Digest of recent pundit writings counters view of Joseph Stiglitz that consumers are out of bullets

May 24, 2010 — 4:31 AM UTC by Brooke Southall


Many experienced advisors and investors believe that the markets of 2008 and early 2009 were a once-in-a-generation nightmare. Even if volatility continued, many thought, the worst was behind us.

Sharp corrections like the one that shaved 376 points off the Dow Jones Industrial Index last week call that presumption into question. With my own nerves jangling a bit, I decided to take a look at as many informed opinions as I could over the weekend about where we’re headed.

I ended up finding an assortment of opinions from market strategists at Charles Schwab & Co and Fidelity Investments. I also found opinions in Barron’s, Seeking Alpha and RIABiz.

The good news: a surprising number of the pundits are optimistic that the worst is behind us, based on economic indicators indicating the recovery is gathering strength. But, there was one important caveat, from the biggest heavyweight among the thinkers whose words I consulted.

Consumer is spent force

“American households will not soon return to their profligate ways,” said Nobel-prize-winning economist Joseph Stiglitz in a speech covered by RIABiz. He pointed out that American consumer spending has been the Atlas of the world economy for the past several decades. He predicted that Europe would export a recession across the Atlantic.

Of course, something out-of-the-ordinary has been going on for the past month. This hasn’t been a plain vanilla correction, according to Dirk Hofschire, vice president of Fidelity’s market analysis, research and education group, writing in a May 20 report on Fidelity’s web site: “A correction is unsettling, not unusual.”

The overall stock market took only 27 days to lose 10% of its value. That rate of decline is twice as fast as the rate at which, historically, the average correction occurs: 54 days, he says.

But does that indicate this correction is the beginning of a 2008-style horror? Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., and Brad Sorenson, director of market and sector analysis, Schwab Center for Financial Research say no. In a report, “Market perspective: Volatility on the rise”, published on Schwab’s website on May 14, they explain why this situation is quite different than the one the markets faced in 2008:

This crisis doesn’t look very contagious

First, the 2008 crisis centered on the massive US housing market and financial institutions, while the current one is overseas in relatively small countries. While there are concerns the European debt crisis could still spread, it seems after recent actions that the European Union, the European Central Bank (ECB) and the International Monetary Fund (IMF) are, at least for now, committed to keeping that from happening.

Second (and perhaps more important), it’s clear that both the US and global economies are well into recovery, and even expansion mode. The financial crisis in 2008 was certainly exacerbated by the global economy sinking into recession.

Among this crew, Stiglitz is the lone voice of pessimism. Is that because he has a broader view? He expressed skepticism that the recovery has the underpinnings to be trusted in his speech at the Orlando conference of IMCA on May 16.

Foreclosure rates are still rising, and Americans have retreated from their free-spending ways, with savings rates in the range of 5% — still not up to their historic levels. What if American consumers don’t step up to the plate again?

That’s where the problem arises, he says.

He described the box that the governments of Europe and the United States find themselves in. Monetary policy has been exhausted; the remedies of fiscal policy are coming to an end. Almost as an aside, Stiglitz gave credit to the government stimulus, saying that without it the unemployment rate would have peaked at 12% instead of 10%.

But now, governments face huge deficits without many tools at their disposal. If they increase taxes to reduce the deficits, growth will slow, and the deficits will be reduced less than expected.

Death spiral

“This is reminiscent of the Argentinean death spiral,” he said.

The words “death spiral” certainly articulate my fears and best describe my feelings of last Thursday.

But that bad feeling may bode well, according to Michelle Gibley, senior market analyst, Schwab Center for Financial Research. In her column on May 21, “Schwab’s Perspective on a Difficult Week”, Gibley wrote:

The potential good news is that optimism has been quickly been replaced with pessimism, and as sentiment is a contrary indicator, the best market returns typically come when pessimism is elevated. While the most oversold, high beta areas of the market are likely to rebound the most on a short-term bounce.

Meanwhile, Sean Maher, a London-based economist and strategy consultant who publishes Dead Cats Bouncing, a markets analysis service, casts doubt that the US economy is in the grips of anything resembling a death spiral in the piece he published on May 21 in Seeking Alpha:

Negligible double-dip risk

So is the global recovery stuttering? Is deflation looming in the US? No, investors have suffered one of their periodic manic-depressive episodes and not much has really changed in the real world. Certainly, leading indicators are losing momentum as is typical at this point in a recovery, but the risk of a renewed slump into recession is negligible; the endless squabbling among eurozone governments hasn’t helped soothe nerves, but Europe has been an incoherent political mess forever, and its citizens and companies just get on with life.

Neither do Schwab’s Sonders and Sorenson see the economy on the precipice of being swallowed up by debt:

Economic growth can help address many of these debt problems without [governments] resorting to onerous spending cuts or tax hikes—although that time is well past for Greece. In the United States, the economy has moved from recovery into expansion.

Leading Economic Indicators have risen for 12 straight months, and the yield curve (the difference between short- and long-term interest rates) remains historically steep—a good indicator of economic expansion in the past. Additionally, both the Institute for Supply Management Manufacturing Index and Non-Manufacturing Index continue to post robust readings.

Macroeconomics aside, are stocks overvalued? Michael Santoli, Barron’s Streetwise columnist, suggested that that is not the case in his Saturday contribution to the Dow Jones weekly.

Low stock multiples again

The U.S. market’s valuation based on expected 12-month forward earnings is right back where it was at the February low. Binky Chadha, chief strategist at Deutsche Bank in New York, notes that each of the market retreats since March 2009 ended with the S&P 500 forward multiple right near today’s 13.

So, if the rules that covered market rhythms for the past 14 months still apply, the signs offer some comfort for those still in the market, and in fact suggest the makings of at least a sharp rally soon. Again, if.

Does the severity of the recent correction itself suggest that there is cause for deeper long-term concern?

Hofschire writes optimistically that this correction has all the hallmarks of being just that – a correction:

The strength of the economic recovery during the past year, particularly in the United States and Asia, has continually surprised on the upside. While that momentum will undoubtedly slow, it does not automatically mean a reversal back to global recession.

Abrupt, painful and normal

Second, while the stock market correction so far has been abrupt and painful, it actually has been relatively typical of what might have been expected to happen given historical patterns.


  • Timing of correction was typical. It’s been about 14 months since the current bull market began on March 9, 2009, which is in the neighborhood of the average length of time that has passed from the start of prior bull markets to a first correction (17 months, see table).
  • The early bull market’s gains were above average. The stock market gained 80% before the recent correction. Historically, the first correction in a bull market has come after average gains of 57%, implying the current bull market was overdue for a correction on a price appreciation basis.

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