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Tuesday, March 9, 2010

David Rosenberg's musings on the March 09's low's one year anniversary

Some solid, big-pictures perspectives from David Rosenberg, comparing then and now:

The media are all over the fact that today is the one-year anniversary of the 12-year low in the stock market reached on March 9, 2009, when the S&P sagged to that diabolical 666 level. (Funny how nobody celebrates October 9, which is the anniversary of the 1,565 high set back in 2007.) A lot has changed over a year, and that includes the factors that have supported the recovery in the equity market:

* The VIX was 50, not 17.
* The yield on the 10-year Treasury note was 2.9%, not 3.7%.
* The budget deficit was $900 billion, not $1.5 trillion.
* Baa spreads were 540bps and tightening, not 260bps and widening.
* The market was 20% ‘cheap’ as per Shiller P/E ratio, not 25% overvalued.
* The DXY was at 90 and depreciating, not 80 and appreciating.
* Oil was at $47/bbl, not $82/bbl (we can see $80+ crude being good for the Saudi market; we’re not sure how it fits in bullishly to the S&P call).
* Equity PM cash ratios were at 5.5%, not 3.6%.
* Market Vane bullish sentiment was at 32%, not 53%.
* Real GDP was -6.4%, not +5.9%; and the ISM was 36, not 57 (we were in the basement looking up, not on the rooftop looking down).

Enough said. This market has come a long way. It was not until September 2006, nearly four years into the last bull market, that the equity market managed to rise this far off the lows. This time it has taken less than 12 months.

While it is fashionable to look at how little the market has retraced its peak to trough declines and instead look at the market in that perspective in terms of potential future gains, recall that at the ‘peak’ of the last cycle, there was so much leverage underpinning corporate earnings that 40% of the profit pie was being influenced by financial activities. There was so much air at the 1,565 peak that it is almost unjust to do any real analysis from such a fictitious high. (There was a reason why one of the most moderate economic growth cycles of all time managed to see profits as a share of GDP soar to its highest level in five decades back in 2008 — it’s called financial engineering.)

The reality is that as the fluff was written down, reported earnings slumped 90% in the bear market and the S&P 500 dropped 60%. This is why the market bottom occurred a year ago with valuations at stretched levels relative to previous troughs. What changed were the rules of engagement as the Fed blew out its balance sheet in support of the mortgage industry, the government guaranteed the survival of the large banks, the shorting industry was sharply curtailed and the banks were allowed to hide losses again on their illiquid assets via accounting changes that were foisted onto the SEC from Congress in the name of saving the system. And of course, a government deficit that is now running at a record $1.5 trillion, and the spending to get the economy going has been so acute that even if revenues had not gone down with the economic turndown, the budget gap would still far exceed the $1 trillion mark.

If the bulls have a retort, it is that in the post-WWII era you have to go back to 1947 to find the last time that there was no follow through from year-one to year-two of a bull run. Well, maybe that is what we have to do in a post-bubble credit collapse where the economic growth is being dictated primarily by state capitalism … go back to 1947, or before.

In a nutshell, it comes down to valuation. Are you willing to outbid everyone else at the auction for the Ford Focus? Today’s WSJ has an interesting debate between Jeremy Siegel (bull) and Robert Shiller (bear) on the appropriate valuation metrics to deploy. The WSJ, usually an optimistic read, settles the score by invoking the work Boston-based Ben Inker, who relies on margins and corporate cash flows. Based on this particular model, the S&P 500 is currently overpriced to the tune of 20%, which makes fair-value around the 900 mark (what our research also shows).

As we said before, it will be interesting to see where the next round of buying for equities will come from. The general public has been selling into the rallies. So have corporate insiders. Portfolio managers have their cash ratios near record lows and foreign investors have been minor participants. Have a look at the front page article of today’s NYT — half of U.S. corporate pension funds are re-allocating from equities towards fixed-income (Public Pensions Are Adding Risk to Raise Returns). Indeed, it is State governments, who have massive fiscal deficits to close, and are busy adding risk to their pension funds (lord help us). They are still assuming average 9.5% returns in equities (and 5.75% in bonds) despite the fact that the trend in nominal GDP definitely augurs for nothing less than a 5-6% range for the future. And, many are still locked into a 60/40 asset mix middle (stocks/bonds) despite the realities of a post-bubble deflationary world.

Rosie follows up on our discussion from last week (The Primary Source Of January's Surprising Boost To Consumer Credit? Why, The US Government Of Course) when we observed the pathetic misread by the mainstream media of the latest consumer credit numbers, which were entirely government driven.

Revolving credit slid $1.7 billion in January and the level, at $864.4 billion, is now the lowest since October 2006. This is key and attests to the lingering consumer frugality theme.

Moreover, the government was the sole supplier of funding that actually showed an increase in consumer exposure. All the gain was in federal government loans, they surged more than $10 billion and this was a student loan program being offered by the federal government. Every other lender — commercial banks (-$5.5bln), credit unions (-$1.4bln), ABS pools (-$1.1bln), savings institutions (-$500mln), nonfinancial business lenders (-$1.9bln), and finance companies (-$3.9bln) each posted declines in outstanding credit during the month. So, the credit contraction is far from over despite the illusion of the headline number.

And, lastly, this amusing tidbit:

We don’t like to appear as conspiracy theorists, but if you recall, the equity market bottomed on February 5 on two pieces of news that triggered a significant intra-day reversal. The first was the initial hints of an EU rescue plan for Greece. Later in the day, December’s consumer credit data were released, showing a modest decline of $1.7 billion versus the estimate of a $10 billion contraction. When you take into account the downward revision to November, what comes out of the wash is a December level of consumer credit outstanding that is was actually $6 billion lower than expected. But obviously not the way the data are being treated by Wall Street research departments or the media for that matter. Finally, with last Friday’s number, December was revised down an additional $3 billion as mentioned above. Hence, December’s number, which originally helped turn the market around, was $9 billion lower than November, versus the original release of -$1.7 billion.

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