Two things of note in today's Rosie piece. On one hand he breaks out the 10 good and bad things that investors are factoring, and while focusing on the positive, and completely ignoring the negative, are pushing the market to its best start since 1997. As Rosie says: "The equity market has gotten off to its best start in a good 15 years and being led by the deep cyclicals (materials, homebuilders, semiconductors) and financials — last year's woeful laggards (the 50 worst performing stocks in 2011 are up over 10% so far this year; the 50 best are up a mere 2%). Bonds are off to their worst start since 2003 with the 10-year note yield back up to 2%. The S&P 500 is now up 20% from the early October low and just 3.5% away from the April 2011 recovery high (in fact, in euro terms, it has rallied 30% and at its best level since 2007)." Is there anything more to this than precisely the same short-covering spree we saw both in 2010 and 2011? Not really: "This still smacks of a classic short-covering rally as opposed to a broad asset- allocation shift, but there is no doubt that there is plenty of cash on the sidelines and if it gets put to use, this rally could be extended. This by no means suggests a shift in my fundamental views, and keep in mind that we went into 2011 with a similar level of euphoria and hope in place and the uptrend lasted through April before the trap door opened. Remember too that the acute problems in the housing and mortgage market began in early 2007 and yet the equity market did not really appreciate or understand the severity of the situation until we were into October of that year and even then the consensus was one of a 'soft landing'." Finally, Rosie steps back from the noise and focuses on the forest, asking the rhetorical question: "Isn't this still a "modern day depression?" - his answer, and ours - "sure it is."
From Gluskin Sheff
What has investors in a better mood? A few things:
1. The survey data so far for January suggests the U.S. economy is still chugging along, especially in the industrial sector. The latest jobless claims data must be taken with a grain of salt (as is usually the case in December and January), but they are trending down nonetheless and that is encouraging for the bull case. Meanwhile, the weekly ECRI leading economic index just tested its best level in five months.
2. The latest GDP and manufacturing data out of China suggest the 'soft landing' crowd has the upper hand.
3. The move by Draghi last month to provide massive ($634 billion!) low-cost three-year funding for the Eurozone banks is widely seen as a very shrewd move to buy time, help the banks delever, and provide back-door funding for the government sector. We are hearing that another major cash infusion from the ECB is coming in February, and likely to be even larger.
4. The ECB has managed to build enormous credibility with the crowd that craves bailouts — to the point where at 2.68 trillion euros its balance sheet is now bigger than the Fed's, having expanded by more than 40% since the mid-part of 2011. Markets work on probabilities and Lehman-like tail-risks have been dramatically reduced by the ECB's incursion.
5. The European bond auctions are going very smoothly this year and most cases, even in the case of Spain and Italy, have been oversubscribed. The worries two months ago over a failed German bund auction are now a distant memory.
6. It looks like Greece is going to reach an agreement with its creditors after the recent impasse.
7. Italy's Mario Monti is proving to be someone that the ECB and Germany can work with the latest accommodations would not have occurred otherwise. Monti is very well respected and is going ahead with major fiscal belt-tightening and tough competitiveness initiatives despite the spectre of massive public sector strike action.
8. There is a growing chorus of calls for a new QE3 out of the Fed, which would primarily include mortgage paper. The Fed's new mode of communicating by providing the median FOMC forecast of where the funds rate is heading is widely expected to show a sustained near-zero level through 2014.
9. Signs of not just a thaw, but a real recovery in housing sales and starts, have created quite a bit of enthusiasm lately— and this is a view espoused by the legendary housing guru, Ivy Zelman.
10. While this has been quite a challenging earnings reporting season, both IBM and Microsoft served up better-than-expected results while Intel's guidance was pretty good — and this has resonated through much of the tech space.
At the same time, there are some nagging issues that could derail this market recovery at any time:
1. That the ECB and Angela Merkel (who now does not want private sector entities to bear losses) have done an about-face to such an extent that it suggests that the insolvency problems in Europe are very deep-seated. Without the ECB-financed LTRO (Long Term Refinancing Operation), it seems as though at least one or probably two major Euro area banks would have gone down for the count. The resolution to the Eurozone crisis remains incremental in nature. Political risks in Greece and France should not be underestimated.
2. Has anyone thought through the implications of the Euro area banks becoming totally reliant on funding from the central bank? All this back-door effort to support government bond markets via private financial institutions may make the bank balance sheets completely toxic.
3. Italy has a total 350 billion euro debt maturity Calendar in 2012 — in other words it will be coming to market to auction off its debt in large chunks every week this year. The country's bond market is hardly out of the woods.
4. Don't take your eye off Portugal — it seems to be following in Greece's footsteps and bond yields and CDS spreads have been surging there of late, to very little fanfare.
5. China's property market is deflating and this deflation is spreading regionally. That doesn't sound too stable.
6. The U.S. housing market is still beset with a flood of foreclosure-related supply, though it is absorbing it without major disruption. Levels of activity are still extremely depressed and pricing remains weak.
7. It is tough to square a vibrant global growth view with the latest chart action as it pertains to the Baltic Dry Index (which tracks the cost of shipping major raw materials like iron ore, coal, grain, cement, copper, fertilizer, sand and gravel). It is down a whopping 50% in just the past month! Moreover, it is equally difficult to square this renewed confidence in the economic outlook with the downward revision to global oil demand growth by the 'EA to 1.1 mbd for 2012 from 1.3 mbd (oil consumption actually contracted 309,000 bpd in 2011 Q4 from a year ago).
8. Political risks in the Middle East remain a key wild card for the oil price backdrop.
9. Ongoing lack of progress in dealing with structural debt imbalances in the U.S. and Japan — demographics in both cases are time bombs.
10.Bad economic policies — it will be interesting to see how the markets react to another four years of Obama as the GOP continues to shoot itself in the foot via what is turning out to be a long and fractious primary season. If you didn't read Peggy Noonan's op-ed piece from the weekend WSJ, I suggest that you do (The No-Obama Drama). To wit:
The bleak thought: Mr. Obama this week blocked Keystone pipeline, a decision that means tens of thousands of jobs lost, new energy possibilities rejected. It is a decision so bad, so political, that it amounts to a scandal. But it just sort of eased through the news, blurrily. All the cameras were focused on the Republicans, who were distracted by their own dramas. They did not, together, in one voice, protest, as they should have. Keystone happened while they were busy looking like the Keystone Kops".
Another column worth reading today on this topic can be found on page A17 of today's WSJ, appropriately title Obama's Keystone Delay Flouts the Law.
Isn't this still a "modern-day depression?"
Sure it is. And just as we saw in 1933, 1934 and 1935, the economy and the stock market can experience a brief cyclical recovery, especially given all the massive monetary intervention by the central banks, but the fragility and vulnerability never go away, and neither does the hardship for many. Yes, yes, the stock market has doubled off the March 2009 lows. Yet, since that time, more than 11 million Americans have joined the food stamp program, including 4.4 million in 2011 alone. That may not fit into your definition of depression, but it does for these folks, I am sure.
The labour force has contracted by over 800,000 since the recession ended — this too is unprecedented. Assuming that the 200,000 payroll gain in December was the real deal, it would take 30 more of these to get employment back to where it was when the recession began four years ago. Real per capita personal disposable income in the U.S. has not grown for six years — despite trillions of dollars of government stimulus. If that's not a 'depression' outcome, then please come forward with your definition.
If you exclude the mountain of government social benefits, real income on a per person basis has rolled all its way back to where it was in 2001! Interest rates have been 0% for over three years and governments around the world have blown their fiscal finances out of the water in order to save insolvent banks and save economic activity from implosion. In fact, as a result, there has been such a radical decline in creditworthiness coming out of the Great Recession, that the pool of sovereign bonds that have unblemished AAA ratings has plunged to $4.5 trillion from $16.9 trillion (see page C12 of last Thursday's WSJ). That is a 73% nosedive and a reminder for investors that in the name of owning "scarcity", high-quality paper is noteworthy for its dwindling supply.