Yesterday, we breached the topic of the real decoupling that is going on: that between the macro and the micro (not some ridiculous geographic distribution of the US versus the world), by presenting David Rosenberg's thoughts on why Q4 GDP has peaked and why going forward it is energy prices that are likely to be a far greater drag on incremental growth than the preservation (not the addition as it is not incremental) of $10 per week in payroll taxes (which only affects those who are already employed), even as company earnings and profit margins have likely peaked. Today, following up on why the micro is about to return with a bang, and why fundamentals are about to become front and center all over again, albeit not in a good way, is, surprisingly, Morgan Stanley's Mike Wilson, who has issued his loudest warning again bleary eyed optimism for the next year: "Think of 2012 as the “payback” year….when many of the extraordinary things that happened over the past 3 years go in reverse. I am talking about incremental fiscal stimulus, a weaker US dollar, positive labor productivity, and accelerated capital spending." Said otherwise, 2012 is the year when everything that can go wrong in the micro arena, will go wrong. And this is why Morgan Stanley being bullish on the macro picture! As Wilson says, his pessimistic musing "tells the story for what to expect in 2012 assuming the situation in Europe doesn’t implode. In other words, this is not the macro bear case." If one adds a full blown European collapse to the mix, then the perfect storm of a macro and micro recoupling in a deleveraging vortex will prove everyone who believes that 2012 will be merely a groundhog year (in same including us) fatally wrong.
Lastly, when it comes to predictions Morgan Stanley (which called the EURUSD short the hour Goldman put it on as a long) should be taken far more seriously than Goldman, which merely wants to be on the other side of its clients.
The complete very troubling forecast from Morgan Stanley:
With thin markets at year end, changes at the margin can have maximum impact on asset prices. This includes policies like the LTRO as well as the Taiwanese government directly buying stocks! Knowing this, many pundits are keeping the dream alive for a Santa Claus rally. Unfortunately, I think time has run out in 2011 and the best we can hope for at this point is to limp across the finish line without breaking any bones. Having said that, I think there is one more positive catalyst for 2011 that could lead to a final surge. The headline would read something like this: “Merry Christmas! Congress delivers gifts by passing full year payroll tax cut and unemployment benefits extension.” No doubt, this would be good news for stocks since there is enough skepticism on Washington’s ability to get anything done before year end. Of course, it could be bittersweet because it would also likely be the perfect rally to sell into and short.
Whatever the next few weeks brings, I think it’s safe to say that everyone is sick and tired of trading headlines and trying to decipher the next statement/rumor surrounding Merkozy, central bank policies, Washington politics, etc. Whatever happened to getting paid for channel checks or betting on a unique product cycle that isn’t appreciated by the market? Ironically, while all this meddling by the authorities has helped prop up asset prices, it has also made it harder to trade and invest. In my view, this is one reason why volatility remains so elevated. According to our Quantitative and Derivative Strategies team, 5, 10, 22, and 60 day realized volatilities are all in the 26-29% range. This is unusual historically, as realized vol has typically fallen by this point in the year. It’s quite possible this higher volatility has compressed multiples and raised correlations, both of which are counterproductive to central banks’ objectives.
The good news is that the fundamentals are about to take front and center stage once again. The bad news is that it is likely to be negative. Specifically, there has been a distinct increase in negative earnings results, preannouncements and/or guidance…..ORCL, RHT, GIS, BBY, WAG, ACN, TIF, ANF, DRI, NTAP, TXN, XLNX, ALTR, AMZN, CRM just to name a few. This is very much in line with my thesis for 2012 that we are likely to avoid an economic recession in the U.S., but we are also very likely to experience an earnings recession. Importantly, consensus estimates do not reflect this reality with bottoms up forecasts still modeling 10% EPS growth for the S&P500 next year and top down consensus in the +4-5% range. While it is a rare outcome to experience positive GDP and negative earnings growth in the same year, it is also just as rare to experience record margins in a world of 9% unemployment and lackluster organic revenue growth. Think of 2012 as the “payback” year….when many of the extraordinary things that happened over the past 3 years go in reverse. I am talking about incremental fiscal stimulus, a weaker US dollar, positive labor productivity, and accelerated capital spending. Exhibit 7 tells the story for what to expect in 2012 assuming the situation in Europe doesn’t implode. In other words, this is not the macro bear case.
The first chart in Exhibit 7 (top left) graphically shows the real deterioration we are now seeing in earnings. I have discussed the rollover in earnings revision breadth many times in prior notes and now we are seeing it meaningfully hit the numbers. We looked at the 20-25 companies that that typically report prior to Alcoa (the official kick off to earnings season) and as you can see in the chart, the trend is disturbing and is now showing outright misses in aggregate. For more details on this, see our Trading Insights out this morning. Second (top right) is just a simple leading indicator for the US ISM mfg index.
It is the y/y change in the S. Korean stocks market (KOSPI). As you can see, while US economic data has persistently surprised to the upside in 2H2011, this trend is likely coming to an end and will begin to rollover again in the new year, perhaps driven by the anniversary of last year’s significant payroll tax cuts. God forbid if Congress doesn’t pass the extension next week. Third (bottom left) is a chart showing the y/y change in the US dollar (DXY) and then a “projected” y/y change assuming various scenarios for DXY over the next 6 months. As discussed here many times, the US dollar has been one of the biggest (if not THE biggest) drivers of SPX earnings growth. For the next 6 months we are potentially facing a much different currency environment that could shave as much as 5-10% off SPX earnings growth on its own. Finally, the last chart shows the relative strength of semiconductors (SOX Index) versus the absolute performance of the SPX. I like this because the SOX/SPX tends to lead the SPX by about 3 months and it suggests the next 3 months is likely to remain rough for US stocks broadly. Since Semis are ultra sensitive to growth, it really suggests that growth is going to struggle in the near term at least from a rate of change standpoint and versus expectations. All of this lines up with my conclusion that while everyone is feeling a bit relieved about the tail risk in Europe being taken off the table, we are about to get a reality check from the micro.
