Does the business cycle matter? The Great Moderation from 1982 – 2007 was used as evidence by economists that “We’ve Figured it Out” when it comes to economic management. In hindsight, that was just piling up the cracks until the dam finally broke. Perhaps a return to accepting the business cycle as a normal state of affairs would be a healthy change of tune.
Global stock markets are mostly back to their pre-FOMC levels (before QE Infinity on Sept 13th). While this currently seems like a garden-variety selloff to work off overbought conditions, it is notable simply because it implies that there might still be a bearish argument in the midst of central bank action. Meaning, stocks can go down as well as up. A novel idea these days for sure. But looking at individual stocks highlights this phenomenon better than looking at the broad market.
Many individual companies are facing the downturn portion of the business cycle. Earnings and revenues are stagnating. Companies don’t earn more from QE – stocks generally gain mainly from the change in sentiment. But sentiment has carried this market to almost 20% gains on the year, so fundamentals likely have to do the heavy lifting from here. Yesterday’s price action seemed to refocus on fundamentals, as heavily shorted names (like GMCR, GME, and GRPN) that had rallied recently on sentiment were the leaders on the downside yesterday.
Fundamentals can change quickly too. Especially in a globalized world of just-in-time inventory and rapid dissemination of information. For example, here is a chart of the smoothed probabilities of recession from the Federal Reserve Bank of Atlanta:
My main thought on this chart is to notice how the probability goes from close to 0 to 100% in just a one or two quarters. Even in a complex system like the $15 trillion U.S. economy, these changes happen quickly. Very quickly.
The bulls have been big winners so far this year. And central banks are rooting for them. But the business cycle is not dead. It might just again remind us that stocks can go down as well as up.
Markets overnight:
- Asia traded in the red all session, after the weak U.S. close. The Shanghai hit new 3 year lows in the session. Japan was the weakest market, moving back below its 200-day moving average.
- Europe also opened in the red, and has been down more than 1% all session. The Italian bond auction went well, but the Spanish bond auction went poorly. SPX futures indicated up 0.1%
- U.S. dollar stronger vs. most major crosses (except the Japanese Yen), and longer dated Treasury bonds are up again, for the 8th straight day!