Are Pre-Emptive Strikes Being Readied?

Posted: Jul 04, 2012 12:01 AM

Monday's ISM Manufacturing report in the U.S. was an eye opener on many fronts. But the key takeaway is that there is simply no denying the fact that growth is slowing down - a lot. While there was some chatter about the ISM data being "off" and several analysts said they preferred to wait for confirmation from data such as Durable Goods before panicking, the fact that the ISM Manufacturing index came in below 50 (which indicates that the sector is contracting) for the first time in 35 months means that the slowdown looks very real.

The problem though is the U.S. remains the best house in this growth-slowing neighborhood. While China's (FXI) economic growth rate remains the envy of nearly every country in the world, the rate of growth has slowed from nearly 11% per year to something on the order of 7.0% - 7.5%. For comparison purposes U.S. GDP has slowed from 3.1% in the fourth quarter of 2011 to 1.9%. The rest of the BRIC's (EEB) are no better as India's (EPI) economy is being hit with the double whammy of slowing growth and inflation. Brazil's (EWZ) economy is also struggling. And then there's Europe (EZU). My guess is I don't need to rattle off any statistics in order for you to acknowledge that the continent is a mess from an economic growth standpoint.

On a micro level, there is already a fair amount of talk about how the current growth slowdown theme will impact earnings. Yesterday, a Thomson Reuters study provided some concrete evidence on the subject. The report showed that of the 85 S&P 500 (SPY) companies that have recently warned about their Q2 earnings coming in below expectations, at least 20 cited Europe specifically as the reason for the expected earnings miss, while 15 highlighted adverse currency movements, and 12 more talked about earnings uncertainty being due to "macro conditions."

So, how did the stock market react to the news that the manufacturing sectors in the U.S., Europe, and China are now all contracting at the same time? Well, after the requisite algorithm-induced dive of 7 S&P points in less than 3 minutes, U.S. stocks bounced around for a while and then managed to stage a steady advance to finish with small gains, of course!

What gives, you ask? Why didn't the market tank on this horrific economic news? Why didn't stocks give back all of Friday's gains and then some? Isn't the risk of recession rising? Hasn't Europe reached the point of no return? And shouldn't traders be factoring in the possibility that the sky might actually be falling this time?

The answer to any and all of the questions posed above is relatively simple. You see, the biggest central banks in the world appear to be readying the launch of pre-emptive strikes against an economic slowdown that no country on the planet can afford right now. So, with no fewer than five central banks (England (EWU), Japan (EWJ), China, EU, and the U.S.) either easing or about to do something that could be considered stimulative in nature, traders know that "fighting the fed(s)" can be harmful to their health. As such, shorts cover and the long-only managers add to positions.

While we may not be seeing a return of the "Tepper trade" the concept is similar. In case you don't recall, late in the summer of 2010, hedge fund manager David Tepper told CNBC that "everything was a buy" due to the idea that investors win whether the economy gets better or worse. Tepper opined (and was proved famously correct in his assumption) that if the economy worsened the Fed would step in and print money, sending "risk assets" higher. And then if the economy improved, stocks would move up for obvious reasons.

In the past, I have suggested that Super Mario and his buddy Gentle Ben might decide to hold back at this point in time due to the fact that they may be running out of ammunition with which to fight this fight. However, it occurs to me the central bankers of the world may be better served to launch pre-emptive strikes now instead of waiting for the downward spiral to get out of control. The thinking is that with just about every major country saddled with debt, the stimulative programs launched in 2008 are off the table right now. In other words, even the U.S. can no longer spend its way out of recession in this environment.

It follows then that instead of waiting until things get so bad that central banks would need to pull a rabbit out of their collective hats in order to stave off a deflationary spiral, launching pre-emptive strikes designed to keep things from falling off a cliff might make a lot more sense. So, although the July 4th festivities may take precedent in your schedule this week, it might be wise to listen to the statements from the BoE and ECB meetings when time permits.

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Positions in stocks mentioned: SPY