The Fundamental Trendline is Still Down (Rosenberg)

Everyone complains about government manipulation of the data — how “hedonics” skew the numbers (like GDP and CPI). But what about the stock market? I’m not saying it’s “manipulated” but it does have substantial “survivorship bias” — especially after a gut wrenching recession. Just cleaning the failures out of the system and erasing them from the S&P 500, from WaMu, to Wachovia, to Bear Stearns, to Lehman, to Fannie and Freddie, and replacing them with companies that survived, was responsible for nearly 40% of the rally in the market off the 2009 lows. Think about that, if those firms who went under were still in the index, according to some help from a strategy friend at an aforementioned bank, the S&P 500 would be trading closer to 900 today than 1,100.

NO DOUBLE DIP?

We have been on the receiving end of endless analysis suggesting that double-dip risks are either zero or completely trivial.

“Double-dip talk would have more merit if no one believed it.” Yet, this investment bank doesn’t believe it!

“Double-Dips are Hard to Find”

“No Double Dip on Indicators”

Even the Cleveland Fed has gotten into the act. Someone sent me one of those charts that illustrate over time the number of times a word or phrase can be found in the financial literature and the term “double dip” has flown off the charts. The individual that sent over the chart said it was a classic contrary indicator until I convinced him that the words are showing up in research reports that are denying the risks of a “double dip” taking place, so this may be a time when the contrary indicator is its own contrary indicator!

The primary reasons given are the positively sloped yield curve, negative real short-term rates, no sign of inventory excess and no sign of a flattening in the trend in the leading indicators (aside from the ECRI, we would suppose). We were sent one particular Street report yesterday that began with a comment on how the analysis incorporated data from the last eight recessions in the United States.

The question we have is why these other eight recessions in the post-WWII era are relevant. This wasn’t just a blip or correction in GDP due to a manufacturing inventory-led recession. This was a traumatic asset price deflation and credit contraction of historical proportions. In essence, this was — or still is — a balance sheet recession that has absolutely nothing in common with the experience of the post-war business cycle when recessions were temporary dips in GDP in the context of a secular credit expansion. And, this wasn’t just a U.S recession and debt-deleveraging cycle — it was global in nature. This is why a re-read of the Rogoff-Reinhart and McKinsey reports on the history of what the aftermath of a secular credit contraction really looks like is imperative. This is all the more so after a six-day power surge in the stock market as the gap to the 200-day moving average gets filled.

Take us at our word that if Ben Bernanke is worried, it is not about what drives a post-WWII cycle. He has the 1937-38 brutal downturn in mind and this is actually a much more appropriate template, notwithstanding the changed structure of the economy (we don’t have one-third of the population living on the farm).

Heading into that downturn, there was no sign of inventory excess (prior to that recession, inventories contributed 20% to the economic expansion versus over 60% contribution this time around from the 2009 lows in GDP). Going into the renewed 1937-38 meltdown in the economy and the stock market, the yield curve was positively sloped to the tune of 240bps (3-months to the long bond). Why do so many cling to the “yield curve” in a credit cycle in any event? Are you going to tell me that a 50 basis point inversion in 2007 was the principal cause of the recession? Seriously now, the same pundits pointing to the yields curve now were telling everyone to ignore it back in 2007 because rates were low, which was a “conundrum”, apparently, because of excess Chinese savings flowing into the Treasury market. These same double-dip deniers never saw the recession coming in 2007 to begin with because after “adjusting” for the bond yield conundrum, the curve was not really inverted, don’t you see? Well, it only inverted by a little bit, anyway, and unlike other post-war cycles, this isn’t what unraveled the economy.

Just as the yield curve flattening and Fed tightening (the funds rate did rise 450bps) were no match for the parabolic credit expansion from 2003 to 2007, it would seem foolhardy to revert to the yield curve’s steepness today as some bellwether leading indicator when we are on the other (darker) side of the credit cycle. At best it gives the banks another way to generate low-multiple trading profits, and that’s about it.