For all the hand-wringing about the euro crisis, soaring deficits, and stubborn liquidity traps, the first half of 2012 wasn't so bad, judging by the major U.S. stock indices. The Dow, S&P 500, and Nasdaq ended the half up 5, 8, and 12 percent, respectively.
And the second half? There are still plenty of questions hanging over investors, like: Which tribe will win the White House? Will Congress will go all Thelma & Louise over the fiscal cliff? Will the eurozone come unglued? Will the individual mandate end Life As We Know It? Talk about a jobs killer.
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True, if you look real hard and squint a bit, you can glimpse currents of strength and threads of optimism. Employment is growing, if slowly. Long-term interest rates are higher than short-term rates, generally an indicator of confidence. At last count (May), durable-goods orders were up more than forecast and pending home sales were rising. Wages and hours worked rose in June as well.
But for every silver lining there's a dark cloud in hot pursuit. Weekly jobless claims fell to the lowest level in four years in July--but apparently because of seasonal factors rather than a long-term improvement. Job creation is anemic and the unemployment rate seems stuck at 8.2 percent. Manufacturing activity contracted in June for the first time in three years. Consumer confidence fell in June, as did retail sales. Factory orders, though up in June, remained down for the year. Some say we're in a "growth recession," meaning GDP is expanding but can't achieve the escape velocity needed to get out of the doldrums that weigh on both investors and job seekers. That leaves the economy vulnerable to the next unforeseen shock, be it a sovereign debt shock or megabank swap deal gone awry.
In a picture this mixed, you can reach just about any conclusion you want. Alex Kozhemiakin, co-manager of the $54 million Dreyfus Total Emerging Markets Fund (symbol:DTMAX), prefers to see a glass half-full. There have been some jolts in recent months, he concedes, "but you have to start thinking about the extent to which these negative surprises have been priced in."
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Kozhemiakin keeps his eyes on the developing world--or what he prefers to call "non-rich countries"--where the big worry of late has been the slowdown of China and Brazil, half of the BRIC bloc (along with Russia and India). But even there, Kozhemiakin sees reason for optimism. Unlike the developed countries, he notes, China and Brazil are not stuck in so-called liquidity traps--which is where you find yourself when interest rates are at zero and you still can't get lending restarted.
Those countries have room to cut rates, and they're slashing away. Brazil just cut its benchmark rate to 8 percent, and China cut its main lending rate to 6 percent. Still plenty of daylight between there and zero.
"I would expect both economies to bottom out, maybe towards the end of the year," says Kozhemiakin. In the meantime, he says, "I'm seeing some attractive opportunities" in non-rich economies.
On the European front, he notes, everyone at least seems to agree that what ails Europe is a structural problem. "There is a recognition that you have to have a common banking union to preserve the currency union," he says. "We are encouraged by the most recent European summit."
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Back in the United States, one indicator as to how murky things look came on July 11, when the minutes of the Federal Reserve's June meeting showed weak support for a third round of "quantitative easing" (buying assets to pump money into the economy), even though Fed officials admit disappointment with the pace of recovery. Some observers took that as a positive sign--no need for drastic measures--while others viewed it as a concession that QE just isn't very effective, except to spark momentary rallies.
"All the rallies really do is affect people with financial assets," says Doug Roberts, founder and chief investment strategist for Channel Capital Research. "It doesn't really do too much for the rest of the economy."
Kozhemiakin, for one, doesn't expect a U.S. recession in the second half, though if Congress doesn't come to terms over its fiscal impasse, all bets are off for next year. "If it's not resolved, it will be a major blow to U.S. economic growth, and I think we're going to see a recession in the first half of next year," he says. "But we don't expect the U.S. to go off the fiscal cliff."
Still, it's probably unreasonable to expect a sharp pick-up in the current half, at least one strong enough to let anyone, least of all Barack Obama, breath easy. There's a whole school of thought, authored by people like economist Irving Fisher, that severe financial shocks (like those in 2008, 1929, 1907--history offers plenty to choose from) take years to recover from. These are not V-shaped events; they're more like the Pacific basin, wide and seemingly endless.
So we seem to be enduring a prolonged period of what Fisher called "debt deflation," aka deleveraging. Until it's over--and lots of folks think it has another two years or so to run--don't expect any miracles from the stock market or the real economy. Roberts thinks the second half won't look too different from the first--the S&P wandering around in a narrow range never too far from the 1300s. "The economy's not particularly bad, and it's not bad enough to be catalyst for Fed action," he says.
On the bright side, no news can be good news. Says Roberts: "The only danger would be something falls apart in Europe, something happens in the Mideast or China and the Fed doesn't move quickly enough."
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