Rosenberg On Buying Rumors, Selling News, And The Interminable Consumer Deleveraging

Even as economics has taken to back seat a geopolitics and a market uncharacteristically lacking in euphoria, Rosie once again provides the daily dose of must read economic summary sans the Kool Aid.


The equity market certainly did turn in a surprisingly vigorous rally in the past few months but it would be a mistake to relate this to any real fundamental improvement in the economic backdrop. As we will likely see in today’s FOMC minutes, the Fed is yet again going to take a knife to its growth and inflation forecast as it has done with regularity over the past eight months.

To be sure, the double-dip has been avoided for now, but what is interesting is that nobody really believed in that scenario back in the summer, nor was any Wall Street research department calling for such even though for a time the risks were rising. The bottom in the equity market rally came, not on a piece of data towards the end of August, but on the back of the comments from Ben Bernanke in Jackson Hole that another round of quantitative easing was coming our way. This is why the rally ended, not on any particular piece of economic data, but right after the FOMC meeting a few weeks ago — a classic case of buying the rumour and then selling the fact. This is how markets often work since so much perception and psychology is involved.

For all the talk of economic improvement, the number of data points that were positive since the market bottomed in late August has been exactly equal to the number of negative data points. We can understand the pre-occupation with nonfarm payrolls, but frankly, the bloom comes off the rose when one turns to the Household Survey and sees that full-time employment has declined now for five months in a row. So many pundits focus on the ISM index but don’t stop to think that this is only a diffusion index and while it is indeed above the 50 threshold, the reality is that industrial production has not budged one iota since July. And, while retail sales have held in nicely, the “control” segment that feeds into consumer spending, came in at a mere 0.2% MoM in October, which was slower than the 0.4% print in September. What about the fact that housing starts collapsed 11.7% in October after a dismal 4.2% decline the month before. (Oh, but of course, who doesn’t know that housing is weak? Right.)

While the upward revision to Q3 GDP was impressive and broad-based (to 2.5% at an annual rate from 2.0% initially and the 2.4% that was widely expected), the monthly data on GDP reveal a sharp deceleration. For example, over the three months to September (point-to-point as opposed to quarterly averages), real GDP actually slowed to a 1.0% annual rate — down from 1.7% in July, 2.6% in June and 4.6% at the turn of the year. Based on information at hand, it looks a though Q4 real GDP is coming in closer to a 1.7% annual rate, so the moderation in overall economic activity will be more evident this quarter than it was in Q3 (sometimes quarterly averages masks what the true momentum really is).

It is not just about the economy — that is our point. In fact, what is normal for Mr. Market to see heading into the second year of a recovery is a 5% growth economy that is accelerating; not a 1-2% growth economy that is rife with downside risks. To be sure, corporate profits have been terrific, but not due to any meaningful increase in top-line pricing power. Fully 96% of the rebound in output since the recession ended has been due to productivity growth — talk about a miracle, especially since there has been no capital deepening now for about a decade. Productivity leads to income growth, but when the U6 unemployment rate is 17% (which means dramatic excess capacity in the jobs market), that income accrues to capital, not to labour.

Compensation per hour is declining and unit labour costs have fallen nearly 2% in the past year, which has been a major underpinning for profit margins, to be sure. How long the productivity miracle can last is anyone’s guess, but the excess slack in the labour market will linger on. What kept the consumer alive through all this was the massive help from Uncle Sam, but that is now coming to an end, which in turn will have some negative impact on domestic demand and revenue growth for the business sector. So, the combination of strong ex-U.S. growth and sustained solid productivity gains are going to be needed more than ever in order for the string of profits-surpassing-expectations to be extended into 2011.

So yes, profits have come in just fine despite one of the weakest recoveries on record, but to some extent, much of this has already been priced in. During the summer, there was far too much attention paid to how much the stock market had come off the April highs, and recently, far too much a focus on how far the stock market has bounced off the July-August lows. The bottom line is that for the past year, the S&P 500 has crossed above the 1,200 mark five times and has moved below the 1,100 threshold no fewer than thirteen times. This is a sideways moving market now for over year — a low of 1,022 and a high of 1,225. Sell at the highs, buy at the lows, until there is a decisive break either way. No doubt the equity market never did cheapen up enough for our liking — that day will come — but the total return to date has been a bit better than 7% compared to 11% for the long bond, 12% for the 10-year T-note and 10% for the corporate bond market. Gold is up more than 20% and silver by over 60%. The bond-bullion barbell that we have been espousing for years actually worked again in 2010.

And some more color on why we expect the December 9 Z1 update to confirm another $750-$1 trillion quarterly drop in shadow banking liabilities.


No sooner did we quote some research out of the New York Fed regarding the consumer frugality theme that we saw a similar report drawing similar conclusions out of the Federal Reserve Bank of Cleveland — titled Mortgage Borrowers Deleverage.
Yes, Virginia, the deleveraging cycle is not just about banks taking write-downs but also about a secular shift in household attitudes towards debt as we discussed yesterday.

The conclusions from the Cleveland Fed:

“Consumers have been able to deleverage by reducing both the amount of debt and the term to maturity of their mortgage debt. Loan-to-value ratios have steadily declined since they peaked, falling 680 basis points for existing homes and 520 basis points for new homes. Moreover, consumers have reduced their exposure to mortgage debt by reducing the debt’s term to maturity. In June, 2007, the term to maturity of all loans closed was 29.5 years; however, as of September of the term to maturity of all loans closed was 27.6 years.”

And, here are other forms of deleveraging coming from the sharp plunge in cash-out refinancing. Home equity is no longer being gutted by the masses.