A week ago, I wrote that I remain on crash alert until it appears that that there is some sign of a pulse from bankers in Europe. (See: Man the Battle Stations: Crash Alert.) This week brought more non-developments in that area, so the prospects have not improved. Meanwhile, more leading indicators are pointing to the growth potential for a full-blown recession (if we haven't entered one yet).
In fact, today, economic forecasting firm ECRI -- which nailed problems in 2008 -- said we are entering a new recession. Couple that with the fact that "bond king" Jeff Gundlach of DoubleLine Capital, one of the best-performing investment managers of the last ten years, says that we are already in recession. The combination of these two forecasts from top forecasters is not good.
So goes the great Macro vs. Micro debate, in which stocks get even cheaper, especially considering the paltry treasury yields. But if global growth is headed back into the dip, all bets are off. (See: IU Weekly Update: It's a Macro vs. Micro World.)
As I pointed out in August, stocks still look cheap but that may be because the "E" in P/E is still elevated, and Wall Street strategists, as usual, have been slow to downgrade their earnings estimates for 2012. (See: Beware the Earnings Trap.) That leaves two ways stocks can continue to move down: P/E multiples can continue to compress, or the earnings levels could fall -- or a combination of both.
Bottom line: The indices are volatile, and there is a general sense of malaise. This is because of the uncertainty that 2012 will bring, and the huge divergence potential of another crisis-induced recession. For example, if the S&P 500 can maintain earnings of $90 per share in 2012 and you apply a 14X multiple, you get S&P 1240 or so.
But what happens if earnings fall 20% (to $72), and the earnings multiple compresses to 10? Then you get S&P 720. My guess is that the market is discounting less earnings in 2012. The stock market, while often wrong at the extreme ends of things, seems to be a pretty good leading indicator at the entrance of a recession.
So if stocks are "cheap" and bulls and bears continue to debate whether another recession is coming (not that it feels like we ever left one), what's my tie-breaker? I usually go to technical analysis in this case. Technically, the market looks terrible. Rallies have been met with selling, and the rallies seem more feeble each time. There is a nasty "head-and-shoulders" pattern in the S&P 500 index, and the 200-day moving average has flattened out and started to turn down. Tie goes to the chart.
In fact, if you look at comparisons between the current US secular bear market -- in case you forgot we are in one -- and the Nikkei bear markets, the parallels are frightening. Here is a chart from Société Générale:
US vs. Japanese Secular Bear Markets
I write this update as the stocks are suffering in a late-market swoon and are threatening to take out the low for the week, even though they remained flat on the week until late Friday afternoon. My gut reaction: It does not look good for next week.
Many stocks in our IU25 continue to get hammered, especially industrial stocks and materials stocks with exposure to Asia and commodities firms such as Agrium Inc. (NYSE: AGU) and Cliffs Natural Resources Inc. (NYSE: CLF). Technology shares were also especially weak this week.
Overall, be very wary. I'm personally holding lots of cash and not making any new stock buys for now. And I await the latest plans to rescue Europe, which seem awfully slow in coming. It may be too late.
(Disclosure: Long a small amount of stocks, short S&P indices as a hedge.)