This week I offer something unusual for outside the Box, in that I agree on almost all points with my friend David Rosenberg, except he tells it so much better than your humble analyst. David was the former Chief Economist at the former Merrill Lynch (ah, Mother Merrill, we barely knew ye.) and is now Chief Economist at Gluskin Sheff + Associates Inc., which is one of Canada’s pre-eminent wealth management firms. Founded in 1984, they manage $4.4 billion. (For those who wonder, David left NYS to return home to Toronto. Much shorter commute time.) David looks at the recent stock market run-up, why he likes corporate bonds better than stocks, what is lagging with the consumer and a lot more. It is a very pithy read.
Have a good week, I am off to a beach in a few days, but there will be an e-letter this Friday. You are in good hands.
Your looking forward to reading with drinks with little umbrellas analyst,
John Mauldin, Editor
Outside the Box
Breakfast with Dave
by David A. Rosenberg
MARKET THOUGHTS
The Dow is coming off its best weekly performance since March 2000, and if memory serves us correctly, that month was marking the beginning of the end of the great bull market at that time. While the bear market rally has been of 1930 proportions, from our lens, that is what it remains and what is lacking in this extremely flashy runup in equity prices are: (i) leadership, (ii) quality, and (iii) volume. There were some very useful statistics in Barron’s (despite the fact that the headline in the ‘The Trader’ column is Why the Rally Should Keep Rolling … for Now):
- The 50 smallest stocks have rebounded 17.2% from their nearby July 10th lows, outperforming the largest 50 stocks by 750 basis points.
- The 50 most shorted stocks have rallied 17.6%, outperforming the 50 least shorted stocks by 880 basis points (over the same time frame).
- The 50 stocks with the lowest analyst ratings have outperformed the 50 with the highest ratings by 380 basis points.
- 85% of the market has already broken above their 50-day moving averages, which in some sense highlights an overbought market, but the other three factoids still attest to a low-quality rally, which is best left for traders and speculators. As tempting as it is to jump in, history is replete with examples of these sorts of short-covering rallies ending very quickly and with no advance notice from analysts, strategists or economists for that matter.
Let’s put aside the conventional wisdom that the stock market puts in its fundamental bottom 3-6 months ahead of the recession ending; it actually bottoms ahead of the economic recovery. That was the lesson of 2002 — recessions can end, but without a recovery there can be no sustainable bull market, though hopes can certainly bring on bouts of euphoric behaviour as we saw in the opening months of 2002 when the Nasdaq surged 45% and as we are seeing currently in the major averages. Japan is another great example. Its economy was out of recession 80% of the time in the 1990s and yet the lack of any sustainable recovery was largely behind its secular bear market. For a great reality check on the situation, have a read of Henry Kaufman’s piece on page 37 of Barron’s (A Long Road to Recovery). To wit:
“Some experts also expect the economy to get a boost from business inventory restocking. Maybe so, but most likely as a one-time event. Firms take on inventory if demand rises, if they expect higher prices and if they expect bottlenecks in the supply chain. But excess capacity is high, and there are no bottlenecks.”
We also believe that the current edition of BusinessWeek is a must-read — there were lots of good stuff in there this weekend, some of it following in Mr. Kaufman’s footsteps (page 14 — A Second Half Recovery Could be Fleeting). To wit:
“Will the upturn last? The question arises because the early stage of the recovery is going to be production-led, not demand-led … to keep the production rebound — and the recovery — going into 2010, overall spending will have to pick up, and that’s the big uncertainty given the headwinds facing consumers.”
There is no doubt that inventories have been pared back over the past four quarters at a record rate, and that the ISM customer inventory index is running at extremely tight levels. That said, the NFIB inventory plan index remains very weak, so what we have contributing to GDP in the third quarter is a mathematical boost to the economy from a lower rate of destocking; much of this in the auto sector. To actually move towards a sustainable inventory cycle, businesses will have to see final sales revive. What businesses have done is essentially recognize that the secular credit expansion has moved into reverse and the process of deleveraging in the consumer and financial sectors is ongoing. So, what companies have done in their re-assessments is to re-align their output schedules, order books and staffing requirements in the context that there will be a whole lot less credit to support any given level of production in the future.
What is very likely going to be missing going forward is the consumer because while it is the “back end” of the economy that helps bring recessions to an end as inventory withdrawal subsides, it is the “front end” that causes the expansion to endure — in normal cycles, that is. Historically, consumers end up adding 3.5 percentage points to real GDP growth in the first year of an economic renewal. As the economic editorial in BusinessWeek puts it, “this time, that’s most likely impossible.”
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