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This arti­cle is a guest con­tri­bu­tion by Eric Sprott & David Franklin, Sprott Asset Man­age­ment

With the sum­mer now upon us, the "Sell in May and Go Away" adage has proven itself true once again. The major mar­ket indexes are all turn­ing down­ward, and while they haven’t dropped enough yet to war­rant panic, we cer­tainly want to be posi­tioned prop­erly if this trend con­tin­ues into the fall. The mar­ket tea leaves are no longer send­ing mixed sig­nals either – most of the new data is decid­edly bear­ish. So what hap­pened to all the ‘green shoots’? What hap­pened to the strong recov­ery the mar­ket rally was promising?

Eco­nomic data released over the past two weeks have dec­i­mated any remain­ing belief in a last­ing eco­nomic recov­ery. Slow­downs are appear­ing in the US, Europe, Japan and even China. Auto sales, hous­ing starts, employ­ment, con­sumer con­fi­dence, fac­tory orders, con­sumer pur­chase inten­tions — just about every aspect of the econ­omy that can be mea­sured, is show­ing decided weakness.

Of par­tic­u­lar inter­est to us over the past year has been the GDP fore­casts released by The Con­sumer Met­rics Insti­tute in Col­orado ("CMI"). CMI caught our atten­tion with their real time track­ing of con­sumer retail sales data. Con­sumer spend­ing rep­re­sents 70% of GDP, and that spend­ing can pro­vide great insight into the work­ings of the under­ly­ing econ­omy. CMI’s retail sales data has inden­ti­fied a long, neg­a­tive con­trac­tion in the econ­omy based on their data set for the last 180 days. This was con­firmed most notably in Walmart’s poor first quar­ter sales results when CFO Tom Schoewe stated, "More than ever, our cus­tomers are liv­ing pay­check to pay­check."¹ If that sen­ti­ment applies to other large retail­ers, it doesn’t bode well for 2010 GDP.

CMI also pre­dicted 2010 Q1 GDP growth at 2.62% all the way back in Novem­ber 2009. It took nearly seven months for the actual US GDP data to even­tu­ally be released, but when it finally did (after three revi­sions, no less) it turned out that CMI’s pre­dic­tion was bang on. Inter­est­ingly, when the real data came out, CMI founder Rick Davis noted that the inven­tory com­po­nent under­ly­ing the 2.7% Q1 GDP growth fig­ure had moved from 1.65% up to 1.88% – mean­ing that the bulk of GDP growth, almost 66%, actu­ally came from inven­tory swings rather than con­sumer demand. No won­der fac­tory orders fell out of bed this past week! With the re-stocking com­plete, there aren’t enough new orders to clear the fresh inven­tory. And if two thirds of Q1 growth came from inven­tory swings (or just plain re-stocking etc.), it makes us won­der what we can real­is­ti­cally expect from the next two GDP announce­ments. CMI pro­vided the fol­low­ing guid­ance for the bal­ance of the year, stat­ing that "We expect GDP growth to be flat for the sec­ond quar­ter, but with inven­tory adjust­ment rever­sals absolutely killing the reported ‘growth’ num­ber just four days before the U.S. mid-term elec­tions." If that turns out to be cor­rect, it will be unfor­tu­nate tim­ing for the elections.

An impor­tant ques­tion to ask is whether the March ’09 rally was really jus­ti­fied at all. Were the green shoots real? Or was the mar­ket just look­ing for a way to jus­tify the effects of government-induced ‘easy money’? The stock mar­ket is sup­posed to be an effi­cient, forward-looking indi­ca­tor after all – and the rally that began in March ’09 was sup­posed to sig­nal a robust recov­ery. So where’s the recov­ery? From the time the term ‘green shoots’ was first uttered by Ben Bernanke on March 15, 2009, the S&P 500 ral­lied 36% to June 30, 2010 and by as much as 60% to April 26, 2010. If the green shoots were really just the early indi­ca­tions of weeds, was the mar­ket wrong to appre­ci­ate so dramatically?

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