David A. RosenbergJune 9, 2009
Chief Economist & Strategist Economics Commentarydrosenberg@gluskinsheff.com+ 1 416 681 8919
Please see important disclosures at the end of this document.
Gluskin Sheff + Associates Inc.is one of Canada’s pre-eminent wealth management firms. Founded in 1984 and focused primarily on high net worth private clients, we are dedicated to meeting the needs of our clients by delivering strong, risk-adjusted returns together with the highestlevel of personalized client service. For more information or to subscribe to Gluskin Sheff economic reports
,
visit www.gluskinsheff.com
MARKET MUSINGS & DATA DECIPHERING
Breakfast with Dave
MR. BOND IS SHAKEN AND STIRRED
The yield on the 10-year note has now risen 185 basis points from the lows andup 135 basis points since the Fed announced in March that it was embarking ona Treasury-buying program (clearly $300 billion is not enough). The question iswhat is driving yields higher and what will cause the run-up to stop? Well, muchis being made of supply and massive Treasury issuance, and to be sure, this hasaccounted for some of the yield backup but not nearly all of it — after all, Aussiebond yields has soared more than 100bps despite the country’s fiscal prudence.Clearly, the ‘green shoots’ from the data has been a factor forcing real rateshigher. The doubling in oil prices and the rise in other commodity prices hasgenerated some increase in inflation expectations, and the 40%+ move in equityprices and sustained spread narrowing in the corporate bond market has triggered a flight out of safe-havens (like Treasuries), and part of the move hasbeen technical in nature owing to convexity-selling in the mortgage market withrefinancings plummeting since early April.The fiscal largesse and new issuance are certainly not going to go away, but theother factors may well subside or reverse course in the second half of the yearleading to a possible significant rally in government bonds. We should add thatin real terms, the 10-year note yield is now 4.5% and the last five times itapproached this level in the past decade the nominal yield rallied each time andby an average of more than 50bps.Where we think the greatest potential will be is in inflation expectations — theyshould reverse course in coming months. Three different articles in today’s WallStreet Journal (WSJ) lead us to that conclusion:
!
More Firms Cut Pay to Save Jobs
(page A4)
!
To Sustain iPhone, Apple Halves Prices
(B1)
!
In Recession Specials, Small Firms Revise Pricing
(B5)
IN THIS ISSUE
• We ask the question, whatis driving yields higher andwhat will cause the run-up to stop?• We believe that inflationexpectation shouldreverse course in thecoming months• The latest surge ingasoline prices offsets thefiscal stimulus• On a positive note, theConference Board’semployment trend index ticked up in May• There is a lack of pass- through from thecommodity rush to finalconsumer prices• The latest I/S ratio datashows that defensivesectors are still betterpositioned than cyclicals
June 9, 2009
– BREAKFAST WITH DAVE
Page 2 of 8
GASOLINE PRICE SURGE OFFSETS THE FISCAL STIMULUS
U.S. retail gasoline prices are now up a full buck from the lows, to $2.62 agallon (up 41 days in a row) — the equivalent of a $130 billion drag ondiscretionary spending at an annual rate. Tack on the 60bps bounce inmortgage rates too, which has triggered a near-60% collapse in mortgagerefinancings. Then tack onto that the 0.2% decline in average weekly earningsin May — down now in two of the last three months — and a consumer relapsecould well be in the offing and end up snuffing out this ballyhooed inventory-led recovery that has underpinned equities and undermined Treasuries over the last 3-4 months. Have a look at the article
Relentless Rise of Treasury Yields Could Choke Nascent Recovery
on page 23 of the FT. Also see
OnBorrowed Time: Consumer-Led Recovery
on page C1 of the WSJ.
NOT ALL THE NEWS IS GRIM, HOWEVER
The Conference Board’s employment trends index ticked up 0.2% in May — thefirst increase in 16 months. Taiwan just posted a 9.0% jump in April exports,adding to expectations that Asia is truly on the mend (the 0.5% increase in theApril OECD leading indicator has also been greeted receptively by the ‘greenshoot’ advocates). The once-bearish Paul Krugman stated yesterday in aninterview that the recession will very likely end in September. In the event, thelows in the market posted in March were probably the lows for the cycle, evenif we believe equities are more than fully priced right now and offer limitedupside potential.
MORTGAGE DELINQUENCIES HIT PRIME LOANS
Everyone seems to believe that the foreclosure crisis has been confined tosubprime, but that is no longer the case at all. In the first quarter, fully half of the foreclosures in the U.S.A. were concentrated in prime mortgages where thedefault rate is now 2.40% — more than double the 1.10% rate a year ago. WhileCalifornia, Nevada, Arizona and Florida are the main culprits, make no mistake,half of the delinquencies are taking place in the rest of the country too.Moreover, the problem has also spread more visibly to the commercial realestate market, where the default rate is set to hit a seven-year high of 4.20% by the end of the second quarter, from 2.25% at the end of March. Along withcredit cards — the delinquency rate at 1.32% in Q1, up from 1.19% a year ago — this is not only the next shoe to drop but is a shoe that is already dropping (more than $300 billion of commercial mortgages have to be refinanced this year).
LACK OF PASS-THROUGH FROM THE COMMODITY RUSH TO FINALCONSUMER PRICES
There seems to be quite a bit of concern that inflation is going to rear its uglyhead now that commodity prices have bounced back so sharply. Well, I wentback to the other five major commodity bull markets back to the early 1970sand compared the run-up in the CRB index to the surge in the CPI to get a gaugeas to how much ‘pass-through’ there was into final-stage consumer pricing.
U.S. gasoline pumpprices are now up $1from the lows …equivalent to a $130blndrag on discretionaryspending
June 9, 2009
– BREAKFAST WITH DAVE
Page 3 of 8
Historically, there is a 37% pass-through, averaging out those cycles. In otherwords, for every 10% increase in the CRB, 3.7% of that advance found its way to the U.S. consumer.But in the 2002-2007 cycle, a 118% surge in commodity prices only managed to translate into a 21% increase in the CPI — for an 18% pass-through. That was the smallest spill-over ever from the commodity sector to the consumer — half of what we usually see (in the second half of the 1970s, by way of comparison, thepass–through was 83%!). Also keep in mind that in the 2002-07 cycle we had abooming leveraged U.S. economy, which took the unemployment rate down to4.4% at the low (versus 9.4% now) and industry capacity utilization (CAPU) ratesup to 81% (versus 69% now). The story was that even with the drop in theunemployment rate and rise in the CAPU rate, the output gap in the U.S.A. neverfully closed in the last expansion — the Fed never allowed the economy tobreach its full capacity limit (closer to 4.0% unemployment rate and 82% CAPU)which made it very difficult for final stage manufacturers and retailers to pass onmuch of the surge in raw material costs.We now have a one-trick pony when it comes to the commodity story and it isChinese demand. While the U.S. economy did manage to expand on the back of soaring housing wealth and surging credit growth from 2002-07, it played asecondary role in the bull market in resource prices. So from my lens, if U.S.retailers had difficulty passing along commodity costs in the last cycle whencredit was abundant, I fail to see how they are going to do so in the current andprospective environment of declining household credit growth, rising savingsrates and near-record excess capacity in the product and labour market.There is very little overall benefit to the U.S. economy from a China-led globalexpansion outside of selected multi-national company sales impact. Insofar asChinese demand exerts strains on the global resource sector, what this meansfor overall U.S. domestic profits is a giant margin squeeze (at least Canadianprofits gain some offset from higher resource-related revenues). This is why it isso difficult to see S&P 500 operating EPS hitting $75 per share anytime soon(before 2012, in fact) even with the clouds parting in the financial space.
CHARTS THAT SAY THE DEFENSIVE SECTORS STILL BETTER POSITIONEDTHAN CYCLICALS
Last week we received the April factory orders/shipments/inventory data for theU.S. manufacturing sector. I thought it would be useful to run a screen onsectors whose inventory/shipment (I/S) ratios are below average and those whoare at or near peak levels. As the charts below illustrate, the two sectors thatreally stand out positively in the sense of excellent inventory control are foodproducts and beverage/tobacco producers.The durable goods sector I/S ratio is still flirting near cycle highs — the metals,machinery and the transportation industries being the major culprits (tech andelectrical equipment have seen their I/S ratios roll off their recent peaks ... goodnews for them).
During the 2002-07commodity run-up,prices at the rawmaterial stage surged118% but only 21%translated to anincrease in CPI
of 00
Breakfast With Dave_060909
331 Reads
Info and Rating
| Category: | Uncategorized. |
| Rating: | |
| Upload Date: | 06/09/2009 |
| Copyright: | Attribution Non-commercial |
| Tags: |
Leave a Comment