Random Thoughts From David Rosenberg
Instead of tackling any specific and highly volatile high frequency macroeconomic data points today (which will most likely be diametrically inverted in the next update iteration), today David Rosenberg focuses on sundry items and flights of fancy that are worth noting, such as that "the S&P 500 has recorded 62 consecutive days in which it has swung by 1% or more in intraday trading. The Dow has also closed 1% higher or lower 38 times since the beginning of August (compared with just 25 in the first seven months of the year)." Additionally, Rosie shares some views on the Paradox of thrift, i.e., that "spending on appliances, jewellery, watches, air travel, recreation vehicles, cameras, gambling is actually lower today than in 2005", on credit unions whose customers don't want to borrow money, " "Too few of its 95,000 members, most of whom live or work in five counties in the San Francisco Bay Area, want to borrow money. And too many are making extra payments on mortgages and car loans — or paying off personal loans ... Provident's loan portfolio has shrunk by 25% since the end of 2008, including a 5% drop in the first nine months of this year" but most notably concludes with the observation that while the 2008 "Great Financial Crisis" was quite memorably, "I wonder whether we'll say 2008 wasn't the real crisis — it was a warm-up, but the real crisis was the sovereign debt crisis in Europe....It is clear that the situation in Greece has deteriorated markedly and that the scope for any further fiscal restraint without triggering some sort of revolution is small. The only way toward fiscal sustainability — to get the sovereign debt/GDP ratio down to 110% by 2020 — is for investors to grant the country a jubilee of sorts and accept a 60% write-down." Naturally, France will throw up over any proposal that sees a 60% haircut Greek haircut, not so much due to Greek losses per se, but due to imminent losses when Portugal, Ireland, Italy and lastly Spain (to which four countries France has exponentially more exposure) decide to do the same as Greece and start underreporting data, striking daily, and overall just shut down their economies.
From Breakfast with Dave, of Gluskin-Sheff
Well, the equity market managed to close out last week with a bang, led by some decent earnings announcements, more hope that European leaders will figure out a solution to the credit crisis (after all, we did just endure the 13th crisis summit in the past 21 months) and now some chatter out of the Fed that, in fact, a round of QE3 is probably on its way. Oh yes, option expiration likely played a role as well.
So we have the Dow up now for four weeks in a row (and in positive terrain for the year once again) and the S&P 500 riding a three-week winning streak. For the blue-chips, they have jumped 9.6% in just the past four weeks. The S&P 500 at 1,238.25 is back to the high end of its range, and is looking rather overbought (indeed, the AAII survey now has the bulls at 36% versus the bears at 34.6%). Also, it is now up 9.4% for October, on pace for its best month in more than 11 years. The best-performing sectors within the index this month are Energy, Materials, Consumer Discretionary and Industrials. Yet the overall index is still down 1.5% for the year. What does this tell you? That we are still locked into this meat grinder of a volatile market backdrop.
According to facts and figures cited in Barron's, the S&P 500 has recorded 62 consecutive days in which it has swung by 1% or more in intraday trading. The Dow has also closed 1% higher or lower 38 times since the beginning of August (compared with just 25 in the first seven months of the year).
To be sure, earnings have been coming in fairly decently overall. So far, 67% have beaten EPS expectations, 10% have met expectations and 23% have missed. These are more or less in line with historical norms. But what is interesting is that the extent of the "beats" is far lower than it has been compared to other quarters during the recovery that began two years ago, and much of the "beats" have come from financials and one-time "accounting" factors to boot.
The YoY trend in S&P 500 operating EPS rose in the past week to 13.8% from 11.5%, with nearly 90% of that improvement coming from the banks. Analysts have also taken their Q3 numbers back up to +14.6% from 12.4% last week (though still below the 16.9% consensus view when the quarter began).
As we said above, two Fed officials came right out and threw their verbal support behind another round of QE support, which likely helped underpin the risk-on trade to close out last week. First it was Governor Daniel Tarullo stating that the central bank could resume outright purchases of mortgage back securities in a bid to stimulate housing activity; and then Fed Vice Chairman Janet Yellen cited "significant downside risk" to the economic outlook in a Denver speech she delivered on Friday, and tacked on her solution for good measure: "Securities purchases across a wide spectrum of maturities might become appropriate if evolving economic conditions called for significantly greater monetary accommodation".
While there are dissenters, they are not growing in number, and the likes of Charles Evans and Eric Rosengren, respectively heads of the Chicago and Boston Fed banks, have spoken out in favour of more policy accommodation in recent weeks.
Perhaps Yellen is suggesting that the Fed could also purchase corporate securities. All the talk of late has been about only providing support for the mortgage market. Recall that QE1 involved the Fed purchasing $1.25 trillion in mortgage bonds, which definitely exerted a substantial positive impact in the months that followed. But let's face it, mortgage rates were near 6.5% back then and trading at nearly a 300 spread over Treasuries. Today the yield is closer to 4%, so at the margin, it is tough to believe that the Fed can incrementally move the needle with more intervention this time around.
What really caught our eye, being bond bulls and all, was Yellen's comment on deflation risks. To wit:
In fact, there is a risk that disinflationaty pressures could intensify if the recovery faltered ... indeed, based on imputations from [inflation-linked Treasury bond] prices, market participants' assessments of the odds of outright deflation have risen significantly in recent months.
And we share her concerns. All the more so after reading some fascinating articles on the frugality theme in the weekend WSJ. These are worth cutting out and keeping:
- Spenders Become Savers, Hurting Recovery — this was the front page story of the weekend WSJ.
First sentence tells all: "American consumers' long-running love affair with debt is on the rocks". There has been more than $1 trillion of household deleveraging in the past three years. We're only past the third inning. Paradox of thrift — spending on appliances, jewellery, watches, air travel, recreation vehicles, cameras, gambling is actually lower today than in 2005. Americans, as the article concludes, are "embracing a frugal life". Buddha would be proud.
- What Does a Credit Union Do When Its Customers Won't Borrow Money— on page A14.
Did you ever think during the height of the parabolic credit surge in the last cycle that we would be talking about households too scared to take on more debt? This article is about California-based Provident Credit Union — "Too few of its 95,000 members, most of whom live or work in five counties in the San Francisco Bay Area, want to borrow money. And too many are making extra payments on mortgages and car loans — or paying off personal loans ... Provident's loan portfolio has shrunk by 25% since the end of 2008, including a 5% drop in the first nine months of this year. The credit union has just 85 cents in loans for every $1 in deposits. Provident typically seeks to have from the low- to mid-90 cents in loans for every $1 in deposits".
- Overseas Allies Reluctant to Try U.S. Debt Diet — page A14 as well. The article kicks off with this:
"Americans are slimming down their debt, but few overseas have gone on a similar diet. The result: Debt will slow the pace of global growth, like extra weight on a racehorse.
The U.S. and South Korea are among the few major economies to have cut their total public and private debt as a share of gross domestic product since the end of 2008, according to the McKinsey Global Institute, the economic research arm of the consulting firm.
South Korea has made the biggest strides largely because its economy has grown. In the U.S., household debt has fallen through payments and defaults.
Japan, Spain, France, Italy, Germany and other countries have boosted debt levels, largely through increased government borrowing, since the 2008 financial crisis, according to figures tallied by McKinsey.
The most startling revelation was made by MIT economist Simon Johnson (and former chief economist for the IMF) — and this is a doozy:
I wonder whether we'll say 2008 wasn't the real crisis — it was a warm-up, but the real crisis was the sovereign debt crisis in Europe.
We share his concern.
We also highly recommend a read of the op-ed piece by Holman W. Jenkins Jr. in the weekend WSJ titled: Why Europe Dithers: German voters don't want to bail out French banks and the French government can't afford to.
In this current backdrop, income is king —just make sure that you are getting paid to take on the risk as opposed to paying to take on the risk. Investors are starting to see the value of being in credit at current pricing and are even dipping their toes back into the high-yield market, which saw net inflows of $4.27 billion last week (the second most on record). And why not — the group has generated a not bad positive return of 3% so far this month. The spreads off Treasuries have come down from the stratospheric levels of 910bps earlier in the month but at 769bps still remain very juicy even in this uncertain macro background.
As for Europe, it is clear that the situation in Greece has deteriorated markedly and that the scope for any further fiscal restraint without triggering some sort of revolution is small. The only way toward fiscal sustainability — to get the sovereign debt/GDP ratio down to 110% by 2020 — is for investors to grant the country a jubilee of sorts and accept a 60% write-down. Without this haircut, the Sunday NYT reports that the country would face a 450 billion euro refinancing wave over the next eight years. New studies suggest that the European banks will now have to raise around 100 billion euros ($138 billion) to meeting their tier 1 capital ratios. The next critical issue is how the banks are going to be able to raise the capital, and if it is with the help of the government sector, how this can be achieved without a destabilizing round of credit downgrades (especially France).