We remain in the throes of a secular era of disinflation. We also are in a long-term period of sub-par economic growth and below-average returns. This has become so well entrenched that U.S. pension plans now have more exposure to bonds than to stocks, as we highlighted two weeks ago. Look, this is not about being bearish, bullish or agnostic. It's about being realistic and understanding that in our role as market economists, it is necessary to provide our clients with information and analysis that will help them to navigate the portfolio through these stressful times. Our crystal ball says to stick with what works in an uncertain financial and economic climate — in other words, maintain a defensive and income-oriented investment strategy.
Many economists are suggesting that the second estimate of Q3 GDP, which showed an initial estimate of 2.0% annualized growth, will be revised sharply upward to 2.8%. The problem is that the surge in demand isn't materializing at the manufacturing level. The month-over-month data has begun to show signs of deterioration as of late which doesn't support the idea of a sharp rebound in economic activity in recent months. The headwinds to economic growth are gaining strength as the tailwinds from stimulus related support programs fade. This has been witnessed not only in the manufacturing reports, such as the CFNAI and Dallas Fed Region surveys where forward expectations were sharply reduced, but also in many of the corporate earnings and guidance's this quarter.
Back in April, we did an extensive analysis of what, in our opinion, is the primary reason for the slow burn experienced by the US, and global economy, and why virtually every liquidity pathway used by central banks is hopeless clogged: the complete lack of capital expenditures at the corporate level, and lack of (re)investment spending. Specifically we said that in both the context of Japan's plunging corporate profitability over the past 30 years despite year after year of record budget deficits, and its implications everywhere else, that "we get back to what we have dubbed the primary cause of all of modern capitalism's problems: a dilapidated, aging, increasingly less cash flow generating asset base! Because absent massive Capital Expenditure reinvestment, the existing asset base has been amortized to the point of no return, and beyond. The problem is that as David Rosenberg pointed out earlier, companies are now forced to spend the bulk of their cash on dividend payouts, courtesy of ZIRP which has collapsed interest income. Which means far less cash left for SG&A, i.e., hiring workers, as temp workers is the best that the current "recovering" economy apparently can do. It also means far, far less cash for CapEx spending. Which ultimately means a plunging profit margin due to decrepit assets no longer performing at their peak levels, and in many cases far worse." Today, with the usual six month or so delay, this fundamental topic has finally made the mainstream media with a WSJ piece titled "Investment Falls Off a Cliff: U.S. Companies Cut Spending Plans Amid Fiscal and Economic Uncertainty."
Yesterday, we were offered 'hopes and prayers' by Gluskin Sheff's David Rosenberg. However, as he warned then, there are some things to be worried about. From the wide gaps in voting patterns across socio-economic lines and the expectations that populist policies will be the hallmark of Obama's second term to the mixed-to-negative data across employment data, consumer spending indications, housing, and Europe; it appears the market is starting to price in some positive probability of a fiscal cliff and these macro data do nothing to subsidize that reality. While the President does not face the Great Recession of four years ago, he does confront the "Not So Great Recovery" nonetheless.
It is not going to be a new government that necessarily ushers in a whole new era of growth, prosperity and confidence. Even under the revered Ronald Reagan, the period of secular growth and bull market activity took two years to unfold — it didn't happen right away. It took the inflationary excesses to be wrung out of the system and concrete signs that the executive and legislative branches could work together to usher in true fiscal reform — and to get blue Democrats on board with reduced top marginal tax rates. Hope isn't generally a very useful strategy, but there is reason to be hopeful nonetheless. The critical issue is going to be how we get Washington to move back to the middle where it belongs. This requires bipartisanship which in turn requires leadership. Reagan's whole eight-year tenure in the 1980s occurred with the House being in Democrat hands the whole way through. Bill Clinton's second term coincided with both the House and Senate controlled by the Republicans.
It can be done!
With this in mind, the best that can happen is a Reaganesque and Clintonesque return to compromise on the road to fiscal reform. It will be painful. We all know it will be painful.
Tired of idiotic "expert assessments" how the destruction in the aftermath of Sandy is good for the economy and "creates wealth" (just ask these people or these how much wealthier they feel with their house halfway still underwater, or with not a bite to eat)? Then read the following brief summary by David Rosenberg what the real and full impact of Rosie on the US will be: "the surprise for Q4? A negative GDP print."
This is no longer your "father's economy." The importance of this shift in the U.S. from away from being the epicenter of global production and manufacturing to a service and finance based economy should not be overlooked. This transition is responsible for the issues that are impeding economic growth in the U.S. today from structural unemployment, declining wage growth and lower economic prosperity. What does this have to do with GDP and exports? Well, just about everything. With exports declining which is impacting corporate profit margins, employment conditions deteriorating, and business spending contracting - these are all the necessary ingredients to spin out a negative economic growth rate at some point in the not so distant future.
What is wrong with this market? The S&P 500, instead of grinding higher in the aftermath of QE3 actually hit its peak for the year the day after the policy announcement. Go figure. Maybe economic reality finally caught up with Mr. Market (there is a very fine line between "'resiliency" and "denial" — and keep in mind that the S&P 500 is still up 14% in a year in which profits are now contracting, not just slowing down)... On average, six weeks hence, the S&P 500 was up more than 9% after the policy announcement. It was all so novel! Tech on average was up over 11%, industrials were up 12%... ditto for Consumer Discretionary and Materials. The cyclicals flew off the shelves. But this time around. either Mr. Market is jaded or the laws of diminishing returns are setting in. Six weeks after the unveiling of QE3, the market is down 2%. This hasn't happened before. Every economic-sensitive sector is in the red, and even Financials — the one sector that should benefit from all the "sucking at the Fed teat" — have made no money for anybody!
Yesterday's massive car bomb in Lebanon, which killed and wounded dozens including the country's police intelligence chief and has thus been dubbed as the most "high-profile assassination in seven years", confirmed once again that when it comes to regional powder kegs, the middle east is second to none, and is the 21st century equivalent of Eastern Europe. While nobody has claimed responsibility yet for yesterday's brazen attack (although the "agenda-less" media is once again insinuating it is the doing of Syria's leader Bashar al-Assad) one thing is certain: provocations of this nature will continue indefinitely until they escalate into something much more lethal. The reason: the melting pot melange of different sects in Syria and Lebanon, which co-exist in perfectly mutual hatred despite, or rather because of, the artificial political borders imposed between the two countries provides a terrific backdrop to which merely add a spark and watch everything go up in flames. Which also means that those seeking to provoke further military escalation in the region, now that attempts to stoke a conflict between Syria and Turkey have so far failed, will likely look to Lebanon as a new conduit for escalation. . Because remember: as David Rosenberg pointed out yesterday, in a time of record partiasniship, political bickering and lack of consensus, "it may end up taking some sort of a crisis, in the end, to galvanize the two parties to work towards a resolution to the fiscal morass." And that is precisely what the endgame here is: the intention to unify a hopelessly split congress (and senate) behind the patriotic banner of war. It is only a matter of time (but certainly in time to address the Fiscal Cliff).
Earlier this week two former Merrill colleagues, since separated, were reunited on several media occasions, and allowed to spar over their conflicting views of the world. The two people in question, of course, are Gluskin Sheff's David Rosenberg, best known during the past 3 years for not drinking the propaganda Kool-Aid, and systematically deconstructing every "bullish" macroeconomic datapoint into its far more downbeat constituent parts, and his ebullient ex-coworker, Richard Bernstein, formerly head of equity strategy at a firm that had to be rescued by none other than Bank of America and currently head of RBA advisors, who just happens to be bullish on, well, everything. And since any attempt at holding an intelligent conversation on CNBC is ultimately futile (as can be seen here) and is constantly broken up by both ads, and interjecting anchors and show producers who care far less about facts than keeping the presentation 'engaging' (and going to such lengths to even allow Jim Cramer to have his own TV show), Rosenberg decided to dedicate his entire letter to clients today to "providing a rebuttal" of the slate of reasons why according to Bernstein the "we are on the precipice of a 1982-2000 style of secular market." What follows is one of the most comprehensive "white papers" debunking the bullish view we have seen in a while. Read on.
Even though we have presented comparable scenarios looking at the coverage of the US money base in gold terms previously, aka "gold coverage" ratio, including once from Dylan Grice, and once from David Rosenberg, now that we have drifted into a new, previously unchartered and very much open-ended liquidity tsunami, it is time to revisit the topic. Luckily, Guggenheim's Scott Minerd has done just that. Not only that, but he presents three distinct gold pricing scenario, attempting to forecast a low, medium and high price range for the yellow metal. To wit: "The U.S. gold coverage ratio, which measures the amount of gold on deposit at the Federal Reserve against the total money supply, is currently at an all-time low of 17%. This ratio tends to move dramatically and falls during periods of disinflation or relative price stability. The historical average for the gold coverage ratio is roughly 40%, meaning that the current price of gold would have to more than double to reach the average. The gold coverage ratio has risen above 100% twice during the twentieth century. Were this to happen today, the value of an ounce of gold would exceed $12,000.”
"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."
Charts Of The Day: Why America Needs To Embrace The Fiscal Cliff Instead Of Kicking The Can Once AgainSubmitted by Tyler Durden on 10/12/2012 13:20 -0400
To quote David Rosenberg: "there is no good time, but better now than waiting to be shocked into the retrenchment later on. If left unchecked, the Federal debt/GDP ratio will breach 100% within the next two or three years. Do we really need to turn European? And more importantly, even under a sustained low interest rate policy, debt service costs will continue to bite into the revenue base - so much so that they will soon begin to absorb more than 20% of total tax receipts. At a time when grim demographic realities will push dependency ratios higher and with that ever-spiralling entitlement spending, the power of compound interest on a continued mountain of debt even assuming years of low rates will ensnare fiscal finances and seriously limit our policy flexibility in the future."
Nothing materially new here from David Rosenberg's latest letter, but it is useful to keep being reminded over and over how central planning has totally destroyed the primary function of capital markets: discounting, and replaced it with a dumb terminal which only responds to red flashing headlines reporting of neverending liquidity. "If the Fed really had its way, the economy would be booming. But it is sputtering. For all the talk of one month's employment report — look at the entire quarter for crying out loud. Looking at total labour input, aggregate hours worked, it eked out a tepid 0.8% annualized gain in Q3....That the stock market is up 16% this year (on track for the best year since 2009) with earnings contracting underscores the major success of Fed policy in 2012 — managing to deflect investor attention away from negative profit trends and towards its pregnant balance sheet. So welcome to the new normal: the Fed has managed to negotiate a divorce between the economy and equity market behaviour.
If interest income as a percentage of total personal income had remained at its 2008 level, the total would now be over $1.5 trillion. It is this $550 billion annual delta that the Fed has directly, though its policies, taken away from US consumers in terms of purchasing power. So while the Fed has taken away the bond market as a venue in which to generate current income, it is the structural failures of equities in a post-HFT world (stories of mini, amd maxi, Flash Crashes are now a daily occurrence) that prevent investors from having the same confidence about current income in a market in which terminal and fatal capital loss are all too real fears. And there are those who still wonder why the US consumer is withering away, and absent such crutches as soaring Federal non-revolving debt, used for anything but its designated purposes, would have less purchasing power now than before the crisis as a result of the Fed's failed policies. As George Magnus so peotically summarizes it "What the left hand giveth, the right hand taketh away."