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 havenât 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 â most of the new data is decidedly bearish. So what happened to all the âgreen shootsâ? 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. CMIâs 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 Walmartâs 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 doesnât 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 CMIâs 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% â 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 arenât 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 âgrowthâ 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 â09 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 âeasy moneyâ? The stock market is supposed to be an efficient, forward-looking indicator after all â and the rally that began in March â09 was supposed to signal a robust recovery. So whereâs the recovery? From the time the term âgreen shootsâ 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?
