Black clouds gather over US equities

If ever there was a case of seeing things as you want to see them, surely this was the day! US equities rose as commentators concluded that the GDP figure and housing slowdown meant that interest rate rises were almost done.

Yet economics is seldom that simple. Up-trends carry on for some time and so do down-trends. Is it not more reasonable to ask, might not this slowdown turn into a recession?

For how can the US consumer - who is the real driver of the economy - keep spending when house price rises cease to provide home equity as a kind of ATM for excessive consumption? Is not the weakening car market also a sign that all is not well with the US consumer, and not just the US auto industry?

Reality check

Might not the Q4 GDP figure actually mean something? It is a quarter of what most economists expected, and it shows that the economy is slowing down. Now will the economy gradually freeze over and take the US stock market with it?

Oil prices of $68-a-barrel are clearly beginning to hurt. Higher oil prices act like a tax on GDP and raise the cost of production, and at the same time depress consumer demand. But the effect of high oil prices has a time-delay. And surely the Q4 GDP figures are a sign that what you would expect to happen with high oil prices, i.e. an economic slowdown, is in fact happening.

Equity crash?

For US equity portfolios this should be a very bearish signal, and a sensible response to an economic slowdown would be to exit US equities entirely or at the very least take a defensive stance in the market. The cheerleaders on TV and the financial media are reminiscent of those commentators who plugged stocks in October 1987 or March 2000, and seem to have lost touch with reality.

For sure, the Federal Reserve still has the capacity to cut interest rates to boost demand. But as we know there is a time-delay between stimulus and response, and that could still leave the US economy in a slump for 18 months.

That is why George Soros is warning about a slide into a recession in 2007, as a complete reversal of Federal Reserve interest rate policy would do nothing to save the US economy from a downward plunge. The Q4 figures tend to suggest that Mr. Soros might also be a little out in his timing, and that the Day of Reckoning for US equities is closer to hand.