By David A. Rosenberg, Chief Economist & Strategist, Gluskin & Scheff | 7 August 2009
Excerpted…
To be sure, the drop in the unemployment rate was a surprise, but it was all due to the slide in the labor force— the employment-to-population ratio gives a more accurate picture of the slack in the labor market and the hidden secret in today’s report was that this metric slid to a 25-year low of 59.4% from 59.5% in June and 61.0% at the turn of the year. Of those unemployed, 33.8% of them have been unemployed now for over 27 weeks— a record amount (was at 29.0% in June and was at 17.5% at the start of this recession).
Based on past linkages between earnings trends and the pace of economic activity, believe it or not, the S&P 500 is now de facto discounting a 4¼% real GDP growth rate for the coming year. That is what we would call a V-shaped recovery. While it is possible— though in our opinion a low-odds event— it is doubtful that the economy is going to be better than that. So we have a market that is more than fully priced for a post-recession world— any further gains would suggest that we are moving further into the "greed" trade.
This is why we prefer the corporate bond market because even though it too has rallied sharply this year, it has gone from pricing in a depression to just a plain-vanilla recession and, at current spread levels, is basically pricing in a flat GDP growth environment for the coming year. While an outright economic relapse or double-dip recession would leave the corporate bond market vulnerable, it would be less susceptible to a pullback than equities and even as cautious as we are, we think the economy can still do marginally better than flat growth for the coming year.
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ADP employment came in at -371k in July and while it is true that the numbers are getting "less negative", the reality is that what is "normal", even after an egregiously oversold low (and there have been many of those over the past 50 years), is that the stock market goes up 20% from the bottom to the end of the negative employment cycle. And now the market is up nearly 50%, which is unprecedented. It is way, way overdone. We realize that the market has to climb a wall of worry and that it will often price in a lot of bad news, but for the first time ever, it has rallied nearly 50% amidst a two-million job slide since March. That is either whistling past the graveyard or at the lows the market was indeed pricing in a full-fledged ("End Of The World") depression.
Initial jobless claims fell 38k in the August 1st week, to 550k, as this decline from the peak proves to the most gradual on record. Continuing claims rose 69k to 6.31 million (July 25th week) while the sum of the extended benefits programs surged 237,000 (for the July 18th week). Not until claims break below 500k on a sustained basis will we be able to declare an ‘all-clear’ sign in terms of signalling the end of the down cycle or the jobs recession.
In the four months after the recent lows in March, employment plunged by two million, which is as much carnage as we saw in the entire 2001 recession— and we are talking about the entire cycle including the 'jobless recovery' that spanned from March 2001 to June 2003! We will guarantee you one thing— it is doubtful that the two million folks who lost their jobs [[and houses?: normxxx]] are going to be heading to the malls, dealerships or restaurants anytime soon. And while that is only a sliver of the 130 million U.S. workforce, change does occur at the margin.
Quality of the Rebound?
Reuters did some nifty work and showed that in this last leg of the rally, which started on July 10th, CCC-rated stocks have surged 26.4%, BBB-rated stocks are up 19.3%, while AAA-rated stocks have risen 9.5%. Look— when China is up 80% year-to-date, India 60%, and both the Kospi and Hang Seng up 40%— and dare we say, the SOX index up 60% in less than six months— it’s probably safe to assume that we have a hugely speculative, junky market on our hands. And, we know from the 2000-2001 and 2007-2008 experiences, they don’t tend to end well.
While the hosts on the CNBC show we were on yesterday afternoon claimed that the bounce in July auto sales was 'evidence of pent-up demand', we would simply have to disagree. If there was 'pent-up demand' we wouldn’t need the subsidy to begin with— it just goes to show that there will always be people who will be willing to accept free money. What we think is important is how low the level of auto sales were in July, at barely more than 11 million units at an annual rate.
It was only nine-years ago that auto-related stimulus ("0% financing") brought us 21 million units; and just four-years ago another gimmick ("Employee discount for everyone") brought us 20 million units. The ‘new normal’, we would have to assume after the response to ‘Cash for Clunkers’, is 11 million units. That’s supposed to get us excited over the consumer spending outlook? Keep in mind that we never saw 21 or 20 million units again after those prior programs were unveiled— could it be that we just saw 11 million for the last time too?
Commodities and Finished Goods
If China were to relapse (see page B1 of the NYT— "Loan Spree By China Ignites Fears of Defaults"), it would be a much bigger deal for commodities than a U.S. double-dip scenario because the marginal buyer of commodities is in Asia— the continent has much higher commodity intensity in their internal consumption [[though much of it winds up in products bound for the US and EU markets: normxxx]]. Remember— the CRB futures index peaked in July of 2008 when the U.S. economy was already eight months into recession. It was Asia in general and China in particular (along with a giant margin call on the hedge funds) that caused the commodity complex to crater.
The U.S. economy expanded 4.4% in 2008 and commodity prices slid nearly 20%. Why? Because Asia went into a depression. Asia is the marginal buyer of materials; the U.S. is the marginal buyer of services— financial, health, education, and how can we forget… recreational (a night at the Bellagio).
No Sails In Retail Sales/Nasdaq Is Rolling Over
Chain store sales dropped nearly 5% YoY in July— in line with expectations but 59% of the retailers missed their targets. The numbers are actually very flattering when you consider the rapidly shifting share of sales being devoted to the discounters. In a very clear sign that the back-to-school season is a dud so far— teen chains posted very weak comparisons— down 9.9% YoY and practically every store missed their numbers.
The S&P retailing sector is up 18% over the past month. There is obviously a lot of hope priced into this group. Note that ShopperTrak is projecting foot traffic at the malls to decline 10% during the back-to-school season; remember, back-to-school leads holiday shopping in the past roughly 75% of the time.
As an aside, the Nasdaq just suffered its second "distribution day" in a row (lower price on higher volume) and it just broke below its 10-day moving average.
GDP and Such
It is tempting to strip out the inventory withdrawal and look at the fact that outside of that, 'real' GDP contracted at a mere 0.2% annual rate— but that misses the point. While inventories will undoubtedly add to current (3Q) growth, we doubt that we’ll see another quarter of 13.3% growth in defense spending either. This added to GDP growth in 2Q by almost the same amount that inventories subtracted. Not only that, but the sharp improvement in the foreign trade sector, which added 1.4 percentage points to GDP growth in 2Q, is unlikely to be repeated either. The overwhelming consensus is that real GDP will be positive in 3Q; but the key for how 4Q will shape up will rest in how real final domestic demand performs, which sagged at a -1.5% annual rate in 2Q, and -3.3% for private sector demand.
We remain in the deflation camp for the sole reason that the data compel us to. Wages and salaries contracted at a 5.0% annual rate in the second quarter and have deflated 4.3% on a year-over-year basis. This is the flip side of having the majority of companies beating their earnings estimates by aggressive cost-cutting— a wage contraction of historical proportions that bites into aggregate demand and requires recurring doses of fiscal stimulus and other gimmicks (like "Cash for Clunkers") to establish a floor under the economy.
We remain in the deflation camp— how can we not— given that most forms of income are deflating from year-ago levels.
It is not just labor income that is still in deflation mode. Practically all forms of income are deflating from a year ago— interest income is down 4.5%, dividend income is down 23.0% and proprietary income is down 8.0%. The only income that is really going up is the income from Uncle Sam, which is up more than 10.0% and we have reached a point where a record of nearly one-fifth of personal income is being accounted for by paychecks out of Washington. But it should be recalled that Uncle Sam himself does not create income— he 'borrows' cash from current bondholders and future taxpayers. Not the stuff that seems deserving of a 760x multiple on reported earnings.
Bob Farrell’s Rule #8
"Bear markets have three stages— (i) sharp down, (ii) reflexive rebound, and (iii) a drawn-out fundamental downtrend".
We have little doubt as to which stage we are in today.
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