Much has been made of Jim Grant's piece in the WSJ over the weekend in which he implicitly professes his conversion from a bear to a bull. Some have already voiced their argument for why Grant, usually a very in depth analyst of historical and prevailing themes, may have otherwise cut some corners in his explanation of the ongoing seemingly unstoppable 6 month long market move. In his Breakfast with Dave, Rosenberg shares his two cents on why Jim's evaluation is not quite up to snuff. One hopes that Grant's Interest Rate Observer subscriptions do not suffer as a result of what could become a bear war (or alternatively, that a subscription "issue" was not one that caused the rather dramatic shift in perception).
IS JIM GRANT THE LATEST TO BE DRINKING THE KOOL-AID?
The Weekend Journal ran with an article by James Grant, which admittedly took us by surprise (he is a true giant in the industry, as an aside) — From Bear to Bull and in the article, he relies mostly on the thought process from two economic think-tanks — Michael Darda from MKM Partners and the folks over at the Economic Cycle Research Institute.
We highly recommend this article for everyone to read to understand the other side of the debate. But we have some major problems with the points being made.
1. Mr. Grant starts off by saying that “as if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless.” Well, frankly, it doesn’t really matter what “leading economists” are saying because Mr. Market has already moved to the bullish side of the debate having expanded valuation metrics to a point that is consistent with 4% real GDP growth and a doubling in earnings, to $83 EPS, which even the consensus does not expect to see until we are into 2012. We are more than fully priced as it is for mid-cycle earnings.
2. Nowhere in Mr. Grant’s synopsis do the words “deleveraging” or “credit contraction” show up. Yet, this is the cornerstone of the bearish viewpoint. Attitudes towards homeownership, discretionary spending and credit have changed, and the change is secular, not merely cyclical. After all, didn’t consumers just see a record $20 billion of outstanding credit evaporate in August?
3. Mr. Grant emphasizes (the Darda argument) how we had a huge bounce in the economy after the worst point of the Great Depression (in fact, the subtitle of the article contains: “The deeper the slump, the zippier the recovery”). Well, we didn’t have the Great Depression this time around — real GDP did not contract 25% but rather by 3.7%. We probably have to go now and redefine what a massive slump is. But all we had in the mid-part of the 1930s — between the worst point in 1932 to the 1937-38 relapse — was a statistical recovery, and nothing more than that. Nobody from that era will recall that any year was particularly good — each one was just different shades of pain and sacrifice. By the end of the decade, the unemployment rate was still 15%, the CPI was deflating at a 2% annual rate and the level of nominal GDP, as well as industrial production, still had yet to re-attain its 1929 peak. The equity market in 1941 was no higher than it was in 1933 (and long bond yields were heading below 2%) and even a child knows that it was WWII that brought the economy out of its malaise, not the seven years of New Deal stimulus.
So, to concentrate on the wiggles in the GDP data in the 1930s, no matter how large, totally misses the point about what the decade was really about, which was social change, a focus on family, less discretionary spending, and a trend towards frugality that few market pundits seem to comprehend. But the 1930s were the antithesis of the 1920s — not unlike what we are witnessing today.
4. The very sexy argument about how all the government stimulus is going to give the economy a really big lift — combined monetary and fiscal measures are worth 19.5% of GDP. This is viewed as a good thing, of course, but nowhere in the analysis is there a comment about how this “stimulus” is just there to cushion the blow and smooth the transition as wide swaths of private sector credit vanish. We are at the point where 85% of housing activity is still being supported by government interventions. Is this really desirable? According to BusinessWeek, it’s not just the FHA financing 40% of new mortgage originations but the USDA is also allowing builders and lenders to take advantage of rural mortgages that require no-money down and with 100% financing through “a little-known loan program”.
Well, as with most bulls, this new era of state capitalism is a reason to rejoice. But from our lens, what would be more noteworthy would be an article explaining that the massive government incursion with all this “stimulus” is actually more a reason to be concerned than be jubilant — what it really symbolizes is an economy that is so sick that it continues to require massive doses of medication.
It’s not what all the stimulus does that matters — of course, it is there to act as a cushion — but it is what all the stimulus has come to symbolize. A fundamentally weak economic backdrop and a precarious banking system that has government guarantees to thank for its survival.
We noted last week that the Nikkei posted six 20%+ rallies since its bubble burst in 1990 and no fewer than four 50%+ rallies. Indeed, you can count 423,000 rally points from all the up-days since the secular bear market began in 1990 and yet the index is down 74% since that time. So actually, there is nothing in this flashy move off the lows in the S&P 500 that is inconsistent with a pattern of a bear market rally — this is not the onset of a whole new sustainable bull market. These are rallies than can only be rented, not owned, and are purely technically-motivated and momentum-driven. They are not premised on improved fundamentals, despite data that are skewed to the upside by rampant government intervention. Just remember, nobody ever built more bridges or paved more river beds to skew the economic data than the Liberal Democratic Party (LDP) did in Japan for much of the 1990s.