“Against stupidity, the gods themselves contend in vain.” – Schopenhauer
I thought of other titles for this week, of course, and lingered for some time over a play on the “confederacy of dunces” theme. However, this is a column about investments, not political science, and so I will leave the latter to others. I do believe that the UK has made a colossal blunder, perhaps no greater a one than calling a referendum at all in the midst of a wave of migration, when friction and bad feelings are bound to be running high. That miscalculation, at least, we can lay at the door of David Cameron and his Tory allies. As for the rest, we will have to wait and see. A British historian opined that in fifty years, we will be calling the Brexit the single greatest instance of self-inflicted national harm in modern history. That sounds about right to me, though one has to be nervous about the fifty years. There’s an awful lot of opportunity to get even stupider.
The British vote has unleashed a massive amount of “Brexit” titles, so much so that one hesitates to speak at all about it. That in of itself gives some important indications, one being the uncertainty about what it will really mean in the end, the second being that it is very much a confusing situation, and the third being that many will simply attach the Brexit event to their pet theories and not change their thinking one iota.
Uppermost in many minds is the question about how much the Brexit might resemble the Lehman bankruptcy. The arguments out there largely stem from whether one was already bearish or bullish, but I will try to be objective about it.
The main similarity that Brexit has with Lehman is that it is an adverse event at an inopportune time. So it could be some kind of tipping point, but Lehman was more the coup de grace to an economy that was already on its third quarter of recession, though few on the Street would admit it at the time. The credit crisis had been brewing since the previous August (Lehman failed in September 2008), when two credit hedge funds sponsored by former investment bank Bear Stearns were faced with almost no market for their holdings. It took some time for the mortgage meltdown to reach critical mass.
Brexit is not a credit crisis and is not based on large-scale financial misdeeds, a huge difference. However, it is a confidence-damaging event that comes at a very late time in the economic cycle. We are not in a recession, but the economy is certainly “recession-ready,” with many indicators already in recessionary territory: I recently compared the global economy to a stumbling drunk – you know it’s going to take a fall, but exactly when and where are nearly impossible to predict beyond saying “soon.”
The Brexit and its knock-on effect could very easily provoke the key stumble into the ditch of recession, but even if that should be the case, that doesn’t mean it’s going to happen next week. No, not unless someone in the credit markets has miscalculated on a massive scale, a possibility that I cannot exclude (cf. Long Term Capital in 1998).
IF the credit markets were to freeze next week – and Brexit is certainly going to make everyone nervous about European banks, especially UK ones – then recession here we come. Yet while a panic is now more possible, it still isn’t likely in the very near term. Instead you should expect a rebound rally in the equity markets sometime this week. Really? Yes, really. Traders are champing at the bit to buy, if for no other reason that everyone can see that the equity markets are seriously oversold in the short term. Traders are only waiting some sort of catalyst to jump back in – for a trade. It ought to be noted that the wrong sort of event would trigger another jumbo flood of sell orders, so we are not out of the woods yet, but if nothing terrible happens, that alone could be a buy catalyst – “Look, we’re still alive!” People tend to forget that despite the initial sell-off, the stock market closed higher the week of the Lehman debacle.
Goldman Sachs has already predicted a British recession in 2017. I can’t argue with that, and the global economy is ill-placed to deal with that outcome. Even so, it is very possible that fears will have receded a week or so from now. The most important thing to keep in mind is that while the Brexit is a definite negative for the global economy, the full effects could very well take months and quarters to be felt. The current situation is still a very fluid one, one that is going to depend heavily on the policy discussions and headlines of the ensuing weeks. If there is one iron rule that experience has taught me, it is to never bet on policy outcomes, the way the market did last Thursday when greedy traders tried to front-run a “remain” decision.
To sum up, we were going to have a recession anyway, the ends of business cycles being inevitable, but the Brexit is a big nudge in that direction. Absent fresh outbreaks of stupid though, in the near term equity markets will want to put on a rally, possibly a terrific one. Should such a lifeboat present itself, get in and be grateful that you can pay with your remaining equities, rather than worrying about whether you got in the best possible boat with the best possible seat at the best possible price, the way we Americans are wont to do. I know it’s not easy, but do it anyway – no one ever went broke by selling out a month early.
The Economic Beat
While the Brexit vote is sure to prove to have been the most significant economic event in the long run, its impact is not immediately quantifiable – certainly not in the terms of a convenient statistical release.
Two of the main reports from last week concerned the housing market, in the form of sales of existing and new homes. Sales of existing homes rose somewhat on a monthly rate in May (5.43mm to 5.57mm) but fell on a year-on-year basis, from 6% to 4.5%, about the same as the gain in the median price (+4.7%). New home sales growth remained fairly steady, though the seasonal adjustments exaggerated the swings. The May rate was reported as 551,000 (551K), down sharply from 586K, itself a sharp downward revision from the original 619K estimate.
However, the year-on-year growth rate eased from 8.7% to 8.63% (NSA), so at first blush not much has changed. Last month’s revision was substantial, not unusual for the series, but the revisions tend to be unpredictable and next month’s could just as well be in the other direction. I would point out that the year-on-year growth rate topped out in July 2015 at 15.6% and has fallen pretty steadily since, declining the last seven months in a row. The median sales price of $290,400 was up only slightly from the year-ago $287,400. As to existing home prices, the federal mortgage people reported year-on-year gains easing to 5.9% in April from 6.2% in March. Next week rounds out housing with the Case-Shiller price index for April on Tuesday and pending home sales for June on Wednesday.
Overlooked in the Brexit excitement was another lugubrious durable goods report, which had a decline of 2.2% (seasonally adjusted, or SA), or (-0.4%) excluding transportation. Core capital goods fell again (-0.7% SA), though the trailing-twelve-month (TTM) rate was virtually unchanged at (-3.63% ) on an actual basis, oddly enough nearly identical to the year-on-year decline of 3.62%. Shipments fell, adding to a cut in the forecast for second-quarter GDP that now stands at 2.6%. The Kansas City manufacturing survey had turned up to +2 from (-5) in May, but if the plunge in oil prices doesn’t quickly reverse the survey will instead.
Belying the Fed’s statement last week about improved economic activity, the Chicago Fed’s national activity index took a sharp drop in May to (-0.51), where 0 is neutral, with the three-month average slipping to (-0.36). The Chicago index is more coincident than predictive and is not widely followed on the Street, but we are edging towards the danger zone of (-0.6) on the three-month average. It’s a four-year low, but the index is oft-revised and in this cycle has often been weakly negative without the economy getting into serious trouble. On the other hand, it is very late in the cycle.
Next week will bring a lot of reports, but not the jobs report, which usually appears the Friday of the month, except when Friday is also the first or second day of the month. We’ll still get the ISM manufacturing survey on the 1st, preceded by regional surveys on Monday (Dallas), Tuesday (Richmond) and Thursday (Chicago). The third scheduled revision to first-quarter GDP comes Tuesday, along with the revision to corporate profits. International goods trade is Monday, personal income and spending Wednesday, construction spending Friday so expect more revisions to the Q2 GDP estimate as the quarter ends.