For the first time in while, Gluskin Sheff's David Rosen­berg recounts his always infor­ma­tive chat ses­sion with Bob Far­rell and shares Farrell's per­spec­tives on the mar­ket ("his range on the S&P 500 is 1,350 to the high side and 1,000 to the low side. He was emphatic that there is more down­side risk than upside poten­tial from here. His big change of view is that we have entered a cycli­cal bear phase within this sec­u­lar down­trend (he sees the P/E mul­ti­ple trough at 8x). Rosie also looks at Europe and defines the term that we have been warn­ing against since May of 2010: "imple­men­ta­tion risk" namely the vir­tual impos­si­bil­ity of get­ting 17 Euro­zone coun­tries (and 27 broader Euro­pean coun­tries as the UK just demon­strated) on the same page when every­one has a dif­fer­ent cul­ture, lan­guage, his­tory and reli­gion... oh, and not to men­tion ani­mos­ity to every­one else. So yes: Europe in its cur­rent for­mat is fin­ished, but what will it look like in its next rein­car­na­tion? And why does he think the Euro­pean liq­uid­ity cri­sis will become a full blown sol­vency cri­sis in Q1 2012? Read on to find out.

First, Far­rell on markets:

I had the oppor­tu­nity to lunch with the leg­endary Bob Far­rell yes­ter­day, and he is as bear­ish as I've seen him in the past two years. At this time last year he said the mar­ket would peak in the spring and then strug­gle, and to avoid the banks — a very early call on that last point but a pre­scient one nonetheless.

Bob strongly believes the cycli­cal peak was turned in April. He advises sell­ing into any rally. His range on the S&P 500 is 1,350 to the high side and 1,000 to the low side. He was emphatic that there is more down­side risk than upside poten­tial from here. He still sees this as a sec­u­lar 20-year bear mar­ket and we are in year 12. His big change of view is that we have entered a cycli­cal bear phase within this sec­u­lar down­trend (he sees the P/E mul­ti­ple trough at 8x).

Bob sees a mar­ket now char­ac­ter­ized by dis­tri­b­u­tion rather than accu­mu­la­tion; in other words, more sell­ing than buy­ing pres­sure. He is dis­turbed by the lack of follow-through in the inter­mit­tent rally phases we have seen of late. The extreme volatil­ity is not con­sis­tent with a bull mar­ket. He favours com­pa­nies in defen­sive sec­tors, good man­age­ment, low cost struc­tures and strong bal­ance sheets. Port­fo­lios should step up in qual­ity. He likes what he sees in terms of sec­u­lar chart action in big pharma, large-cap tech, and automotive.

Inter­est­ingly, he talked about how the delever­ag­ing cycle has caused the tra­di­tional pres­i­den­tial cycle equity per­for­mance to turn topsy-turvy. Nor­mally, the mar­ket does not dou­ble in the first two years of a pres­i­den­tial win as the White House first adopts the "unpop­u­lar" mea­sures, then enacts pop­ulist pro– growth poli­cies in years 3 and 4. This time, all the stim­u­lus has already hap­pened. Bob thus thinks that next year is a down year for the mar­ket, espe­cially given elec­tion and tax uncer­tainty, let alone lin­ger­ing Euro­pean problems.

The only pos­i­tive he sees is that sen­ti­ment is quite neg­a­tive, and thus should help con­tain the down­side. He is watch­ing put-buying activ­ity along with sen­ti­ment sur­veys and mutual fund out­flows. But the neg­a­tive sen­ti­ment is not yet extreme enough to turn him more constructive.

And Rosie's "thots" on Europe:

What a rever­sal yes­ter­day — the rever­sal in the S&P 500 totalled over 24 points and the swing from the intra-day high to low on the Dow was 243 points. While improved tone to the Ger­man ZEW and the U.S. NFIB small busi­ness indices helped over­shadow a ho-hum U.S. retail sales report (restau­rant sales are a notable lead­ing indi­ca­tor and it fell 0.3% in what was the first decline in seven months; note as well that auto sales look to have sput­tered in Decem­ber for the first time since August), it was likely the fact that the Fed offered no clue of a future QE3 pro­gram to a mar­ket that, like a child, needs mummy to hold its hand.

The Fed acknowl­edged in a mark-to-market exer­cise that the econ­omy was on a firmer foot­ing, but the press state­ment was so laden with caveats that it is obvi­ous that Bernanke is not a buyer of the sus­tain­able eco­nomic growth view. Foreign-related growth risks were cited as was a com­ment per­tain­ing to a slow­ing in the pace of busi­ness invest­ment. So not only did Bernanke not play the role of Santa (or Judah the Mac­cabee for that mat­ter) but the mar­ket con­tin­ues to digest last week's EU sum­mit and is now com­ing to the con­clu­sion that the deal is lit­tered with com­pli­ca­tions that go far beyond Britain's veto (and likely exit from the EU as a result).

First, the ECB has refused to give in to demands to embark on debt mon­e­ti­za­tion. So far, the 208 bil­lion euros of bond buy­ing by the cen­tral bank amounts to just 1/10 of what the Fed has done in its cumu­la­tive inter­ven­tion­ist activ­i­ties to date. More­over, while it is nice for the banks to bor­row three-year funds at 1% from the cen­tral bank, going out and load­ing up on sov­er­eign bonds can hardly be a pri­or­ity right now see­ing as they them­selves have 1 tril­lion euros of delever­ag­ing in order to meet their stip­u­lated capital-asset ratios.

Did any­one expect all 17 sov­er­eigns to be put on Cred­it­Watch as the stock mar­ket rejoiced last Fri­day over the fabled 'grand bar­gain' ini­ti­ated by Mer-kozy (or that Ital­ian bond yields would top 7% again this quickly)? And now we have Sarkozy all but acknowl­edg­ing that France is on the road to a down­grade, which will impede the fire­power of the EFSF.

The 200 bil­lion euro loan from indi­vid­ual cen­tral banks to the IMF to then be used to assist periph­eral coun­tries with fund­ing prob­lems falls about 400 bil­lion short of what is needed if both Spain and Italy are ever shut out of the cap­i­tal mar­kets like Por­tu­gal, Greece and Ire­land were. As it stands, the Bun­des­bank has already said that this pro­vi­sion deserves par­lia­men­tary approval in Ger­many and we already have Social­ist can­di­date Fran­cois Hol­lande (who is now in the lead in the polls) say­ing that he would seek a rene­go­ti­a­tion of the deal struck last Friday.

Indeed, what the mar­kets did not fac­tor in right away but are now, is the high degree of imple­men­ta­tion risk. Besides the Bundesbank's com­ments on Ger­man leg­is­la­ture approval for the country's 45 bil­lion euro stake (one-quarter of its FX reserves, by the way), the Irish gov­ern­ment is decid­ing now whether a ref­er­en­dum is going to be needed to accept the pact; the agree­ment will most cer­tainly require par­lia­men­tary approvals in Swe­den, Hun­gary, the Czech Repub­lic, and, accord­ing to the WSJ, quite pos­si­bly Den­mark. Is there not a rea­son to be skeptical?

There was lit­tle spe­cial about this deal that fell so short of blaz­ing the trail for a true fis­cal union and for growth strate­gies that could help con­tain the ero­sion in credit qual­ity. Instead, coun­tries will have to cut into bone on the fis­cal front at the same time reces­sion­ary pres­sures begin to build — and likely to back­fire. So ... it is becom­ing appar­ent that once again we have a sum­mit that promised a lot and actu­ally deliv­ered very lit­tle. Time is run­ning out, folks, espe­cially when you look at the euro­zone gov­ern­ment fund­ing needs in Feb­ru­ary and March, in particular.

The unthink­able is on the table too, at least it should be, which is a Greek exit from the mon­e­tary union. We see in the NYT that Nomura and UBS have already pub­lished detailed reports on this topic — a 50–60% drachma deval­u­a­tion would likely ensue, along­side cap­i­tal flight, social unrest and chaos. The mar­kets are then fig­ur­ing who would be the next to go and what hap­pens when a CDS event is then trig­gered? And what then hap­pens to the ECB's bal­ance sheet, which owns 60 bil­lion euros of Greek debt. It would suf­fer the most.

What signs are out there point­ing in the direc­tion of a pos­si­ble Greek exit? How about the fact that 40 bil­lion euros of deposits have fled the country's bank­ing sys­tem in just the past year. This is equal to 17% of GDP! More than 30% of that out­flow took place in Sep­tem­ber and Octo­ber alone. This remains a pow­der keg sit­u­a­tion and what is clear to us is that the Euro area is not at all close to resolv­ing its prob­lem of exces­sive debts, insuf­fi­cient growth and com­pet­i­tive­ness (Ger­many aside), glar­ing country-by-country cur­rent account– sav­ings imbal­ances and an ever-growing lack of con­fi­dence. As we saw with Lehman, once enti­ties reliant on whole­sale cap­i­tal mar­kets for their fund­ing lose con­fi­dence among the invest­ment com­mu­nity, a liq­uid­ity cri­sis can morph into a sol­vency cri­sis and do so very quickly. This all promises to come to a head some­time in the first quar­ter of the new year, in my opinion.

via Gluskin-Sheff

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