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March 23, 2007
Coming Soon To A Market Near You -- ‘The Landing’
As tempting as it is to join Professor Roubini’s call for a U.S. recession, it is possible that the recent eruption of volatility in the financial markets does not foreshadow pending recession. This is the case not only because volatility in the markets has quickly receded (like it did following the GM/Ford downgrades and the collapses of Refco and Amaranth), but also because a bevy of historically cyclical equity issues are not signaling tough times ahead.
To note: this is not to suggest that yield curve inversions, subprime blowups, and weak economic reports should be ignored, only that it may be presumptuous to speculate that U.S. economic activity will contract in 1Q07 or 2Q07. As for what may happen in the second half of 2007, that is open for debate.
Stock Prices Stirred But Not Shaken
Financial stocks started to sell off in late February, with the KBW bank index (formerly Philadelphia bank index) briefly sinking below its 200 day-moving-average. However, despite ongoing subprime woes the bank index has closed above its 200 DMA in each of the last four sessions.
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Another less obvious area worth keying on for slow down clues are stocks that produce the packages that embrace products around the globe. Logic being that as less demand for packages arises less product is being (or about to be) shipped. Defying the outlook for an economic slow down (and some might say common sense), many package related issues have seen their share prices rally strongly in late 2006-early 2007.
“Producer shipments of corrugated boxes have declined by 2.6% in the first two months of this year.”
Purchasing
Along with GEF and PKG, less focused competitors like Rock-Tenn (RKT), Temple-Inland (TIN), Bemis (BMS), and Longview Fibre (LFB) are all trading at or close to 52-week highs. Not exactly what you would expect if the U.S. economy was in a recession. As for Sealed Air Corp., although Buffett removed SEE from his holdings in 4Q07, the company’s stock price continues to bubble higher.
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If the U.S. economy was already contracting it is difficult to believe that shares in cyclical packaging companies would be soaring. It is likewise difficult to believe that recession would bring with it a surge in the Baltic Index, firm/rising commodity prices, massive hedge fund IPOs, daily takeover announcements, etc.
The caveat worth stressing is that while ‘difficult’, it is not impossible that many traditional indicators will fail to predict the next U.S. recession. For example, there is the possibility - however remote - that a U.S. recession will not drag the rest of the world down and/or that commodity prices will not tumble due to continued demand from places like China.
Conclusions and Speculations
The return of volatility to the markets and the implosion of subprime have made policymakers nervous, a point that was highlighted earlier this week when the Fed came close to dropping its tightening bias. However, whether or not ‘nervousness’ spells imminent recession is tough to say.
What can be said is that with no landing yet achieved recession fears are likely to intensify going forward rather than abate. This is the case not only because mortgage blowups are likely to keep housing inventories elevated/prices weak for some time, but also because corporate earnings growth has likely already peaked (i.e. despite today’s strength in packaging company share prices a soft outlook from a company like FedEx may be a more important forward looking indicator). In other words, while Roubini, Soros, and others may be a little early in calling for a recession, a few more months of continued economic deterioration and the focus could quickly change to why the majority of economists (once again) saw the recession too late.
In short, the majority of economists are currently looking for a soft landing, and the action in financial and packaging stocks has yet to contradict this rosy outlook. This is not to say that a hard landing will not arrive in the second half of 2007 (I happen to think that one will), only that more sustained financial market carnage may be required before recessionary speculations can become more firmly rooted. |
