Market Thoughts From David Rosenberg

From Gluskin Sheff's David Rosenberg

Market Thots

Well, things are getting quite interesting.

The consensus view was that QE3 was going to send the stock market to the moon. Yet the peak level on the S&P 500 was 1,465 on September 14th, the day after the FOMC meeting.

The consensus view was that the lagging hedge funds were going to be forced to play some major catch-up and take the stock market to the moon too. Surveys show that the hedge funds have already made this adjustment.

Meanwhile, divergences are appearing almost everywhere — high volume on the selling days, as we saw on Friday where composite volume surpassed 2.1 billion. Breadth is bad — for every stock rising, almost two fell on the NYSE.

The defensives are outperforming, with consumer staples the leader to close out the week. Transports are lagging. So are the small caps. Financials are sagging even though this is the group that should be a prime beneficiary of the Fed's endless largess.

Meanwhile, the VIX index continues to reveal a high level of complacency and surveys continue to highlight many more bulls out there than bears. We are sure Bob Farrell would have a thing or two to say about that from a contrary perspective.

The S&P 500 was down 2.2% for the week — the opening week of the earnings season. It is becoming apparent that investors are becoming much more discerning. Wells Fargo and .1P Morgan appeared to heat consensus estimates, yet their stock prices slid on the back of narrower net interest margins — the fly-in-the-ointment from the Fed's ultra-low-rate policy.

Alcoa also beat estimates, but like the World Bank and IMF, downgraded the global demand outlook.

And Advanced Micro Devices saw its stock punished on the news that revenues sagged 10% last quarter in what is clearly now a demand problem across the PC industry as opposed to just a market share situation.

On top of that, Q3 EPS estimates are still coming down and now stand at -3% YoY from -2% at the start of October.

For now, the S&P 500 is sitting right on its 50-day moving average, in what the Saturday NYT biz section aptly characterized as "a technical red flag hanging over the market". The article right below (on page B3) titled A Global Perspective: More Economic Slowing leaves one wondering whether the deteriorating macro outlook will trigger a break of this technical support line.

One thing seems sure which is that consumer sentiment surveys jumping to a five-year high (of 83.1 from 78.3 in August as per the UofM poll) are obviously no match for the earnings contraction. If they were, the market would have closed higher on Friday. In fact, not even the ECB-induced rallies in the Italian and Spanish bond markets managed to seep into firmer equity valuations as was the case through most of the summer Again, the eroding global economic outlook and negative trim in corporate profits may be too swift a current. After all, this is the first time the Fed embarked on a nonconventional easing initiative with the market overbought and with profits and earning expectations on a discernible downtrend. The flattening in the core producer prices in August and the -0.1% reading in capital goods prices attests to the exceedingly challenging top-line environment

Not only that, but the fact the pace of U.S. economic activity is still running below a 2% annual rate, which is less than half of what is normal at this stage of the business cycle with the massive amount of government stimulus, is truly remarkable. Not just zero percent rates for four years and a tripling of the Fed balance sheet but yet another year of trillion-dollar-plus fiscal deficits. It is a whole new world where everyone is worried about a fiscal cliff at a time when the budgetary gap is 7% of GDP! The fact that the Treasury market closed the week with a bid (the 10-year note yield at 1.66%) attests to the view that the bond market crowd is more consumed now with downside economic risks than on sustained large-scale deficits. Keep an eye on the debt ceiling being re-tested — the cap is $16.394 trillion and we are now at $16.119 trillion. This is likely to make the headlines again before year-end — the rating agencies may not be taking off much time for a Christmas break.

The power of the earnings cycle is so acute that the fact that Romney has caught up with Obama at the polls (46% support for both in the just-released IBD/TIPP survey) could elicit a rally in the stock market. That really says something because one would think that Wall Street would greet a Mitt victory with noisy applause.



Look at what the yellow metal has accomplished. And we haven't even seen the inflation yet! Wait till that happens (in fact, at 2.6%. UofM long-term inflation expectations from Friday's report for September came in at its lightest level since March 2009!).

What matters most are real rates, which the Fed has pledged to keep negative as far as the eye can see. It was commented on at the excellent Big Picture conference last week that none of the speakers even mentioned gold (including me!). That is a huge contrary bullish standpoint.
Even Byron Wien (see his superb interview on page 38 of Barron's) has become constructive on the outlook for bullion, and like me, he sees it as a steady alternative to paper currencies — a currency in its own right that is no government's liability and has a much more inelastic supply curve. I have to say that the venerable Buttonwood column on page 84 of the Economist also contained numerous reasons to have core exposure to gold — imagine one of the biggest buyers have been developed world central banks (I guess they want to get ahead of the big inflation they want to generate as debts get monetized). The article goes on to say, by the way, that the current level of negative rates is consistent with a gold price of $2,000 an ounce.

As an aside. the gold mining stocks have finally started to outperform and have a ton of catching up to do. This is one area of the market we are excited about Gold and income-generating securities. Its called the bond-bullion barbell.



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