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Is The Market Correction Over?

Tyler Durden's picture





 

Now that the market has decisively entered into correction territory, two of the most bullish investment banks around, Goldman and Deutsche Bank, are long overdue for reports that describe just how this event was dully expected and in fact, priced in, and that investors should in now way draw and conclusions about a potential recession emerging from something as innocuous as a recession. Furthermore, the 10%+ pullback is "perfectly normal", and has no impact on either Goldman's 1,250 or DB's 1,375 end of year target for the S&P. And yet, there is a 'but' - both firms now sound far less confident than they did a few short months ago, and the hedging of year end targets has begun (more so at GS than DB). And while Goldman's report is more focused on the European context, and is thus appreciably more bearish, Goldman's tone is far more subdued than Deutsche's, which is understandable: with assets at two thirds of German GDP, and with a government dead set on minimizing bank bailouts for the foreseeable future, the German bank has far less margin for reality than the primary recipient of Hank Paulson's bailout generosity.

First, we present the opinion of Goldman's Sharon Bell, who most certainly is neither David Kostin nor A. Joseph Cohen.

The pace of global economic growth is showing signs of slowing, although the level itself remains high. It is frequently the case that markets suffer a setback when growth indicators turn down – even if other factors such as strong earnings growth and loose monetary policy remain in place. We analyze market corrections in previous similar periods and argue that much of the slowdown in growth is already now discounted.

In addition, the European market is facing other headwinds, namely sovereign debt risks, bank funding issues and concerns over fiscal tightening. We acknowledge that these concerns are likely to mean the risk premium stays higher for longer, and as such reduce our year-end target for the STOXX Europe (SXXP) to 280 from 300.

The primary client concern that Goldman attempts to address is the slowing momentum in various macro economic indicators. This is particularly relevant now that the ECRI leading economic index posted its 44th sequential weekly decline this Friday, and has for the first time plunged to an annualized negative rate. As Bell says:

The correction in the market can be attributed to a number of factors, including sovereign debt concerns, fiscal tightening, bank funding and the possibility of greater regulation from policymakers. All of these have contributed to the rise in risk perception and concerns over the medium-term outlook for growth. But fears have also started to accumulate about a slowdown in the current momentum of economic growth. In the US, there have been some weak payroll numbers, in Europe, the PMIs have come off their highs, and our proprietary global lead indicator (GLI) has started to show signs of slowing momentum (although the headline numbers are still very strong).

This point in the cycle, when growth has picked up from the trough but momentum is starting to show signs of peaking, is often a soft period for equity markets. We alluded to this at the end of last year in our 2010 outlook piece, Europe: Portfolio Strategy: Outlook 2010, December 2, 2010. We didn’t expect the falls that we have seen, but we did see the period when growth momentum started to slow as a trigger for a more subdued period of equity market returns, and discussed the risks of a temporary setback in equities (although this was not our core view).

This risk has now become a reality and it is useful to compare the falls seen in this current correction with those of previous similar periods. In Europe, there have been four correction periods that in our view are most comparable to today: 1976, 1984, 1994/95 and 2004. In each of these periods, there was a correction in the equity market that coincided with (or was  very close to) a slowdown in the main lead indicators, the ISM, GLI, and the German IFO.

Goldman's empirical study indicates that in the US, of the five "corrections" which commenced at around the time the "growth" phase of the economy was ending, and was being supplanted by the "optimism" phase (toward the end of the economic expansion, when markets rise faster than earnings growth and hence multiples rise rapidly), on average record a 14% real correction for the S&P 500. On the other hand the 12 month pre correction rise in the market was 25%, not nearly the double seen from March 2009 to 12 month later, this begging the question just how relevant, if at all, any empirical studies on this matter are at a time of unprecedented monetary and fiscal stimulus. Additionally, as Rosenberg will point out, none of the prior discussed recessions were both a manufacturing and a credit crunch. This in itself renders Goldman's entire study worthless.

Goldman summarizes these results as follows:

There are a number of observations worth making:

  • On average, the market fell by 13% during these corrections, 15% in real terms.
  • So far, Europe has fallen by 15% and the US by 14% from the mid-April peaks.
  • The duration of these corrections has averaged 150 days, or five months.
  • So far, the current correction has lasted just under two months; if it should last a similar time to previous corrections, then October would mark a turning point.
  • The rise in the market this time in the 12 months prior to the correction was 43% versus an average rise of 24% prior to historical corrections. However, there is no obvious relationship between the size or duration of these corrections and the rise in the market in the previous 12-month period.
  • On average, the corrections do coincide with the peak in the survey data, but the market sometimes leads by a few months and sometimes lags.

Given that these corrections lasted only 4-5 months, a key question is what the catalyst was for markets eventually turning again.

A good question, and those interested can read up on it in the attached full presentation, which however as we pointed out in our opinion is fatally flawed, as there is no direct connection between a correction seen in the current environment in which the very survival of stimulus driven intervention is at stake, and prior plain vanilla recessions driven by economic overcapacity. The fact that Goldman even consider comparing such apples and organes is indicative of the naievete of some of the firm's economists (or their outright disdain for the intellectual capacity of their clients).

It is no surprise that based on the presented cherry picked data, Goldman says:

"We would not recommend a short position on European equities from this point; we continue to believe the valuation case is strong, that policymakers are ultimately  doing the right thing in reducing fiscal spending and that this will not have a huge detrimental impact on growth (indeed, we believe quite the opposite)."

But, here is the but part:

But there are clear hurdles for the market; our economists expect growth in the US economy to slow to 1.5% qoq  annualized in 3Q and 4Q of this year before the economy rebounds again from 1Q2011. At the same time, China’s economy is likely to gradually slow as tighter monetary conditions impact on growth. Finally, the concerns about the policy framework in Europe are unlikely to be fully addressed over the next few months.

Given this, we acknowledge that the risk premium is likely to stay higher for longer. We therefore lower our year-end target for the STOXX Europe to 280 from 300 and now expect the STOXX Europe to reach 300 only in 12 months’ time. On a threemonth basis, we move our SXXP target down to 250 from 270 and on a six-month view, we move it down to 280 from 290.

However, these targets still represent reasonable returns on the year. Our new year-end target implies a nominal price return of 10.3% for 2010, roughly in line with the historical average real price return in the Growth phase of 10.9%.

And while Goldman's attempted defense of the status quo comes off as marginally credible if rather disingenuous, DB's analysis of why the correction is unlikely to be disruptive is a work of art. The ever optimistic Binky Chadha leads of with the following:

Equity market corrections outside of recessionary periods have typically not derailed economic recoveries. Out of the 14 such post-war episodes, only 3 eventually slowed payrolls growth. Common to all 3 of these episodes were equity market declines of more than 20% and sell downs lasting more than 7 months. These were joint necessary conditions. In the current context, this would imply the S&P falling below 975 and the correction dragging on till mid-November. But fundamental initial conditions are also important and, in our view, the main cyclical driver of the current recovery, the large gap between final demand and corporate activity levels, remains and will continue to drive corporate spend and hiring.

The full-on assault against any bearishness continues:

Historically, episodes of risk aversion have lasted an average of 2 months, which translates to mid-July for the current episode. As to fundamental catalysts, first, we see mutual funds and long short equity funds as defensively positioned, while non-dedicated equity investors are short equities and record short the euro. A positioning squeeze is possible at any point, but to sustain will likely require other catalysts. Second, a heavy calendar of Euro-periphery debt rollovers in July argues risk aversion will persist through then. Third, Q2 earnings reporting season begins mid-July. Investors have covered underweights going into recent earnings seasons. This time, concerns about euro appreciation and slowing growth may make them slower to cover, but with many companies noting limited impacts, it remains a distinct and likely possibility. Fourth, we view last week’s payrolls as leaving the labor market recovery trend intact. Labor income, the driver of consumer spending, grew at a healthy 7% annual rate. The trend in payrolls also indicates the recovery in the labor market is on track though jobs growth in earnest will begin only in July, reported in the first week of August.

How naive of us to think that Mr. Chadha would mention even one of the relevant economic statistics this time around, such that the labor market is now completely distorted courtesy of the millions of transient workers entering and leaving thanks to the census. But yes, pointing out that companies see limited impact of a historic move in the FX scene, with the dollar now back to post-Lehman highs, is truly value added. Maybe next Binky can deconstruct the great foresight the Fed's Chairman had in 2006 when he said the subprime crisis was contained, and when in 2007 all major IB economicsts saw an S&P north of 1,600 by the end of the following year.

Just in case the DB spin is not quite heard, Binky continues:

Our baseline remains that the economic recovery will continue, driven as it has been so far by the large sales-production gap which remains sizable. On this baseline view and the implied path of corporate earnings, equities are inexpensive (S&P 500 trading today at 12.7x 2010, 12.3x normalized and 11.3x 2011 earnings) and will likely correct up as they have in past episodes when corrections did not disrupt the economic recovery. We therefore maintain our year-end target of 1375 (16.4x $84.6) on the S&P 500. But the rally in equities reconnecting to the economic recovery will likely take time. Both history and a variety of fundamental catalysts suggest risk aversion will persist through July and this is our baseline view. The persistence of risk aversion or vol by definition of course means that the range for the S&P can and likely will be large. Indeed a narrowing of trading ranges would be a sign that the episode of risk aversion was coming to an end. Key levels in the S&P 500 to note are (i) 975 which would mark 20% down and what history suggests is a necessary condition for disrupting the recovery; and (ii) 915 which would mark 25% down, which is the average recession decline from the recent 1217 peak, i.e., the market would have completely priced in another average recession. On the duration of risk aversion, we see the risks from the fundamental catalysts on net as being tilted to risk aversion ending earlier than in our baseline of end July, either on a positive surprise in June payrolls or an unwind of defensive positioning as Q2 earnings deliver or provide the sixth surprise in a row. We stay fully allocated to equities.

Well, of course you do. And we would venture to guess that the stock of DB is one of the main equities you stay allocated to, as the last thing a bank as massively undercapitalized as DB needs is for the economic reality to catch up with those firms levered to the gills to an economic upturn.

Yet DB does point out one useful data point, namely that cross asset, sector and stock correlations have now spiked to 20 year highs, as the only thing driving the market are daily shifts of risk perception, and the resultant signal execution by the few computers left trading the market amongst each other. At this point, we are confident that should the current pace of market structure deterioration continue, coupled with ongoing sovereign liquidity and solvency risks, that within a few months cross correlations will finally hit 100% and all alpha-hunting hedge and mutual funds can dissolve as the only variable in stock returns will be pure beta, thus making any relative outperformance in the market impossible by definition:

Cross asset class correlations, measured by the proportion of variation in returns across equities, bonds, credit, oil and FX that is explained by the first principal component, reached a new high of 65%--above late 2008 post-Lehman peaks. Across S&P 500 sectors (93%) and stocks (75%) it also reached late 2008 peaks. While vol rose sharply, the move has been below the average of past risk aversion episodes. We interpret the high cross-asset, sector and stock correlations as indicative of investors in less liquid asset classes hedging in more liquid equity and FX markets, using the indexes to do so.

Below are some of the more interesting charts from DB on market technicals and cross-correlations:

Notably, the S&P 500 has seen a very minor % change in EPS estimates since May 20, 2010, even as companies continue to pump up earning beat after earning beat, as more and more people continue being let go, and capex plans are reduced.

And specifically on the topic of corrections, here is the chart that allegedly demonstrates that while of the past 14 corrections, only 3 have resulted in payroll slowdown, and thus the ongoing "correctional" situation should be considered safe.

In other words, to DB the critical low in the S&P, which has likely been telegraphed to the relevant market supporters, is 975. Should that level be taken out, even DB would be forced to admit that the economic double-dip has arrived. As expected, there is little mention of previous observations by both David Rosenberg and Shiller, both of whom repeatedly point out that at current levels the market is approximately 30% overvalued, based on a bottoms-up analysis. In summary, both firms are right in noting that the economic-market disconnect is starting to shift to the economy proper, as the variation between macro and micro economic indicators is starting to flash red warning light. Should the relative strength of corporate bottom line metrics, which we believe has been driven almost exclusively by ongoing years of mass layoffs and retrenchment, leading to SG&A and CapEx reduction, thus sacrificing future revenue potential, invert, then even this last bastion of economic bulls will be abandoned. It is our belief that corporations, especially multi-national exporters, will increasingly indicate future top line weakness as a result of unhedged FX losses leading to end market weakness. This will likely be the next catalyst to push the corporate micro picture to recouple with increasingly weaker macro readings.

Full DB presentation.

 


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Sun, 06/13/2010 - 14:48 | Link to Comment ratava
ratava's picture

we had our two weeks of bad news, last week held on support. watch all the dumb money pouring in on monday.

Sun, 06/13/2010 - 15:12 | Link to Comment TexDenim
TexDenim's picture

I think the volume of late, and especially Friday, suggests the peasantry is keeping its money under a mattress.

Sun, 06/13/2010 - 15:16 | Link to Comment ratava
ratava's picture

peasantry aint got no money left, mutual muppets are the target audience

Sun, 06/13/2010 - 16:05 | Link to Comment Implicit simplicit
Implicit simplicit's picture

The market must be smokin cause it has short term memory loss big time with BP. All that ocean oil must have made it slip their minds

Sun, 06/13/2010 - 14:55 | Link to Comment unwashedmass
unwashedmass's picture

well it has to be pretty damn sobering that the peasantry hasn't shown up to take all this stock off their hands at these ridiculous prices.

and hell, CNBC has been waving those pom poms so frantically that they've got streamers in their hair....and its not working.

at some point, someone is going to end up holding a lot of stock...insanely overpriced stock, and right now, it doesn't seem like the usual patsies are going to show up.....

of course, that kind of thing happens when you suck the very life out of the lower classes, leave them penniless, and facing decades of ruinous taxes.

they just don't have it to give to GS and the boyz any more. its all gone.

 

Sun, 06/13/2010 - 15:12 | Link to Comment RobotTrader
RobotTrader's picture

Isn't next week Options Racketeering Week??

LOL.....

Look for virtually all puts and calls to get vaporized.

Here's the playbook:

Monday:  Up 100

Tuesday:  Down 200

Wednesday:  Flat

Thursday:  Up 350, then down 150

Friday:  Up 50, then down 100

 

 

Sun, 06/13/2010 - 15:34 | Link to Comment SilverIsKing
SilverIsKing's picture

What's Bill doing with his right hand?

Sun, 06/13/2010 - 17:24 | Link to Comment Sudden Debt
Sudden Debt's picture

Looking for his sigar box?

Sun, 06/13/2010 - 16:08 | Link to Comment Hephasteus
Hephasteus's picture

LOL.

The last starfighter. Death Blossom Attack.

http://www.youtube.com/watch?v=hlAsSyDAWR8&feature=PlayList&p=86D5F347F4...

Sun, 06/13/2010 - 20:26 | Link to Comment TheSettler
TheSettler's picture

So if my math is right Friday we will be up 1OO?

Sun, 06/13/2010 - 15:27 | Link to Comment jedwards
jedwards's picture

The market has digested all the bad news for now.  It gave them a bit of indigestion, but I think we're headed up now, until the next bout of bad news.  We'll probably start ping-ponging the bad news between various countries, Europe, US, China.  My guess is that the economic indicators will turn down, and a double dip will be evident and people will run for the hills.

 

Sun, 06/13/2010 - 15:30 | Link to Comment Sudden Debt
Sudden Debt's picture

For Europe it will be all about the details and roll out plans for the Austority plans. And that shit can take as much as 6 months befor e they are started so that can create a whoble in the markets for quite some time.

Sun, 06/13/2010 - 15:28 | Link to Comment Sudden Debt
Sudden Debt's picture

The bear got shot in the woods this weekend  and now we go back to the arena to watch the bull fights.

I'll start unloading most of my puts on monday and lets hope I can sell some long positions witch I've been holding since feb. with a profit.

Sun, 06/13/2010 - 15:30 | Link to Comment GovernmentMule
GovernmentMule's picture

The song remains the same as the squid swims on...

Sun, 06/13/2010 - 15:33 | Link to Comment poorold
poorold's picture

I don't get it.

 

Sovereign debt skyrocketing into territory where even the uneducated realize it cannot be repaid.

State and local governments whose budgets cannot and will not be balanced without serious pain and actual layoffs of employees, thereby further slowing things down.

 

and these "investment" firms continue forecasting the same old ****.  Market correction???  Yeah, wait till it just breaks.

Oh, my mistake.  They are just providing tomorrow's racing sheet for the betters.

 

How soon till the track closes?

Sun, 06/13/2010 - 17:55 | Link to Comment jedwards
jedwards's picture

Go watch "Wall Street" from the 80s.  They say the EXACT same thing about debt, trade deficits, the US being in the toilet, etc, and we managed to squeeze out another 25 years of "prosperity".  People on Wall Street have made billions upon billions, during this time when we should have been worried about our levels of debt.

Don't invest based on that thesis, because people who have thought that for the past 20 years, like Jim Rogers, have been on the wrong side of the trade.

The world is more than willing to extend credit to the US.  The only thing that would stop that is if another, more suitable country came around, but so far that country doesn't exist, so until then, the US will remain king, and everyone in the world will keep on giving us more rope to hang ourselves.

Once China gets its shit together and forms a politically stable and reliable place where we can put our money, then the US is fucked.  But not one second sooner.

Sun, 06/13/2010 - 20:36 | Link to Comment TBT or not TBT
TBT or not TBT's picture

The sovereign debt-to-GDP ratios were wildly lower in the 80's, and the demographics were better.   We could plausibly grow our way out of those debt levels, and so we did.  This time around, short of a series of technological miracles extending working lifetimes and lowering costs, there will be no pulling out of this dive.

As to China, have a look at their demographics.   China will get old before it gets rich.

Sun, 06/13/2010 - 20:45 | Link to Comment Nikki
Nikki's picture

When you shit on Jim Rogers you remind me of those ass clowns on Fox Biz every Saturday that laughed at his rants for years about Fannie, Freddie and sChitty bank. Think those fuckers are still laughing ?. Why are you ?. His commodity calls were right as was his advice to not short last years Fed rally. I'll go with Bow tie Jimmy instead of you. Watch for a short term Euro rally and weep.

Do not disrespect the bow tied one...

Mon, 06/14/2010 - 02:57 | Link to Comment jedwards
jedwards's picture

Wrong.  He was completely wrong about the USD and commodities for the better part of 25 years.  He was wrong about oil in 2008, he thought it would stay high, but it dropped 80% down to $35.  He has been completely wrong about USD.  The only thing he's been right about is gold, and that is only in the last 3 years or so.

His track record is worse than mine, and mine is terrible!

Sun, 06/13/2010 - 15:40 | Link to Comment GeorgeHayduke
GeorgeHayduke's picture

I'm holding my few positions for a couple more weeks to see if they rise on this BS wave. Then, I think I might bail out completely at the end of June. Too many bombs and traps laying around. Although, even being in cash in the account might be a crappy deal when they trash the dollar too. Oh well, I'm as ready as I can be right now for what they throw at us.

Sun, 06/13/2010 - 15:55 | Link to Comment mcguire
mcguire's picture

just for fun, thought i would post this... this is a cartoon slideshow that appeared in the UK Telegraph over a year ago, predicting events to start next week (monday into tuesday), june 21,22.  (in this video, it is set to music, but you can still see it posted in the telegraph as a slide show) (i always freak out on tuesdays, always want to be short the market or long vol.)  it is laughable, i know, but still presents an interesting trading point... the question is, if this were to happen, would all trades be made meaningless?  would you be able to collect anything, even if you put together a winning option strategy???  whatever happens this week, remember this for next week. 

http://www.youtube.com/watch?v=WCDlndLvCMs&feature=fvst

Sun, 06/13/2010 - 16:18 | Link to Comment mcguire
mcguire's picture

as far as this week's trading and the broad equity markets in the US, i am using the 200 day moving average to guide my decisions (around 1100 in the sp500).  if the pump and dump machinery manages to break through this point, i am giving up on this being a capitulation with any teeth (at least until it retests april highs).. just my thoughts...  

Sun, 06/13/2010 - 17:02 | Link to Comment Bohica
Bohica's picture

RE  "the ECRI leading economic index posted its 44th sequential weekly decline this Friday, and has for the first time plunged to an annualized negative rate."

The ECRI WLI posted its 5th sequential weekly decline on Friday 6/11 for data as at 6/4.  It's still up 5.8% y-o-y (52 weeks), but the 52-week change is declining rapidly.  6-month change (26 weeks) has been negative for three weeks.

Sun, 06/13/2010 - 17:12 | Link to Comment Thoreau
Thoreau's picture

The correction is over; long live the erection... until the blood vessels blow-out and we start pissing blood. Now go eat your dinner.

Sun, 06/13/2010 - 17:13 | Link to Comment bigkahuna
bigkahuna's picture

Does anyone remember what bernie ebbers said about worldcom stock just before it tanked? Something like, now is a great time to buy--right from the mouth of the scumbag who was behind all of the bs. This sounds familiar to what is taking place on a market wide scale right now.

Sun, 06/13/2010 - 17:15 | Link to Comment Edna R. Rider
Edna R. Rider's picture

Last week I suspected the markets would move up (if there isn't seriously bad news, that's good news, it seems).  I am guessing that until August the market will slowly go up, mostly overnight, with excellent moves on Sunday nights.

Sun, 06/13/2010 - 17:36 | Link to Comment mcguire
mcguire's picture

i kind of suspected the market would move up after it shrugged off japan minister saying "we are the next greece". 

Sun, 06/13/2010 - 17:36 | Link to Comment mcguire
mcguire's picture

i kind of suspected the market would move up after it shrugged off japan minister saying "we are the next greece". 

Sun, 06/13/2010 - 17:28 | Link to Comment Sudden Debt
Sudden Debt's picture

For Europe we're getting into extreme right government mode. Belgium just voted for a seperation government.

Sun, 06/13/2010 - 17:35 | Link to Comment ratava
ratava's picture

right is the only side capable of fiscal consolidation tho. czech and slovak voters showed surprising amount of sanity and elected someone else than populist socialists.

Sun, 06/13/2010 - 17:36 | Link to Comment Borat
Borat's picture

Honestly, very confusing text. The title says one thing and the article seems to contradict it. I would use other indicators to show that a pull back is due in a couple of weeks. Just get the news and see how biased to the down side ( Bob Pretcher on Cnbc, Bears on magazines, the phrase " we are in correction territory"...). My guess we should test again the 1050 and then... Who knows....

Sun, 06/13/2010 - 18:05 | Link to Comment mudduck
mudduck's picture

An economist named Binky. To bad his last name is not Bernanke, now that would be a good name for an economist. Anyhow, I think these guys have got it backwards, I think the correction started in March 09 and just ended in April 2010.

Sun, 06/13/2010 - 18:14 | Link to Comment buzzsaw99
buzzsaw99's picture

I hope there is a rally as I have some equities I need to unload.

Sun, 06/13/2010 - 18:15 | Link to Comment Maxiarg
Maxiarg's picture

I believe the short term correction ended.... but, taking a longer perspective, (technically), the "double dip" is possible... look at this charts:

 

http://tradingeffect.blogspot.com/2010/06/following-1929.html

The similarity between 1929 / 1932 and 2007 / 2010 are amazing...

 

Sun, 06/13/2010 - 18:20 | Link to Comment The Rock
The Rock's picture

Is The GSHS (Goldman Sachs Horse Shit) Over?

Enquiring minds would like to know...

 

Sun, 06/13/2010 - 18:36 | Link to Comment keepmydollar
keepmydollar's picture

Options manipulation week next week.  I think the bounce has another week, but we are headed back down.

Sun, 06/13/2010 - 18:37 | Link to Comment All_Is_Well
All_Is_Well's picture

But fundamental initial conditions are also important and, in our view, the main cyclical driver of the current recovery, the large gap between final demand and corporate activity levels, remains and will continue to drive corporate spend and hiring.

Translation: AAPL sold another million iPads therefore everything is "peachy" and SP 1350 is just around the corner!

Mon, 06/14/2010 - 05:47 | Link to Comment lewy14
lewy14's picture

far less margin for reality

 

Brilliant. Soon entering a lexicon near you.

Mon, 06/14/2010 - 07:05 | Link to Comment Treeplanter
Treeplanter's picture

Nobody has a clue about where the market is going short term.  We do know long term.  Wishful thinking tends to lose money.

Mon, 06/14/2010 - 07:36 | Link to Comment Lighty
Lighty's picture

With all this official bullishness, a market crash is guaranteed. Time to reload shorts!

Mon, 06/14/2010 - 11:45 | Link to Comment Eric Cartman
Eric Cartman's picture

Maybe the regulation on banks will kill the market down the hill.

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