Stocks and bond yields are sinking as Wall Street disses the debt deal and instead focuses on a likely double-dip recession.
Everyone is gloomy. But is this pessimism getting a little overbaked?
Granted, the economy is sputtering, with less than 1 percent growth in the first half of the year. But if there is a recession in the cards, it will be the first time one occurs when the yield curve is steeply positive (an ultra-easy Fed) and corporate profits are strong.
And since we do have ultra-easy money and strong profits, I don’t believe we’re heading into a recession. Nor do I believe stocks will continue to swoon.
The principal reason for the sub-par first-half economy is the rise of inflation, which severely damaged real incomes and consumer spending. We experienced a mini oil shock, which has dampened the whole economy. Actually, it’s worth remembering that oil shocks and inverted yield curves, along with falling profits, are the most important leading indicators of recessions. We don’t have this right now.
Fortunately, oil and gasoline priceshave come down well below their highs. That’s going to take pressure off the economy.
Of course, QE2 (quantitative easing) backfired as the dollar sank and the inflation rate temporarily jumped 5 or 6 percent. However, as energy prices have eased back down, the inflation rate as measured by the consumer deflator has fallen, and is up only 1.3 percent annually for the past three months. If the dollar can hold its current level and energy prices remain quiescent, the economy will be okay.
Not great. The second-half economy could grow by 2.5 to 3 percent. There are so many tax-and-regulatory threats out there that it’s hard to expect much more growth. But at least it’s not recession.
Recent reports from the ISM purchasing managers for manufacturing and services are not signaling recession. Car sales have actually bumped up. And at least employment is rising, although slowly.
It’s all sub-optimal, but it’s not recession.
Meanwhile, profits are at record highs as a share of GDP. Second-quarter earnings are coming in much stronger than expected. For some reason investors have chosen to ignore profits. But they’re still the mother’s milk of stocks and the economy. Stocks may well be undervalued right now.
At roughly $95 a share profits for 2011, stocks are running near a 13-times price-earnings multiple, which calculates to a near 8 percent forward-earnings yield. Compare that to a 2.6 percent 10-year Treasury bond or a 5.5 percent Baa investment-grade corporate bond, and you can see that stocks have good value. The equity-risk premium is very high.