Comstock bearish article
Bullish Case Not Well Founded
The struggle between the bulls and the bears has increasingly become centered on the issue of where we are in the economic cycle, with the bulls looking for an early bottom and second half recovery, and the bears (including us) expecting conditions to get worse and take longer to come back. In addition many bears (again including us) expect this cycle to be particularly nasty since it follows the bursting of an economic and financial bubble. We believe that the economy will get a lot worse before it gets better and that earnings estimates will continue to slide. Consider the following hard and cold facts.
The economic downturn is being driven by a sharp cutback in capital spending, particularly in technology, but in the old economy as well. Durable goods orders ex-aircraft are down by the greatest percentage since 1991.
Electronic equipment orders are down by the highest percentage in at least 14 years.
The semiconductor equipment book-to-bill ratio fell to 0.64. Bookings dropped by 49% over year-ago levels, while semiconductor capacity jumped by 72% last year, creating a huge capacity overhang that will take a long time to correct. The result is severe price weakness and cancellation of expansion plans on a global basis.
Layoff announcements are the highest since records have been kept while initial unemployment claims are soaring and temp employment has been sharply reduced. Help-wanted ads have fallen to the lowest level since 1993. All of this means that a sharp increase in the unemployment rate is probably imminent. Such increases often coincide with the capitulation leg of a bear market.
Earnings estimates are still declining. First call now estimates that earnings for the S&P 500 will be down by 8.1% in the first quarter, 9.5% in the second quarter, and 1% in the third. They are still looking for a double-digit rise for the fourth quarter, but this is likely to be as unrealistic as were previous rosy projections.
Both consumers and corporations are deeply in debt. U.S. private debt as a percentage of GDP is 135%, the highest ever.
Leading economic indicators are falling throughout the globe, including Europe, Asia, Latin America and Australia. The odds of a global recession are high for the first time since 1973-74.
Bulls are placing their bets on the continued stability in the housing and auto industries as well as the aggressive Fed rate cuts. However, the interest rate reductions will have a tough time turning around an economy that is declining as a result of the previous capital spending boom. Why would anyone borrow to build unneeded capacity or to buy consumer goods when the labor market is so weak? In addition both the housing and auto markets are highly vulnerable to current conditions and are more likely to deteriorate rather than carry the rest of the economy to recovery. As the unemployment rate rises and the labor market weakens, housing is almost certain to feel the pinch. People uncertain about their job prospects are unlikely to purchase a new home. The same goes for the auto industry, which is plagued by global overcapacity. As a result auto prices have not increased in four years and the industry has been forced to entice consumers with unusually low finance rates and cash rebates. The average value of vehicle incentives has now soared to a record $2,500, and manufacturers cannot eliminate them without destroying their sales. All in all we think that investors will find the coming economy extremely disappointing, and that the highly overvalued market will sink to a level where valuations are reasonable or cheap. |
