Listening to My Uncle’s Gut

With economic indicators rolling over, and debt crises no closer to a sustainable solution, extra caution is in order, writes MoneyShow.com senior editor Igor Greenwald.

Here’s a real-world financial problem: My uncle’s just about had it with the stock market.

In this, of course, he’s like many, perhaps most, Americans who’ve lost faith in Wall Street as an engine of wealth building.

According the flow of funds data from the Federal Reserve, direct equities ownership by households has declined in five of the last six years, by a cumulative $900 billion or so, a figure only modestly offset by increased holdings of mutual funds.

My uncle has been one of the holdouts. He came to America well into his middle age, from a country that trained him to be an excellent software engineer but not a very sophisticated consumer of financial services.

I’ve managed his retirement money since 2006, when we discovered that the Ameriprise (AMP) financial consultant he employed had an unhealthy affinity for in-house funds with 5.75% up-front loads.

He’s since done considerably better than the S&P 500’s unacceptably modest 3% annualized return over that span, via aggressive equity trading.

But now the gut feeling he claims to have had in mid-2008 and on a couple of other inauspicious occasions since is back, and he’d like his nest egg to lead a quieter life.

“I have an unpleasant premonition that this way-above-average volatility in the market won’t end any time soon,” he wrote me in an e-mail late Sunday, with Dow futures up 180 points in the wake of the debt-ceiling compromise. “Of course, I could be wrong, but I don’t have hopes for some sort of a fantastic jump.”

By noon on Monday, that anticipated 180-point jump had turned into a 160-point rout, on fresh signs that the spring “soft patch” is turning into a debt morass with no obvious means of escape.

The market would finish off those lows, but score one for my uncle’s gut. The market is starting to look punk.

And much as I would like to write this off as a summer fluke—between the lousy economic data, dysfunctional politics, and volume increases on the declines that hint at distribution by institutions, caution seems especially sensible right now.

So I dramatically lightened up in all the family accounts I manage. I did it right as the market started to reverse in the face of the Institute for Supply Management survey indicating that the manufacturing expansion has stopped and is in danger of reversing.

In fact, the closely watched new-orders component fell below 50, another bad sign.

So I purged the family portfolios of Freeport McMoRan (FCX), because copper is economically sensitive, and of Dell (DELL) simply because it’s done well, and while still enticingly cheap is not immune from economic vagaries. And I also cashed some of the gains in Apple (AAPL), because even the strongest companies and stocks become riskier in a market environment like this one.

NEXT: Something Is Missing

It’s possible to dismiss the ISM as a byproduct of the debt default scare. Also, people don’t always act the way they talk, so sentiment polls are notoriously fickle. But it’s also true that recessions start with a change of mass psychology, and the ISM has in the past been a reliable early indicator of such changes.

But even before the ISM unexpectedly slid from 55.3 in June to 50.9 for July, even before we learned that personal spending fell in June for the first time in 20 months, the tea leaves were looking ominous, as John Hussman ably describes.

It’s all well and good to celebrate strong corporate profits, but these are plainly not translating into domestic job gains, a crucial stage that sustained past economic recoveries.

Companies are hiring, alright—in fast-growing emerging markets. That suggests not merely a lack of confidence in domestic growth prospects, but also that US workers remain uncompetitive with counterparts abroad when factoring in the soaring health-care costs.

Why would any multinational hire in a jurisdiction where a major chunk of its labor cost has been rising so much faster than inflation in good times and bad? Indeed, General Electric (GE) chief Jeff Immelt, the Obama administration’s so-called jobs czar, has just shipped a few more American jobs to China.

Without job growth, the economy is simply not strong enough for a heavy debt burden that has yet to be restructured. Bond purchases by the Federal Reserve have masked this weakness for a time, but no longer.

Meanwhile, another earnings season of the sort that’s repeatedly bolstered stocks in the last two years is mostly done, and the news backdrop now gets a lot less friendly. Even if US growth is about to pick up, August will not be the month we learn that.

Maybe Europe supplies some fireworks, because at this rate its financial system will be completely wrecked by mid-month. But I don’t care to bet on a quick and clean solution to its credit problems, badly aggravated by misguided austerity policies.

With stocks likely headed lower, I’ve started looking for shelters where my uncle’s money can ride out the storm. More on that tomorrow.