David Rosenberg Explains What (If Anything) The Bulls Are Seeing
While we have long asserted that any attempt to be bullish this market (and economy) by necessity should at least involve the thought experiment of eliminating such pro forma crutches as trillions in excess liquidity from the Fed, not to mention direct and indirect intervention by the central planners in virtually all asset classes, which in turn drives frequent periods of brief decoupling between various geographies and asset classes (which always converge) and thus economic performance (because as Bernanke will tell you gladly, the economy is the market), an exercise which would expose a hollow facade, a broken market and an economy in shambles, in never hurts to ask just what, if anything, do the bulls "see" and how do they spin a convincing case that attempts to sucker in others into the great ponzi either voluntarily, or like in China, at gun point. Alas, our imagination is lacking for an exercise such as this, but luckily David Rosenberg has dedicated his entire letter to clients from this morning precisely to answer this question. So for anyone who is wondering just what it is that those who have supposedly "climbed the wall of worry" see, here is your answer.
From David Rosenberg at Gluskin Sheff
It never hurts to keep an open mind — I say that as I debate Wells Capital's famously bullish strategist Jim Paulsen at a CFA event — and tip your hat to the other side of the argument.
When asked if there is anything — even one thing! — that I can identify that is market-positive, what would it be?
Well, it's certainly not any shift in view over the economy. The leading indicators of activity are not behaving nearly as well as the coincident or lagging indicators have been of late. Indeed, averaging out the wiggles and real GDP growth, at best, was 1.7% in 2011, far short of the 3% advance reading in 2010. And we head into 2012 with many imbalances yet to be fully addressed and a variety of headwinds, none stronger than the looming hit to exports, manufacturing activity and profits from even a mild European recession
What has changed is valuation and the high-bar regarding investor expectations.
Let me explain.
The story for 2011 was one of P/E multiple contraction as risk aversion set in. The year ended with operating EPS growth in high-single-digit terrain, which was slower than the string of double-digit gains since the profit recovery began nearly three years ago, but positive nonetheless. What held the market back was the multiple, which contracted roughly 3 points on the year — and remember: every multiple point equates to nearly a 10-point shift in the S&P 500. This often counts more than earnings do when formatting your targets for the year. In the end it is the direction and the multiple that investors were willing to pay for that caused so many pundits to be so wrong last year.
So we have a situation now where the trailing P/E ratio is sitting at 13x. That may not be a classic trough by any means, but only 20% of the time in the past quarter century has the multiple been this low. Okay — something to consider.
Now, trailing P/E is the proverbial "bird in the hand" whereas forward multiples are "hit and miss" and subject to the vagaries of analyst earnings estimates, which have been declining in dribs and drabs for the past three-to-six months. But as it now stands, on this basis, the multiple is now just a snick below 12x. In the past quarter century, we only saw one other time when it was this low on a one-year "forward" basis, and it was the first quarter of 1988. A year later, the S&P 500 rallied 15%. Not my call, but something to at least mull over and debate.
Now we must keep in mind that valuation is not a timing device. If all you did was focus on such metrics, you would have missed out on the final three years of the late-1990s tech boom. That said, a respect of valuations will also help keep you out of trouble, as we saw following the tech wreck and the bust of the housing and credit bubble seven years hence.
But we do understand that P/E ratios at current low levels do serve up a certain degree of confidence (a source of some comfort, if you will) that there is some downside protection to the overall market here. While I'm still on the cautious side, I do see the case for why the floor may be higher than it was before. Of course, that is due to valuation metrics. The key going forward will be how earnings perform — and I'm not expecting any growth this year. In fact, we could see a contraction, based on where margins are (60-year highs) and the impact of slower global growth and the stronger U.S. dollar on foreign-sourced revenues (40% of the pie).
The next question is whether the P/E multiple can expand in 2012. As was the case in 2011, in a year when profit growth was positive but the broad market flat, the multiple may yet again hang in the balance.
Well, it may pay to assess what the factors were in 2011 that caused the P/E multiple to shrink. I can think of a few. The ECB pulled a 2008-style bonehead move and raised rates to combat inflation (surreal). China was draining liquidity as it moved to rein in a potentially destabilizing uptrend in inflation — with its stock market and the emerging market space taking it on the chin. All the while, the Fed more or less stood on the sidelines for much of the year, notwithstanding Operation Twist and the verbal pledge to keep the funds rate at the floor through to mid-2013 at the earliest.
If we look at what could possibly go right, we have the Chinese central bank now easing policy — that is a shift from a year ago. If inflation there falls further, which has already slowed from the 6.5% peak to sub-5% (we get the key December CPI data-point later this week), then the latitude for more policy stimulus will become even greater. This is why the Chinese stock market has rallied more than 6% in the past four days — it is sniffing something out here. Remember that Chinese stocks lead commodities. Furthermore, the Canadian stock market, which turned in a rare underperformance last year relative to the U.S., has about half its market capitalization in basic materials.
We also have the ECB, with a new chief, not only cutting rates but in some sense going even further than the Fed did. Perhaps not in the way of non-sterilized purchases of government bonds, but the move toward lending to the banks for three-year terms with the junkiest of collateral (one-third more products that the banks can now put up on the central bank balance sheet) has dramatically reduced tail-risks (a French bank or two would have gone down absent this ECB intervention) and we see that now in terms of Libor rates easing.
Furthermore, Eurozone politicians were completely in denial this time last year, believing that the problems would stay "contained" to Greece. Over the last few months of 2011, a view was building in the markets that either Germany was going to exit the euro area or kick Greece out. So far, neither seems likely.
Merkel and Sarkozy seem dedicated on using the crisis as a way to foster more integration — with a common fiscal policy — not less. Of course, it remains to be seen how many of the other members will opt for German-style austerity at a time of intensifying recession pressures. But this is a problem of their own making since it was their decision to load up on debt to fund their welfare states, and the move to fiscal probity is probably the lowest cost strategy for them (us too). And Merkel came right out and said earlier this week that Germany wants Greece to remain in. So...in a sea of uncertainty, at least we have more clarity now that the Eurozone experiment is about to disintegrate in a destabilizing fashion.
Finally, based on the latest comments from two Fed bank presidents (Dudley and Williams) there seems to be some momentum building for a QE3 program out of the Fed.
What is different about 2012 is that while there are many headwinds, global policy is moving into a higher gear. We have no doubts that the beta-junkies will go to town on the prospect of a "coordinated" global stimulus cycle. This is what the market has been feeding on repeatedly since the March 2009 lows. It's called government mixed juice.
What also is different is the level of expectations. We went into 2011 with everyone geared up for 3% real U.S. GDP growth and we will be lucky to get 1.7% when the final results for the year come in. Now the consensus is much closer to 2%. While growth may in fact come in softer than that, we do start the year with more realistic expectations than was the case 12 months ago. The next few weeks will be key as Q4 earnings come out. Keep in mind that the bottom-up estimates right now have penned in a sequential quarter-on-quarter contraction, which has only happened 2% in the past 25 years outside of recessions. There may still be one, but it didn't start in Q4 of 2011.
Meanwhile, the survey data continue to flash a green light. The NFIB small business sentiment index improved in December for the fourth month in a row to 93.8 from 92 in November. This is the best reading in 10 months, though the components were not universally positive.
For example, the job openings subindex dipped to 15 from 16. Hiring plans also dipped one point to 6. Moreover, the index assessing whether small businesses added jobs in the past three months edged down to 1 from 2 in November, not exactly in line with those booming results from the ADP survey.
Capex spending plans stagnated at 24. The good news for bonds at least was the subdued inflation readings. The index measuring pricing power stayed at zero and the percent raising wages was stuck at 10. Even better were the forward-looking "planned" figures. Intentions to raise prices dipped from 15 to 14 and plans to boost wages slipped to 5 from 9 to stand at the lowest level since last January. In fact, the share of respondents citing inflation as their top worry fell from 6% to 5% (it has been sliced in half since last May) — it hasn't been this low since early last year.
A bright spot was in the credit measures; the thaw continues as the index measuring how tough it is to secure financing receded from 10 to 8 in December — the lowest since June 2008. One of the most acute concerns evident in the survey are taxes, with the share saying this is first and foremost on their minds rising to 21% from 19% in November and 16% three months ago. Just wait until the realization sets in that President Obanna is going to remain in the White House and the Bush-era tax cuts go the way of the Do-Do bird by the end of 2012 (not to mention the health care tax on "high-income" earners).
The JOLTS data (Job Opening and Labor Turnover Survey) more or less confirmed that the labour market has less pep in it than many believe (but consistent with the aforementioned NFIB employment readings). Job openings actually declined 63k in November on top of a 153k plunge the prior month. Hirings did rebound 107k but that only recouped the like-sized decline in October. Finally, firings came to 96k and belie the recent downtrend we have seen in the jobless claims numbers.
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