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What a day.  There was no bid under this market after the ADP report came out at 8:15 this morning.  The ISM report added insult to injury and contributed a serious concern over the economic slowdown theme.  Overall, it was an awful day from just about any perspective.

But more importantly – is this just a mild slowdown or a collapse in growth?  The economic story remains much the same in my opinion.  We’re in a balance sheet recession, the government response has been largely misguided, however, the growth in China and the continuing fiscal deficits of 10% of GDP are enough to sustain moderate but entirely inadequate growth.  That’s turned out to be a pretty good environment for stocks as margins have expanded and revenues have remained stronger than most expected.

The double dip debate or economic slowdown is the wrong debate in my opinion.  We never exited the balance sheet recession.  This was always a balance sheet recession so it’s not surprising to see growth at tepid rates.  All that happened was that the government entered the picture with massive support.  There has been very little that is organic about the current recovery.  That’s how balance sheet recessions go.  But are we about to fall off the economic cliff?  I am inclined to say no.  Given the size of the deficit I think we should expect more of the same – weak economic growth with a high risk of exogenous shocks from China, Europe, fiscal austerity and the unstable environment the Fed has created in commodities.  In short, the balance sheet recession continues and economic risks remain elevated.

Of course, this macro economic approach only touches on a portion of the picture.  The equity market requires a more precise approach in this sort of environment.  I utilize a top-down approach.  The broader investment environment remains much the same to me as it has in recent years.  Since 2006-7 I have been concerned about the macro picture and the potential for elevated risks.  This environment of elevated risk means a buy and hold strategy is an inadequate way to generate high risk adjusted returns.  While that approach has been less successful in the last two years, it has worked very well over the course of the entire cycle.  Because of my macro belief in the balance sheet recession I continue to view the markets as such – risk is elevated and a nimble trader will generate better risk adjusted returns than the blind buy and hold investor.

I last mentioned the broader markets in early May when the S&P 500 was just shy of its year to date highs and I was adhering to the “risk off” signals.  In the very near-term, I think the intelligent investor should remain positioned for downside (particularly in commodities where the Fed has created an excessively risky environment), however, I don’t yet believe there is evidence that the current downturn in equities will result in a protracted decline and a bear market (20%+).  Equities are likely to remain volatile into the end of QE2 as uncertainty dominates the markets, but I would expect this uncertainty to taper off as we allow the QEs to become distant memories and can again focus on an environment of adequate bottom line earnings and meager economic growth.

In short, the current economic environment remains very weak, however, we shouldn’t be concerned about a protracted growth collapse unless one of the above four exogenous risks implode and translates directly into severe downside risk in corporate profits.  I don’t see evidence of that occurring just yet although the downside in commodities is worrisome.  The nimble trader will continue to find opportunities, equities are likely to find their footing sooner rather than later and buy and hold will remain an excessively risky strategy given the potential for economic volatility.


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