Bull trap

So, we’ve seen a bounce in the American and Australian economies recently. In the US, September has proved better than August with a modest lift in the manufacturing indices, consumer confidence and stable service sector activity, even if personal consumption has stalled. Markets are betting on a decent employment number tomorrow night.

In Australia, we’ve had a couple of months of better (but far from stellar) data, with a big bounce in consumer confidence, decent retail sales, a nice reversal in building approval, as well as runaway exports. There are also rumours of increased mortgage activity but nothing showing up yet in indices. I pin most of this on the general acceptance that rates have peaked, which began in late July.

For both of these economies, these positive outcomes have transpired against a dire background of deteriorating stock markets driven by ceaseless bumbling in Europe and declining global growth. So, it is time to ask, can we get through this OK?

I would like to say yes. I would like to say that the cycle is turning up again. There is one reason I can think of for why it might. The collapse of commodity prices, especially oil, has freed up some greater consumptive power.

But, sadly, I just don’t buy it. This is a head fake, a false signal, a bull trap. Why so?

A few weeks ago, the IMF answered the question nicely:

Relative to our previous World Economic Outlook last April, the economic recovery has become much more uncertain. The world economy suffers from the confluence of two adverse developments. The first is a much slower recovery in advanced economies since the beginning of the year, a development we largely failed to perceive as it was happening. The second is a large increase in fiscal and financial uncertainty, which has been particularly pronounced since August. Each of these developments is worrisome—their combination and their interactions more so. Strong policies are urgently needed to improve the outlook and reduce the risks.

Growth, which had been strong in 2010, decreased in 2011. This slowdown did not initially cause too much worry. We had forecast some slowdown, due to the end of the inventory cycle and fiscal consolidation. One-time events, from the earthquake and tsunami in Japan to shocks to the supply of oil, offered plausible explanations for a further slowdown. And the initial U.S. data understated the size of the slowdown itself. Now that the numbers are in, it is clear that more was going on.

What was going on was the stalling of the two rebalancing acts, which we have argued in many previous issues of the World Economic Outlook are needed to deliver “strong, balanced and sustainable” growth.

…The first leg is fiscal policy. Fiscal consolidation cannot be too fast or it will kill growth. It cannot be too slow or it will kill credibility. The speed must depend on individual country circumstances, but the key continues to be credible medium-term consolidation.

…The second leg is financial measures. Fiscal uncertainty will not go away overnight. And even under the most optimistic assumptions, growth in advanced economies will remain low for some time.

…The third leg is external rebalancing. It is hard to see how, even with the policy measures listed above, domestic demand in the United States and other economies hit by the crisis can, by itself, ensure sufficient growth. Thus, exports from the United States and crisis-hit economies must increase, and, by implication, net exports from the rest of the world must decrease. A number of Asian economies, in particular China, have large current account surpluses and have indicated plans to rebalance from foreign to domestic demand. These plans cannot be implemented overnight. But they must be implemented as fast as possible. Only with this global rebalancing can we hope for stronger growth in advanced economies and, by implication, for the rest of the world.

I know, I know, the IMF has a questionable record, but on this occasion they look spot on to me. The US has planned (if not yet in detail) roughly 1.5% of GDP in fiscal cuts for next year. Europe has ongoing austerity and blowback on its banks. It may be able to pass the Greek bailout but larger measures are far distant and will require greater crisis to move forward. Driven by this troubled backdrop the $US has begun to rise and without further quantitative easing will continue to do so, choking off external demand for US goods. This will also continue to damage commodity prices, which will retard emerging market growth, even if it benefits China some.

That’s it. Not that complicated. There’s simply no evidence for how a virtuous cycle can form in the global economy next year. Conversely, there is evidence that a negative feedback loop is forming and will continue to do so.

That doesn’t mean we won’t get a big bear market rally. We probably will on some new European progress. Markets clearly want it. But in the end, the macroeconomic settings as they are currently projected will win.

Houses and Holes


  1. Other estimates put US fiscal cuts at 0.75% of GDP. Google and get the spread of guestimates and take your pick.

    More generally, who are these bulls that are going to be trapped? Apart from a handfull of the usual suspects most punters seem cautious at best.

  2. I think there is a lot of cash on the sidelines looking to be destroyed in the markets and this will surely unfold as the greedy stake out their positions in the share market.

  3. There’s simply no evidence for how a virtuous cycle can form in the global economy next year.

    Wrong again! We’re nowhere near a recession in the US…

    In the US, markets are getting another leg up on the European news flow, but we are also finding – and despite the disproportionate amount of time some economists and the press spend talking about a double-dip recession – that the US actually isn’t in one! The non-manufacturing ISM survey was stronger than expected at 53 in September and virtually unchanged from 53.3 in August. What this tells us is that the US services sector is growing at a trend-like pace. It’s nowhere near a recession and in no way a sign that the recovery is faltering.

    • Of course it’s growing, Adam. US rates are zero. The problem, Adam, is this kind of ZIRP-inspired growth isn’t sustainable.

  4. a bull trap? i dont know H&H a set up for a bear market rally is more like it. The bears are getting very frustrated there has been absolutely NO negetive developments for weeks now.

    “But, sadly, I just don’t buy it. This is a head fake, a false signal, a bull trap”

    that is too bad for you then H&H becuase you are going to miss out on some very easy gains from these low levels, ive been “buying it” for the past 2 weeks and hasnt felt this good for years.

    shorts about to get blown out of the water if you ask me

    • H&H is not a trader and this is not about timing equity markets – its about economic analysis and being won over by a small sample of positive data.

      In other words, stand back, look at the big picture, view the cycle as it is, and weigh up the risks to the economy.

      Somewhere in there, yes you have to be concerned about your portfolio, and yes, some people will take advantage of a bear market rally for short term gains.

    • > ive been “buying it” for the past 2 weeks and hasnt felt this good for years.

      Me too. I am buying when the ASX200 drops under 4000. I think it provides good medium term value.

    • Earlier this morning I could see pretty much equal merit in the bullish and bearish cases, in the short term:


      Got a gut feeling that we’ll see one more poke lower to silence the bulls before we get a bigger rally (several weeks) …. but I wouldn’t trade on the basis of that feeling.

      The only “sure thing” trade for me at the moment is long term short EUR/USD. I always get worried when I think I am on to a sure thing, means I might not see or heed the warning signs if things don’t go my way.

      Thanks for the macro opinions and analysis H & H. Spot on, I think.

      • > The only “sure thing” trade for me at the moment is long term short EUR/USD

        Yes, if you have that view you would be bearish on stocks too. But we seem to have forgotten everything about USD weakness, commodity prices, and about Ben policies. What happens to EUR/USD if a full QE3 is announced?

      • What if, indeed. No idea. It’s hard enough to make decisions based on what we do know, without considering the What Ifs.

        I trust that the charts will keep me on the right side of the market no matter which of the What Ifs transire. They’re good like that, the charts.

  5. Remember when the GSEs were rescued; and the market spiked -‘We’re saved’- and it gave The States the moral courage to let Lehman go, the next weekend? Well I wonder if this ‘saving’-the implied bailing out of the Eurobanks- will be followed by the ‘courage’ to let Greece go?

    • Remember what happened to the ASX after it went down to 3100?

      The European situation will stay with us for a few years still. And the deflated US housing too. But my take is that company profits will not hurt as much as it is priced in. You can’t have a major recession from such already depressed levels. We won’t have a spectacular recovery… but neither a new major recession.

      • Of course you can have a major recession if demand falls further, triggering an new inventory cycle. If you are going to bet on sustained demand don’t kid yourself you’re doing something else.

        • Maybe. I think we are in a new flattish normal. No big jumps in demand, no major drops, in the western economies. Austerity, sovereign debt, housing will depress demand for the foreseeable future. Low interest rates and developing economies will balance that.

        • “You can’t have a major recession from such already depressed levels”

          you certainly can mb, its called a depression

  6. Your (or rather the IMF’s) macroeconomic summary seems spot on to me. The question as far as markets are concerned is, to what extent has this scenario (or worse) already been factored in to current prices? If prices have been driven down by fear of an even worse outcome (eg a major European collapse) then there may be scope for upside as that fear gradually eases.

    • +1000 AH

      although “there may be scope for upside as that fear gradually eases” is an understatement

    • Let’s not forget oil… when oil prices rise above $100, the US economy seems to stall, each time. It happened in 2008, it happened in 2011. Now, at least, oil is a lot cheaper.

      The big drop in the S&P500 is mainly due to the financials in US and EU which are now back at 2008 GFC levels: http://www.zerohedge.com/news/finaler-countdown

      That’s a lot to price in.

    • Deus Forex Machina

      YEp…on the money.

      Westpac and few of the global banks have built indices they call “data pulses” for want of better term.

      they are normally diffusion indices of how much data has been better than forecast minus how much has been worse.

      Given the beauty parade nature of markets if data is better than expected but worse than last month it can still have a positive impact. For example the ISM non-manufacturing data in the US last night was 53.0 versus expectations of 52.8 so its positive BUT last month was 53.3 so its actually negative. But the market is only concerned with expectations.

      You are spot on AH

  7. Trade the volatility and keep my risk low.
    That’s it for me.
    I’ll get a nasty nip from the bulltrap at the end of this, but thats life.

  8. From the most ebullient of the bulls:

    As I suggested yesterday, we may well be on the cusp of a rally larger than the 100% gain the Dow Jones Index seen in 2009.

    masters of the universe, often wrong, have never been so wrong ! ASXSP200 target remains 8,000 9,000, happy to call it 10,000 in 3 years !