Remember when back in September 2010 [4], David Tepper moved the market by nearly 2% when he told a stunned world that he is "balls to the wall" stocks because no matter what happens, stocks can only go higher (a ludicrous proposition in any other universe except perhaps for this one where the "Greenspan Put" has since been replaced with the "Bernanke Guarantee [5]"). He did out perform the market that year. The next year he lost over 3%. Why? Was it because the Fed did not go through with promises of LSAP (even though it did engage in QE3 curve shifting by ZIRPing the short end in perpetuity, and buying 91% of long-end issuance [6]). Or because the master can only create alpha when the puppet is flooding the market with liquidity. Whatever the reason, the Pavlovian creature known as the market, has been salivating for LSAP version 2012 since the beginning of January, courtesy of bearish remarks by the Chairman. And yet Tepper has yet to make a guest appearance on CNBC to discuss why the "balls" may make a repeat appearance next to the "wall." Because, as Morgan Stanley's Mike Wilson explains, instead of focusing on the means, investors should consider the end: "I think QE3 will end just as badly as QE2" and "I would feel better if earnings and economic growth were accelerating like during QE2. But they aren’t." Sure enough, one glance at the chart below explains not only why this time QE will be different actually applies, but also why when it comes to comparisons to Japan, the US may be lucky if ends up in the same condition as Japan, when the probability is one of a far worse outcome...
From MS' Mike Wilson
Just Tell Me A Story, And Don’t Let the Facts Ruin it
Ultimately, I think QE3 will end just as badly as QE2 even though there may be more room to run in the near term. At this stage of the rally, I believe stocks levered to inflation expectations is the best way to play for further equity market upside (see Trades at end of note for details). Unfettered QE would normally be good for all risky assets, but I think the remaining part of this rally will be concentrated in a narrow group of stocks. I would feel better if earnings and economic growth were accelerating like during QE2. But they aren’t. Call me old school (or maybe just old), but I subscribe to the tenet that growth is what really matters for stocks. And on this score, the count is not favorable. Exhibit 3 vividly shows the facts.
First, we have our earnings breadth measure for the S&P500 going back to 2004. As you can see, 4Q11 is proving to be the worst quarterly earnings breadth since 4Q2008. Oh, and this is despite the fact that earnings revisions have been coming down rapidly for the past 3-6 months. Imagine how low the earnings beat ratio would be if they hadn’t? For those that think the bad earnings news is behind us or that the high frequency economic data will remain positive, don’t hold your breath. The Economic Surprise Index is rolling over and it has a long way to fall. Remember, this is a mean reverting index and it’s rarely “stable.” As you can see in Exhibit 3, once it turns down or up from an extreme level, it typically falls sharply for 3-6 months. This is very much in-line with MS Economist Vincent Reinhart’s view for imminent deterioration in the US Economy. The final chart in Exhibit 3 is a nice reflection of what is really going on with the US economy and why we will probably remain stuck in a liquidity trap. Specifically, the chart examines the 10-year compounded annual growth rate (CAGR) of per capital real GDP in the US and Japan over the past 20 years with the Japan numbers shifted forward by approximately 10 years. If one subscribes to the view that the structural peak in the US economy was in 2000, the following narrative will make a lot of sense. If not, I encourage you to consider it. As you can see, the decline in the real per capital GDP CAGR for both the US and Japan went through a very rapid and deep retreat that took both down to a similarly anemic rate of 0.6%. We all know what happened to Japan thereafter as they remain mired in a deflationary liquidity trap. Fast forward to the situation in the U.S. today, and it doesn’t look very promising. In order to see a comparable recovery to Japan, the U.S. would need to grow real per capital GDP by 3.5% per annum for the next 5 years. Even the bulls would have a hard time arguing for this kind of outcome. Recall that MS economist Vincent Reinhart’s 3-5 year forecast for US real GDP is approximately 2% as we continue to de-lever and recover from the financial crisis. Under this more realistic assumption, the outcome is much worse than Japan’s and suggests Adam Parker’s call for persistent multiple compression is likely. But, we don’t want to let the facts ruin a good “story,” do we?
[7]
