David Rosenberg Presents The Six Pins That Can Pop The Complacency Bubble
The record volatility, and 400 point up and down days in the DJIA of last summer seem like a lifetime ago, having been replaced by a smooth, unperturbed, 45 degree-inclined see of stock market appreciation, rising purely on the $2 trillion or so in liquidity pumped into global markets by the central printers, ever since Italy threatened to blow up the Ponzi last fall. In short - we have once again hit peak complacency. Yet with crude now matching every liquidity injection tick for tick (and then some: Crude's WTI return is now higher than that of stocks), there is absolutely no more space for the world central banks to inject any more stock appreciation without blowing up Obama's reelection chances (and you can be sure they know it). Suddenly the market finds itself without an explicit backstop. So what are some of the "realizations" that can pop the complacency bubble leading to a stock market plunge, and filling the liquidity-filled gap? Here are, courtesy of David Rosenberg, six distinct hurdles that loom ever closer on the horizon, and having been ignored for too long, courtesy of Bernanke et cie, will almost certainly become the market's preoccupation all too soon.
From Gluskin Sheff
1. The nascent job market improvement was little more than a reflection of deteriorating productivity growth. As such, companies will respond in the spring by curbing their hiring plans. This is exactly what happened a year ago when private payroll gains averaged 207k from January to April and the biggest mistake the emboldened bulls did at the time was extrapolate that performance into the future. No sooner did we mention the likely renewed corporate focus on reviving productivity growth than we saw Proctor & Gamble announce a 5,700 job cut or 10% of its manufacturing work force — and the stock price was rewarded with a $2 advance.
2. The ballyhooed housing recovery represented a weather report. January was the fourth warmest on record, skewing the data, and February looks to be a record for balmy temperatures. As such, we could be in for a setback in the housing data, and the latest weekly data on mortgage applications for new purchases may already be signaling a renewed downturn in sales activity. The volume index for new purchases was down 2.9% in the week of February 17th on top of an 8.4% slide in the prior week and it has been trending down for four of the past five weeks.
3. The European recession is just getting started (See Recession Looms for 10 Nations on page 2 of the FT) and the impact on Asian trade flows is already evident in the data — with Chinese export growth completely vanishing in January and manufacturing diffusion indices flashing modest contraction in February. We are potentially one to two quarters away from seeing a significant shock to the U.S. GDP data from an eroding net foreign trade performance. To catch a glimpse of just how far reaching the Eurozone recession is, have a look at Austerity in Europe Puts Pressure on Drug Prices on page B6 of the NYT.
4. What upset the apple cart this time last year was the run-up in oil prices, followed by a lag with a surge in gas prices at the pump. So instead of getting the 4.0% first quarter GDP growth number in 2011 that many pundits anticipated, we got 0.4% instead — right digits but in the wrong place. The problem was energy costs and what that did to the GDP price deflator — it crushed real economic growth (this time it's not the Arab Spring but heightened Israel-Iran tensions at play). Within 24 hours of the release of that GDP report in late April, the stock market peaked for the year.
Once again, oil prices have ratcheted up and with a lag, we can probably expect a return to $4 per gallon for regular gas at the pumps by the time spring rolls around. The front page of the USA Today makes the case for why $5 per gallon is likely coming ... that would represent more than a $200 billion drag out of household cash flows. As it stands, consumers have responded by cutting back on energy usage at a pace we have not seen in 15 years. Note that motorists in California are already paying north of $4 per gallon. And Brent crude prices have hit record highs in the U.K. in sterling terms and back to 2008 levels in euro terms for the already recession-gripped euro area.
Not only were January retail sales already weak, but we just saw two bellwethers —Gap and Kohl's — all post lower Q4 earnings. Kohl's actually posted its first revenue decline in three years. And we haven't even seen the full brunt of the energy price impact hit home yet.
The transport stocks see what's coming, having peaked on February 3rd, and since then this group has suffered 9 losses out of the past 13 sessions, representing a 4% decline from the nearby peak. This is a bit of a problem for the bulls because the transports never did confirm the new highs that the Dow and S&P 500 made — and the index is now at a critical juncture as it kisses the 50-day moving average on the downslope.
5. This hurdle will likely only become apparent in the second half of the year and it relates to tax uncertainties and the implications for rising personal and corporate savings rates.
First, the top marginal personal tax rate rises to 39.6% from 35% as the Bush tax cuts expire at the end of 2012. A limit on itemized deductions will add a further 1.2 percentage points to the top rate. Second, a new 0.9% Medicare tax on incomes over $200,000 gets imposed ($250,000 for joint filers). Moreover, the top 15% rate on long-term capital gains rises to 20%. And dividends will once again be taxed at ordinary rates — 39.6% for the top income earners. A new 3.8% tax on investment income also gets introduced for incomes over $200,000 ($250,000 for joint filers). The top estate tax rate goes from 35% to 55% (60% in some cases). The estate tax exemption falls to $1 million from $5 million (the gift-tax exemption also drops to $1 million and the rate adjusts hither to 55%). In all, 41 separate tax provisions expire this year.
6. Financial contagion. Just as there is a deep-seated view of economic re-acceleration in the United States, so too is there a widespread consensus that Europe will muddle through. The ECB's massive liquidity infusion last November and the upcoming move on February 29th for what practically everyone hopes will be a huge LTRO (Longer-term Refinancing Operation) take-up has the masses convinced that Europe is out of the woods.
Markets have treated Greece's default with a shrug. But what if a CDS event does get triggered? It is possible. And what if Portugal decides that it wants its bail-out terms renegotiated, as the FT hints at? Spain is doing likewise as well — see Spain Pushes Brussels to Cut Deficit Target as Growth Hopes are Dashed on the front page of the FT and also have a look at Spain Counts Social Costs of Austerity Drive on page 2 of the FT.
The lack of confidence is so palpable that some corporates in Portugal, like Portugal Telecom, trade at a 600 basis point discount to comparable government bonds. Even Italy is far from out of the woods (let alone Spain) — the ECB's intervention efforts may have helped drag 10-year yields down to 5.4% from the recent peak of over 7%, but debt and debt-service dynamics are such that fiscal sustainability can only be achieved, barring an economic boom (which is not in the cards), if yields can break decisively below 4% and stay there.