David Rosenberg is a 20 year veteran of the Street, David most recently was Merrill Lynch’s chief North American Economist, where he correctly warned about the Housing and Credit Collapse and Recession in advance. He is the Chief Economist of Canada’s Gluskin Sheff
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
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.
We noted last week that the Nikkei posted six 20%+ rallies since its bubble
burst in 1990 and no fewer than four 50%+ rallies. Indeed, you can count
423,000 rally points from all the up-days since the secular bear market began in
1990 and yet the index is down 74% since that time. So actually, there is
nothing in this flashy move off the lows in the S&P 500 that is inconsistent with
a pattern of a bear market rally — this is not the onset of a whole new
sustainable bull market. These are rallies than can only be rented, not owned,
and are purely technically-motivated and momentum-driven. They are not
premised on improved fundamentals, despite data that are skewed to the
upside by rampant government intervention. Just remember, nobody ever built
more bridges or paved more river beds to skew the economic data than the
Liberal Democratic Party (LDP) did in Japan for much of the 1990s.