Stock Market Bulls Point to Leading Economic Indicators

The rising market is driving the majority of the economic data supporting the "green shoots" crowd. The Index of Leading Economic Indicators, which has been pointing up for a few months, is heavily influenced by the stock market. Now, stock market bulls are pointing to the Leading Economic Indicators as a reason to buy stocks. It's circular reasoning, plain and simple, and it is now in vogue to the extent that now is a very dangerous time to be holding stocks.

Here are six lawn mowers from the real economy - the parts that don't revolve around Wall Street of Washington, DC - that could easily mow down the green shoots:

1. Stabilizing numbers for continuing unemployment claims are painting a misleading picture. In reality, hundreds of thousands are rolling off of the traditional six months of benefits into extended unemployment benefits rolls. The recent payroll data was temporarily inflated by a rebound in auto production from depression levels, and the government's hiring of census workers. Also, the unemployment rate fell because the number of people actively looking for work keeps falling. There are absolutely no signs that those who were laid off will find a new job anytime soon.

2. The federal government's income tax receipts are still collapsing. Paycheck withholding tax receipts are still falling sharply. As data services like TrimTabs have demonstrated, income tax receipts are far more accurate gauges of trends in personal income than the highly massaged employment figures from the government. Falling tax receipts translate into a higher threat of confiscatory marginal tax rates in the future, deficit monetization and more inflation.

3. Last Friday's aggregation of July same store sales in the retail business confirms that end demand for many products remains bleak (aside from auto sales in the "cash for clunker" program, compliments of the ballooning national debt). For perspective, gasoline prices in July 2009 were about 35% lower than the $4-plus per gallon level of July 2008. One would think that this would be a major tailwind for retail, but it's not.

4. The federal government is spending other people's money like a drunken sailor, yet a good portion of the sugar high "stimulative" effect of this spending on GDP will be offset by lasting cuts in state and local government budgets.

5. The bond market will continue balking at absorbing trillions in new Treasury bond supply to fund the deficit. Rising mortgage rates, which are tied to Treasury Note yields, will limit the positive impact of refinancing those few homeowners that have any equity left in their homes.

6. Has the market noticed that the FDIC is stalling on its duty to shut down and eat heavy losses at several zombie regional banks - Corus, Guaranty, and Colonial to name a few? When it when it does so, it will have to draw down tens of billions of dollars from its emergency line of credit with the Treasury.

These factors all indicate that the economy is most certainly not returning to pre-credit bubble conditions. Yet the stock market is pricing in a return to such conditions - especially in the rallies in junk stocks that we've seen since the market lifted off on July 13.

I'll add a seventh lawn mower: the growing risks posed by debt bubbles in China and other emerging markets...

The Chinese government realizes that its stimulus spending and pressure on banks to expand lending is inflating a massive bubble in the Chinese stock and property markets. The problem with unsustainable economy activity is, of course, that it must eventually end. Michael Cembalest, the Chief Investment Officer of J.P. Morgan Global Wealth Management, describes the Chinese lending bubble in his Aug. 6 "Eye on the Market":

And in China, while there are positive recovery signals, I've never seen a country expand its loan base by 34% in one year without massive inefficiencies and asset speculation in its wake. Only 5% of this year's loans went to private enterprises (which employ 75% of the urban workforce), as 95% went to state-owned enterprises or provincial entities. While there have been substantial productive improvements in rail and other infrastructure, our contacts in Asia also indicate that funds designated for stimulus are ending up pushing up land price auctions to 4 times the original bids.

This is mal-investment on a monumental scale. But for now, the Chinese have much more room to borrow and inflate than the US (which has spent the last few decades doing so). Eventually, the market will cut them off. The end will not be pretty, and at some point in the future, shorting Chinese stocks may be one of the best short selling opportunities in history.

But in the meantime, it makes no sense to bet against China. The Communist government has proven very efficient at stealing the resources of its people (via inflation and taxation) and channeling them into whatever infrastructure project they deem necessary.

This process could end next week, or next year. That's the annoying part about bubbles: they tend to expand until the last patsy has bought in, and there's no telling how many patsies there are. There are already signs emerging that the furious pace of loan growth is slowing down. Today, Bloomberg reports:

"China Construction Bank Corp. will reduce new lending by about 70 percent in the second half after a surge in loans in the first six months increased credit risk, President Zhang Jianguo said in an interview.

"CCB, the world's second-largest bank by market value, plans to extend about 200 billion yuan ($29 billion) of loans, down from 708.5 billion yuan in the first half, said Zhang, 54. The company's new lending through June 30 was 42 percent more than for all of 2008."

Lots of debt loans are being made, but as long as loan growth is running hit, they will be hidden. Once loan growth stalls, bad loans will come to light, and the Chinese government may implement its own version of TARP to recapitalize its banks.

But the situation in the US is different...

Society has too much unaffordable debt at nearly every level. To top it off, we have a Federal Reserve run by central planners who not only misdiagnose their own complicity in the credit bubble, but also remain smugly confident that they can withdraw excess reserves before fears of inflation pick back up. This is turning out to be the financial market's largest ever game of chicken: the Treasury and Fed acting in a brazen manner to depreciate all forms of US paper (government debt and dollars), and, with each passing year, foreign creditors with fewer and fewer reasons to hold the liabilities of a bankrupt government that's accelerating its move deeper into bankruptcy.

The ingredients add up to the potentially explosive move up in gold-related assets. The more developments I see regarding economic fundamentals, and fiscal and monetary policy around the world, the more I want to own gold, and sell most stocks.

Regards,

Dan Amoss
for The Daily Reckoning Australia

Stock Market Bulls Point to Leading Economic Indicators, 9.4 out of 10 based on 8 ratings

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