Here are my thoughts. I believe the fears of a recession are overblown. There are lots of not great things going on right now certainly but we are still growing, albeit slowly. That said, I’m not particularly bullish on US equity markets right now. I’m finding a lot more things I want to short than I want to buy right now. The destruction in energy markets is having knock on effects into industrial companies such that low input prices from oil aren’t helping margins as much as would be expected.
The market is currently at a slightly expensive multiple on historically peak earnings margins. We have a period of low nominal growth, increasing regulation/compliance costs, low total factor productivity gains and heavy debt burdens. Even without a recession that situation easily sets up to see limited topline growth, increasing overhead expenses, lower earnings and lower multiples on those lower earnings. For individuals who can’t/shouldn’t short stocks in their personal accounts I would be looking to sit on some extra cash and start adding to names with depressed valuations.
China is a potential disaster and that represents a wildcard that is hard to predict. The short metals/mining trade was a fairly obvious one but the potential fallout from a credit crisis in China is more difficult to estimate. Here is some food for thought though. Before the financial crisis the US banking system had assets equal to 100% of GDP, China today is at 340% of GDP. 10% loan losses in China would equal $3.5T in losses (prior credit cycles have had loan losses as much as 30% so 10% is conservative), losses in the US during the financial crisis totaled $650B. To combat that $650B the Fed had to expand their balance sheet by $4.2T, what is China going to have to do to recapitalize $3.5T in losses? Is it even possible?
There are my semi-coherent Friday morning ramblings as I procrastinate doing real work.