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Will the U.S. experience a Perfect Storm of fiscal woes?

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Will the U.S. experience a Perfect Storm of fiscal woes?

by Matt Lloyd On June 13, 2011 | Categories: Equity Markets, Market Commentary, U.S. Economy
My recent Google search of the term, “perfect storm,” returned over 1,300 results from Google News in the excruciatingly slow 0.25 seconds (said with sarcastic inflection). In reading any number of articles in a week, you might think that the perfect storm occurs on a daily basis.

Over the weekend, famed New York Professor of economics, Nourel Roubini, cited just such a potential event in 2013. One would be wise to listen to his prognostications as he “predicted the global financial crisis,” according to the Bloomberg article, Roubini says ‘Perfect Storm’ May Threaten Global Economy in 2013 by Shamim Adam. However, as one looks closer, he gives the “perfect storm of fiscal woes in the U.S” a 1-in-3 chance of occurring in 2013. The other scenarios mentioned in the article are “anemic but okay” global growth and a growing expansion. It seems to me that there is a reasonable chance he may be right in 2013.

To paraphrase what President Harry S. Truman once said, “Give me a one-handed economist. All my economists say, ‘on the one hand (this may happen), on the other hand (this may occur).’

This prediction is often heard by many economists who are still a bit gun shy after missing the credit crunch of 2008. We like to refer to this as the Black Swan Hoax; the perception that chance anomalies are occurring in far greater fashion; therefore, becoming common occurrences and violate the pure definition of anomalies. When this happens, as we have seen in the last few years, the anomalies must become an even greater exaggeration than history may present itself.

If one were to find a dodo bird, it’s as if one would expect a flock of them to be right around the corner.

Right now it’s easy to latch onto the argument that the soft patch we are entering economically will transfer into quick sand. The predisposition of retail and institutional investors is greatly formed by events over the last decade as well as the sixth straight weekly loss for equity markets. With deposits and household liquidity standing at all time highs, is there truly exuberance and overly-hyped expectations for the economy and equity markets? It appears not, which should caution those who are longer-term bearish.

Consider the last three decades in measuring the University of Michigan Consumer Confidence and the S&P 500. In each decade, the bottom in the reading of consumer confidence marked a prominent lower point on equities.

• Consumer Confidence reached a low in May of 1980 and S&P 500 measured at 110. By the end of the decade, the S&P 500 stood at 352, or an annualized return of 15.17% with dividends.
• Consumer Confidence reached a low in October of 1990 and the S&P 500 stood at 314. By the end of the decade, the S&P 500 stood at 1467, or an annualized return of 19.84% with dividends.
• Consumer Confidence reached an all-time low in November of 2008 when the S&P 500 stood at just about 900. By the end of the decade, 12/31/09, the S&P 500 rose 24.67%.

Now there are three points of contention that one might have with the above analysis:

1) We missed a large chunk of time in the markets from 2000 – 2008, during which time the S&P 500 lost -3.37% annually.
2) The timeframe above saw above average equity returns compared to history and also had a very oscillating market, which makes entry points seem a bit more profound (as most charting systems like to claim) than they would under all market conditions.
3) We are not near the bottom of the consumer sentiment set in 2008.

To address the third point, the low in the University of Michigan Consumer Confidence was made in March of 2011 when the S&P 500 stood at 1325, or now down 4% since that mark. In the short run, as we pointed out last week, the second quarter to-date is down much less than the market experienced last year. With the build-up of cash deposits, still strong corporate profits, the pre-election year campaign promises that are about to heat up and overall lack of bullish conviction, one might expect the short-term drop in the markets to be a longer term buying opportunity. Even the six consecutive losses in the equity markets (not seen since 2002) are only a little over half the drop seen last year during the second quarter.

Though we would expect more downward pressure in the very short term, we look for a capitulation early in the third quarter to reinforce our equity position. Perhaps a perfect storm of negative headlines, domestic budget deficits, European debt challenges and Japan reconstruction delays will exist.

But how common are perfect storms and should we stop fishing just because one happened nearly 20 years ago?

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.


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