Bullish Outlook

This week I am seeing steady declines in stock indices, Treasury bond yields are off and the dollar is strong. There are many possible explanations floating around (see the end of this post for a summary). For me the explanation not mentioned enough is that this pullback has been overdue. Until the beginning of May, the markets have been rising steadily one month after another since March 2009. There was always a question about when it would turn and rest. The problems in Europe are easy to write about as causes and the pissed off Greeks are easy to show in pictures. Headlines bringing up political problems from around the world are very easy to tie into the wall of worry in front of us. What is not so easy is to say that despite all the fires and uprisings around the world map, the businesses in the US still are healthy and growing revenues. Businesses in Europe have some steep challenges in front of them and they too will make hard choices and their businesses will be stronger (completely disregarding the pain that supports this result). Don't take your eyes off of China, although for the moment they are shadowed by the euro crisis. This is not the beginning of a return to the good old days.

I recently met and talked personally with two senior market strategists from two of the largest investment companies. Fritz Meyer was representing Invesco and Claus te Wildt represented Fidelity. I spoke with both of them, on different days, about their points of view on the US economy. My conclusion is that they are both near term optimists for the US economy and its stock markets. However, their outlooks separate from the other when getting to medium term outlooks, past 2012.

Fritz Meyer remains optimistic that the government will remain influential of the financial markets, allowing the consumer to recover financially and psychologically. Meyer asserts that the US saving rate will increase enough that domestic savers will actually provide demand, to a much greater degree, for US Treasury bonds. He agrees that there will be economic pain as a result of the growth of public debt and quantitative easing though he puts the timing down the road, ten or more years. I don't see any more than a 20% chance for that scenario happening and suspect his long-term optimism is framed by products at Invesco. On the other hand, Claus te Wildt sees markets breaking down under the weight of deflation and the burden of debt, government (public) and consumer (private) sooner, within the next three to five years. He worries that the bond buyers who currently are supportive of our public debt will end their support in some significant way leading to high interest rates, that the growth of corporate revenues will wain as personal consumption expenditures do not significantly add to GDP , and home prices may suffer a setback as the supply of housing remains high and new foreclosures are marketed. I give this scenario an 80% chance of occurring.

te Wildt's medium term caution and Meyers optimism were the focus of my questions for them. Fritz Meyers made a great case in support of his optimism so I asked him to comment on the economic conditions that he did not include in his discussion of his outlook. I referenced issues like the real condition of the banking system, without the benefit of accounting rule modifications. I pointed to the lack of resolution and transparency in the credit default swap markets as well as other financial derivatives. Meyer explained that he cannot address every issue in his presentation due to time constraints and that my concerns are valid. He simply believes there will not be any recurrence of financial panic with so much liquidity floating about. Hearing that te Wildt shares my deflation point of view for our underlying economic condition, I asked him how much gold is reflected in his personal investing. He told me it is 20-30% of his portfolio!!! He's serious about deflation. It's fun to gives odds on these two scenario's. What do I base the odds on? My own economic interpretation? I don't know.

Here is a concise summary of today's observations, from Bloomberg:

Another frightening session for the stock market as the S&P ended at its lows, down 3.9 percent at 1,071. Talk of a double-dip recession is bursting open, driven not only by questions over shifting European policy but also by a surprise jump in U.S. jobless claims which were stubbornly high to begin with. A dip in the index of leading economic indicators also didn't help and neither did a second big drop in mortgage applications for home purchases. A Wall Street reform bill that is moving through the Senate took apart financial shares on proposals to limit trading operations.

The euro swung wildly and staged a big afternoon short-covering rally amid rumors of central bank buying. The euro rose nearly 1 cent to end just below $1.2500. The dollar index in turn dipped 0.8 percent to 85.80. Long rates are being dramatically squeezed lower in what will be a major plus for banks, borrowers and home buyers. The 30-year yield fell 15 basis points to 4.10 percent. Commodities swung lower led by oil which fell nearly $3 to end just over $68. Gold, given its unique safe-haven value, looks to be the only commodity that will hold up should flight to safety continue. Gold did dip $10 in the session to $1,182.