David A. RosenbergJune 2, 2009
Chief Economist & Strategist Economics Commentarydrosenberg@gluskinsheff.com+ 1 416 681 8919
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
DUE TO TRAVEL REQUIREMENTS, BREAKFAST WITH DAVE WILL RETURN ONFRIDAY.IN THIS ISSUE
• The Dow trades in twolegends — will shift techand financial weightings• There are four factorsdriving the equity markets: technicals, fund flows,valuation andfundamentals• The folks at the ISMclaimed that the recessionhas come to an end …wishful thinking • Caution on the Canadiandollar as we head into theBoC meeting
WHILE YOU WERE SLEEPINGA slightly different tone to start the day:
Europe is off 0.6% and most of Asia is down as well (the Hang Seng indexslipped 499 points or 2.2%; the Kospi dipped 0.2%, Singapore Straits and theSensex closed 0.7% lower; though the Shanghai and the Nikkei eked outfractional gains). All in, emerging markets declined 1.1% (reports that NorthKorea is getting set to test launch more missiles didn’t help much). Emerging markets in general can hardly be described as cheap as they trade at 43xearnings, but nothing really stands out as being undervalued right now. The S&P500 has gone ahead, in our view, and priced in an earnings profile we don’t seeoccurring for another three years — at the earliest. As everyone gazes at the200-day moving average being taken out for the first time in 18 months, we arestill wondering (see below) what the omen was yesterday from the fact that theVIX index, for the first time in at least seven years, rose alongside a 2%+performance in the S&P 500 (normally, the VIX index declines between 10% and20% on such a rally).Bonds are still trading quite defensively, and the yield on the 10-year T-note hasmanaged to do in less than six months, which is to soar 170 basis points, what it took 48 months to do in the last bear market in bonds (June/03 to June/07).Inflation expectations are getting way ahead of themselves — the 5-year/5-yearbreakeven levels in the TIPS market are now at 2.4% (above the average of thepast five years — you would think we’d be staring at a fully employed economyright in the face). This is at a time when both the YoY trends in the CPI and PPIare negative to boot, not to mention the highest underlying jobless rate andlowest industry CAPU rates in modern history! Talk about a new paradigm. TheU.K. gets its credit outlook downgraded, and its currency soars and its bondmarket vastly outperforms Treasuries. Welcome to silly season. The 2s-10scurve is back at 275bps, a record steepness, and never before has a curve thissteep been sustainable — it will flatten, the question is how.
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June 2, 2009
– BREAKFAST WITH DAVE
The futures market, without perhaps understanding what history teaches usabout the stance of monetary policy following a credit collapse, which is to keeprates to the floor for, oh, about a decade, has gone ahead and priced in no fewer than three Fed rate hikes over the next 12 months. Then again, it’s the samefutures strip that started to price out the easing cycle in late 2007 and price inFed tightening this time last year. This is what opportunities are made of. Westill expect to see long-dated yields enjoy a significant second-half recovery onceit becomes evident — likely later this summer — that there is no durable recoverystarting in the third quarter.
We still expect to seelong dated yields enjoy asignificant 2H recoveryonce it becomes clearthat there is no durablerecovery starting in Q3
As an aside, from our lens, part of the run-up in Treasury yields may be related to the shift to risky assets, perhaps related as well to exuberance over some of the economic data and hopes the recession will end. Though we did see yieldsbottom in 1993 and again in 2003, long after recessions ended, so the contoursof the recovery are also very important in the interest rate outlook — bond yieldsnever hit their bottom until after the unemployment rate peaks, and that is likelyat least a year away, in our view. But there are technical factors at play too,which is mortgage-related selling (mortgage investors move to offset theirduration exposure when rates back up by selling Treasuries — this last happenedin a situation like this in the summer of 2007 and it ushered in one of the mostfantastic buying opportunities in years at the long end of the curve). Thosepundits calling for higher yield activity seem more bent on following the market than calling it.In any event, overnight, we did see along with the profit-taking in equities (andwe shall soon see if yesterday’s move was a classic ‘double top’ with the January6
th
intra-day high or if the break of the 200-day m.a. was the onset of a wholefresh set of legs for this cyclical up-move), the yen and dollar recover and oil andcopper retreat a tad. The commodity-based currencies are also off a bit, in partbecause the Reserve Bank of Australia said that there is “scope for some furthereasing” in policy. That trimmed about 0.5% from the Aussie — will the BoC alsofind a way to curb the over-enthusiasm over the loonie when it releases its pressstatement on Thursday? (We think so.)
On the data front, a mixed bag overall:
While the U.K. printed a ‘green shoot’data-point in the form of home loan approvals (43,201 in April from 40,038 inMarch — best in a year), the CIPS construction index dropped to its lowest levelin at last three years (45.9). France’s PPI deflated 0.9% MoM in April and -6.4%on a YoY basis versus -4.7% in March (consensus was for a -5.5% reading on a YoY basis). And, the Eurozone unemployment rate jumped to a 10-year high of 9.2% in April from 8.9% in March (coming in above the 9.1% consensusestimate). Inflation rates through most of Asia have just plunged to their lowestlevel in two years.
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June 2, 2009
– BREAKFAST WITH DAVE
BOND SELLOFF BELIES DEFLATION REALITIES
Nothing is as important to the inflation backdrop as the labor market —wages/salaries/benefits are seven times more powerful in determining thecorporate pricing structure. With this in mind, we see today a reference to aChallenger, Gray and Christmas survey conducted in May showing that 52.4% of companies have instituted salary cuts and/or other cost-cutting initiatives.
DOW TRADES IN TWO LEGENDS — WILL LIFT TECH & FINANCIALWEIGHTINGS
The Dow 30 is dropping not just GM (for the first time since 1925 — only G.E.has been in the index longer) in favor of Cisco (bringing the tech weighting to17% and likely to usher in more volatility as a result), but Citi is also going to bereplaced by Travelers, which in turn raises the financials share to 10% from 7%.
THERE ARE FOUR DIFFERENT FACTORS THAT DRIVE THE EQUITY MARKET
They are:1.
Technicals2.
Fund flows/Market positioning 3.
Valuation4.
Fundamentals
Let’s examine each one at the current time.
1.
With regard to the technicals, they are uber-bullish. Not only has the A-Dline broken out to the high side, but the S&P 500 yesterday broke above the intra-day high of 943 set back on January 6, not to mention taking out the 200-day moving average. The ultimate retest will have to waitanother day. This market is at risk now of melting up; and, as I saidbefore when I was keeping an open mind regarding the longevity of thisrally, notwithstanding my skepticism, if credit spreads, Libor, the Tedspread and commodity prices could all go back to pre-Lehman levels, whycouldn’t the S&P 500 too? That would mean a possible test to the highside of 1,200, believe it or not. That is an observation, not a forecast, by the way. Back when we hit that level last fall, it was a glass-half-emptyfeeling of being down 20% from the highs; this time around it is a causefor celebrating an 80% move off the lows! The S&P 500 is now up more than 4.0% for the year; the Nasdaq, which was the first of the majoraverages to break above the 200-day m.a., is up 16.0% year-to-date. TheDow is roughly flat.
Technicals for the equitymarket are uber-bullish
2.
The rally seemed to have stalled out on May 8 and for the next threeweeks, all the market seemed to do was range-trade between 880 and920 on the S&P 500 … until yesterday. The initial source of buying powerin March was the dramatic short-covering and pension fund rebalancing.Then in April the retail investor became enamoured of the ‘green shoots’and found $12 billion of money to put into equity mutual funds (only thesecond net inflow in the last year, by the way). And, as May morphed intoJune we likely have started to see the capitulation among institutionalportfolio managers, who collectively shard by cautious view.
In the last three weeks,it seems that the marketwas going nowhere …until yesterday
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Breakfast With Dave June 2
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