David Rosenberg: Six Roadblocks For Stocks

Tuesday, April 10th, 2012

There is no free-lunch – especially if that lunch is liquidity-fueled – is how Gluskin-Sheff’s David Rosenberg reminds us of the reality facing US markets this year and next. As (former Fed governor) Kevin Warsh noted in the WSJ “The ‘fiscal cliff’ in early 2013 – when government stimulus spending and tax relief are set to fall – is not misfortune. It is the inevitable result of policies that kick the can down the road.” Between the jobs data and three months in a row of declining ISM orders/inventories it seems the key manufacturing sector of support for the economy may be quaking and add to that the deleveraging that is now recurring (consumer credit) and Rosenberg sees six rather sizable stumbling-blocks facing markets as we move forward.

CHALLENGES FOR THE MARKET

First, there is liquidity — this major catalyst for equities since last October looks set to subside with the Fed seemingly backing off from a QE expansion, at least over the near-term. And the ECB is back talking about inflation so it doesn’t even look like a rate cut is coming despite escalating recession pressures in Europe. It is now also highly doubtful that China will re-open the monetary taps following the disappointing March inflation data. The liquid lunch looks less likely.

Second, there is the U.S. economy — not just the disappointing jobs data on Friday but the reality that 70% of the releases in the past month have come in below expectations. While the chain stores did report what seemed on the surface to be a solid +3.9% YoY sales gain in March, keep in mind that yet again we had very mild weather and we also had an early Easter effect.

Third, there is the rapid slowing in corporate earnings (Alcoa kicks off the reporting season tomorrow). In Q4, we had the YoY trend in S&P 500 operating earnings slip into single-digits (+9.2%) for the first time in two years, and absent Apple, the pace would have been 6.2% (see the front page of the Investor’s Business Daily). Only 62% of companies beat their estimates, which is far below average. As for Q1, the consensus is all the way down to +3.2% on a YoY basis — well off the +5.5% expectation at the turn of the year and the +12.8% forecast in the mid-part of 2011. Strip Apple out of the numbers, and you are talking about earnings growth of practically nothing— +1.8%.

Not only has earnings growth basically evaporated, but the ratio of negative to positive guidance has risen to levels we last saw two years ago, margins are poised to shrink to a two-year low as well, and only three S&P 500 sectors are actually seen raising their earnings from year-ago levels. Now the question is whether or not the market can move up with earnings contracting and the answer is — of course! We have seen that in the past, as rare as it may be. Just go back to 1998, when the Asian meltdown and strong U.S. dollar severely pinched U.S. corporate earnings, yet the S&P 500 rallied more than 20% that year. But what else happened? Well, we had the Fed cut rates three times as a super-strong antidote, and did so at a time when there was no evident slack in the labor market. Plus, we were in the early stages of an internet-led productivity spree, which underpinned profit margins. In addition, we had a Democratic president working with Congress to pass legislation that reduced red tape, labour rigidities and taxation — with no budget deficit! Please, tell me if we currently have these as antidotes for a weakening trend in corporate profits.

Fourth, there is Europe making the headlines again, and not in a positive way. Spain is back on the radar screen with a very bad bond auction last week serving up as a referendum on the government’s fiscal plan — sending the 10- year yield back up close to 6%.

We have the two rounds of French elections looming (April 22nd and May 6th) and the new government is going to have precious little time or margin of error with regard to delivering a fiscal package that will pass the ‘sniff test’ for Mr. Market. It is very clear that, in Italy, Mario Monti’s honeymoon period is over as he vacillates over parts of his economic reform package. Financial stress is highlighted by the poor performance of the euro area banks (the group that got the cyclical bounce going last November) as the group sagged 4.3% last week and is now trading near three-month lows.

On the macro front, Germany had been an economic lynchpin but no longer with industrial production sliding 1.3% in February and a downward revision to January. U.K. factory output also fell 1% — a big shock to a consensus looking for a 0.1% gain. Not just Europe, but the global economy in general is cooling off. The HSBC diffusion survey of China’s service sector slipped to 53.3 in March from 53.9 in February. Russia’s economy ministry just shaved its 2012 growth forecast to 3.4% from 3.7%.

Fifth, there is the poor technical picture. The large number of distribution days of late. The number of stocks making fresh 52-week highs is on the decline. At last week’s highs in the major averages, divergences were popping up everywhere. One particular glaring anomaly was the surge in global equities in Q1 and the sharp rise in government bond yields at a time when the CRB index faltered — if the first two asset classes were actually prescient in the view of global reflation, wouldn’t it have shown up in basic material prices given their inherent cyclical sensitivities?

Sixth, valuation support is less of a positive than it was six months ago. The cyclically-adjusted P/E at 22x for the S&P 500 is nearly 40% higher than the long-run average of 16x. The forward P/E ratio at over 13x now is about in line with the historical norm. Some nifty analysis cited on page B6 of the weekend WSJ (Why Stocks Look Too Pricey) found that when real rates are negative, as they are today, they tend to represent periods of economic turmoil and as such, the typical P/E multiple during these times is 11x — versus today’s trailing multiple of 14x. On this basis, the market as a whole (keeping in mind that we don’t buy the market, just the slices of it that we strongly believe are undervalued) is overpriced by more than 20%.

Tags: Alcoa, Corporate Earnings, David Rosenberg, ECB, Fed Governor, Gluskin Sheff, Inevitable Result, Inflation Data, Kevin Warsh, Liquid Lunch, Manufacturing Sector, Mild Weather, Qe, Reporting Season, Roadblocks, S David, Season Tomorrow, Solid 3, There Is No Free Lunch, Wsj
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Hatzius On The Three Reasons The Recovery Is Overstated

Tuesday, March 20th, 2012

Economic Surprise Indices have been rolling over for a month or two now. The trend of US macro data has also disappointed in a period when it would be expected (empirically) to accelerate. However, taken anecdotally or cherry-picked managers can find plenty of ammunition to support the to-infinity-and-beyond Birinyi forecast (though often it relies on the most manipulated and adjusted government provided time-series). Overnight’s concerns on China show just how quickly confidence can be upset but Goldman’s Jan Hatzius sees three main factors for why their GDP-tracking estimate is weakening already (more like 2% than 3-3.5% growth) and that we are seeing slightly softer data already. The end of the inventory cycle, the pulling forward of demand thanks to the warm weather aberration, and the already clear impact on consumption from higher gasoline prices will likely shift from an overstated economic trajectory to more muddle-through or worse for Q2 onwards.

Goldman Sachs: Sticking With Sluggish

The US economic data over the past few months have clearly outperformed expectations. Our current activity indicator (CAI) is running at 3.5% in February given the data in hand so far, and is tracking 2.9% for the first quarter as a whole. However, we expect the numbers over next 2-3 months to slow to a pace that looks more consistent with a 2% overall activity growth pace rather than 3% or even 3.5%.

1. Warm weather has pulled forward activity.

 

Some of the recent strength in the CAI is likely to reflect the exceptionally mild 2011-2012 winter. To be sure, there are some areas where mild weather has a negative impact on economic activity, such as utilities output and perhaps some retailers that sell seasonal goods. But this is likely to be offset by areas where the impact is positive, as construction and other outdoor activities decline by less in not seasonally adjusted terms than the seasonal factors “expect” and this gets translated into a large seasonally adjusted increase. Overall, we found that the weather has contributed an estimated 0.3 percentage points to the 2.9% annualized growth rate of the CAI in the first quarter so far (see Zach Pandl, “Growth Impact of a Mild Winter,” US Daily, March 1, 2012). The impact on a more comprehensive measure of activity that includes both the CAI and GDP would be a bit smaller, perhaps 0.2 points, as GDP is probably less weather-sensitive.

 

2. The inventory cycle has helped.

 

The pickup in inventory accumulation from -$2 billion (annualized) in the third quarter to +$54 billion in the fourth quarter contributed 1.9 percentage points to the Q4 growth rate. Moreover, inventory accumulation seems to have picked up a bit further in the early part of the first quarter, judging from the Commerce Department’s book-value inventory numbers for January as well as the ISM manufacturing survey for January/February. This suggests that inventories may still be making a positive growth contribution for the time being. But while we are not close to a situation where inventories start to look “heavy,” a further positive impact in coming quarters is not likely.

 

3. Gas prices are starting to cut into real income.

 

Gasoline prices rose sharply in January and February. Using weekly data from the US Department of Energy, they are now up 9.1% from their end-2011 level on a seasonally adjusted basis, with most of the increase likely to show up in February and March on a month-average basis. According to our models of the link between gasoline prices and growth, such a hit might take 0.3-0.4 percentage points off real GDP growth over the subsequent year. Moreover, using monthly data on the link between gasoline prices and consumption, we find that the impact becomes visible about 1 month after the initial hit, so this would imply that the impact would show up in March and April.

There may be some early signs of deceleration in the data.

The data surprises have indeed turned a bit less positive in recent weeks, although it is too early to say definitively whether this is noise or a more lasting shift. In March so far, our US-MAP scoring system for the economic data relative to consensus expectations has averaged a slightly negative reading, despite the better-than-expected February employment report. Of course, some of this just reflects the fact that consensus expectations have caught up with the better data. However, there are also some faint signs in the more forward-looking indicators that the tone of the data may be shifting down a notch. In particular, the new orders indexes of the February ISM, March NY Empire State, and March Philly Fed survey all fell moderately.

Our bottom line is that there are several reasons to believe that the recent data may have overstated the strength of the US economic data. For the first quarter as a whole, our current best guess is that a broad measure of activity growth that puts most of the weight on the CAI but also some weight on the GDP bean count is currently running at a 2.6% pace; we believe that this might overstate true growth by perhaps 0.2 percentage points because of weather, so that the second quarter is likely to understate growth by 0.2 percentage points (for a “swing” of 0.4 percentage points); the end of the inventory cycle might take a couple of tenths off growth; the impact of the gas price increase might take another few tenths off growth; and we may be seeing some signs of softer growth in the most recent data already. All told, we believe that the numbers are likely to slow to a pace that looks much more consistent with a 2% rather than a 3% or even 3.5% growth pace through the end of the second quarter.

Tags: Aberration, Ammunition, Anecdotally, Birinyi, Economic Activity, Economic Data, Gasoline Prices, Goldman Sachs, Growth Pace, Inventory Cycle, Macro Data, Mild Weather, Muddle, Negative Impact, Q2, Seasonal Factors, Seasonal Goods, Time Series, Trajectory, Warm Weather
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U.S. Equity Market Radar (March 19, 2012)

Saturday, March 17th, 2012

U.S. Equity Market Radar (March 19, 2012)

The S&P 500 Index rallied by 2.4 percent this week to the highest level in almost four years, the biggest weekly gain year-to-date. The rally was driven by the financials, industrials and technology sectors.

Strengths

• The financials sector was the best performer this week as the Federal Reserve announced that 15 out of the 19 largest U.S. banks passed a stringent stress test that assumed a 13 percent unemployment rate, 50 percent drop in stock prices, and 21 percent decline in home prices. J.P. Morgan Chase raised its quarterly dividend by 20 percent and announced a $15 billion stock buyback.
• The industrials sector was underpinned by strong performance of railroad companies led by CSX. The company forecasted record full-year earnings, with higher demand for automotive, metal and housing-related goods offsetting lower coal shipments.
• The building products and real estate services groups were among the best performing industry groups in the S&P 500 this week, as multiple surveys suggested February homebuyer traffic would reach a record high, thanks to enhanced affordability, improved buyer confidence, and mild weather.

Weaknesses

• The utilities sector was the worst performer this week as investors preferred to take on more risk with market volatility continuing to slide. Higher treasury yields also weighed on this income-generating sector.
• The consumer staples sector also underperformed as a result of risk-taking investor behavior.
• Newmont Mining dragged the single-constituent gold industry group to be the biggest laggard this week, with the correction in gold prices on the back of the Fed’s reticence on further quantitative easing programs.

Opportunities

• Large banks pushed the S&P 500 to new highs, a potential sign of further market strength based on historical observation that bull markets tend to be led by financials.

Threats

• After such a strong start to the year, a pullback or consolidation in the market would not be surprising.
• The S&P 500 is arguably overbought in the short term and could be vulnerable to profit taking.

Tags: Bull Markets, Coal Shipments, Consumer Staples, Gold Industry, Gold Prices, Industry Groups, Investor Behavior, J P Morgan Chase, Market Radar, Market Strength, Market Volatility, Mild Weather, Newmont Mining, Quarterly Dividend, Railroad Companies, Stock Buyback, Stress Test, Technology Sectors, Treasury Yields, Unemployment Rate
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Energy and Natural Resources Market Radar (January 1, 2012)

Sunday, January 1st, 2012

Energy and Natural Resources Market Radar (January 1, 2012)

Strengths

• The Global Resources Fund beat its benchmark this week primarily due to stock selection across various industries.  Also, the fund was aided by better relative performance of junior exploration stocks versus senior resources stocks.
• Oil climbed 8.7 percent this year, set for a third annual gain, on speculation that escalating tension in the Middle East may disrupt supplies as a recovery in the U.S. economy bolters demand. (Bloomberg)
• First Quantum’s workers at their Mauritania mine ended a week-long strike after receiving water and electricity allowances and yearly bonuses.  Water and electricity allowances are now the equivalent of $171 and $257, while annual bonuses will be as much as six months’ salary.
• Macquarie noted that iron ore is having a slight rally into year end, boosted by interest from Chinese traders ahead of an expected steel production push into Chinese New Year. The Steel Index 62%Fe reference price CFR China is now $138.4 per ton, over 5 percent above its mid-December lows. The annual average 2011 spot iron ore price is set to come in around $168 per ton for 62 percent material, up 14 percent from 2010’s record.

Weaknesses

• Copper finished down 3 cents per pound for the week to close the year at $3.43 per pound (COMEX).  Copper fell $1 per pound down 23 percent from its starting point of $4.45 per pound last year.
• The LMEX index of six industrial metals contracted 23 percent this year, led by declines in tin, nickel and zinc.  Spot silver is 9.3 percent lower in 2011, set for its first annual decline in three years.  Palladium is poised to fall 21 percent, and platinum has lost 22 percent.
• Natural gas futures dropped below $3 per British thermal units for the first time in more than two years as mild weather and rising production contribute to a growing U.S. stockpile surplus.
• Bloomberg reported that Brazil’s oil regulator fined Chevron for the third time for not properly managing an offshore oil field that leaked last month.  The Agencia Nacional do Petroleo said on its website today that Chevron didn’t comply with the development plan for the Frade oil field off the coast of Brazil.  The amount of the fine has yet to be finalized, but the first two fines may be as much as the equivalent of $26 million.

Opportunities

• Bloomberg reported that Goldman Sachs said in a December 1 report that the world is likely to avoid a recession and maintained its overweight allocation to commodities, predicting a 15 percent return in the next 12 months.
• Chinese coal stocks at IPPs continue to drop in terms of days of use according to data from China Coal Resource.  A Vietnam state-owned coal exporter, Vinacomin, has said it will also cut its coal exports from the following year to 13.3 million tons from 16.8 million tons this year, as domestic demand increases. This just points to an opportunity for coal imports into China to pick up.
• The Baker Hughes U.S. rig count, a key indicator of activity in the oil and gas sector, hit a 27-year seasonal high last week. At 2008 rigs, this is up 17.5 percent year-over-year and indicates ongoing strong demand from the U.S. energy sector for high performance commodity materials.

Threats

• Bloomberg highlighted that the weakest growth in demand in at least a decade for shipments of iron ore, the second-biggest commodity cargo after crude oil, means rates for the largest vessels will plunge to the lowest level since 2002.  It has been estimated that capsizes, each hauling about 160,000 metric tons of ore, will earn an average of $15,000 a day next year, about a 4 percent decrease than in 2011, implying losses for ship owners and investors in their companies.
• Hitachi Construction Machinery said Chinese demand for excavators will decline in the fist half of 2012 as monetary tightening slows construction projects. The sales downturn in China will continue after the Lunar New Year next month, CEO Michijiro Kikawa said, adding that he had expected Chinese demand to come back sooner. Kikawa expects industry-wide sales of excavators in China to decrease by 30 percent in the year to March 31, compared with a forecast of a 20 percent decline two months ago. China will probably see no growth until June or July, Kikawa said.

Tags: Chinese New Year, Chinese Traders, Comex Copper, Exploration Stocks, Global Resources, Industrial Metals, Iron Ore Price, Junior Exploration, Lost 22, Market Radar, Mild Weather, Natural Gas Futures, Reference Price, Relative Performance, Resources Fund, Senior Resources, Spot Silver, Steel Index, Steel Production, Stock Selection
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