FMX | Connect – www.fmxconnect.com - (Reported 9/22/2010)
Excerpt from MARKET MUSINGS & DATA DECIPHERING
WHILE YOU WERE SLEEPING
Once again, overseas equity markets are choppy and sloppy – Europe now down three days in a row -- after the incredible rally in September brought most of the major indices into overbought terrain. As we show below, sentiment measures have swung wildly to the positive side – in short order and on spurious strength in the ISM and employment data. Bonds are still rallying and after a huge 30 basis point jump in recent weeks – but the yield on the 10-year note is now just 5bps away from a new low and the 2-year and 5-year are already there. The U.S. dollar has consolidated but a lot of technical damage has been done. What has provided some support this morning is the renewed weakness out of Europe – the manufacturing and services PMI for the region came in at 53.8 for September, down from 56.2 in August and well below the 55.7 consensus estimate.
As with Canada, the recent strong set of solid European data releases has come to a thundering halt. Ditto for New Zealand, where Q2 real GDP came in well below expected (+0.2% QoQ versus +0.8% expected and Q1 was revised down a touch to +0.5% from +0.6%), which knocked 1% off the kiwi – the entire commodity currency complex is actually in retreat so far today. FX intervention concerns have taken the edge off the Asian currency complex too (especially in high-flying Malaysia and Thailand) – the reality is that no country wants a strong currency right now, which is why gold has so much allure as it makes the transition from commodity to monetary metal. Have a look at the excellent column on this topic on page 24 of the FT — Get Ready For a New Era in Currency Intervention; while the focus is now on the Fed, keep in mind that the Bank of England very recently also hinted strongly at another round of U.K. policy stimulus. Meanwhile, oil is trading back below $75/bbl on an unexpected bulge in U.S. inventories (a 970,000-barrel build instead of the consensus view of a 1.75 million barrel drawdown) – perhaps telling us something about the current direction in what was a hot pace of industrial activity.
Since the S&P 500 hit its interim peak back on April 23rd, after a whippy bear market rally that looked just like the bungee jump we had in the opening months of 1930, the index has managed to pop up to around the levels we just saw two days ago (1,142) no fewer than four other times … May 12th, June 18th, August 9th and September 20th. And this time around, there were a whole range of non-confirmation signals and unfortunately for the bulls, it did not take much to get sentiment back to wildly optimistic levels which is a classic “contrary negative”. There has been far too much emphasis placed on what appears to be positive headline data that have contained poor details beneath the surface – avoiding a double-dip recession is not good enough to be overweight risk assets.
Risk assets thrive on growth and liquidity – right now we only have the latter and the bulk of it is sitting on corporate, bank and household balance sheets. The reason for this is because economic agents are cautious on the economic outlook while many investors, strategists and economists continue to project, at the very least, a “muddle through” scenario.
Now a “muddle through” scenario is just fine when the economy approaches full employment and inflation risks are becoming acute – we all look forward to the fabled “soft landing” in those episodes. But generally speaking, heading into the second year of a recovery, which according to the NBER is in fact the case, what is normal, and in the context of far less government support than we have today, the economy is accelerating, not decelerating, and is doing so at a 5% clip – not slowing below 2%, which is now the case.
In addition, “muddle though” will mean that a 10% unemployment rate will either be a permanent feature of the landscape, with obvious political and social repercussions, and that deflation will be inevitable as a current 6% output gap either is sustained or widens at a time when every measure of underlying inflation is running below 1% at the current time.
You do not need to sift through the economic data points to realize that the largest economy in the world is fundamentally weak and susceptible to a relapse. Economists and strategists, for the most part, are downplaying where we are in the deleveraging cycle – that is literally amazing. There continues to be talk of housing stabilizing, which is impossible at the current time based on the prevailing massive amount of excess inventory. The fact that jobless claims have not gone back up over 500,000 is viewed as a good thing when at this point of the cycle we should already be south of 400,000. For a clear sign that the economy is at risk and that the government interventions have thus far failed, have a look at what is happening to President Obama’s economics team: First Romer, then Orszag, and now Summers … all gone, in this Agatha Christie remake of “And Then There Were None” (speculation is rife that Mr. Geithner is next).
The reality is that this is the weakest recovery ever in terms of the growth rate in real final sales and as it pertains to employment, housing, and organic personal income, there has not really been any recovery at all. Every single measure of consumer and small business sentiment is locked in recession terrain, but these do not go into the NBER determination process. In fact, the Investor’s Business Daily cites a survey of small business owners conduced by the U.S. Chamber of Commerce, which found that 78% of the respondents believe that the economy will “remain stagnant or get worse over the next year.” We may well have not been bullish enough at the March/09 lows in the equity market but what we questioned was the sustainability of the rally and if the truth be told, the major averages are no higher today than they were last November – 10 months of nothing but a saw-toothed pattern – and as things now stand, the facts are that the peak was turned in around the middle of April. You’ve been at least as well off clipping coupons.
The Fed just laid down the gauntlet and is preparing for a battle with the inevitable deflationary backdrop, while central bankers think they can merely start up a printing press, the reality is that the current crew of policymakers have only lived their lives fighting inflation and actually have no experience at all in combating deflation. This will be a long war and along the way, before we get the real policy-induced inflationary credit cycle that turns the secular bull market in bonds into a bear market, yields at the curve are going to drop to levels that will literally freak everyone out — perhaps everyone except for us, Van Hoisington, Doug Behnfield, Stephanie Pomboy and Gary Shilling.
Take a look at Chart 1, in this post-bubble credit collapse everything is mean reverting from P/E ratios, to savings rates, to debt/income ratios, to homeownership rates and the process is going to take more time and extract more domestic demand growth and pricing power out of the economy. We closed the 1930s with a 2% long bond yield, which makes perfect sense to us since the typical spread between the 30-year and the overnight rate is around 200 basis points. It won’t be a straight line, and based on past long interest rate cycles, which can last up to 32 years, we could be looking at a bottom roughly two years from now. So we wouldn’t quibble with the view that the secular bull market in bonds is in the mature stage. But it ain’t over yet.
Our strategy since the Fed cut rates to zero in late 2008 has been S.I.R.P. (Safety and Income at a Reasonable Price) — from Z.I.R.P. (Zero Interest Rate Policy) to S.I.R.P. is what we called this backdrop. Tack onto that strategy the items that will benefit from the reflationary policies as the government continues to throw more spaghetti against the wall to see what sticks, and a focus on precious metals also makes good sense. Classic hedge fund strategies that aim to limit the inherent volatility in the equity market during these deleveraging phases is also key. Taking out the volatility and the correlations with the stock market is a prudent thing to do for investors wanting access to stocks but at the same time seeking some form of capital preservation in such a tumultuous time.
And of course, a focus on yield — well diversified hybrids that combine preferreds with bonds and trusts and royalties and reliable dividend streams are as good as gold. And it’s a very good thing that corporate balance sheets are in such good shape and that the maturity calendar has been pushed into the future with all the refinancing activity that has gone on so that we can also dip a few toes into credit strategies.
The emerging markets are nice and the economies booming, but this is the Wild West in many respects and the way we have preferred to play this secular theme is through exposure to the commodity complex and we are long-term oil bulls — also for geopolitical reasons. The rising specter of trade protectionism and government procurement polices are an additional factor to consider in terms of formulating commodity investment strategies — not to mention the prospect of military skirmishes (does anyone really need to be reminded about what really ended the Great Depression?). Now this is not part of an “income” theme but rather an acknowledgment that (i) we live in a troubled world with an uncertain economic outlook and so having core exposure to hard assets that people need to have (food and energy) is simply a prudent insurance policy, and (ii) whether or not you are a fan of emerging market equities, which move up and down like a yoyo, the reality is that the secular economic growth rates in this region are not going to go away. In many cases, they have stronger government finances and superior demographic underpinnings than the so-called industrialized world, and they already went through their depression and gut-wrenching financial, economic and political reforms a decade ago. They faced the music up front — ask anyone who lives and works in Korea — and did not kick the proverbial can down the road as is most certainly the case in the U.S.A. and Europe today.
David A. Rosenberg
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
+ 1 416 681 8919
Source: Market Musings & Data Deciphering
http://www.fmxconnect.com/
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