Posts Tagged ‘Time After Time’

“This Time It’s Different?” – David Rosenberg Explains The Melt Up And The Latent Risks

Monday, March 19th, 2012

The market is ripping. That much is obvious. What some may have forgotten however, is that it ripped in the beginning of 2011… and in the beginning of 2010: in other words, what we are getting is not just deja vu (all on the back of massive central bank intervention time after time), but double deja vu. The end results, however, by year end in both those cases was less than spectacular. In fact, in an attempt to convince readers that this time it is different, Reuters came out yesterday with an article titled, you guessed it, “This Time It’s Different” which contains the following verbiage: “bursts of optimism have sown false hope before… Today there is a cautious hope that perhaps this time it’s different.” (this article was penned by the inhouse spin master, Stella Dawson, who had a rather prominent appearance here.) So the trillions in excess electronic liquidity provided by everyone but the Fed (constrained in an election year) is different than the liquidity provided by the Fed? Got it. Of course, there are those who will bite, and buy the propaganda, and stocks. For everyone else, here is a rundown from David Rosenberg explaining why stocks continue to move near-vertically higher, and what the latent risks continue to be.

UP, UP AND AWAY!

It has been quite a move up in the U.S. equity markets. The S&P 500 just completed its fifth straight week of gains, the longest streak of the year. From the closing low of last October 3rd, the index has rallied a breathtaking 28%. So far in 2012, the Dow is up 8%, the S&P 500 is up 12% and the Nasdaq is up 17%. Breathtaking to say the least.

What accounts for all this optimism:

  • The European LTRO program has obliterated financial tail risks in the region.
  • The successful second bailout of Greece.
  • Chinese inflation down to 3.2% has fuelled hopes of monetary ease.
  • Perceptions that that the U.S. economy is reaccelerating — all the Fed had to do was change “modest” to “moderate” (plus the ECRI leading index has improved to a seven-month high).
  • Tentative signs that the secular headwinds are subsiding — housing, credit, employment, local government fiscal restraint.
  • Oil prices stabilizing with a calm emerging with respect to Iran.
  • Technically, the market is making higher highs and higher lows — a confirmed uptrend.
  • Global earnings estimates are no longer going down.
  • Financial conditions are easing with corporate bond spreads narrowing sharply.
  • The success evident in the Fed’s latest banking sector stress tests — bank
  • stocks advanced 9% last week.
  • The snapback after the early-March triple-digit decline in the Dow — the first of the year has emboldened the ‘buy the dip’ psychology.

What are the risks?

That we wake up some time in the second quarter and discover that the economy may well have contracted if not for the extremely warm weather we had in the opening months of the year, which provided a huge, if not unprecedented, skew to the data (see Weather Alert: Why the Sun Could Be Bad for Risky Assets on page 14 of the weekend FT).

Remember —January and February were both 5 degrees warmer than usual. For months usually beset by winter weather, the seasonal factors attempt to correct for this by boosting the raw data, which at that time of year are about the lowest given that many folks are snowbound. If not for the seasonal adjustment process, we would only be able to compare the data on a year-to-year basis because there is no apples-to-apples comparison between economic activity in January and what you would typically see in May. So in January and February in particular, the raw nonseasonally adjusted basis get a “bell curve” like we would in school in a tough mid-term exam. The problem this time is that January and February were downright balmy. This wreaked havoc on all the data, especially housing, employment and spending.

We estimate that over 40% of the job gains were weather-related, taking both months into account. We also know that productivity is contracting and 100% of the time in the past decade, companies responded by curbing their hiring. So taking the weather effect into account and the reversal this will have in coming months with respect to the data impact, combined with the likely cooling-off in hiring plans already evident in many surveys, and we could well see the nonfarm payroll numbers get cut in half and come in closer to 100k than 200k as we move into the spring and summer months.

This is not a disaster story at all, but recall that it was this sort of sluggish backdrop that brought at least a temporary end to the equity market rally last year and forced the Fed into more intervention in support of the bond market. Don’t write off QE3 just yet. On top of all that, we do expect to see the trade deficit continue to widen as the European recession and Asian slowdown hit the U.S. shores, and contraction in net exports is going to very likely emerge as a big headwind for the GDP data in the next few quarters. In fact, it is only now starting.

And by the time it subsides later this year, households and businesses will be preparing for next year’s massive tax grab. If logic prevails, this preparation is probably going to include a move to boost savings and raise liquidity (ostensibly at the expense of spending growth — expect the retailers to head into the 2012 holiday season lean and mean).

The weather also had a direct impact on spending by releasing more than $30 billion in recent months in terms of household cash flow from a radically lower utility bill. Absent that de facto tax cut’, and retail sales would have stagnated over the past three months as opposed to rising at what appears to be a healthy 8% annual rate. This will subside now and we have not yet seen the full brunt of $4 gasoline either — many a commentator has stated that the consumer sector is less vulnerable now and there is less of a “shock factor” this time around. We shall see about that.

As it stands, nominal spending at the pumps is at its lowest level since last June — we have not seen the draining impact on household cash flows yet. But we did see the impact on University of Michigan consumer sentiment, which surprised to the downside in a month that saw the Nasdaq head to 12-year highs and employment rip by more than 200k — going from 75.3 on sentiment to 74.3 is largely explained from the rise in gasoline prices.

The IBD/TIPP economic optimism index also slumped to 47.5 in March from the one-year high of 49.4 in February. The components of the recently released March survey data from NY Fed Empire and Philly Fed looked on the soft side, especially order books and production plans. This has also shown up in a recent reversal in President Obama’s approval ratings — so the gasoline impact, with a lag, is only now starting to rear its ugly head.

Keep in mind that even with WTI consolidating, the prices that consumers pay at the pump are on a steady march higher — up 31 cents in the past month to an average of $3.82 a gallon (nationwide) — but already nearly one-third of Americans are paying $4 or higher. What does this then do to the GDP price deflator and hence to real growth — well, just have a look and see what happened in the first quarter of 2011. It’s called stall speed, not escape velocity.

It is unclear just how stable things are in Europe. The ECB has papered over the problems for now but has jeopardized the sanctity of its balance sheet at the same time. The U.K. is seemingly on the precipice of losing its AAA rating status. Then we have Asia. India in a full-blown economic downturn and its banking system is in disarray. And the Chinese economy is now slowing down at a pace we have not seen since the 2009 hard landing. As the U.S. market has been surging, the MSCI China index sagged 2.7% in March —not a constructive signpost for the commodity complex. While this has caused the TSX index to lag the S&P 500, the Canadian dollar has managed to stay above par, in part because the rate-hike that is now being priced into the local bond market (Canadian 2-year note yields now offer a hefty 90 basis point premium to the U.S. comparable).

Back to China for a minute — the country’s A shares are down 3.3% in the past month while the H shares have gained 18%. The Chinese stock market now trades at a 9.9x forward multiple, versus a 15-year average of 12x. So the market there is well valued and the A shares (those listed in China; the H shares trade in Hong Kong) may well be poised to play some catch-up here. Something we have noticed and are definitely keying on.

As for the overall market, our CIO, Bill Webb, likes what he sees in the form of the lingering wide gap between the prevailing return on capital and the cost of capital. Screening for GARP (Growth at a Reasonable Price) and yield remains in vogue. While we are involved in those slices of the market, the major averages have managed to rally to levels above the year-end targets the consensus established at the start of 2012 (of 1,355 on the S&P 500), as was the case this time last year. The S&P 500 has actually risen as much in 2012 so far as it did at this stage in 1998 and when you consider how benevolent 1998 was in terms of fiscal, monetary and economic stability just three years after the advent of the Internet, how can anyone really compare the two years?

What we are seeing unfold really is a liquidity-induced rally that is built on a lot of hope. Neither were required in 1998 — the Fed kept a neutral policy in place for most of that year and there was no need for hope; the growth in the economy was organic and self-sustaining without unprecedented government assistance. Even then, we had a near-20% correction that summer. Nothing moves in a straight line indefinitely and while Bill and the investment team have been tactically bullish for most of this year, we are feeling the need to dial back the risk somewhat near-term given the high levels of complacency and the fact that valuation is less compelling than it was four-six months ago.

For example, the FT cites research showing that the S&P 500 is now two standard deviations above its 50-day moving average, which is far beyond the norm of even an overbought market and in the past this has proven to be a pretty good ‘chill for now indicator. Breadth has also deteriorated of late as the market has scaled new highs, which is often a technical sign that an intermediate top is at hand.

In the name of being ‘tactical’ and ‘nimble’, which is critical in today’s rapid-fire volatile backdrop, getting a little more defensive here is not a bad idea at all. We also remain long-term bulls on gold and commodities, but with the U.S. dollar breaking out and the Chinese data coming in softer than expected for the most part, we have taken on a less ebullient posture for the time being and plan to get more involved at better pricing levels once this corrective phase runs its course. The mining stocks have broken below key support levels here and over the near-term, the chart points are to be respected.

Also keep an eye on the bond market, which has become a bit unglued in recent weeks. Of course, this happens at least four times a year so hiccups like this are really par for the course. And as usual, we are hearing once again how we should all be prepared for the end of the secular bull market in Treasuries. These Wall Street reports come out at least once per year, the latest coming from UBS strategists. When will these people ever learn? In any event, it has been a rocky road as the 10-year note yield spiked 27 basis points last week to a five-month high of 2.3%. This is all part of the global risk-on trade because German bunds sold off just as much, and other assets that tend to do better in risk-off environments, such as gold, also suffered setbacks (the yellow metal lost S50/oz over the week).

Bond yields are not yet at a level to upset the equity market apple cart, especially with the yield on the banks improving so much in one fell swoop. But if we approach 3% on the 10-year note then we could start to see the stock market pay some attention — it’s not so much the level, as the change, and at a time when gasoline prices start to really pinch the consumer (driving season is right around the corner), rising borrowing costs are not going to provide a very constructive backdrop.

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Goldman’s Jim O’Neill: “2008 All Over Again?”

Sunday, August 21st, 2011

via ZeroHedge.com

Remember when Jim O’Neill was openly taunting the “bears“? Yeah, those days are long gone. In his latest weekend letter the BRICster proceeds to do what so many have already been doing for weeks and months, namely compare the current precarious global economic situation to 2008: “Another ugly week passes, and it is still only August 20th. What a particularly brutal August this is turning out to be so far, even when compared to many challenging ones in recent and distant years. Although there are many substantive reasons why things are very different, many cannot resist the temptation to make comparisons with 2008. So, I thought I would discuss the comparison this weekend.” And like a true Keynesian, O’Neill proceeds to do not just that but to provide his solution to all the world’s problems: more G7 intervention. Because they keep getting it so right time after time after time…

2008 All Over Again?, by Jim O’Neill, Goldman Sachs

Another ugly week passes, and it is still only August 20th. What a particularly brutal August this is turning out to be so far, even when compared to many challenging ones in recent and distant years. Although there are many substantive reasons why things are very different, many cannot resist the temptation to make comparisons with 2008. So, I thought I would discuss the comparison this weekend.

MARKET DEVELOPMENTS.

After nearly recovering all of their previous week’s losses early this week, world equity markets crumbled from Wednesday onwards, with few signs of discrimination between countries. If anything, those markets with the greatest “global exposure” – such as Germany and Korea – saw the greatest weakness, which suggests concerns are now very much about a fresh major global slowdown and contagion from the weak economies to the stronger ones. The DAX has lost more than 20pct this month, turning an outperformer into an underperformer. It is also hard to decipher movements between so-called developed and emerging economies, with relative weakness spread across many. China has held up better than most, but given its earlier weakness, this could be argued is a bit clutching for straws.

The inability of equity markets to sustain their early attempts at recovering their steep losses since late July has many technicians suggesting that, not only is any bull market over, but this is the beginning of a fresh prolonged bear market. The move of the S&P below its 200-day moving average as well as the 50-day moving average now being below the 200-day moving average mark are cited by some as evidence of a major trend change.

On the bond markets, not withstanding the continued irony that one of the supposed causes of current economic angst is the sustainability of government finances, many markets reached levels not seen for decades in the earlier part of the week, with the UK, US and Germany sharing the continued role of safe havens. Interestingly, in the last two days, despite the renewed onset of equity weakness, these markets no longer rallied. Whether this is because the whole frenzied bond rally of the month to date was essentially short covering, or whether investors are starting to worry more seriously about the true credit worthiness of these governments is impossible to know. It might be neither. It could be that bond investors want to take a breather ahead of important possible policy initiatives, such as the Jackson Hole speech of Ben Bernanke this week. Or, it could simply be just a pause for some other reason.
On the foreign exchanges, the Yen continued to make new highs performing its rather odd role as a safe haven. It’s odd because Japanese government debt is more than double the Euro Area average and more than double the US, which in my view, makes it highly likely that there will be fresh FX intervention in Tokyo in coming days.

Interestingly, despite the “risk off” mentality, the Swiss Franc struggled to make renewed gains following efforts by the Swiss authorities to reverse at least some of its huge overvaluation. The Chinese Yuan reversed some of its previous strength, questioning many views that the authorities have recently deliberately adopted a stronger FX policy.

On commodity markets, not surprisingly, many experienced considerable weakness.

One clear continued winner from all the unfolding mess continues to be Gold. It almost seems in the minds of some that Gold is a winner either way, from the fears of a fresh 2008-like global recession or stronger monetary (and fiscal?) measures to avoid it.

ECONOMIC AND POLICY DEVELOPMENTS LAST WEEK.

Last weekend, I highlighted three important events coming up this past week. It was indeed those events that dominated the week.

The much anticipated Sarkozy-Merkel meeting came and went late Tuesday, with the apparent reality that they don’t want to offer any new quick fix to the immense challenges around European Monetary Union (EMU). I shall return to this below, but this was a major factor in renewed market weakness.

The meeting of the Swiss authorities Wednesday resulted in further aggressive actions by the SNB and kept open the notion that fresh dramatic policy measures might be used to weaken the Franc further, hence the inability of the Franc to play its usual “risk off” strengthening.

Thirdly, the much anticipated Philly Fed survey Thursday was beyond even the most depressed end of expectations, and its drop to -30.7 is consistent with an economy already in, or about to enter, recession. While the Philly Fed survey can be extremely volatile, it has also proven statistical qualities as a lead indicator. Many, probably including most at the Federal Reserve, had maintained a degree of belief that a modest 2 pct plus real GDP performance was likely in Q3 and Q4. And, until the Philly Fed release, the ongoing evidence was supportive of such views. Adding to these hopes were the release of better-than-expected Industrial Production and the continued gentle trending down in weekly job claims. But, the Philly Fed weakness raises the possibility of a darker path ahead. It is entirely possible that the weakness of the survey has been exaggerated by both the equity market weakness since late July, and also by the highly public and disappointing squabbling over the debt ceiling. But whether this is the case or not, it is also true that they survey might be accurate. As a result, it was no surprise to see the latest bout of US equity market weakness take hold after this release, as market participants priced in the risk of a further related sharp drop in the August manufacturing ISM survey to be released in early September. This now becomes a huge data release in the US.

THINKING BACK TO 2008 AND EARLY 2009.

As I said, it is difficult for us all to avoid 2008-2009 comparisons. So against the background of what happened last week, here are some of my reflections:

1.    At the time, as Chief Economist and Head of the Economics Department, we tried to focus even more closely on all the proprietary leading and coincident indicators we had developed over the years, as well as focusing on the policy options that were available. It would seem as though the same is pertinent now.

2.    In my view, the build up to the crisis of 2008-09 was different because, even though the apparent bursting of the credit bubble had already started in 2007 and gained momentum in 2008, none of us knew the consequences of major financial institutions failing. This included policymakers. In hindsight, we all have that – only too recent – experience to call on now.

3.    In the context of both of the above points, watching measures of financial stress as well as other reliable indicators is critical for following what’s happening.. These include the GS Financial Stress Index (GSI), the GS Financial Conditions Index (FCI), and the GS Global Lead Indicator (GLI), for example.

4.    So far, of the three, the GLI is pointing more darkly than the other two. Following the Philly Fed survey, the Advanced GLI for August shows a negative reading and suggests more global economic weakness ahead. Because of the speediness of the Fed’s response, US financial conditions have only tightened modestly this month, and as a result, OECD financial conditions have not tightened much at all. This suggests that, unless the power of an FCI has been completely broken, any economic weakness, including the degree warned by the GLI, will be temporary. The FSI has tightened notably in the past fortnight, but is nowhere close to what we witnessed in 2008.

5.    Many bears now say that the reason we managed to recover in 2009 is because there were many conventional monetary and fiscal options open to US, European and G20 policymakers. Now, they claim these are all exhausted.

6.    This is valid, but I am not in agreement. Many conventional monetary and fiscal tools were exhausted by 2008, but not all, and there are many policy initiatives still available. The Fed has already highlighted that they will do “more” and we will no doubt get a flavor of that from Ben Bernanke next week. The Swiss National Bank has demonstrated that it had further policy options this past week. The ECB has plenty of conventional policies it can offer, including reversing the two – arguably mistaken – interest rate hikes it undertook earlier this year.

7.    On the fiscal policy front, while the bond market vigilantes are demonstrating their power, the performance of non Euro Area troubled bond markets suggests that specific targeted fiscal initiatives may be supportable. In this regard, more targeted tax measures in some countries seem likely. In the US, steps to help hiring through payroll taxes seem possible. In the UK, a reversal of the top rate of income tax might be offered.

8.    The position of the so-called BRIC economies and markets. In 2008, the valuation of many equity markets, especially China and India, were much higher as we went into the market meltdown. This is not the case today, especially after the past fortnight, and especially for China. All markets are trading at quite modest undemanding multiples. As far as their economies are concerned, the biggest cyclical challenge facing most of the BRIC and other Growth Markets has been food- and energy-induced inflation. One of the few good aspects of the recent behavior of financial markets is that it virtually ensures that inflation is going to ease in many of these economies, and local policymakers will no longer have to tighten monetary policy. As I have written on many occasions, this decade, the combined additional GDP created by the eight Growth Market economies will be around $16 trillion, more than double that of the US and Europe put together. In this regard, I find myself thinking that the relative strength of the Growth Markets will be solidified even more because of recent events. This is a great opportunity for all those investors that have claimed they want to invest in them to do so.

WE NEED POLICY LEADERSHIP.

Away from the specific policy measures adopted in 2008, we also saw some evidence of determined leadership, which was perhaps best represented by the emergence of the G20 in November 2008 and then its re-appearance in the Spring of 2009 and the collective determination to stand against recessionary forces.

Similar leadership is again necessary now. I would argue that this is especially true with respect to Europe. While I have misread the US cyclical developments since the Spring, I remain unruffled about the strength of China and the BRICs.    I have been concerned about the forces surrounding EMU throughout the past 15 months. It has been clear for months that markets no longer have confidence in its stability, and the vicious circle between sovereign debt and the European financial system has gotten much worse.

At the core of the European problem – which may be the only true global economic dilemma currently – is that the EMU as constructed doesn’t work. As I have written on endless occasions now this year, in hindsight, too many countries were allowed to join. There has been no mechanism for ensuring fiscal discipline; there has been no mechanism for encouraging productivity and competitiveness. The markets now realize this and are clearly scared about it. Many European policymakers appear to be in denial, although this doesn’t stop many from making lots of statements which isn’t helping.

Until a week ago, it was vaguely possible for German policymakers (as Germany was seen as the anchor for the region) to offer some kind of self righteous stance that all EMU member countries had to undertake policies to behave like Germany, and then the system would work just fine. Surely this past week must have laid this mistaken belief to rest? Two things happened of great importance. First, Q2 German GDP rose by just 0.1 pct, actually below the Euro Area average. Second, since August began, the German stock market has continued to fall by more than most. The DAX has gone from being an outperformer – a sort of developed market BRIC index if you will – to being a notable underperformer.

It is questionable whether or not the German economy is as weak as Q2 suggests, but the markets don’t think so. Moreover, not for the first time, the GDP breakdown suggests that there has not been any domestic consumption again. There cannot be a sustainable EMU if the biggest member never consumes, especially at a time when those that have consumed too much have to undertake significant corrective policies. This is now happening in Greece, Portugal, Spain and Italy. All countries in the world cannot export at the same time.

Despite their considerable complex internal political issues, German policymakers can’t afford to simply hope that the EMU problem will go away. It is going to require some stronger leadership, and something that Germany will support. It seems as though German (and at least in public, French) leadership is hoping for a fresh EU proposal for a new tougher fiscal mechanism to be announced in September, which then can be adopted by all member countries. This may be the foundation for a true common Euro-denominated bond, but without the tougher fiscal discipline, the Euro bond won’t happen, at least in the minds of many German leaders. Germany needs to start opining quickly as to what kind of EMU it wants and will support, rather than simply opining on the EMU that it won’t support.

Throughout my career, I have learnt that out of every crisis comes an opportunity. The same is true again now, but it requires leadership to bring the opportunity about. Worried by the lack of economic policy leadership, many market dislocations have occurred. If the leadership comes, the opportunities created by this crisis will be snapped up by investors.

In the meantime, luckily, we have plenty of football to watch this weekend.

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