David A. Rosenberg
February 10, 2011
Chief Economist & Strategist Economic Commentary
drosenberg@gluskinsheff.com
Breakfast with Dave
We may be in for a perfect storm here. The S&P 500 got stopped at the top of a
diagonal triangle, which is key for any technical analyst. We had a bond reversal
of significance after the successful 10-year auction helped take the yield back
below 3.65%, which is 10 basis points shy of the recent high. We had three Fed
officials come right out and say that the days of QE are numbered and as we
show below, the equity market followed the Fed’s balance sheet very closely in
the past year. We are also at the tail-end of earnings season — and again as we
saw throughout 2010, this typically tips off a corrective phase. All the shorts
have been squeezed (short interest on the S&P 500 is down to where it was a
year ago — what do you know, just a couple of months ahead of the huge
correction). This is going to be a problem because it is during corrections that
the shorters take profits that help act as “buying power” on the way down and
ultimately put a floor under the correction. But the Fed did such a wonderful job
in creating a one-sided market in the past six months that there are very few
shorts in the market to provide support on the way down.
Of course, the market is at least as complacent now and confident over the
prospects of vibrant economic growth and double-digit earnings as it was this
time last year and at least as overbought and in some respects more expensive
too. The end of QE and signs that the first quarter GDP was going to be the peak
for the year alongside debt problems in Europe were all critical in engineering
what was quite an unexpected near-20% correction from last April through to the
tail end of the summer. We may be on the precipice of seeing something similar
(check out what bond yields and CDS spreads are doing in the eurozone
periphery today — not a pretty picture).
Those of us that chose to watch the speculative fervor will have another kick at
the can in coming weeks and months as the “trapped longs” on this market are
forced to liquidate. The Chinese, Indian, and Brazilian stock markets are all
down double-digits from their nearby peaks and bond markets there are
weakening substantially, which may be telling us something about the policy,
liquidity and macro (inflation) outlook in these regions. And let’s keep in mind
that S&P 500 revenues have been growing 8x faster from overseas operations
than from what has been happening at home where the trend is still barely in
low single-digit terrain. India’s stock market, one of the world’s darlings not too
long ago, just traded down to a seven-month low.
At a time when there are at least three times more market bulls as there are
bears, the VIX index is south of 16x, and signposts of bullish sentiment and
complacency at extreme levels, it will be interesting to see how this plays out. All
we can say is that the probable end to QE is likely going to prove to be a very big
deal (see more below). Sorry, but there are some serious folks at the Fed, Mr.
Fisher from Dallas is one example and there are others, who really do not want
to see oil at $130 a barrel, gasoline at $5 a gallon or wheat at $50 a bushel,
even if that means the stock market has to correct 20% from here.
A rising stock market may do wonders for the 20% of the U.S. population that
actually own equities; but as we saw in the first two rounds of QE, they do not
bring down bond yields, and as such they do not bring down mortgage rates
which in turn does very little to help the one sector with the most powerful
domestic economic multiplier impacts — otherwise known as housing.
Wouldn’t it be nice to wake up to headlines other than this that made it to the
front page of the USA Today section — More States Launch Help for Distressed
Homeowners? These QE programs have failed to do what the Fed told us they
would do, and that is to bring down long-term interest rates. So if you are
thinking about fixed-income, duration and the direction of rates, consider what
the end of this central bank balance sheet expansion, which has only spurred on
massive speculative behaviour, will do to longer-dated yield once QE2 ends and
is replaced by … nothing other than Mother Nature.
Because the data that covers “sentiment” have been so strong, but yet so
correlated with the equity market, the overwhelming view is that the U.S.
economy is doing a lot better. Well, for now, it is doing better than it was last
summer when double-dip concerns were real and had to be expunged by
another huge round of fiscal and monetary stimulus. But with house prices
declining again, bank credit contracting again, and employment failing to keep
up with either the growth in the population or labour force, it is more than just a
tad premature to be crowing about how great the economy is doing.
And as Congress puts the kybosh [Unfug] on further rounds of Fed balance sheet
expansion — if you think sparks flew yesterday just wait until the real deal at
Humphrey-Hawkins — keep in mind that Bernanke reminded Congress that the
days of him signing onto more fiscal largesse is over too (and there is a spending
rebellion going on within the ranks of the Republican party, and the conservative
wing is pushing hard for upfront spending cuts — fascinating article on this on
the front page of today’s NYT and page A4 of the WSJ).
Finally, by the end of the second quarter, we shall see what the U.S. economy
looks like without the life support provided by rampant fiscal and monetary
policy stimulus. We had a bit of a taste of what this environment looked like last
spring and summer, but alas, this has been rendered a distant memory in most
people’s minds. It’s amazing what a 25% vertical line up can do to somebody’s
memory bank. But North American investors trained by the media to judge what
the market is doing by gazing at the Dow 30 stocks, “will it end in positive
territory for the eighth day in a row” [siehe meinen Rant zum DOW hier] was the question being peppered at viewers as the Dow teeter-tottered into the close — it was as exciting as the ball dropping
on New Year’s eve.
Keep in mind that Europe is now down three days in a row
and emerging market stocks are down in six straight sessions. This will hit home
and may be starting to already because what you didn’t find out watching the
bubble-heads on bubble-vision or reading most Wall Street research reports was
that the Nasdaq, NYSE composite, and the S&P 500 all closed lower yesterday
and on higher volume — what is called a “distribution day” in technical lingo.
...The bond market has a bit of a bid to it and the U.S. dollar is firm and likely ripe
for a nice countertrend rally. The Aussie dollar has taken a bit of a hit from some
soft January employment data, which saw full-time jobs post a rare decline. We
also saw U.K. manufacturing production dip 0.1% and was the first decline in
eight months (typically everyone is blaming it on the weather — winter in January
seems to have come as a big surprise this year to a lot of pundits). Swedish
industrial production plunged 2.1% versus expectations of +0.6% (that gap was
all weather related?). And production in South Africa fell 0.2% in December and
again this was benchmarked against a +1.9% consensus estimate. Somehow
there seems to be a bit of a disconnect between the equity market-driven
diffusion indices around the world and what actually happened with global
business spending in recent months.
Two final items — with little fanfare, the Chinese yuan has been allowed to
strengthen to a 17-year high against the U.S. dollar — good news for Chinese
consumers but not necessarily for the exporters....
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