David Rosenberg On The 'One-Trick Pony Market'
Global economic fundamentals are awful, bearish divergences are occurring everywhere, investor sentiment is nearing bullish extremes, political risks remain high and last week's market performance can be summed up in four words - 'lack of follow through'. As Gluskin Sheff's David Rosenberg explains, more than two-thirds of the rally points the stock market has enjoyed since the summer-time lows occurred around central bank policy announcements. So the market is really a one-trick pony here, breathing in the fumes of central bank liquidity.
David Rosenberg, Gluskin Sheff: BUMPY ROAD
What the stock market lacked last week can be boiled down to two words — follow through. It's as if all the QE and then some got priced in the week before. Not even the ballyhooed introduction of the iPhone 5 managed to elicit much excitement. It was interesting to see the Dow fail to hold onto its early gains on Friday and close with a 17 point loss and to see the sector leaders narrow to a group of defensives like health care and telecom services_ The financials and materials segments were very soft and yet in the past these were the major beneficiaries of Quantitative Easing. For the week, the S&P500 dipped 0.4% — which was not supposed to happen. What was supposed to happen, as the elites told us, was that the lagging hedge funds were going to throw in the towel and chase this market. Everyone expects this to be a major source of buying power.
Alas, but at what price level?
At the same time, what if the bulls who lucked out this year because they hung onto Ben Bernanke's arm decide to take profits or at the least lock in their gains? Or what if there is no progress made on the fiscal front and we go into year-end with the gnawing realization that top marginal capital gains tax rates will be heading back to 43.4% on January 1 from the current 15%? It may be a widely-held view but it is no slam dunk that we finish off 2012 with the double- digit returns — twice what is normal — that have been posted thus far (for more proof, have a look at Money Managers Take a Timeout From Stocks in today's WSJ. And the best quote goes to "nothing the Fed has done has increased earnings expectations').
Further on the political front, it shouldn't be lost on those who are proponents of capitalism that President Obama now enjoys a 49% approval rating — it is up six points in the past year (and election handicappers should note that this is the exact same mting that George W. Bush had at this same juncture of the 2004 campaign — which he won handily against another gaffe-prone opponent).
Interestingly, prices are up impressively this year, but trading volumes are down around 20%. Yet another non-confirmation.
And its not as if the equity market has been rallying off news at it pertains to the fundamentals like the economic data and corporate earnings. Indeed, more than two-thirds of the rally points the stock market has enjoyed since the summer-time lows occurred around central bank policy announcements. So the market is really a one-trick pony here, breathing in the fumes of central bank liquidity.
The global economic fundamentals are awful. China's industrial sector is in decline_ France's PM I data is at a 41-month low, and while Germany did manage to pull off an upside surprise, the whole euro area now has its manufacturing sector behaving as though it is 2009 all over again_ Italy just sharply cut its economic growth forecast (and the stock market there was clocked for a 4% loss last week), shortly after the Japanese government downgraded its own assessment of the economy. Declines occurred in U.S. household employment, real wages, Industrial production and core retail sales. In other words, this is not QE1, when the recession was coming to an end. This is not QE2 or Operation Twist when the economy stopped looking as though it was going to do a "double dip-. No. this latest round of central bank manipulation is happening at a time when there is no sign of an imminent turnaround in the economy, and the weakness has gone viral. The real problems for investor risk appetite comes if we see signs that inflation is heading higher which will limit what the Fed can do, or if we see the economy falter which would then expose Bernanke as the non- wizard that Toto exposed behind the curtain and the Fed as pushing on a string.
Investor sentiment is not at a bullish extreme yet, but it's getting there — at just over 54% bullish sentiment in the latest Investors Intelligence survey. The wedge between the bulls and bears is flirting with the 30-percentage-point spread that typically signals interim market tops.
Earnings expectations are far too optimistic and destined to come down. The consensus has operating EPS accelerating to a 13.4% growth rate in 2013 from 5.4% this year. But with margins at cycle high levels (9.4%, rivaling the 2006 record, just as the market was about to put in its last gasp to a new high) ;and 30% above long-run norms, it will be difficult to see EPS growth that strong absent a return to vigorous corporate pricing power. And with the P/E multiple for the overall market already back to the high end of the range for the past two years, what I see at best is a sideways moving market from here. Some pundits will use interest rates as an excuse, but the weekend WSJ provided some nifty insight showing that the market multiple historically was 12x when the 10-year real bond yield was negative (versus around 14x now).
I don't know but a 12x multiple on a forward earnings stream that will likely be flat around $100 in the coming year doesn't sound like a market that has a whole lot of upside from here (or until we get another announcement from a major central bank).
There are various non-confirming developments taking place, and Dow Theory advocates know exactly what I am talking about as the Dow Transports slumped 5,9% this past week, the largest decline since November of last year That this ultra-cyclically sensitive sector is down 2,2% for the year at a time when the S&P 500 is up 16% is one of the great anomalies for 2012.
The railroad stocks not only sagged 7% last week but were also the fourth worst performer in the IBD's 197 industry group. This is a warning sign, make no mistake, underscored by the last week's guidance cuts by both FedEx and Norfolk Southern,
As someone from Miller Tabak put it to the WSJ this weekend:
This is a major divergence that should not be ignored. It tells me the risks of being in the market at these levels is growing. The Transports are the first major index to reflect an underlying change in the market. The market is now saying 'yes, the economy does matter'. You can't close your eyes and buy everything anymore.
Pretty heady stuff.
China is another anomaly as its stock market suffered its steepest decline in nearly a year as the Shanghai index closed last week at its lowest price since 2/2/12. It is down 8% for the year, and this is likely important insofar of what it is pricing in for ther world's second largest economy. It's more that just the islands dispute with Japan and the looming political transition - profits there are in a recesion, having comntracted 2.7% this year and the diuffusion mneasures of industrial activity flashed an 11th month in a row of receding manufacturing sector.
And what about Europe. Yet another non-validation. The stock market there, with an 11x forward multiple, 20% below normal, is close to telling us that the recession is getting worse. Since Super Mario embarked on his newest bond buying program in September 6th, Spanish two-year bond yields - the benchmark for global risk trades - have jumped 40 basis points.
What makes QE3 different and maybe even less potent than its predecessors is that the trend in global economic activity is still down. In the prior QEs, activity was already reviving and actually this may have played a more significant role in stimulating investor 'animal spirits' than the actual liquidity boost. Let's not also forget that earnings, both operating and reported, are now contracting sequentially. And the ISM is in a multi-month sub-50 pattern. This was not the case during these other QE episodes and serves up a greater hurdle for market performance this time around.
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