This article is a guest contribution by David Rosenberg, Gluskin Sheff.
WHILE YOU WERE SLEEPING
Global equity markets have turned around dramatically in the past few hours and are enjoying a technical bounce from oversold levels. The S&P 500, after all, is coming off losses in nine of the past 10 sessions and is due for a respite and Europe was coming off its longest losing streak in a year — so far today, though, more than 30 stocks are rising for every decliner. A 5% decline in the pre-July 4th week when the U.S. market is usually up three-quarters of the time is rather telling. So, U.S. equity futures are in the green column; the MSCI index is also up 1.4% as it enjoys its best session in two weeks.
Be that as it may, there is certainly nothing on the fundamental front to elicit a rally at the current time as double-dip risks continue to rise; at a minimum a growth slowdown of significance. The U.S. employment data revealed wage deflation, slow job creation and the manufacturing components signalled that the peak of the inventory cycle is behind us. The recent giveback in exportimport flows also points to some reversal in the explosive expansion in global trade, which helped underpin the nascent economic recovery. And now, governments in the industrialized world are embarking on fiscal tightening that will drain more than 1% from baseline GDP growth starting next year after stimulative fiscal expansion added more than 1% per year to OECD growth from 2008 to 2010. (Governments seemingly responding to market prices which raised the odds of a default by 30% in the past quarter — those probabilities more than doubled in the European periphery.)
The reason why everyone bought into the V-shaped recovery view was because the equity market told them that this must be the case. Now, we have a situation where $1.6 trillion of wealth has been wiped off the books in the past three months from the stock market setback and so it’s no coincidence that at the margin, question marks are surfacing over the longevity of the recovery — if not the longevity, then certainly its veracity.
The next key event is Q2 reporting season with Alcoa kicking things off on July 12 — guidance will be even more important than ever, especially since the analysts have been busy raising their estimates for 2010 EPS to +34% from +27% at the end of March. But then again, according to Bloomberg estimates, the consensus was, on average, 13 percentage points too optimistic from 2007Q3 to 2008Q4 on their earnings growth projections … pass the salt please. There is no doubt that the combination of lower prices and higher earnings estimates has enticed the bulls into claiming that the stock market has entered into deep undervalued zone at a 12.5x P/E multiple. However, history shows that trough multiples could get as low as 10x, so there is nothing to say that the market could not get cheaper still, especially with all the uncertainty overhanging the economic outlook.
In addition to the revival in the stock market today, we also have the euro rallying against both the U.S. dollar and the yen in a pro-risk signpost and bonds are selling off hard in Europe. The DXY index has sliced below its 50-day moving average to an extent we have not seen since late last year and commodity prices, which have been moving inversely to the greenback and positively with the equity market, are rallying this morning: oil up for the first time in six days, and copper has rallied 1.3% today on news that LME inventories have now hit seven-month lows. Still, this snapback all seems to be rather temporary and technical from our standpoint.
There were no economic data to speak of overnight, but we did see the Reis Q2 commercial vacancy rate data and it showed a 17.4% nationwide figure in the U.S.A. from 17.3% in Q1 and 16.0% a year ago. Net effective rents slid 0.9% QoQ in Q2 and by 5.9% on a YoY basis, and down in 60 of the 82 markets assessed. So any improvement that pundits were seeing occur a few months back seems to have been more a statistical illusion than any durable improvement.
The one lingering downward influence on the U.S. payroll data that is worth mentioning is the State/local government sector, which is in full-fledged retrenchment mode — losing 10k last month and by 95k year-to-date. The USA Today cites a Moody’s Economy.com study, which estimates that another 400k jobs at the lower levels of government are at risk in the coming year. See Expect Lots of Layoffs at State, Local Levels: on page B1.
As a sign of just how much slack there is in the U.S. labour market, and how much job insecurity there really is, the number of work stoppages (there were only five strikes in the past year at companies employing 1,000 workers or more) fell to the lowest levels since records began in 1947. Just another sign of deflationary worker anxiety — makes us want to go out and buy even more fixed-income securities. In fact, that is where the massive savings pool is headed — into bonds — as the first of the 78 million boomers turn 65 next year (retirement age) — 42% of mutual fund IRA money is sitting in equities as are 46% of all mutual fund defined-contribution plans (like 401(k)s). When the boomers first turned 25, the mutual fund industry had assets of $55 billion; today that number is closer to $11 trillion of which more than $4 trillion is in retirement accounts (good take on this on page B1 of the USA Today).
We see this morning that our friend, Nouriel Roubini, is being interviewed on CNBC and is discussing what he sees, which is a visible slowing in the U.S. and European economies. He stops short of calling for a double-dip, as many commentators do not believe this can happen with policy rates as low as they are. In fact, a Cleveland Fed report is making the rounds as it concluded that based on the shape of the yield curve, there is almost no chance of a double-dip recession. We question whether this is true or not in the context of a post-bubble credit collapse.
After all, Japan’s yield curve never inverted because it couldn’t after the Bank of Japan brought short-term rates to near-zero levels and yet even with a positive slope to the JGB curve, Japan still managed to experience outright recessions beginning on April 1997, September 2000 and March 2008. In each case, Japan slipped into recession, and in the aftermath of a credit collapse, the signal was not whether the curve was inverted since it could not invert with policy rates at zero, but rather how the curve was shifting. In each case, it was flattening (as the Treasury curve has for the past three months — and by over 100 bps to boot).
