REVIEWING SOME SECULAR THEMES
Excellent macro thoughts here from David Rosenberg at Gluskin Sheff:
We are in a post-bubble credit collapse environment. The transition to the next sustainable bull market and economic expansion is likely years away. The most notable “non-confirmation” signpost for this bear market rally in equities is the 3-month Treasury bill yield, which is just 13 basis points away from zero. This could be Japan all over again.
The global economy is being held afloat by rampant fiscal stimulus, which is accounting for all of this year’s growth rate and 80 pct of next year’s. This is very much like the 1930s when the pace of economic activity was in need of major stimulus. The sharp downdraft in the equity market and the steep recession in 1937-38 after the government had the temerity to remove the life support fully eight years after the initial shock is case in point.
As for the U.S.A., real GDP would have contracted at a 6% annual rate in 2Q, not 1%, if not for the dramatic fiscal stimulus out of Washington. As for the current quarter, that 2-3% annualized GDP gain penned in by the consensus would actually be flat to negative without all of the fiscal help (ie, Cash for Clunkers) While policy reflation is massive, there are limits and to date, the initiatives have only helped cushion the blow. The key to the inflation process is not what the Fed is doing to the money supply but the extent to which, if at all, the “liquidity” is being circulated in the real economy. Velocity is still contracting. You can bake a cake as a central banker, but that doesn’t mean anybody is going to eat it. Rents are declining for the first time in 17 years. Consumer credit is contracting at a rate not seen in 65 years, and this not only reflects a desire to bolster depleted savings rates but also rising charge-off rates among lenders; and, wages/salaries are shrinking at an unprecedented annual rate of nearly 5%. Between rents, credit and wages, we have a deflation on our hands of epic proportions.
As a result, an income focus in the portfolio is necessary. Investors must not only be aware of returns, but must also be aware of the extremely high level of risk there is in the stock market today. Greed is again testing our long-term resolve. The S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings and history shows that at these high valuation levels, the market declines in the coming year 60% of the time.
While there is a chance we could see corporate bond spreads widen over the near-term, we still see them as relative outperformers. As a group, investment-grade credit is discounting 2% real growth versus 4% for (U.S.) equities. For bonds to play catch up to equities, in terms of pricing in “growth”, spreads would have to narrow to 200bps — about 100bps of tightening from today’s level. If stocks played “catch down” to corporates, the S&P 500 would correct towards the 850 area. In essence, for the risk involved, corporate bonds are more attractive relative to equities, which offer historically low earnings AND dividend yields (the latter at just over 2%).
While rampant fiscal largesse will keep the yield curve steeper than would have otherwise been the case, the work published by Rogoff and Reinhardt show that government debt always explodes after a credit collapse. But if the U.S. experience of the 30s and Japan experience of the 90s are any indication, the ultimate lows in long-term yields is down the road and south of 2%.
Commodities are a group that, at this stage, is also discounting a reasonable global growth trend of 3%. We see them as fair-value right now, but are clearly in a secular bull market. While China may have already stockpiled enough raw materials for the year, as long as the Asian economy does not relapse, basic materials are likely to remain on their long-term uptrend. That is principally why we favor the Canadian equity market over the U.S. equity market and the Canadian dollar over the U.S. dollar (note that since the secular bull market in commodities began eight years ago, the TSX composite index has outperformed the S&P 500 by 8,200 basis points in Canadian currency-adjusted terms).
Source: Gluskin Sheff
I have to agree with Rosie on this one..the only growth we will see going forward will be from fiscal stimulus as private sector balance sheets contract. I would expect to see the beginning stages of another large stimulus next spring to be passed sometime next year before this one fully runs out. Because the administration knows they get the highest multiplier from spending, the stimulus will be in the form of spending as opposed to tax cuts. There will most likely be public outrage and dems could be in for a tough 2010 election cycle. The trade off is without that spending, we would essentially go into a very severe depression.
How will stocks act? Most likely Q3 earnings will lead people to raise 2010 estimates – so even if there is a setback in Sep/Oct (unless the setback leads to sharp earnings reductions for 2010), stocks will most likely rally through the end of the year, although at a much slower rate than we have seen the last six months.
Right now, my feel is that it is too late to be committed to being long stocks, but I would buy treasuries. I again agree with Rosenberg that with no private sector demand for funds, there is no chance of inflation – in fact it is just the opposite. While the cash is piling up within the banking system – what will banks end up doing with that cash? Most likely buying treasuries and lending to the government instead of lending to the private sector.