales are down sharply from last year, as is electricity use and steel production. A prominent Credit Suisse analyst is arguing that the "golden age" of infrastructure investment and policy stimulus is over now.
-- Brazil reported last week that its economy grew around 2.7% in 2011, less than half the rate the government predicted a year ago. And industrial production fell 2.1% in January. The country's central bank is cutting rates in an effort to spur growth.
So far investors are shrugging all of this off. And it is their prerogative. The cliche we can all repeat in our sleep is that bull markets rise along a wall of worry. Fine. But we still need to distinguish between the benefits of a liquidity flood and the deeper crisis of deleveraging and fiscal cutbacks underneath.