ETN Eaton Corp New

One the world's top investment banks today lowered their forecasts for global GDP by 30 basis points and 70 basis points for this year and next, respectively. Here are Morgan Stanley’s revisions to prior projections:

2011: Global GDP forecast of 3.9%, down from 4.2%

2012: Global GDP forecast of 3.8%, down from 4.5%

This is exactly what I have been saying to expect since July 29 when we got final -- and abysmal -- GDP revisions for the US economy for the previous three quarters. When the first half clocked in at a dismal 0.8% growth, I said stocks would go lower as large investors priced in a probable recession even before they could prove it was coming.

What proof were they looking for? Visibility on corporate earnings and domestic demand, which is essentially GDP since 45% of the S&P 500 earnings are from abroad and a large part of this is not part of the domestic math.

Proof was needed because of these new concerns:

China trying to cool its red-hot pace of growth

Europe on the verge a systemic banking crisis

Weak manufacturing and consumer data in the US

Philly Fed Drops a Bomb

And the other dose of data we got Thursday that can be put in the "confirms a coming recession" camp was the Philly Fed Survey. How serious is it that this one came in at -30.7 when the market was looking for something closer to zero?

The Philadelphia Federal Reserve Survey of business conditions tracks sentiment and trends among industrial manufacturers in that district, including data for orders, shipments, employment, and prices. Its correlation to the national industrial production data is strong and it is considered a relatively solid leading indicator for the rest of the country.

There was concern in June when the Philly Fed dropped below the zero line to a minus 7.7 reading. July saw it peek its head back above zero, so it looked like we could have a repeat of last August to October in this data, where a sub-zero mark was quickly erased by a surge above 40.

But given the other "slowdown is here" data and the tone of the Federal Reserve after both its June and August FOMC meetings, manufacturers may have begun pricing in the recession just as quickly.

The significance of the -30 reading is that it brings us right back to where we were during the 2008-09 recession when industrial production measures were hitting anywhere from -2% to -4%. That's scary territory for stocks.

Are the Philly Fed district manufacturers right? Is the slowdown more severe than most investors had imagined? We shall have to wait for more data to know for sure. Meanwhile, the stock market ecology remains unstable...

Sell First, Investigate Later

The month of August so far has been a classic example of "shoot first and ask questions later." In this case, good stocks are being shot while the recession gets discounted.

Morgan Stanley will not be the last investment or research house to downgrade growth. We still await the Fed to revise its GDP projections as I wrote about in these two articles...

QE3 and the Probability of Recession, August 10

Bernanke: I See Unemployed People, August 9

Where it will get really interesting is when we get specific calls on US GDP. Surely, many strategists are at work formulating their revisions based on an overall analysis of the global economy since Emerging Markets are such a driver of US economic growth.

Does Philly Fed in Recession Territory Make it a Done Deal?

Thursday's market meltdown is driven as much by the fears in Europe and Morgan Stanley's downcast view as by the depressing Philadelphia Fed survey.

This puts Federal Reserve leaders in new light, especially with three dissenters on the last FOMC vote and dovish Dudley out there already this week explaining the necessity of continued extraordinary monetary accommodation.

Even though I said on Bloomberg TV Thursday that I had moved my recession probability from 40% to 50% based on Philly Fed, I still wait for more confirming data. I hope this doesn't become a self-fulfilling recession as I wrote about last week.

And I trust that monetary accommodation can beat the threat of deflation. In the meantime, I won't be afraid to take positions in my favorite stocks on these fear-driven sell-off days.

Plus, in addition to my thesis from Wednesday that there is extreme fundamental value in the S&P 500 around 1,100, I saw two barometers of risk appetite holding up well on Thursday: copper and the euro.

If the recession were a done deal, copper would be selling off more dramatically. It continues to stay close to $4. I still like my current long holding in Southern Copper (SCCO) here, especially near its 52-week lows and kicking out an 8% dividend yield.

And if Europe's banking system were going to implode, the euro would not be holding on above $1.43 so well. The crude oil market, conversely, is definitely taking it on the chin, so I have reasons to worry about my energy stocks like Suncor (SU) and National Oilwell Varco (NOV), as well as my industrial names like Cummins (CMI) and Eaton (ETN).

But I also don't think Philly Fed spells a certain recession. And I look forward to seeing what opportunities the next few weeks bring.

To see why I think the market is getting very close to a screaming buy again, just like the correction of 2010, see "S&P 1,100: Extreme Value Area?"

Kevin Cook is a Senior Stock Strategist for Zacks.com
 
CUMMINS INC (CMI): Free Stock Analysis Report
 
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