"The consensus view was that QE3 was going to send the stock market to the moon. Yet the peak level on the S&P 500 was 1,465 on September 14th, the day after the FOMC meeting. The consensus view was that the lagging hedge funds were going to be forced to play some major catch-up and take the stock market to the moon too. Surveys show that the hedge funds have already made this adjustment...Q3 EPS estimates are still coming down and now stand at -3% YoY from -2% at the start of October....this is the first time the Fed embarked on a nonconventional easing initiative with the market overbought and with profits and earning expectations on a discernible downtrend. Not only that, but the fact the pace of U.S. economic activity is still running below a 2% annual rate, which is less than half of what is normal at this stage of the business cycle with the massive amount of government stimulus, is truly remarkable. Keep an eye on the debt ceiling being re-tested — the cap is $16.394 trillion and we are now at $16.119 trillion. This is likely to make the headlines again before year-end — the rating agencies may not be taking off much time for a Christmas break."
While earlier we were presented with an extra serving of hypocrisy courtesy of the Fed's James Bullard who lamented the lack of income for America's "savers", next we get a less than random selection of US CEOs, those of UPS Scott "Logistics spending would be great if only world trade hadn't completely collapsed" Davis, Honeywell's David "Look over there, Isn't Iran bombing something" Cote, NASDAQ's Bob "I destroyed IPOs" Greifeld, and, of course, Larry "About to switch jobs with Tim Geithner" Fink, who via Bloomberg TV get to opine on such issues as the fiscal cliff and America's $16.2 trillion, and very rapidly rising debt. Some of their views: "It's Washington's fault we're not hiring and not spending." Honeywell's Cote says, "If we were playing with fire in the debt ceiling, we'll be playing with nitroglycerine now when it comes to the fiscal cliff." Larry Fink says, "We need to speak out as CEOs…Politicians generally address things when their back's against the wall…We have the threat of going into a recession in the first quarter…This is a very uncertain moment." And thanks to the Fed, which has come at just the wrong moments, and always bailed out Congress every time a difficult decision had to be taken, the likelihood of a benign outcome on the fiscal cliff is far worse, than even Goldman's latest worst case scenario which sees just a 33% probability of resolution before the year end.
The overhwelming majority of investors seem to believe that some compromise will be reached to resolve the looming fiscal drag, and as we noted here, this fact is more than priced into markets. As Barclays notes however, a big deal that encompasses entitlement and tax reform is very unlikely before year-end. Hence, if the ‘cliff’ is avoided, it will be because Congress extends all expiring provisions for some time while it works on a bigger deal. Such an 'extension/compromise' move would not reduce investor uncertainty if it were only for a few months; bond markets would simply start counting down to the new date. More importantly, the discussion about the fiscal cliff misses a broader point: the US will probably have significant fiscal tightening over the next decade that is a drag on medium-term growth. Yet more investors dismiss last year's reaction to the debt-ceiling debate - a 17% decline in 2 weeks - as any kind of precedent, claiming (falsely) that this was more due to European financial difficulties. We expect fiscal issues to be the defining drivers of the next several quarters and as BofAML notes, Washington's view of this 'process' as a 'slope' combined with the dangerously negative election campaign (which will need a 180-degree reversal for any compromise) means the likelihood of a Wile E. Coyote Moment is considerably higher than most expect.
Just how much havoc does living within one’s means wreak?
Goldman's equity strategist David Kostin has been very quiet for the past year, having not budged on his 2012 year end S&P target of 1250 since late 2011. Today, he finally released a revised forecast, one that curious still leaves the year end forecast unchanged at a level over 200 points lower in the S&P cash, and thus assuming a ~15% decline. The reason: the same fiscal cliff (which would otherwise deduct 5% in GDP growth) and debt ceiling debate we have warned will get the same market treatment as it did in August of 2011 when the only catalyst was a 15% S&P plunge and a downgrade of the US credit rating. However, one the fiscal situation is fixed, Kostin sees only upside, with a 6 month target of 1450 ("We raise our medium-term fair value estimates for the S&P 500 in response to openended quantitative easing (QE) announced by the Fed."), and a year end S&P target of 1575, calculated by applying a 13.9 multiple to the firm's EPS forecast of 114. Of course, this being bizarro Goldman Sachs it means expect a continued surge into year end, then prolonged fizzle into the new year. Why? Because there is not a snowball's chance in hell the consolidated S&P earnings can grow at this rate, especially not if the Fiscal Cliff compromise is one that does take away more than 1% of GDP thus offsetting all the "benefit" from QE. Simply said, companies who have already eliminated all the fat, and most of the muscle, and are desperate for revenue growth to generate incremental EPS increase, have not invested in CapEx at nearly the rate needed to maintain revenue growth, having dumped all the cash instead in such short-sighted initiatives as dividends and buybacks. Also, recalling that revenues are now outright declining on a year over year basis, and one can see why anyone assuming a 14% increase in earnings in one year, is merely doing all they can to make the work of their flow desk easier.
The market appears convinced that it now has nothing to worry about when it comes to the fiscal cliff. After all, if all fails, Bernanke can just step in and fix it again. Oh wait, this is fiscal policy, and the impact of QE3 according to some is 0.75% of GDP. So to offset the 4% drop in GDP as a result of the Fiscal Cliff Bernanke would have to do over 5 more QEs just to kick the can that much longer. Turns out the market has quite a bit to worry about as Goldman's Jan Hatzius explains (and as we showed most recently here). To wit: "our worry about the size of the fiscal cliff has grown, as neither Democrats nor Republicans look inclined to budge on the issue of the expiring upper-income Bush tax cuts. This has increased the risk of at least a short-term hit from a temporary expiration of all of the fiscal cliff provisions, as well as a permanent expiration of the upper-income tax cuts and/or the availability of emergency unemployment benefits." This does not even touch on the just as sensitive topic of the debt ceiling, where if history is any precedent, Boehner will be expected to fold once more, only this time this is very much unlikely to happen. In other words, we are once again on the August 2011 precipice, where everything is priced in, and where politicians will do nothing until the market wakes them from their stupor by doing the only thing it knows how to do when it has to show who is in charge: plunge.
Yesterday we brought you the news that US debt quietly soared by $90 billion overnight to celebrate the new fiscal year end, reaching $16.2 trillion and sending total US debt to GDP to 103%. Needless to say, this comes at an exciting time, with the first Wall Street muppet presidential debate in about 12 hours, where the US debt crisis will be a front and center topic because in about 2 months, the US debt ceiling will again be breached adding to the Fiscal Cliff fiasco, resulting in a flashback to August 2011 when the market had to tumble by nearly 20% for Congress to get the hint that first and foremost its job is to make sure the money on Wall Street keeps flowing, all else secondary. And while it has become fashionable to say that US debt rose by this much under that president, the truth is that the Presidency is merely one of three institutions that are responsible for the shape of the US debt-to-GDP line (which is now going from the lower left to the upper right by default). The other two are, of course, Congress and the Senate. Luckily, to simply things substantially, we have a handy graphic from today's Bloomberg Brief which conveniently plots not only the political affiliation of the presidency, but of the House and Senate, in the chronology of the US debt crisis.
Evoking the dark days of 2009 - after a steep and bumpy slide
The Philly Fed's current September Business Indicators index, long ignored when bearish and cheered when bullish, came slightly above expectations of -4.5, printing higher from last week's -7.1 to -1.9. This was the fifth consecutive negative print. And while there were no major highlights in the index, whose New Orders rose from -5.5 to 1.0 at the expense of Shipments and Inventories, both of which imploded to worse then -20, the real story is the Six Months expectations index, which exploded from 12.5 to 41.2: this was the biggest spike may not ever, but certainly in the past 22 years! Is there any wonder why everyone is transfixed with hope that Q4 will be the deus ex that saves the US economy. And so we are back to being a hopium driven economy - when reality sucks, there may not be much change, but there is always hope that finally, the central planners will get it right, and the future will be so bright you've gotta wear Made in China shades. One word of caution: if the so very much anticipated and 100% priced in Q4 recovery does not materialize, and with the fiscal cliff and debt ceiling issues still unresolved, get the hell out of Dodge, as the spread between hope and reality comes crashing.
Bob Janjuah - "Central Banks Are Attempting The Grossest Misallocation And Mispricing Of Capital In The History Of Mankind"Submitted by Tyler Durden on 09/18/2012 07:45 -0400
"The bottom line is simple: The Fed and the ECB are directing and attempting to orchestrate the grossest misallocation and mispricing of capital in the history of mankind. Their problem is that their actions have enormous unintended and even (eventually) intended consequences which serve to negate their actions in the shorter run, and which could create even bigger problems than we currently face in the near future. Kicking the can is not a viable policy for us now. The private sector knows all this, consciously and/or sub-consciously, which is why I feel these current policy settings are doomed to fail. Having said all that, the one area which for some reason still holds onto hope that Draghi and Bernanke can still perform feats of "magic" is the financial market, which central bankers assume, rely on and are happy to encourage Pavlovian responses. The reality here though is that even financial markets are, collectively, either sensing or assigning a half-life to the "positives" of central bank debasement policies, which to me means that even markets are only suggesting a short-term benefit from the latest policy actions. This is not what Draghi and Bernanke are hoping for, but in order for them to see the half-life outcome averted they know that we need to see major political and structural real economy reforms which somehow make Western workers competitive and hopeful again. The track record of the last four to five years inspires very little confidence that we will see such great necessary reformist strides taken anytime soon."
As we have explained recently, the US fiscal cliff is a far more important issue 'fundamentally' than the Fed's economic impotence. While most market participants believe some kind of compromise will be reached - in the lame-duck session but not before the election - the possibility of a 3.5% drag on GDP growth is dramatic to say the least in our new normal stagnation. As Goldman notes, the window to address the fiscal cliff ahead of the election has all but closed, the 40% chance of a short-term extension of most current policies is only marginally better than the probability they assign to 'falling off the cliff' at 35%. The base case assumptions and good, bad, and ugly charts of what is possible are concerning especially when a recent survey of asset managers assigned only a 17% chance of congress failing to compromise before year-end. Critically, and not helped by Bernanke's helping hand (in direct opposition to his hopes), resolution of the fiscal cliff will look harder, not easier, to address as we approach the end of the year - and its likely only the market can dictate that direction - as the "consequence is terrible, but bad enough to force a deal."
To all who miss the highly volatile days of August 2011, when as a result of the congressional deadlock on the debt ceiling, and the S&P downgrade of the US, the DJIA swung by 400 points every day for 4 days in a row just to get Congress to come to the "compromise" exposed in painful detail by Bob Woodward a few days ago, fear not: they are coming back, and with a vengeance. Because while last year only the debt ceiling was under discussion, now we get the double whammy of the debt ceiling and the Fiscal cliff. And just so the suspense meter is pushed off the charts early, and the performance gets maximum billing for theatrics if not execution, House Speaker John Boehner has just said he's not confident Congress can reach a budget deal and avoid a downgrading of the U.S. debt rating. Let us paraphrase: there will be no deal until the 11th hour, 59th minute, 59th second, and 999th millisecond, at which point the market will plunge and get Congress to do what it always does: Wall Street's bidding, which now and always, is a smooth and seamless continuation of the status quo.
13 months ago, in the aftermath of the debt ceiling fiasco, which we now know was a last minute compromise achieved almost entirely thanks to the market plunging to 2011 lows, S&P had the guts to downgrade the US. Moody's did not. Now, it is Moody's turn to fire up the threat cannon with a release in which it says that should the inevitable come to pass, i.e. should congressional negotiations not "lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term" then "Moody's would expect to lower the rating, probably to Aa1" or a one notch cut. Moody's also warns that should a repeat of last year's debt ceiling fiasco occur, it will also most likely cut the US. Of course, that the US/GDP has risen by about 8% since the last August fiasco has now been apparently forgotten by both S&P and Moodys. Sadly, continued deterioration in the US credit profile is inevitable, as every single aspect of modern day lives that is "better than its was 4 years ago" has been borrowed from the future. More importantly, with the S&P at multi year highs courtesy of Bernanke using monetary policy to replace the need for fiscal policy, Congress will see no need to act, and Moody's warning will be completely ignored. This will continue until it no longer can.