David A. RosenbergJune 8, 2009
Chief Economist & Strategist Economics Commentarydrosenberg@gluskinsheff.com+ 1 416 681 8919
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MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
WHILE YOU WERE SLEEPINGReversal of fortunes
Equity markets are lower today — Europe off 1.8% thus far and Asia down 0.8%even with a rally in the Nikkei (Korea, Hong Kong, Singapore and India all in thered column).Commodity prices are down across the board and resourced-based currenciesare under some downward pressure (CAD above 1.12). Note that while we hadbeen constructive on the commodity complex since last December, as withequities, resource prices may have overshot the fundamentals — after all, crudeoil prices are up more than 50% YTD and over 30% from a year ago even thoughU.S. stockpiles have risen about 20% from a year ago (enough to meet 25 daysof usage, up from 20 days this time in 2008). Also, when one reads articles likeCaterpillar’s Hopes For Recovery Built on Shaky Foundations on page 19 of today’s Financial Times (FT), one wonders whether there is too much hype over the sustainability of the global recovery (or the efficacy of the Obamainfrastructure package for that matter — there is an interesting article on thefront page of today’s New York Times (NYT), by the way, on the tensionssurfacing on the President’s economics team) — sales outside North Americaaccount for over half of the world’s largest producer of construction equipment.Credit default swap (CDS) spreads are widening as well but we see no flow intogovernment bond markets. In fact, Treasuries are selling off moderately yetagain as supply ($35 billion of 3-year notes, $19 billion of 10-year notes, and$11 billion of long bonds hit the market this week — another $65 billion of newTreasury issuance) and stagflation concerns are on the front burner. In our view, the economy is too fragile to withstand a 4%+ yield on the 10-year note — it’sone thing to have a Treasury selloff without private sector rates being affected —but that is no longer the case and the proof in the pudding is the fact thatmortgage refinancings have sunk nearly 60% in the last two months.
Problem for equities may transcend just a weak economic backdrop:
According to data compiled by Bloomberg, there has been so much in the way of secondaryofferings that the share count in the S&P 500 is rising at a 3.4% annual rate sofar this year. Tack on the fact that in this age of cash-conservation, companiesare also slashing their dividend payouts by more than 20%, the sharpest declinesince 1938, and the combination of these two effects is likely going to shavemore than 4% from S&P 500 total returns this year. Considering that the S&P500 total return has averaged 6% per year since 1900, the trimming impactfrom a higher share count and lower dividend yield looks to be rather significant.
IN THIS ISSUE
• Problem with equities may transcend just a weakeconomic backdrop• This is one very selectivemarket• Consumers paying downdebt in record amounts• Secular labour marketheadwinds
June 8, 2009
– BREAKFAST WITH DAVE
Page 2 of 1
ONE VERY SELECTIVE MARKET
The markets are in a phase right now where they are picking and choosing how to respond to the incoming data, and this is indeed a very fascinating process.Equities roared ahead and bonds sold off violently after we heard that the ISMindex jumped in May to 42.8 from 40.1. We were put on notice from the experts that this meant the recession was over. Then we saw the manufacturing components of the nonfarm payroll survey on Friday, and in no way, shape orform did it conform to the ISM poll. Manufacturing employment sagged156,000. The factory workweek dropped at a 6.0% annual rate. Themanufacturing diffusion index — one would think this would at least line up with the ISM — slipped from 19.9 to 12.0 in what was the steepest decline sinceJune 2008. In a month when the ISM jumps 2.7 points, the guts of the payrollreport point to a near 1% plunge in industrial output (believe us when we tell that you that this is an extremely rare combination).All we know is that on a day when we had the mother of all ‘green shoots’, apayroll headline that came in 200,000 better than expected, the S&P 500 couldnot finish the session higher. The rally has finally taken us all the way back to the intra-day high for the year established back on January 6, but even as itkisses the 200-day moving average, the S&P 500 seems to be struggling topierce this technical threshold and establish a whole new trading range:
•
June 1
st
: 942.87
•
June 2
nd
: 944.74
•
June 3
rd
: 931.76
•
June 4
th
: 942.46
•
June 5
th
: 940.09Remember, the intra-day high on January 6 was 943.85. That the S&P 500could not be sustained above that level in the last five sessions despite the ISMand nonfarm green shoots suggests that the ‘second derivative’ improvement isalready fully priced; the next leg up needs to see a sustained ‘first derivative’ turnaround in the economic data.Oil prices just below $70/barrel have more than doubled from their lows; and10-year note yields approaching 4% (which are now pulling up mortgage rates — the 30-year fixed rate is all the way back to 5.45% — not to mention competing now with a near 4% earnings yield on the S&P 500) are starting to put a bit of acrimp in this rally. Once it becomes clear, before Labour Day, that the recessionis not coming to an end quite so soon (as the National Bureau of EconomicResearch’s Robert Hall said Friday, it’s “way too early” to make that call), wewould be looking for a corrective phase to start taking place.
On a day when we hadthe mother of all‘green shoots’, theS&P 500 could notfinish the sessionhigher
June 8, 2009
– BREAKFAST WITH DAVE
Page 3 of 1
Yes, yes, we are going to be hearing a lot of background noise about the ECRIleading index improving to a 45-week high of -7.1% in the final week of May(from -9.3% the week before and the record low -29.7% in December 2008).The reality is that during the expansion this index peaked in January 2004 — oh,about four years before the cycle ended. We want to be early, but not that early.That sharp selloff in the bond market may well end up sowing the seeds for asizeable rally because it has driven a hole in the mortgage refinancing boom,which began in February and ended with a thud in May — the Mortgage BankersAssociation’s refinancing index is now 57% below the early April peak. Not only that, but new home-buying activity has stalled out too, as the MBA purchaseindex sagged at a 20% annual rate in May — the first time it has declined in three months. Some of these green shoots just got shot!
Chart 1: THE ECRI LEADING INDEX IS IMPROVING
United States
ECRI Weekly Leading Index Growth Rate
Avg, %
050505050
3020100-10-20-30
Source: Haver Analytics, Gluskin Sheff
As an aside, the part of the yield curve that got smoked the most following thenonfarm payroll figure was not the “reflation-sensitive” long bond but rather the2-year T-note whose yield soared 34bps to 1.29%. One would have thought weprinted +345,000 instead of -345,000 based on that reaction. Indeed, themarkets have now price in three Fed rate HIKES over the coming year. Wedoubt this happens until the unemployment rate peaks and heads lower, and that is likely going to take at least a year to unfold and/or until home prices stopdeclining, and this could also take at least another year (see Robert Shiller’scolumn on page 4 of the Sunday NYT business section —
Why Home Prices May Keep Falling
).
At this point in time,don’t be fooled by theimprovement in theECRI leading index
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Breakfast With Dave June 8
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