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Gluskin Sheff
David Rosenberg
March 11, 2010
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MARKET COMMENT
When we look at the last 12 years, dating back to LTCM and the bailout that ensued, we have endured a 60% rally, followed by a 50% selloff, followed by a 100% rally, followed by a 60% selloff, followed by a 70% rally. The whole way along, the equity market is basically flat for a buy-and-hold investor. The point in all this is the intense volatility that has been and continues to be nurtured by government stop-and-go policies. The really important lesson though is that this is a great case for active portfolio management, also a lesson that investors will not lose out by going long after a 50% collapse from the high; nor are they likely to feel much pain from selling into a 70% rally from the low. Chasing performance at this juncture is probably unwise.
As I mentioned in my Bloomberg debate with Bob Doll yesterday (we had to remind him that Japan has endured two decades of lost growth, so if the U.S.A. gets away with just a decade, that will likely be a fortunate outcome) housing is the quintessential leading indicator of economic activity, not exports or capital spending, and many realtors are still saying business is slow. This is painfully obvious in the NAHB housing market index and the record length of time it is taking homebuilders to find a buyer upon completion of a new housing unit.
Investors ostensibly are “starving for yield” because rates are so low and as a result, and this is in my humble opinion, they are taking on more risk than they think. Missing out on a 70% rally is not quite the same as seeing 60% of your wealth wiped out in a bear market and we have had two massive declines in the past decade along with two huge rallies — one rally induced by massive overinvestment in real estate and hugely overextended leverage and the one today skewed by State capitalism (the list is long from housing, to banking, to autos). As the Congressional Oversight Panel just concluded, the taxpayer is not likely going to recoup the $17.2 billion bailout money used to save GMAC. Instead of putting the company through bankruptcy, the government instead put a 56% stake into the company — no, of course this isn’t Japan.
The question must be asked: wasn’t the reach for yield one of the factors that caused the great credit crisis of 2007-08? It is amazing how so many investors have switched from fear to greed despite the fact that we are still writing chapters in this post-bubble-credit collapse book; so many people still do not realize Return of Capital is more important than Return on Capital. It is almost a given that we will return to this theme at some point and likely sooner rather than later. The economy is not in some sort of equilibrium state — it has been fueled by high-octane government stimulus in all parts of the planet, especially in the U.S.A., the U.K. and China.
So we have today, as per the latest Investors Intelligence poll, 44.9% bulls versus 23.6% bears; the number of optimists doubles the number of pessimists. Nearly 70% of the investing public has also given up on the idea that we will see a correction over the near-term. Investor complacency is running at a dangerously high level.
IS IT ALL ABOUT GDP?
The GDP numbers that the markets have been trained to focus on may be misleading. Look at the charts below. While GDP has to do with spending, there are other accounts in the National Accounts that also focus on income. In the final analysis, income is what drives everything in the economy — it is just a different measure of economic activity.
What is interesting is that as of Q3, Gross Domestic Income was still contracting, albeit fractionally. And the ‘statistical discrepancy’ between it and the spending accounts, at $253 billion (annualized), is without precedence. Could it be that we were actually not joking around when we mentioned previously that this was, in fact, the Houdini recovery? Could it be that the GDP data that portfolio managers are focusing their attention on are actually as mis-stated as the nonfarm payrolls were as per the latest massive downside benchmark revision?
If it is about GDP, then all we can say is that even with the latest statistical bounce that has largely reflected State capitalism and inventory adjustment, this measure of economic activity is still, amazingly, 1.7% lower today than it was at the pre-recession peak — despite the mountain of government stimulus. What is “normal” is that by now — eight quarters after a recession begins and the stimulus follows — real GDP has actually not just surpassed the pre-recession peak but has not so by nearly 5%.
Employment at this stage of the cycle is typically growing at least 150,000 per month and here we are still waiting for the turn (payrolls by now are also normally at a new all-time high, having taken out the recession losses and then some — by over 300,000). Instead, the level of employment is 8.4 million lower now than it was before the recession began. Not only that, but the output gap is so big that the U.S. economy is now nearly 12 million jobs shy of being at full employment — it will take at least five years to get there and in the meantime, expect deflation to remain the primary trend. Income will be king.
Meanwhile, the excitement continues for now. The Russell 2000 has rallied 15% since the February low and is up now for eight straight sessions as the speculative fervor builds. Japan also enjoyed its share of intermittent sharp technical bounces along the way — including a post-collapse 40% rebound back in 1991 and there were others in the past two decades as the Nikkei posted no fewer than 260,000 rally points in a market that is still down 70% from the highs. Even the Dow managed to accumulate 30,000 rally points during the 1930s but even then the Great Depression did not end until the early 1940s and the next secular bull market did not ensue until 1954. (And, despite sharp swings in GDP — many double digit advances, by the way — by 1939 it was still 10% below the 1929 peak.)
To reiterate, there are other measures of economic health.
It’s all very bullish, indeed.
If there is a lesson learned from the Japanese experience, it is that recessions or “double dips” come faster than you think. After going nearly 20 years without a recession at all, Japan then went on to endure one in every four years after its credit bubble burst two decades ago. Has it dawned on anyone what it means to have come out of this credit bubble collapse with the employment-to-population ratio for adult males declining to a record low of 67% (it was 73% when the recession began) and the same for the labour force participation rate (89% from 91%)? Surely one cannot be serious about being worried about inflation after a glance of these labor market trends.
But everyone does seem to focus on GDP; that much is for sure. So for what it is worth, the U.S. wholesale trade report was a bit surprising in terms of the weakness it showed for January inventories, and there were revisions, which suggests that Q4 real GDP growth will be lowered to a 5.5% annual rate from 5.9%. Moreover, it now looks like Q1 GDP will do very little better than a 2% annual rate, with very little to show from final sales.
To read the full posting, go here. (Free site registration required.) (c) Gluskin Sheff
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