By David A. Rosenberg | 15 April 2010
Chief Economist & Strategist Economic Commentary
We went back to the history books and found that never before this past month had retail sales ever come remotely close to a 1.6% gain in the same month that average hourly earnings fell.
The S&P 500 has broken above the 1,200 threshold in style. It may be worth noting that the first time it pierced this milestone back in mid-2005, the 4 quarter trailing EPS (the bird in the hand, not some 'consensus forecast') was running at around $75. If we take the consensus estimate for Q1 ($18) and tack on the prior three quarters, then the trailing EPS as of now is less than $65. So conceivably we have on our hands a market that is 15% ahead of the profit fundamentals.
Not only are earnings currently 20% below the last time the S&P 500 pierced the 1200 threshold, but the consensus sees operating EPS rising more in the next four quarters ($85) than was the case back then ($80 forecast)— despite the fact that we had operating rates more than 10 percentage points higher than is the case currently and unemployment rates that were 5 percentage points lower (not to mention that bank lending was expanding at a 10% rate). The consensus is actually calling for EPS of 97.20 for 2011— basically in line with the 2007 peak. Quite an amazing feat if it ends up being accomplished this early in the cycle and with all the excess capacity lingering in the labour, product and housing markets.
Sentiment is wildly bullish now. The ratio of bulls to bears from the Investors Intelligence survey are at levels last seen as the market rolled off its cycle highs (bull share up to 51.1% from 48.9% a week ago and the bear share stayed at 18.9%). This is just another way of saying that this is a market operating on fumes right now and is seriously overbought, overextended and overpriced. But momentum is taking over.
The experience of 1999 and 2007 serve as a reminder that the market can remain frothy for an extended period before reality sets in. After finishing at the high for the day, the S&P 500 is shy of hitting its next key retracement level of 1,225. Alcoa is a distant memory right now in the aftermath of Intel and JPMorgan, and the likes of MBA, NFIB, NAHB and ADP are relics compared to the latest flashy news we've received out of the March retail sales data.
But there is no question that the perception that we are into a strong and sustainable economic expansion is proving difficult to break— not just the momentum, but the VIX at around 15x is telling you that investors are becoming more confident in the bullish forecast (the range around the forecast or the 'error term') coming to fruition. In other words, the consensus is that not only that earnings are going to hit new record highs within the next two years but that the variability around that view is compressing over time.
We realize that the Treasury market sold off yesterday due to the retail sales data, and basically ignored the CPI report, but a look at 40 years worth of data show that over time, bond yields are 75% correlated with the direction of core inflation and only 36% correlated with the pace of retail sales. Especially a sales report that owed its success to a variety of transitory factors.
Reading The Fed's Tea Leaves
The Fed supposedly has better information than everyone else and Ben Bernanke has a rolodex that extends beyond Jamie Diamond (as if the surge in bank earnings has anything to do with the economy). In his JEC testimony yesterday, the Fed Chairman could not have possibly been more cautious in his economic outlook— you would never have thought that the stock market had just rallied 80 pct off the lows reading this sermon. To wit:
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This is what Greenspan had to say on April 17th, 2002 to the JEC— the same venue as yesterday: " the behaviour of inventories currently is the driving force in the near-term outlook The pickup in the growth of activity, however, will be short-lived unless sustained increases in final demand kick in before the positive effects of inventory investment dissipate". Tell us that what Bernanke had to say yesterday that did not strike a familiar tone— and this was near the peak of a whippy bear market rally at the time too.
This was actually one of the 70% of the time that Greenspan had the right call (according to his memory, anyway) because the economy relapsed in the second half of 2002 as final sales never did back up the initial inventory spurt and the S&P 500 from that day to the October lows sagged 30%. And at the time, nobody thought that heading back to and through the low would be possible— go and challenge your memory cells; I remember that period very well and the [premature?] longs got crushed).
Bernanke went on to emphasize, not the upside risks (are there any?) but the "significant restraints on the pace of recovery". The pronounced weakness in construction spending, the steep fiscal cutbacks at the state and local government level, and the lingering large resource gap in the labour market ("particularly concerned" that the "44 percent of the unemployed had been without a job for six months or more". Note that in the Q and A, he did state that policy would remain accommodative for "an extended period" so he obviously doesn't see eye to eye with Mr. Hoenig (who has made a career out of dissenting).
And what about the Fed beige book that came out yesterday? The widespread consensus is that it was more optimistic than the prior one. And it was, but hardly by much. Mirroring the tone by Chairman Bernanke, "economic activity increased somewhat". That's it? Consumer spending and manufacturing activity "increased"— but nothing told us by how much.
And both vehicle sales and tourism "improved". And that was it for the good humor man. The labour market "generally remained weak". Wage pressures were "minimal or contained". Commercial real estate remained "very weak". Banking activity and credit quality "decreased". Business services were "mixed". And as for inflation, "retail prices generally remained level".
Bernanke emphasized, not the upside risks (are there any?) but the "significant restraints on the pace of recovery".
Sector Update From Beige Book
The Fed's Beige Book is great for timely anecdotal evidence as to what is happening in the USA both with regards to regional and sectoral data. Every month we highlight the favourable and unfavourable mentions.
The list of favourable sectors gained some serious ground this time— including those solid performers in the past along with some new ones. They include technology, health care, housing (this was new!), automotive, staffing firms, tourism, energy drilling, department stores, discount stores, agriculture, steel. The laggards were banking, commercial real estate, machinery manufacturing and advertising.
Note that sometimes you see in the Beige Book a sector or two that are doing well but are actually countercyclical. For example, "Law firms in Minneapolis specializing in debt collections and bankruptcy saw strong demand, while a Richmond property manager noted a large number of repossessions". Somehow this little tidbit doesn't quite jibe with the prevailing view of a smooth-sailing economic revival.
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