The Weekly View
Comment of the Day

June 29 2010

Commentary by David Fuller

The Weekly View

Ten Conditions for a Sustainable Recovery: One Year Later Progress Continues, but Structural Headwinds Remain
My thanks to Rod Smyth, Bill Ryder and Ken Liu for their excellent letter, published by the RiverFront Investment Group. Here is a brief sample:

Lower leverage: Underway. As debt is paid down or defaulted on, savings rates naturally increase (#1). This may be seen in household deleveraging with debt service as a percentage of disposable personal income falling to 12.5% (Ed: see graph in report) in the first quarter from 14% at its 2007 peak. However, we expect several more quarters, if not years, of deleveraging for the debt service ration to trough (historically, this has been around 11%). We think this entails more defaults, but also requires ongoing restructuring, asset sales and income generation; a slow process, but one which will ultimately leave US consumers on firmer footing and better able to support sustainable economic growth.

David Fuller's view Yes, a prior period of deleveraging is necessary to create the conditions for sustainable economic growth but it is also a slow and painful process. There is plenty of deleveraging going on in the world today and its negative implications for growth are the main concern for stock markets today.

The best thing that can be said about the technical action, which I reviewed extensively in response to Email 1 yesterday, is that with today's additional slump it is beginning to appear overextended. However, it obviously takes demand to turn a weak market around and we see little evidence of that at the moment.

The key stock market in terms of influence is always going to be Wall Street and everyone can see that the S&P 500 Index is challenging its range lows in the 1050 to 1040 region. An upward dynamic and eventual push above the high on 21st June, when the downside key day reversal occurred, is now required to reaffirm prior support. Incidentally, that key may not look like much but it was clearer on the Nasdaq 100. Meanwhile, until we see some clear evidence of demand, the bias remains to the downside and this is a negative leash effect for all other stock markets.

How low might the S&P go? I do not know but we can look at the weekly chart above and see what investors will focus on. That would include 1000 and then the top of the former base at 960. The one thing we can be certain of is that sentiment will deteriorate with each additional move to the downside, including forecasts for a test of the March 2009 low. I would regard such comments as a contrary indicator.

Theoretically, anything is possible in markets but should we expect a depression-discounting level to be retested with short-term interest rates near zero and US 10yr Bond Yields under 3%? I do not think so and I would be more worried if they were over 4%, even though that might signal growth while Treasuries are clearly discounting slower growth at today's level. This will keep monetary policy accommodative.

Should we expect a bear market with the Ted Spread at current levels, or more importantly, the Yield Curve well above the dangerous zero level? I do not think so. Instead, having seen an outstanding rebound last year, stock markets are experiencing a dramatic correction, the worst of which I suspect we have already seen.

This is more volatility than most of us would hope for but it is also an opportunity. Valuations are improving with each down day. Does not stock market history show us that it pays to buy fear and sell euphoria? Fear is returning.

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