Rosenberg: U.S. Unemployment Rate Headed For 12-13%

Rosie (of Gluskin Sheff) shares his insights on unemployment:

There are serious structural issues undermining the U.S. labour market as companies continue to adjust their order books, production schedules and staffing requirements to a semi-permanently impaired credit backdrop. The bottom line is that the level of credit per unit of GDP is going to be much, much lower in the future than has been the case in the last two decades. While we may be getting close to a bottom in terms of employment, the jobless rate is very likely going to be climbing much further in the future due to the secular dynamics within the labour market that need to be discussed:

• For the first time in at least six decades, private sector employment is negative on a 10-year basis (first turned negative in August). Hence, the changes are not merely cyclical or short-term in nature. Many of the jobs created between the 2001 and 2008 recessions were related either directly or indirectly to the parabolic extension of credit.
• During this two-year recession, employment has declined a record 8 million. Even in percent terms, this is a record in the post-WWII experience.
• Looking at the split, there were 11 million full-time jobs lost (usually we see three million in a garden-variety recession), of which three million were shifted into part-time work.
• There are now a record 9.3 million Americans working part-time because they have no choice. In past recessions, that number rarely got much above six million.
• The workweek was sliced this cycle from 33.8 hours to a record low 33.0 hours — the labour input equivalent is another 2.4 million jobs lost. So when you count in hours, it’s as if we lost over 10 million jobs this cycle. Remarkable.
• The number of permanent job losses this cycle (unemployed but not for temporary purposes) increased by a record 6.2 million. In fact, well over half of the total unemployment pool of 15.7 million was generated just in this past recession alone. A record 5.6 million people have been unemployed for at least six months (this number rarely gets above two million in a normal downturn) which is nearly a 36% share of the jobless ranks (again, this rarely gets above 20%). Both the median (18.7 weeks) and average (26.9 weeks) duration of unemployment have risen to all-time highs.
• The longer it takes for these folks to find employment (and now they can go on the government benefit list for up to two years) the more difficult it is going to be to retrain them in the future when labour demand does begin to pick up. Not only that, but we have a youth unemployment rate now approaching a record 20%. Again, this is going to prove to be very problematic for employers in the future who are going to be looking for skills and experience when the boomers finally do begin to retire.

In a nutshell, to be calling for a 12.0-13.0% unemployment rate is meaningless except that it is very likely going to be a headline grabber. The most inclusive definition of them all, the U6 measure of the unemployment rate, which includes all forms of unemployed and underemployed, is already at 17.5%. The posted U3 jobless rate that everyone focuses on is at 10.2% (though if it weren’t for the drop in the labour force participation rate, to 65.1% from 66.0% a year ago, the unemployment rate would be testing the post-WWII high of 10.8% right now). The gap between the U6 and the official U3 rate is at a record 7.3 percentage points. Normally this spread is between 3-4 percentage points and ultimately we will see a reversion to the mean, to some unhappy middle where the U6 may be closer to 15.0-16.0% and the posted jobless rate closer to 12%. This will undoubtedly be a major political issue, especially in the context of a mid-term elections and the GOP starting to gain some electoral ground.

Think about it. We haven’t yet hit bottom on employment but that will happen at some point. Employment is not going to zero, of that we can assure you. But when we do start to see the economic clouds part in a more decisive fashion, what are employers likely to do first? Well, naturally they will begin to boost the workweek and just getting back to pre-recession levels would be the same as hiring more than two million people. Then there are the record number of people who got furloughed into part-time work and again, they total over nine million, and these folks are not counted as unemployed even if they are working considerably fewer days than they were before the credit crunch began.

So the business sector has a vast pool of resources to draw from before they start tapping into the ranks of the unemployed or the typical 100,000-125,000 new entrants into the labour force when the economy turns the corner. Hence the unemployment rate is going to very likely be making new highs long after the recession is over — perhaps even years.

After all, the recession ended in November 2001 with an unemployment rate at 5.5% and yet the unemployment rate did not peak until June 2003, at 6.3%. The recession ended in March 1991 when the jobless rate was 6.8% and it did not peak until June 1992, at 7.8%. In both cases, the unemployment rate peaked well more than a year after the recession technically ended. The 2001 cycle was a tech capital stock deflation; the 1991 cycle was the Savings & Loan debacle; this past cycle was an asset deflation and credit collapse of epic proportions. And economists think that the unemployment rate is in the process of cresting now? Just remember it is the same consensus community that predicted at the beginning of 2008 that the jobless rate would peak out below 6% this cycle. Thanks for coming out.

David Rosenberg on Deflation

Rosenberg on the deflation question:

The question is when will we ever move from deflation to inflation. Everyone looks at the Fed’s bloated balance sheet but the problem is that the reserves the central bank has created are sitting as cash on banking sector balance sheets and not being re-circulated into net new credit creation which suggests that velocity is still contracting. Not only is velocity contracting, but so are the broad monetary aggregates.

From a labour market standpoint, there cannot be inflation without accelerating wages, and the economy is now operating at a level that is equivalent to 10 million jobs short of full-employment. So basically, what this means is that we are anywhere from five to 10 years away from seeing any sustained increase in inflation. Indeed, the article on page A2 of today’s WSJ cites a Rutgers study suggesting that we will not see 5% on the unemployment rate again until the end of 2017; Global Insights has a 5.75% jobless rate occurring no sooner than 2019 (see It Will Be Years Before Lost Jobs Return – and Many Never Will).

In turn, this implies that the chances that we get to $83 on S&P operating EPS, which the equity market is in effect now discounting a doubling from current levels, could take at least that long to occur (five to 10 years). Again, this means that income-focused investment strategies are going to remain critical in terms of generating adequate real risk-adjusted returns for the foreseeable future.

To repeat, the employment/population ratio (the “employment rate”) has fallen to a quarter-century low of 58.8%; it peaked at 63.4% in 2007. To get back to a cycle high, we need to create more than 10 million jobs. Before that happens, deflationary pressures are going to trump whatever inflationary risks arise from the Fed, Congress and the White House.

The last time the ratio was this low was back in December 1983. Back then, household debt per capita was $9,900; today it is six times larger at $58,000. At the margin, one has to wonder what is going to be paid for first. The debt-service payments coming out of the paycheck are looking increasingly vulnerable. Default rates are extremely likely to worsen for the foreseeable future; groceries will not be sacrificed; however, credit will.

THE U.S. CONSUMER IS IN HUNKER-DOWN MODE

While thrift is still considered a ‘bad thing’ by most economists who crave a consumer-led revival, we would be happy to open that for debate. It would be much more heartening to see a revival fuelled by capital investment but when over one-third of manufacturing capacity is sitting idle, that may be a stretch; and considering that exports comprise little more than 10% of GDP, the foreign sector is hardly going to be adding a whole lot of torque to the GDP data, at least over the intermediate term. Looks like we are left with government.

This secular frugality theme was on our minds when we saw Flat Holiday Sales? Retailers Say They’ll Take It on page B1 of the Saturday NYT. Is this what a 65% surge in the S&P retailing index from the lows has priced in? A flat sales growth at the most important time of the year. And this would be flat over a 2.0% YoY decline in 2008, which was the weakest holiday showing in 40 years. A holiday study just published by Nielsen found that 85% of Americans are going to be spending the same or cutting back this year compared to what was the worst holiday season since the late 1960s. This is incredible and shows how the near-60% surge in the equity market over the past five months has been totally divorced from economic reality.

The NYT article hit home because it concluded that “people are also continuing to nest in their homes.” We were on top of this about two years ago. And here we are, and the article says that the best-selling item this holiday shopping season is expected to be – get this – “cookware and other kitchen sundries.” Can there be any worse news for the restaurant sector? Husbands are going to be buying their wives a new roasting pan for Christmas and wives are going to be giving their hubbies a fryer.

Luxury goods are expected to fare poorly (jewellery, sporting goods, vacations), and it looks like we may see some very deep discounting in the apparel space (NPD Group is calling for a 4-5% YoY decline this year – see Sales Hanging on By a Thread on page A8 of the Investor’s Business Daily). Ditto for toys, the specials are starting early – Wal-Mart is bringing back its $10 toy section back to all its stores and we’re not even close to Halloween yet. Moody’s reported last week that the holiday shopping period “may be more promotional than anticipated, as consumers have learned to delay shopping in anticipation of higher markdowns”. Now that is definitely a deflationary mindset.

David Rosenberg on Unemployment

Rosie (of Gluskin Sheff) shares his insights on unemployment:

In the last three months, the Household survey shows that civilian employment has plunged 1.33 million. At the time of the end of the 2001 recession, the three-month rally was -3,000 – we hadn’t even entered the jobless recovery at that point. There has never been a time, ever, when a recession ended during a span when the economy lost 1.33 million jobs. So all the calls that the recession is over may have been a tad premature. If the jobs data are correct, and the recession is in fact not over, this entire 60% rally is at risk of unravelling.

There were absolutely no redeeming features in the data. The private nonfarm diffusion index sank to 31.9 in September from 34.9 in August (the manufacturing diffusion index fell to 22.9 from 28.3 in August) which means that for every company adding to their staff loads, more than two are cutting back. The labour force contracted by 571,000 and has plunged now by 1.1 million since May. That again is a sign of the labour market seizing up, which is very disturbing when you consider all the government efforts to stem the tide last quarter – from housing subsidies, to cash-for-clunkers, to mortgage modifications.

The fact that initial jobless claims have peaked and rolled over – modestly by historical standards – tells only half the story which is firings. It is so painfully obvious from the data what is lacking most, is new hiring, especially in the small business sector which accounts for half of the job creation in the United States. The average duration of unemployment rose to 26.2 weeks – a half year! – from 24.9 weeks in August; the median spiked to 17.3 weeks from 15.4. It is so difficult now to find a job that a record 36% of the ranks of those unemployed have been searching with futility now for at least six months. In “normal” recessions since 1950, this ratio peaked at just over 20%. It is nearly double that today. In number terms, we are talking about 5.4 million Americans who have been out of work – but looking – for at least six months. This is troubling.

The U6 measure of the unemployment rate, which is the most inclusive definition of the labour force and takes into account the fact that we have a record 9 million people working part-time because they have been pushed off full-time payrolls, hit a new high of 17.0% in September from 16.8% in August. The gap between this rate and the ‘official’ rate of 9.8% is at a record of seven percentage points. The historical norm is closer to four percentage points and so the concept of mean reversion – Bob Farrell’s first market rule to remember – suggests that the unemployment rate is going to be setting new highs for the post-WWII era before too long (the prior high was 10.8% in November-December of 1982). So the chances that we see a 13% peak unemployment rate this cycle is far from a ludicrous proposition at this point; and just in time for the mid-term elections.

The index of aggregate hours worked, which combines hours worked with the number of bodies at work, seemed to be carving out a bottom in July and August; however, it was a false bottom because this critical ingredient into GDP fell 0.5% in September, to stand at its lowest level in six years. For Q3, aggregate hours worked actually contracted at a 3.0% annual rate, so basically, what is keeping the economy afloat is continued strong productivity gains. But productivity growth alone cannot possibly lead the economy into a sustainable recovery — labour input at some point is going to have to kick in. For Q3, aggregate hours worked actually contracted at a 3% annual rate so basically, what is keeping the economy afloat, is continued strong productivity gains. But productivity growth alone cannot possibly lead the economy into a sustainable recovery, labour input at some point is going to have to kick in.

Take note that the Bureau of Labor Statistics (BLS) also announced a preliminary estimate regarding the benchmark revisions that get published every February and they suggest an additional 824,000 jobs were lost in the year to March 2009, which would put the cumulative decline at over 8.0 million (versus 7.2 million currently, which, even in percent terms – down 5.2%, is the worst in 64 years).

Many of these jobs are never coming back, either. The share of the unemployed who are not on layoff is at record 54.3% as of September. In prior recessions, this ratio would barely pierce the 40% mark. In number terms, we are talking about 8.5 million Americans who have lost their job due to permanent shutdowns, a figure that is double what you typically see at the peak of the recession.

Full-time employment is down 10.5 million from the late-2007 peak. Many of these folks have lost their job permanently; but over the past two years 2.8 million have managed to at least find part-time work. Even with this surge in part-timers, total employment relative to the size of the population sagged to a quarter-century low of 58.8% in September.

Looking at the demographic split, we can see the new game that families are playing. Parents are working longer to keeping their kids out of a job – but look at the bright side, at least their education will be paid for. Amazingly, employment among those 55 years of age and older rose 69,000 in September while all the other age cohorts combined lost an aggregate 854,000 On a YoY basis, the older age category is up 1.4% while everyone else is down 5.5% so it is so painfully obvious that the aging boomers are either coming into the workforce or are not leaving their jobs as early as their predecessor did – and this in turn is creating a huge unemployment headache for the younger generation because the youth unemployment rate has jumped to a record 26%.

Which Sectors Look the Best

David Rosenberg has an answer:

We ran screens looking at three variables:

• Equity sectors that have seen the least pronounced jump in price-earnings multiples (a sign of neglect).

• Equity sectors that have seen the most pronounced increase in earnings revisions in recent months (signs of improved fundamentals).

• Equity sectors that have the lowest analyst earnings growth estimates for 2010 (a low hurdle to jump across).

The envelope please …

…the winners would be consumer staples, health care and technology.

Note that these three sectors should also benefit from a weaker U.S. dollar (currency translation effect) given their relatively high share of foreign-derived revenues. We may not be bullish on the overall market, but it does not mean that investors should completely shun the space … there are specific opportunities out there.

Is Jim Grant the Latest To Be Drinking the Kool-Aid?

David Rosenberg of Gluskin Sheff comments on Jim Grant’s WSJ column:

The Weekend Journal ran with an article by James Grant, which admittedly took us by surprise (he is a true giant in the industry, as an aside) — From Bear to Bull and in the article, he relies mostly on the thought process from two economic think-tanks — Michael Darda from MKM Partners and the folks over at the Economic Cycle Research Institute.

We highly recommend this article for everyone to read to understand the other side of the debate. But we have some major problems with the points being made.

1. Mr. Grant starts off by saying that “as if they really knew, leading economists predict that recovery from our Great Recession will be plodding, gray and jobless.” Well, frankly, it doesn’t really matter what “leading economists” are saying because Mr. Market has already moved to the bullish side of the debate having expanded valuation metrics to a point that is consistent with 4% real GDP growth and a doubling in earnings, to $83 EPS, which even the consensus does not expect to see until we are into 2012. We are more than fully priced as it is for mid-cycle earnings.
2. Nowhere in Mr. Grant’s synopsis do the words “deleveraging” or “credit contraction” show up. Yet, this is the cornerstone of the bearish viewpoint. Attitudes towards homeownership, discretionary spending and credit have changed, and the change is secular, not merely cyclical. After all, didn’t consumers just see a record $20 billion of outstanding credit evaporate in August?
3. Mr. Grant emphasizes (the Darda argument) how we had a huge bounce in the economy after the worst point of the Great Depression (in fact, the subtitle of the article contains: “The deeper the slump, the zippier the recovery”). Well, we didn’t have the Great Depression this time around — real GDP did not contract 25% but rather by 3.7%. We probably have to go now and redefine what a massive slump is. But all we had in the mid-part of the 1930s — between the worst point in 1932 to the 1937-38 relapse — was a statistical recovery, and nothing more than that. Nobody from that era will recall that any year was particularly good — each one was just different shades of pain and sacrifice. By the end of the decade, the unemployment rate was still 15%, the CPI was deflating at a 2% annual rate and the level of nominal GDP, as well as industrial production, still had yet to re-attain its 1929 peak. The equity market in 1941 was no higher than it was in 1933 (and long bond yields were heading below 2%) and even a child knows that it was WWII that brought the economy out of its malaise, not the seven years of New Deal stimulus.

So, to concentrate on the wiggles in the GDP data in the 1930s, no matter how large, totally misses the point about what the decade was really about, which was social change, a focus on family, less discretionary spending, and a trend towards frugality that few market pundits seem to comprehend. But the 1930s were the antithesis of the 1920s — not unlike what we are witnessing today. To concentrate on a bungee jump that wasn’t even sustained is akin to focusing on the noise around the trend-line as opposed to the trend-line itself.

4. The very sexy argument about how all the government stimulus is going to give the economy a really big lift — combined monetary and fiscal measures are worth 19.5% of GDP. This is viewed as a good thing, of course, but nowhere in the analysis is there a comment about how this “stimulus” is just there to cushion the blow and smooth the transition as wide swaths of private sector credit vanish. We are at the point where 85% of housing activity is still being supported by government interventions. Is this really desirable? According to BusinessWeek, it’s not just the FHA financing 40% of new mortgage originations but the USDA is also allowing builders and lenders to take advantage of rural mortgages that require no-money down and with 100% financing through “a little-known loan program”.

Well, as with most bulls, this new era of state capitalism is a reason to rejoice. But from our lens, what would be more noteworthy would be an article explaining that the massive government incursion with all this “stimulus” is actually more a reason to be concerned than be jubilant — what it really symbolizes is an economy that is so sick that it continues to require massive doses of medication.

It’s not what all the stimulus does that matters — of course, it is there to act as a cushion — but it is what all the stimulus has come to symbolize. A fundamentally weak economic backdrop and a precarious banking system that has government guarantees to thank for its survival.

Janet Yellen’s Superb Speech

Ask and you shall receive. Here’s your double dose of Rosie for the evening. From today’s daily letter:

San Francisco Fed President Janet Yellen delivered a superb speech last night that really resonated with us — a true reality check for a stock market which has galloped ahead by 54% from the lows, purely on a record eight point expansion of the P/E multiple. The move in equity valuation suggests that stock market investors are anticipating 4% real GDP growth in the coming year. Janet Yellen has proven to be one of the more astute economic forecasters at the Federal Reserve and so we thought it prudent to re-print part of her sermon.

First, the good news

“I’m happy to report that the downturn has probably now run its course. This summer likely marked the end of the recession and the economy should expand in the second half of this year.”

A slow motion recovery lies ahead

“But I regret to say that I expect the recovery to be tepid. What’s more, the gradual expansion gathering steam will remain vulnerable to shocks. The financial system has improved but is not yet back to normal. It still holds hazards that could derail a fragile recovery. Even if the economy grows as I expect, things won’t feel very good for some time to come. In particular, the unemployment rate will remain elevated for a few more years, meaning hardship for millions of workers. Moreover, the slack in the economy, demonstrated by high unemployment and low utilization of industrial capacity, threatens to push inflation lower at a time when it is already below the level that, in the view of most members of the Federal Open Market Committee (FOMC) best promotes the Fed’s dual mandate for full employment and price stability.”

Sorry, but the credit crisis is not over

“Unfortunately, more credit losses are in store even as the economy improves and overall financial conditions ease. Certainly, households remain stressed. In the face of high and rising unemployment, delinquencies and foreclosures are showing no sign of turning around. The delinquency rate on adjustable-rate mortgages is now up to about 18 percent, and, on fixed-rate loans, it’s about 6 percent. Delinquencies on both types of loans have increased sharply over the past year and are still rising. This trend is consistent across other major loan categories, and is affecting high- and low-quality borrowers alike. Even recent-vintage loans are experiencing rising delinquency rates …

…As I said, financial conditions are better, but not back to normal. And the likelihood of continuing losses by financial institutions will add new fuel to the credit crunch. In particular, small and medium-size banks could experience damaging losses on commercial real estate loans. Thus far, the largest losses have been on loans for construction and land development. Going forward, however, rising loan losses on other commercial real estate lending is likely because property values are falling, office vacancy rates are rising, and credit remains tight or nonexistent for those many property owners that will need to refinance mortgages over the next few years. Financial contagion from this sector is one of the most important threats to recovery.”

Severe consumer headwinds

“The chances are slim for a robust rebound in consumer spending, which represents around 70 percent of economic activity. Of course, consumers are getting a boost from the fiscal stimulus package. But this program is temporary. Over the long term, consumers face daunting issues of their own. In fact, it’s easy to draw a comparison between the financial state of households and that of financial institutions. For years prior to the recession, households went on a spending spree. This occurred during a period that economists call the “Great Moderation,” about two decades when recessions were infrequent and mild, and inflation was low and stable. Credit became ever easier to get and consumers took advantage of this to borrow and buy. Stock and home prices rose year after year, giving households additional wherewithal to keep spending. In this culture of consumption, the personal saving rate fell from around 10 percent in the mid-1980s to 1½ percent or lower in recent years. At the same time, households took on larger proportions of debt. From 1960 to the mid-1980s, debt represented a manageable 65 percent of disposable income. Since then, it has risen steadily, with a notable acceleration in the last economic expansion. By 2008, it had doubled to about 130 percent of income.

It may well be that we are witnessing the start of a new era for consumers following the traumatic financial blows they have endured. The destruction of their nest eggs caused by falling house and stock prices is prompting them to rebuild savings. The personal saving rate is finally on the rise, averaging almost 4½ percent so far this year. While certainly sensible from the standpoint of individual households, this retreat from debt-fueled consumption could reduce the growth rate of consumer spending for years. An increase in saving should ultimately support the economy’s capacity to produce and grow by channeling resources from consumption to investment. And higher investment is the key to greater productivity and faster growth in living standards. But the transition could be painful if subpar growth in consumer spending holds back the pace of economic recovery.”

Read more »

It’s Not “Liquidity” Driving the Market

What’s that? You need more cowbell David Rosenberg? Here’s Rosie in his daily letter explaining how it’s not liquidity that’s driving the market:

You can always rest assured that a peak is at hand when you read and hear about how “liquidity” is driving the market.  For one, nobody even has a clue as to how “liquidity” is even defined.  It’s basically a catch-all term for “I don’t know”.  But what we do know is that short covering remains an important source of buying power for equities as the bears bail out — short interest on the NYSE, for example, shrunk 2.4% in the second half of August, and was down 2.9% on the Nasdaq.  Just in case you were wondering how it was that the S&P 500 managed to advance 20 points in the second half of the month.

The truth of the matter is that investment grade corporate bonds have outperformed the S&P 500 by 70 basis points so far this year — income at a reasonable price remains a primary theme.  The problem with the equity market is that dividends no longer comprise a critical part of the total return pie as it used to.  The reliance now is almost purely on capital appreciation, which can be secured when unit labour costs are falling at annual rate of at least 5%, as has been the case over the last two quarters.  However, that rate of decline cannot possibly be sustained.  But what can be sustained, and likely will be, is the deflationary backdrop in private sector demand, which influences the revenue line.  Take note that 250 S&P 500 companies cut their dividends in 2Q, the highest number in over 50 years (and as per the WSJ, stock buybacks have declined now for six quarters in a row).

Take note that the Fed is now pumping reserves aggressively into the banking system again, with the monetary base accelerating at a 141% annual rate over the past four weeks.  But the money multiplier is still contracting — over this time frame, M1 has contracted at a 28.7% annual rate; M2 has fallen at a 4.9% annual rate; and MZM has shrunk at a 6.2% annual rate.  In other words, and with all deference to the excitement that a 50%+ bear market rally can engender in the media, the credit system is still … broken.  When the investment community eventually figures out that the economy is not in, or even is it entering, a V-shaped recovery there will undoubtedly be a new round of deflated price discovery, followed by years of anemic economic growth, persistently high unemployment, ongoing consumer frugality, rising savings rates, and a prolonged period in which portfolios will move further towards strategies that provide income and preservations of capital rather than a focus on aggressive capital appreciation potential.

Rosenberg: A Vote for Bonds Over U.S. Stocks

This is from an interview with Rosie in Barron’s:

The equity market is de facto priced for 4% real GDP growth. The corporate-bond market is priced for 2% real GDP growth. So in terms of asset mix, it’s pretty clear that you have more downside protection in corporate bonds right now than you have in equities. And if you can tolerate the risk, you can pick up a 12% coupon in the high-yield market. But if you are a more cautious investor, you have an array of solid investment-grade securities in the A-rated universe where you can pick up a 6% yield. With a negative 2% inflation backdrop, that equates to an 8% real yield — a very juicy rate of return. In the equity market, you have a 4% earnings yield plus a 2% dividend yield, and you are in a riskier part of the capital structure. Corporate bonds are priced for the sort of recovery I have in my forecast.

We are in a post-bubble credit-collapse environment, and what is critical is capital preservation and income. Asset mix is extremely important. We at Gluskin Sheff have a cautious view toward U.S. equities. We’re more positive on Canadian equities, given that the banks are stable and the commodity market is in a bull phase. We’ve been big fans of corporate bonds, though, admittedly, a good part of the low-hanging fruit is behind us. But they will be relative outperformers.

The rally in the U.S. equity market has been so pronounced that it is no longer just pricing in the end of the recession. It is pricing in two years of recovery. At this stage, there is a little too much risk. If the S&P 500 were to correct back to around 840 or 850, versus 1025 recently, I would be much more interested.

Read the full interview here

Rosenberg: Five Points on the Markets, Earnings and Economy

The always insightful David Rosenberg makes the following five observations:

Five Points Worth Making on the Markets, Earnings, and the Economy

1. This remains a hope-based rally (with strong technicals). I say that because during this six-month 50%+ rally in the S&P 500, the U.S. economy has shed 2.4 million jobs, which is almost as many as we lost during the entire 2001-02 tech wreck — in just six months. The market’s ability to shrug off the loss of 2.4 million jobs is either a sign that it is treating this as old news or sees the cost-cutting as good news for profits. Either way, what we are seeing transpire is without precedent — the magnitude of the employment slide versus the magnitude of the market advance. Truly fascinating stuff.
2. Companies have not really been beating their earnings estimates — only the very final estimates heading into the reporting quarter. For example, the consensus view for 3Q EPS at the start of the year was $21.00, last we saw the estimates were down to just over $14.00. But there is a deeply rooted belief that earnings are coming in better than expected. This is a psychology that is difficult to break. It is completely unknown (for some reason) that corporate revenues are running at a -25% YoY rate, which compares to the -10% we saw at the worst part of the 2001-02 bear market and the -3% trend at the most negative point in 1991.
3. Valuation is a poor timing device but even on “normalized” trailing 10-year earnings, the S&P 500 is trading near 18x, which is now above the historical average of 16x.
4. All the growth we are seeing globally this year is due to fiscal stimulus; not just here in Canada and the U.S., but also in Korea, China, the U.K., and Continental Europe too. For 2010, the government’s share of global growth, by our estimates, will be 80%. In other words, there are still very few signs that organic private sector activity is stirring. For a Keynesian, government stimulus is necessary, but the question for an investor is the multiple one attaches to a global economy that is still relying on a defibrillator. The problem is that governments do not create income or wealth, and today’s stimulus is really a future tax liability. Curiously, that future tax liability is likely going to pose a roadblock for the return to a “normalized” $80 operating EPS estimate that strategists are now starting to pen in for 2011.
5. While Mr. Market may be pricing in a fine future for the U.S. , but when the 3-month Treasury-bill yield is 13bps north of zero, which is completely abnormal, you know that there are still substantial fundamental imbalances that need to be worked through.

Rosenberg: The U.S. Solution to Fighting the Credit Crunch? Take on More Credit

Alternative title: Give Another Bottle of Scotch to the Drunken Sailor

Rosie laying it down:

No wonder we are seeing a housing recovery, and it’s not just about the $8,000 tax credit for first-time buyers.  How does the White House possibly allow this extra goodie to expire in November?  The FHA is picking up where subprime lenders left off: the agency has seen its mortgage business jump 70% in the past year (!) and its market share in just three years has gone from 3.0% to 23% — it is allowing borrowers to finance up to 96.5% of homes priced all the way up to $729,750.  Guess what, the default rate has risen to nearly 7% from 5½% a year ago.  And, it is the taxpayer that is going to be picking up this tab … again!  So, the policy formula here is that after excessive leverage got us into this mess, is to encouraging even more debt and come to think of it, Cash-for-Clunkers did the exact same thing — enticing people who were probably quite content with their jalopy to take on more than $10 billion of new debt.  Amazing.  It’s like giving another bottle of scotch to the drunken sailor, but hey — we can’t have the economy weak going into a mid-term election year now, can we?