Questionable Rally

By Comstock Partners

We find little reason to change our opinion that the US faces a high risk of slipping back into recession. We cite continuing intractable unemployment, a long term poor housing market, low business confidence, unsustainable growth in sovereign debt, uncertain political and global leadership, and in the current headlines, debt problems in Europe as some of the key systemic problems impeding a recovery.

We note the political landscape is currently dominated by debate about "Jobs". Politicians of both camps point to "small businesses" as the hope for job creation that will turn around the unemployment picture. We want to bring to everyone’s attention the results of two important surveys that were released recently. The first survey addresses the likelihood of small business hiring to improve the job situation in the US. The National Federation of Independent Business (NFIB) is essentially the voice of small businesses (the same entities that produce the new jobs that everyone is concerned about currently) and the headline this week states, "Small Business Confidence Takes Huge Hit in August."

The NFIB Research Foundation collects small business economic trends data with quarterly surveys since 1974 and monthly surveys since 1986. They started this month’s release by stating that the Optimism Index is now in a decline for the past six months. They continued, "Confidence in the future of the economy crashed in August," taking the Small Business Optimism Index down 1.8 points to 88.1 (the sixth straight month of declines). This is down from around 100 throughout most of 2005 and 2006 before dropping to the low 80s during the worst period of the "Financial Crisis" in 2008. It rebounded to the mid 90s during the rebound in the stock market in 2009 and 2010 before dropping again in 2011. Expectations for real sales growth and business conditions were major contributors to the decline of -12% in August following a -10% decline in July.

The second survey was by the National Association for Business Economics (NABE). The NABE survey represents the consensus view of 52 professional forecasters. In the August survey, GDP growth forecasts for 2011 and 2012 were revised dramatically downward for 2011 to 1.7% from the 2.8% forecast just 3 months earlier in May. The forecast for 2012 was also revised downward to 2.3% from 3.2% in May. Thirty percent of respondents expect the economic recovery to be "subpar with severe wealth losses and onerous debt burdens inhibiting spending and lending," up from just 11% just 3 months earlier. Growth at these levels does not support an economy capable of adding net jobs and driving down unemployment.

Finally, earlier today the latest Weekly Jobless Claims came out at 428,000, higher than expected and the 4 week moving average rose 4,000 to 419,500. Remember also that in August there were zero net new jobs created!

We continue to be amazed at the eagerness of the market to rally in the face of negative fundamental data. The U.S. stock market rallied today on the news that the European Central Bank is getting together with other Central Banks (Bank of Japan, Federal Reserve, Bank of England, and Swiss National Bank) to provide more liquidity to help Europe as they are trying to keep their heads above water. The coordinated action between governments has generated a "trust" that we expect to be short lived. This is like "plugging holes in a leaky boat" and not a "game changer" since it is essentially providing an ability to liquefy with more short term debt (by continuing the 7 day repos, and adding 90 day repos). The solvency of Greece, Portugal, Ireland, Italy, and Spain are still in question and providing more debt to debt ridden countries never helps for very long. We would use the strength in the S&P 500 to sell stocks on any rally up to the 1250 level, which we expect to provide significant resistance.