Breakfast With Dave: Market Musings & Data Deciphering

¹²Breakfast With Dave: Market Musings & Data Deciphering
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By David A. Rosenberg | 22 March 2010
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheffcom.

What Is Priced In?

We ran some regressions and found that the cyclically sensitive segments of the S&P 500 have priced in an extremely robust economic landscape:.
• In the S&P 500 materials index the CRB futures level that's priced in is 362 (versus 475 actual).
• We prefer energy stocks that are priced for a $69/bbl oil.

What the S&P 500 is pricing in:
• Investor sentiment very bullish— Investor Intelligence poll bullish sentiment at 46.2% vs. 21.3% for the bears and this week's Barron's is loaded with reasons to be bullish
• Why the U.S. consumer is hanging in— three words: juicy tax refunds
• Look for more rent deflation— the share of homebuyers who consider themselves as "investors" jumped from 12% to 17% currently. What are they doing with these units? Renting them.
• Housing starts: pricing in a level of 800-900k (versus 575K actual)
• Existing home sales: pricing in a level of 5,500k (versus 5,050k actual)
• NAHB housing market index: pricing in a level of 35 versus 15 actual.

Arguably this is the most expensive part of the market.
• S&P 500 industrials: They are priced for 61.0 on manufacturing ISM (versus 56.5 actual and the index, looking at the orders-to-inventories ratio, looks to have peaked). (One really has to wonder what sort of manufacturing recovery this is when parts suppliers to the large-cap industrials are going cap-in-hand for $30 billion of TARP funds— obviously not one that can be sustained without taxpayer support— see Tool Firms seek Aid From U.S. Loan Plan in the weekend WSJ).
• S&P 500 retail stocks: The sector has priced in 7.5% YoY growth in retail sales (actual retail sales are running at a 3.9% pace0. So the group is discounting a doubling of the current trend. Good luck.
• S&P 500 tech: The group is pricing in a whopping acceleration of 30% YoY growth in tech production— versus the current trend of 11%.

Sentiment Also Very Bullish

• First, we see from the latest Investors Intelligence poll that bullish sentiment is now running at 46.2% versus 21.3% for the bears. You don't have to be a very big contrarian to be nervous about that ratio.
• Second, this week's Barron's was chock full of reasons to be bullish (and the front page headline screams out Double Dip? Hell, No!). Michael Santoli (page 13) sees new highs coming even if the market corrects near-term and lists a bunch of questions that the bears "need to answer". Kopin Tan, on page M3, opined that "it's hard to see stocks suffering a severe setback … not all the popular distress signals are worthy of worry".

A record-low 6.2% of Americans buy into the recovery story and it looks as if this picture is already in the process of double-dipping. Rarely, if ever, has the perception gap between Wall Street and Main Street been so wide as it is today.

Well, there may be a few worries:

• Most investor surveys, as we mentioned above, show a high level of complacency. Market Vane bullish sentiment has shot up to 56% from 50% a month ago. The Rasmussen survey of investors is already north of 86. The VIX index, at 17x, is a clear reminder of the lack of fear in this market. No wall of worry seems too big to climb any more.
• Most economic indicators are pointing to a slowdown ahead— the leaders have peaked out.
• Home prices appear to show signs of rolling over again.
• Jobless claims are not yet at a level consistent with sustained jobs growth.
• The credit crunch continues unabated with the FDIC eating seven (!) more failed banks last Friday, bringing the year-to-date tally to 37. Last year, 140 banks failed, so at the current pace, we are talking about at least 160. And, some of the recent closures were biggies— like Utah-based Advanta— at $1.6 billion in total assets and $1.5 billion in total deposits; and Georgia-based Appalachian with $1 billion in total assets.
• If there is one thing, employment aside, that is not making new post-crisis recovery highs it is bank-wide consumer loans, which just fell last week to a fresh two-year low.
• The liquidity backdrop is becoming less alluring— MZM has declined YoY for the first time in 15 years and the trend in M2 is down to a mere 1.5% from 10% when the bear market rally began in March 2009.
• The consensus is as optimistic on earnings growth as it was bearish this time last year— consensus is expecting +70% YoY for Q1 EPS, as an example. Analyst earnings revision ratios have gone from 62% two-months ago to 50% today (see page M4 of Barron's).
• Fiscal policy is actually set to tighten, not ease, due to the accelerating restraint at the State/local government level (see Bob Herbert's column on page A15 of the Saturday NYT— A Ruinous Meltdown and read about the "draconian cuts in services" across the country— "the tissue-thin national economic recovery is being undermined". This guy gets it. Fiscal conditions at the lower levels of government are in such a mess that criminals are being released from jail before their terms are served (see More Ex-Cons on the Streets, Fewer Jobs on page A3 of the weekend WSJ). You really cannot make this stuff up.
• The equity market is overvalued by more than 20% on a normalized Shiller P/E ratio basis.
• The expensive health care reforms will require higher tax rates on investment income (Mr. Market is aware of this, correct?). A 3.8% Medicare tax on capital gains on "upper bracket taxpayers" is part of the Obama plan, effective 2013 (see House Seeks Tax Policy U-Turn With New Medicare Levy on page A5 of the weekend WSJ).
• Global macro risks are rising.
•• India just raised rates unexpectedly (ahead of its quarterly policy meeting) by 25bps to 5.0% on the repo rate to combat an inflation rate that has accelerated to a 16-month high.
•• Greece is not yet out of the woods— going to the IMF will be a very bearish signal for the euro. Moreover, 61% of the German public opposes a bailout for Greece, only 20% are supportive, and another survey shows 40% of Germans would welcome an exit from the Eurozone (for more see page 4 of today's FT)
•• The U.S. is pressuring China to revalue even though China's trade surplus has all but vanished. Meanwhile, the Peoples Bank of China continues to tighten overall credit conditions, having mopped up $31 billion in liquidity from last week's open market operations (hence the nosedive in commodity prices to round out the week).
•• At least one BoE policymaker has raised the specter of a double dip recession (10-year Gilts very quietly have rallied to their low point of the year— breaking below the 4% mark). All of this uncertainty is showing through in a firmer tone to the U.S. dollar, which therefore eliminates a very important crutch to the U.S. profits recovery.

It's amazing that so many pundits are still talking as if we are still in the bear market rally because the S&P 500 has managed to fractionally take out the interim January high. In fact, at 1,160, it has really done little more than range trade since the middle of October. That's really five months of basically nothing.

And, the notion that there is really anything beyond a 'statistical' bounce in the data over the past year in the aftermath of bank bailouts should be put to rest after you read the article about New York City on the front page of the Saturday NYT showing that the number of people living on the streets soared 34% in the past twelve months (Number of People Living on New York Streets Soars). The technical recession may well have ended but the depression is ongoing.

Why The Consumer Is Hanging In

First, as we mentioned last week, strategic mortgage defaults have added a full percent to consumer spending as delinquent homeowners divert their monthly payments towards discretionary expenditures. Remember, the villain banks have no recourse and it is no longer a shame but somehow fashionable to be behind on your mortgage obligations. Add to that the juicy tax refunds (courtesy of last year's fiscal package)— up 10% or $206 per filer to a record average of $3,038 (recall that the Recovery Act provided a $400 tax credit for low-income earners).

Look For More Rent Deflation

Thank the lord for the investor class for it is the one helping to underpin activity in the residential real estate market as the natural first-time homebuyer who needs a mortgage is all but dormant. According to the National Association of Realtors, more than one in four housing transactions is now all-cash deals. From November to January, a separate survey found that the share of buyers who consider themselves "investors" jumped to 17% from 12%. What are they doing with these units? Renting them out. There is a literal glut of apartment units on the market and rents are a critical part of the deflation/disinflation pattern evident in the CPI.

Canadian Housing Bubble

The combination of extremely lax CMHC guidelines over the past three years coupled with ultra-low interest rates have triggered a housing mania in Canada that rivals what we saw state-side from 2003 to 2007. Now the Bank of Canada is on the precipice of raising rates, and if the consensus and money markets are correct, then the wave of borrowers that opted for short-term mortgages are going to be paying the proverbial piper in coming quarters. Recall what the Bank of Canada had to say on the matter late last year. As we said back then, forewarned is forearmed:

"Financial institutions need to carefully consider the aggregate risk to their entire portfolio of household exposures when evaluating even an insured mortgage, since a household defaulting on an insured mortgage would likely be unable to meet its other debt obligations. This implies that the overall quality of a bank's loan portfolio would deteriorate, even if no loss is incurred on the insured mortgage itself. In addition, claims to recover losses on insured mortgages are not themselves without cost. "The potential for system-wide stress arising from substantial credit losses on Canadian household loan portfolios remains a relatively low-probability risk at the moment, particularly given the near-term prospects for growth. However, the likelihood of this risk materializing in the medium term is judged to have risen as a result of increased indebtedness. While this suggests that positive momentum in the global economy is stronger than envisioned at the time of the last FSR, economic growth is nonetheless likely to remain subdued for some time as necessary structural adjustments take place. Deleveraging of the balance sheets of both financial institutions and households, for example, remains incomplete. "Although the uncertainty [[ie, risk: normxxx]] surrounding the global economic outlook has diminished somewhat, it nevertheless remains elevated. As well, there is risk that self-sustaining growth in private demand, a prerequisite for a solid recovery, may take longer than expected to materialize, given that the recovery currently relies on an unprecedented level of policy stimulus. Reflecting the high level of uncertainty worldwide, there is a wide divergence in forecasts for global economic growth. "With the slow pace of the recovery, the global economy is vulnerable to additional negative shocks. While the probability of a renewed, synchronous decline in world output is fairly low, even a slower-than-expected recovery may have important implications for the international financial system. If the global recovery does not live up to market expectations, a market correction could ensue. "A modest market correction can normally be considered a useful purging of excess risk taking and a re-evaluation of fundamental factors. In the current environment, however, an economic downturn or a significant market correction arising from renewed pessimism could, in a worst-case scenario, reactivate the adverse feedback loop between the real economy and financial markets (by which declines in overall economic growth and in markets reinforce each other)."

The Last Thing A Canadian Dollar Bull Wants To See

What we are talking about is the "front page" effect. As an example, the Loonie began to roll over last week just as every Canadian newspaper ran headlines of the Loonie heading to par against the greenback. Now the "headline" has shifted to the international, 'southern' press with page C1 of the WSJ screaming out This Time, Canada Inc. Is Set for Dollar Parity.

We too are fans of the Canabuck, but the net speculative longs on the exchanges are so large and the media is so filled with enthusiasm what one can only assume that all the good news— and then some— is already being discounted. Beware of the high level of positive sentiment as well as the high degree of overvaluation— no doubt fair— value has improved from 87 cents a year ago to 92 cents now, underscoring the secular bull market,.


  M O R E. . .


Normxxx    
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