David Rosenberg: "It's A Gas, Gas, Gas!"

Once again, if one wants to get nothing but schizophrenic noise from several momentum chasing vacuum tubes which very way may take the market to all time highs on 1 ES contract churned back and forth, by all means focus on the "market" which for the past three years is merely a policy vehicle of the monetary-fiscal fusion regime (thank you Plosser for confirming what we have been saying for years). For everyone else, here is the traditionally solid economic commentary from David Rosenberg. Considering that the central planners have pumped $7 trillion, or 50% of their balance sheet, in the stock market in the past 4 years, to offset precisely the warnings that Rosenberg issues on a daily basis, we are far beyond debating whether or not those who observe the economy realistically are right or wrong. The only question is whether the central banks can continue to expand their balance sheet at an exponential phase to offset the inevitable. Answer: they can't.

From Gluskin Sheff's David Rosenberg


"There are fluctuations in the market that don't mean anything."

Ira Gluskin, February 14, 2012

If there was a Rule #11 added to Bob Farrell's list of gems, this would be it. We have added this ditty before from Ira, and will continue to do so as a reminder. A reminder of what you ask? A reminder of how the stock market can be divorced from economic realities for a period of time. The stock market ignored the perils of the busted tech bubble for a good eight months back in 2000, ultimately to its own chagrin. It ignored the meltdown in the housing and mortgage market for at least 10 months back in 2007. The examples can go on, but hopefully the point is taken.

At any given moment of time, the market is driven by a variety of factors. Some are more important than others, and they include technicals, seasonals, sentiment. fund flows, valuations and, Of course, the fundamentals. The key driving force this year has been the expanded P/E multiple, in line with a 16 reading on the VIX index, as the markets seem to believe that the massive expansions of global central balance sheets will end up saving the day for dilapidated sovereign government balance sheets and woefully undercapitalized European banks. Too bad the Graham and Dodd classic text on value investing didn't include a chapter on central bank money-printing.

From our lens, liquidity-based rallies are fun to trade, but tend to have a relatively short shelf life. Imagine what is on everyone's minds for the coming week is not the economic data or earnings results but instead the second LTRO round on Wednesday — this is what investors are biting their nails over: will it be 1 trillion euros or 'just' 300 billion? Page M10 of Barron's dubs this the 'LTRO put', which "sparked a massive risk-on rally in global markets". Incredible how easy it is to avert a bear market why didn't the Fed do this in 2007 and 2008, simply print money — and help us avoid the Great Recession?

What about the fundamentals? Well, let's have a look at earnings. It is completely ironic that we would be experiencing one of the most powerful cyclical upswings in the stock market since the recession ended (the S&P 500 is now up 25% from the October 3rd nearby low) at a time when we are clearly coming off the poorest quarter for earnings, in every respect. The YoY trend in operating [PS is now below 6%, and without Apple, growth has basically vanished altogether (down to a mere +2.8%). Corporate guidance over the past three months is at the lowest point since August 2009 — before the term 'green shoots' was invented! Only 44% of companies beat their revenue targets, the weakest since the first quarter of 2010: and 64% surpassed their profit estimates and this too is the lowest since the third quarter of 2008.

If memory serves me correctly, you did not want to go long the market heading into either the second quarter of 2010 or the fourth quarter of 2008 with these factoids in hand. I have to admit that I find it perplexing as to why so many folks dub this a tech-led rally when we came off a week that saw both Hewlett- Packard and Dell disappoint in their Q4 earnings results — the former with a 7% YoY revenue dive.

All that said, the S&P 500 did manage to close out the week at 1,365.74 and establish a level not seen since June 5, 2008 (only 200 points shy of setting a new all-time high —Jeremy Siegel must be licking his chops). If you are wondering why it is that consumer sentiment jumped to 75.3 in February (better than the reading that was widely expected), this is the reason. The University of Michigan index does a much better job tracking the equity market than it does the labour market or consumer spending for that matter.

Page 13 of the weekend FT quotes a strategist as saying

"... we also had a combination of a couple of good earnings reports and little bright signs coming from the housing and labour markets. Some people are even talking about the S&P 500 hitting the 1,400 mark."

Actually, earnings growth and earnings estimates are going down on net. As is corporate guidance, what little of it there is. The bright signs from housing are really a commentary on the balmy weather skewing the seasonally adjusted data and there is certainly no sign of any recovery in prices (it's incredible how so many people get excited over a 321,000 new home sales tally — never mind that they are still near record lows in per capita terms). To be sure, the new housing inventory is down to a six-year low of 5.6 months supply, but taking into account the supply coming down the pike from foreclosures, the entire backlog in the pipeline is at least double that posted number.


The precious metals market is hardly signalling good times ahead — rather more turbulent times ahead — as gold finished last week near a three-month high (silver has been behaving even better and platinum has hit its best level in five months).

Meanwhile, what is largely being ignored is the rapid move up in oil prices as Iran-based tensions escalate further. The WTI crude price rose to nearly $110/bbl and more importantly. Brent has soared over $125/bbl (highest level since August 2008), and forward contracts are pointing to gasoline breaking back above $4 a gallon in the next two to three months (already there in California and within 10 cents in New York state). The nationwide average has already risen 37 cents in just the past month and 7 cents last week alone — it hasn't been long enough to show through in the confidence surveys, though let's face it, we are seeing early signs already of some fraying at the edges in the retail sector — despite the apparent improvement in the labour market (indeed, it is income that people spend, and growth on this front, let's be honest, has been less than stellar).

Meanwhile, as if to represent the consensus of opinion out there. page A2 of the weekend WSJ quotes a pundit as saying "$4 probably isn't going to be the threshold that changes peoples' behavior this time. I think people have gotten used to $4".

What claptrap. Its not that people have gotten used to $4 — it's only there in the Golden State, Hawaii and Alaska ... wait until it grips the whole country. And consumers have yet to fully process this rapid move up in gas prices, but recall what happened a year ago. To be sure, there was no recession, but economic growth came to a virtual halt in the first half of the year because of the impact that energy costs exerted on the GDP price deflator. Second, it is not the level but the change in prices at the pump that influences the growth rate of the economy — every penny at the pumps siphons away around $1.5 billion from consumer wallets into the gas tank. Moreover, a little history lesson for the pundit quoted above. According to work conducted by the University of California at San Diego and cited on page 14 of the weekend FT. all but one of the 11 post-WWII recessions followed an oil shock (the lone exception was the 1960 downturn). Recall what happened the last two times Brent hit current levels — in 2008 (recession) and 2011 (stall speed). Neither outcome was very good.

The key is how long this elevated energy price environment sticks around in terms of overall economic impact. Brent had already been hovering near $110/bbl for 12 months but this most recent price run-up has actually taken the 200-day moving average higher now than it was in the 2008 recession year. Let's keep in mind that the jump in crude prices has occurred even with the Saudis producing at its fastest clip in 30 years — underscoring how tight the backdrop is. Even with slowing demand in the weak economies of the 'developed world', continued rapid growth in emerging markets is providing an offset on the demand side (which does little good for the American or European consumer).

Meanwhile, estimates of spare capacity are all over the map but what we do know is that just to meet the burgeoning demands of the emerging market world requires a further 1 mbd this year of production — and yet supplies are being withdrawn. It will not be very difficult to see oil retest $150 a barrel, and we are talking WTI here, not Brent.


It is also fascinating to watch the action in the much-despised Treasury market (the net speculative short position on the 10-year 1-note is 63,328 contracts on the CBOT while the comparable for Dow contracts is net long 14.803 contracts). Despite the slate of supply last week ($99 billion of new issue activity) the yield on the 10-year T-note closed at 1.98%. Someone out there (Bernanke?) is
coming in and buying whenever the yield pops above 2% — a level that simply is not being sustained on apparent break-outs. The long bond yield actually finished the week lower in yield at 3.1% from 3.14% (the 10-year was down 2bps).

At a time when energy prices are spiking, this is a clear sign that the bond market is treating this as a deflationary shock rather than a durable increase in inflation. That makes total sense to us. It's not as if global consumption is going up — even with higher auto sales, Americans are spending less time on the road: miles driven are down 1% over the past year. And the IEA (International Energy Agency) has cut its 2012 forecast for global oil demand twice since the beginning of the year. This is an exogenous supply shock, pure and simple.


And now the consensus is that the recession in the euro area will be mild because of one month's worth of diffusion indices. Such is human nature — extrapolate the most recent economic indicator into the future. The region suffers from a credit shock, a fiscal shock, and now an oil shock and at the same time, an overvalued currency. What is the euro doing at an 11-week high and how does this help the region export its way out of its economic downturn? Yet there are still a net short 137,479 speculative euro contracts on the CME, which could have a further impact as they cover in the near-term; there are 17,136 net long yen contracts and 29,101 net long speculative U.S. dollar contracts.

Brent crude oil hit a record high in euro terms (in Sterling as well) last week and has surged 11% in just the past month on this basis, and even if prices stay where they are, what energy is going to absorb out of Eurozone GDP this year will be 5.5%, which would surpass the 2008 recession shock of 4.8% (the highest drainage from the economy in three decades — see Soaring Oil Price Threatens Recovery on page 14 of the weekend FT).


The U.S. economy is either generating jobs in low-paying service sector jobs or the employment that is coming back home in manufacturing is doing so at lower wage rates than when these jobs left for Asia years ago. So much for wage stickiness. Throw in rising gasoline prices and real incomes are in a squeeze, and there is precious little room for the personal savings rate to decline from current low levels. On a year-to-year basis, real after tax incomes are running fractionally negative and in the past that was either associated with an economy in recession, about to head into recession or just coming out of recession. So perhaps there is no contraction in real GDP just yet. but there is one in real incomes.

What else do people spend? Their wealth. And here too, courtesy of a flat equity market performance and renewed declines in home values, household net worth also contracted in the past year. So here we have real incomes and wealth both deflating and the masses believe that recession is off the table because of a liquidity-induced four-month rally in the stock market. Go figure.


But David, things are up in nominal terms: just as the Chairsatan wants it. And never forget: daytraders who fail to realize that the market is down 50% in real terms in the past decade will be spot on in jumping out of stocks the next time we get an HFT STOP moment.