David Rosenberg, who has very patiently taken the peanut gallery's swipes at him for the past month during the latest bear market rally bout (of which Japan had roughly 25 as the broader secular one took its market about 75% lower over two decades), finally lashes out at all those who still fail to see that there is nothing organic about the US economic recovery, and the only reason the numbers are "better" is due to the $4+ trillion in fiscal and monetary stimuli: "What we have on our hands has been an economic revival and market bounce back premised on unprecedented monetary and fiscal stimulus. How the Fed and the federal government in the future manage to redress their pregnant balance sheets without creating a major disturbance for the overall economy is a legitimate question and, sorry, does not deserve a double-digit market multiple, in our view." That is about all that needs to be said on the matter of the economic recovery. But we will immediately grant that there is an organic economic boom if the Fed removes QE right now, and the economic data points over the next quarter continue trending higher. Somehow we don't think this will (ever) happen...
Barrons.com ran an article yesterday quoting some obscure analyst criticizing our macro economic and bond yield call for 2010, basically ridiculing us, calling for a contraction in either Q3 or Q4 and for the yield on the U.S. 10-year note to get as low as 2% or below. Here is the reality. The U.S. economy was clearly sputtering by the spring and summer and we were calling for that early on as the consensus was gazing at 5%+ fourth quarter growth in Q4 of 2009 and 3%+ in the first quarter of 2010. Only when the long arm of the law — another round of monetary and fiscal stimulus — was extended to give Mr. Market a nice lift did the clouds part. That shows how fragile this recovery has been and remains — just read the FOMC minutes to get a glimpse of the array of downside risks cited (more on this below). While the 10-year yield did not finish the year at 2%, it almost got there in the fall and nobody, except us, was calling for that a year ago. So put that in your pipe and smoke it.
There is no doubt that we have had an incredible bear market rally on our hands. But that is exactly what it is. As we noted yesterday, as per Bob Farrell, even these spasms can go further than anyone thinks. But after a monstrous 80%-plus rally from the March 2009 lows (over such a short time frame, and the most pronounced bounce since 1955) this market has become seriously overextended in our view. Meanwhile, we have practically every market pundit extrapolating the recent trend into the future because that is the easy thing to do. But the Farrell’s and Walter Murphy’s of this world have become very cautious and frankly, that is good enough for us. The fact that Laszlo Birinyi published a report yesterday concluding that the S&P 500 will rally to 2,854 (what … no decimal place?) by September 4, 2013 (oh, only another 125% from here) is perfect. Absolutely perfect.
Meanwhile, the masses only see the returns, they do not see the risks that are nearly invisible to the naked eye. But we see the risks. We assess them; we measure them, and we benchmark the returns against them. I recall all too well that 2003-07 bear market rally — yes, that is what it was. It was no 1949-1966 or 1982-2000 secular bull run. It was a classic bear market rally, and did last five years. I was forever skeptical because what drove that bear market rally was phony wealth generated by a non-productive asset called housing alongside wide spread financial engineering, which triggered a wave of artificial paper profits. I knew it would end in tears … sadly, I didn’t know exactly when. I was constantly defensive in my investment recommendations at the time and there was a huge price to be paid for being bearish when there is a bull on your business card, trust me on that one.
We have been patient and will remain so, with an eye towards maximizing risk-adjusted returns, not merely gross nominal returns, which are the only ones that get reported. Remember those returns only count if they aren’t ultimately reversed by excessive greed. At the current time, we believe our clients are well served by our equity strategies (minimal cyclical exposure and a focus on an income equity-hard asset barbell); our long-short strategies (vital in controlling risk in the portfolio and underscore our focus on capital preservation thematic) and our fixed-income products (outside of commodities, deflation in the developed world remains the primary trend and is in such a backdrop that “yield” makes perfect sense).
As investors discovered that the world wasn’t flat after all from late 2007 through to early 2009 as the roof caved in for most, who remembered that I was just plain wrong in 2003 when the S&P 500 surged 26% or even in 2006 when it rallied 13%. It is quite amazing that as the market rolled over, nobody remembered how “wrongly bearish” I was during those years in the wilderness when everyone believed in the wonders of financial market innovation and the democratization of the housing market. I recall a senior portfolio manager in Texas scolding me in 2005 about how his nanny just got a subprime mortgage to buy her first home … let’s hope he didn’t co-sign).
It is an amazing commentary on human behaviour that I was forgiven for having been more focused on bonds and gold during those go-go leveraged years of 2003-2007, and then treated like a hero after the financial system collapsed under its own weight of dramatic excess. It goes to show that in the final analysis, as much as it hurts, not to be involved in a speculative rally that sees the market surge more than 80%, it is much much tougher to actually experience a correction in the other direction. For the time being, it takes extreme courage and resolve to not jump on the bandwagon (“don’t fight the Fed”) and buy “the market” at current expensive pricing points.
As far as equities are concerned, make no mistake, we are in the throes of an intense bear market rally, which is likely at the very late stage. Nobody will know to get out at the peak and as we saw in late 2007 and into 2008, many of the “longs” will be trapped. Bear market rallies are not the same as secular bull markets — the former are to be rented, the latter are to be owned. Those claiming to be adept market timers today that have been and are staying long will be repeating the same mistake they made three-years ago.
This is not the 1949-66 secular bull market that was underpinned by troops coming home and spurring on a baby-boom that would unleash years of tremendously strong domestic demand growth. The demographics in the U.S.A. are now downright poor — just look at the ratio of the working age population to the total population. Nor is this the 1982-2000 secular bull market that saw the central bank usher in years of disinflation (the current one is trying desperately to create inflation!) and a wave of innovation that saw the mainframe, the personal computer, the Internet, and then the smartphone, a boom in the capital stock that enhanced structural productivity growth and led to sustained gains in private sector economic activity, which by the end of that secular bull run, allowed the government to actually start to record budgetary surpluses. What is the major innovation today? The iPod? The iPad? Facebook? These may be fun, but they don’t do much to promote the growth rate in the nation’s capital stock or productivity.
What we have on our hands has been an economic revival and market bounce back premised on unprecedented monetary and fiscal stimulus. How the Fed and the federal government in the future manage to redress their pregnant balance sheets without creating a major disturbance for the overall economy is a legitimate question and, sorry, does not deserve a double-digit market multiple, in our view.
Maybe last quarter’s and next quarter’s GDP growth is relatively certain, but last we saw, the stock market is a long-duration asset. If 2011 was a building block for 2012, much like 1982 was for 1983, we would be impressed. But the growth we will likely see in 2011 will be bought by the government and the Fed at the expense of 2012 where there is likely going to be a huge air pocket, and the presidential election of that year in the U.S. will likely be fought and won on which party can successfully convince the voting public that the recession was not its fault.
Just as the 2003-07 bear market rally was built on a shaky foundation of unsustainable credit and house price appreciation, the current bear market rally has been built on even shakier ground of surreal public sector intervention. This may well have “saved the system” or “prevented a depression” back in the opening months of 2009, as many like to believe; however, the reality (and even former communist regimes figured this out a few decades ago) is that there is no such thing as a free lunch.
The best buying opportunities for investors that actually do have a horizon that lasts more than five months or even 15 months for that matter; investors that are more focused on building wealth for the long-term as opposed to trying to make recurring short-term trading profits, will happen when we see the payback period. And this could happen sooner than you think. Don’t assume for a second that Ben Bernanke has any more rabbits in his hat or that the new Congress is going to fill anyone’s stockings with more fiscal goodies towards the end of the year.
At least the editorial board at the Wall Street Journal get it. See page A14 of today’s paper — The GOP Opportunity. To wit:
“John Boehner takes the Speakers gavel from Nancy Pelosi today, and the transfer represents much more than a change in partisan control. It marks perhaps the sharpest ideological shift in the House in 80 years, and it could set the stage for a meaningful two-year debate over the role of the government and the real sources of economic prosperity.”
As the chart below illustrates, growth in the U.S. private sector capital stock has actually turned negative for the first time since the post WWII era. This does not bode well for future productivity gains, the U.S. economy’s non-inflationary growth potential or consensus views that somehow a market multiple between 14x and 16x (depending on how it’s measured) is close to anything resembling “fair-value”
While today’s ADP number for December was surprisingly strong, the reality is that U.S. labour market remains in a state of disarray. The labour force gaps are huge if not unprecedented. Fully 6.3 million Americans have been actively looking for a job with no success for at least six months — a record, both in absolute and relative terms, to the size of the workforce. One cannot help but contemplate the looming social issues that will be involved if youth unemployment rates at 25% and adult male jobless rates at 10% are sustained. Even the Fed did not offer much hope in yesterday’s minutes that the dramatic excess capacity in the jobs market will be resolved in the coming year, even with the last gasp attempt to stimulate the economy with monetary and fiscal steroids. Again, this is a source of uncertainty that would ordinarily require a lower fair-value P/E multiple than a higher one.