The stock market can only handle one bad news item at a time, throw in a European debt crisis, mixed with worries about a recession, coupled with a hard landing in China and you’ve got yourself a bear market. With European leaders finally acknowledging that they have a problem and no evidence that China’s growth is slowing materially, the market can now focus on worries about a recession.
It’s important to remember that a recession is borne of excess. To get a recession, excess housing demand, excess labour demand and excess capital spending by businesses all have to dry up. The good news is that housing, job and capital spending demands are so low, they can hardly go lower. Consumer and stock market confidence are already at depressed levels. The bottom line question is how much worse can things get?
Even better news is that recent economic data from the U.S. is improving. We have had strong numbers from the following sectors, rail traffic, auto and retail sales, factory and service sectors and even job creation. Corporate profits are still on track to be at record levels in 2011. The bears who say that corporate profits could fall 25-30% if a recession materializes, need to remember that corporate profit growth in the first half of the year was earned with only 1% GDP growth. Q3 GDP will probably hit close to 3% and barring a further collapse of confidence due to the European mess, Q4 GDP could be on track to show at least 2% growth. Not a recession. So if a recession is not on the horizon than what is the S&P 500 worth? Assuming earnings reach the $100 range this year and grow a modest 3% next year to $103, fair value on the S&P 500 would be somewhere in the 1,400 range a year from now, a gain of 16%, not including dividends. That sure beats zero percent from cash.
I’ll leave you with the most important quote I’ve heard this month, from the company that has first-hand knowledge of the state of the economy.
“We don’t see a contraction; we don’t see a recession,” FedEx’s Smith said at a meeting in Columbus, Ohio, where General Electric unveiled research on midsized companies. It’s steady as you go, slow growth,” Smith said”. Fred Smith, CEO FedEx, October 6, 2011.