Green Square

Soft Patch or if You’re Feeling Sinister Something Worse

Our title references one of the best albums of the 1990’s, Belle and Sebastian’s, If You’re Feeling Sinister .  In fact, when it was released in 1996 the Internet was infantile, the tech bubble just getting under way, and the full blown melt up in financial based assets was just getting out of the gate.

How curious it is that as we stood on the starting line of the first of two massive back to back bubbles, a band from Scotland would foreshadow a decade that would end up “lost.”  Sometimes we need to listen more and look deeper than we are accustomed to in order that we understand what is truly happening around us.

And so today with our first post of the new month we take a look back at last week’s horrendous data and ask the question whether what we are going through is the same type of “soft patch” we went through last Spring or if there is something larger a foot in the global economy.  What happens if we are seeing a “both and” scenario.

Last week we lowered our fair value calculation for the S&P to 1200.  This is based on an earnings revision that sees earnings at $94.50.  Our previous estimates were closer to $98.50.  We revised this number based on the following three items that suggested to us that not only are equities mis-priced for today they are missing the very Sinister environment that is boiling under the surface.

The issues at hand:

1) Higher Sustained Energy Costs

2) Emerging Economy Cyclically topped out

3) Developed Markets  remain over levered in both public and private balance sheets
1) Energy costs will remain elevated for two reasons a) extraction costs are likely to go up and b) geopolitical tensions are unlikely to abate in either the middle east or the “Stans.”  So, one must plan for a continued high level of energy cost plugged into both production and consumption models.

Yes - We do have options

Who are the winners in this environment?  At this time the answers are not clear but the issue that crimps consumption is, and that is a higher prices for resources going forward. 

Enough... For now

The above chart shows you the expanding delta between resources and demand.  This too will function to keep energy prices in higher ranges, thus crimping the already crimped consumer.

2) For the first time in the post war period (and there have been a lot of these lately) it was not the developed economies that pulled the world out of recession but rather those newer more dynamic emerging economies.

Up Down Up

Their work is done

While on the surface this is an anomaly we actually think that it signals something, again, more sinister about the prospects for growth in the developed markets.  If and when (its actually more of a when) the emerging economies decide to trade with each other, realizing that they need not cater to the whims of the DMs, then we are setting up for the emergence of a new nationalism, tariffs and the prospects for a breakdown in global trade.

 3) And finally we present you the only piece of evidence that you need to see.

We've got a lot of wood to chop

With wages stagnant or falling (or depending on who you talk with BOTH)  there is little chance that the US consumer explodes into spending mode any time soon.  As research done by Dan Alpert(See Alpert’s Blog also onEconomonitor – 2Cents) and me suggests  there will be little more than frequent Micro Bursts of spending and saving that will keep the economy moving but no where near the kind of speed needed to dent jobs and, more importantly, bring down the huge amount of credit extended over the last ten to fifteen years.

And of course it wouldn’t be a really solid third leg to the stool if you didn’t get a quick reminder of how much debt the world’s largest economy has been piling on as of late.

Are you ready for take off?

We should be muddling through and instead we are like a professional cyclist who can’t get into the Peleton without the help of EPO or some other performance enhancing drug.  In the end though, with test after test, the cyclist finally succumbs to the fact that they must muddle through or be racked with other issues for the duration of his or her career. Inflation, out of control currency, wars, famines, political unrest in key parts of the globle energy and production markets.

Something very Sinister could be brewing indeed.

The time to face up to our reality and get hunkered down for the hard road ahead is now.


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