Who Knows?

“Doubt is not a pleasant condition, but certainty is an absurd one”
Voltaire

You got to love those who state with certainty that stocks have made their lows and a resumption of the bull rally is underway. God may favor the bold, but fools do rush in where angels fear to tread.

Who knows if various stock market indices, which have produced a wonderful bounce from the lower end of their trading ranges, will broaden out and help numerous other indices reverse their bearish Mega Trend (“death cross”) signals? Who knows if the US economy has evolved into a private sector driven sustainable path of growth and, thereby, avoid an economic backward slide into hell?

In the macro economic realm, certitude is shared by those who declare that the global economy is fine, that the US economy is fine, that GDP and other key US economic indicators (e.g. unemployment) will be fine (see the accompanying table* from the Fed). Yet, for all the certitude that may be uttered, just about every reliable measure of the stock market and the economy shouts, “Who knows?

What Is Known

Thus far, the macro economic reports and forward earnings guidance from company’s reporting their 2Q10 results paint a fairly clear picture of a US economy that is decelerating**. Since mid May, the majority of US macro economic indicators have been coming in steadily below consensus expectations. Thus far, the magnitude of the shortfalls have been, for the most part, moderate. Whether this remains the case remains to be seen. However, if there is one thing that is a characteristic of our globalized networked economy and markets it's that seemingly small things can become very large in a very short period of time. In bad times, correlations tend to go to 1 rather quickly.

Importantly, an economic deceleration does not necessarily mean a recession will follow. It may simply be the natural process in the transition from the early strength of an economic recovery to the more moderate growth rate in an economic expansion. At least, this is the argument heard from traditional economists, who assume away the unusual circumstances that preceded the current recovery/expansion and apply their well-educated tried and true methodologies that kind of, sort of, worked okay in the past – a past, I might note, that was quite different from the present.

As for stocks, this much is known: The global stock indices have been locked in a multi month trading range that will be resolved with either an upside or downside breakout. An upside break signals the trading range was a consolidation – the bull has been refreshed and ready to run again. Whereas, a downside break signals the trading range was a distributional top and everyone should get out of the pool. Death crosses will abound.

Harmony

It isn’t often that the real economy and the financial economy mirror one another so neatly. In the US economy, the deceleration is quite evident. Both the forward guidance from corporate America and macro economic reports published since mid May point to an economy that is still expanding but at a slower pace. Most areas of the global economy are decelerating that will either become the pause that refreshes or the prelude to a recession that will almost be far more difficult to manage than the cutsey phrase “double dip” suggests. The outcome – continued expansion or recession – remains to be determined.

As for the stock market, we have a trading range whose outcome suggest a bearish outcome but cannot be stated with certainty until such time of a clear breakout signal. Hence, the appropriately cautiously bullish posture expressed previously.

Human nature may prefer those who state they know with certainty to those who say, “Who knows?” However, in highly fluid situations in the social sciences of economics and markets, certainty may be a most expensive attribute.

*click image to enlarge

**This is also the case in other developed economies – Eurozone, Japan – and, from a different perspective, the high growth rates in emerging economies that are being pressed by their respective governments to cool their overheated economies.