It is time to take a big picture look at everything: This is a summation of everything we have discussed over the past month and quarter. Where are we in this particular cycle?
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Macro-Economy: The economic backdrop seems to be confusing quite a few people. Perhaps its the psychology of the moment. I keep hearing weak, data free analysis. Here is our 7 point overview:
1. The Economy is recovering; The recession is over: Of that, we have no doubt, as the data is clear. The free fall of 2008-09 is over, and a gradual improvement is seen across the board. Industrial manufacturing, exports, autos, retail sales, durable goods, travel all confirm the economy is “healing.”
2. But, the recovery is “Lumpy”: — Part of the reason some people doubt the recovery story is how unevenly distributed the improvements are. Geographically, much of the country is still soft. In retail, it is pent up demand plus luxury goods. In technology, its mobile devices and consumer products. Financial firms are taking advantage of the steep yield curve and ZIRP to arbitrage profits, as opposed to actually lending. Profits are not evenly distributed either.
3. Government spending is only part of the story: In the midst of the crisis, Credit froze, the consumer panicked, and business spending looked to be going extinct. Uncle Sam temporarily bridged the gap.
But the argument that government spending is the only game in town is overstates the case. Private sector CapEx spending and hiring is improving (albeit slowly); Consumers have come out of their bunkers and are dining out, going to the movies, hitting the malls, traveling.
We have not returned to the Home ATM days of 2004-07 — and probably wont in our lifetimes — but the present environment is a massive improvement from the 2008-09 contraction.
4. Weak Improvement in Employment: The massive labor under-utilization is one of the two biggest drags on the economy (RE being the other). Near record low hours worked suggest that employers can simply increase hours rather than make new hires. Thus, I do not look for a V-shaped employment recovery — forget about 400-500k NFP data — anytime soon.
There are 15 million unemployed, and 8 million underemployed — it will take a long time for them to be re-absorbed into the economy. The 2001 recession took 47 months to return employment to pre-recession levels. This recession will likely take 65-75 months to achieve that goal — if not longer.
5. Real Estate (Commercial and Residential): We do not believe that residential real estate has found its natural price level yet. It remains over-valued. This is due to artificially low mortgage rates, foreclosure abatements and mortgage mod programs. We are probably 10-15% over valued, when measured by Median Sales price to median Income, Rent vs Ownership Costs, and Home Value as a Percentage of GDP.
Commercial real estate tends to lag residential by 18-24 months. It is still adapting to the downsizing of America, particularly retail. The over-investment in commercial real estate of the past decade will take at least another 5 years to resolve, if not longer.
6. Deflation? Inflation?: Well, as my pay Jeff Saut notes, we definitely have “flation.” Just not the type that everyone fears.
As of today, Deflation is a fact, inflation is an opinion. We are still living in a period of falling prices, heavy discounts, wage deflation, asset depreciation and lack of pricing power. The S&P500 is below levels seen in the 1990s; Wages are flat for a decade.
The risk going forward is that the Fed fails to remove the accommodations in time. But they have Japan as an example of Zirp with no inflation. So long as labor under-utilization is near record levels, they can take their time in tightening.
7. The rest of the world: Europe is a disaster, and is likely to remain that way for a while. Asian economies are doing very well, helping to pull the rest of the world along — but China’s market is at 6 months lows, something few people are discussing. The risk in China’s real estate and stock markets has been mostly ignored,. Commodity regions and emerging markets still have strength.
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Market Overview: Unfortunately, most of the commentary we see about markets have been unusually ignorant, myth driven, and based on rationalizing bad decision making.
Our views:
1. Cyclical Bull, Secular Bear: The secular bear market collapse of 55% was right in line with other such debacles. The collapse was faster and more furious than typical, but the depth was normal. The snapback is also well within the range of bear market rallies — cyclical bull runs that last 6 to 24 months and range from 25% to 135%.
While it is possible that we are witnessing the start of a new 1982-like Secular bull market, the valuations argue against it. Stocks most likely simply did not get cheap enough — or despised enough — to initiate a multi-decade bull run. My best guess about that bottom is its likely 3-7 years away.
2. Snapback: The 75% bounce over a year seems like a lot — until you put it into the context of a six month 5,000 point collapse. we call that the Armageddon trade — Dow 5000! 3000! We’re going to zero! – was a spasm of panic. It has been mostly unwound the past year.
3. Correction coming (eventually): The cyclical bull tends to end with ~25% correction that lasts about a year. So we are always looking for signs that this run is over. Despite the recent turmoil, we have not found confirmation that the bull run is over — yet.
We look at many factors to help identify that inflection point:
4. Liquidity: Institutional fund managers seem to be all in (only 3% cash), while Investors are at only median levels of equity exposure. Liquidity is still abundant, free money abides. Money flow for the past few months have gone into US equities — that is a new element — at about $2B per week.
5. Internals: The market technical/internals remain constructive: Breadth and momentum are positive. New 52 week highs are also strong. Earnings are supporting some of the move, as year over year comparos are absurdly easy. The uptrend remains in place, and until it is broken we maintain an upside bias.
6. Sentiment: The biggest risk is the unusually high level of bulls. Note however that event hat has moderated over the past week. We are not at the sorts of extremes yet that make the contrarian in us scream SELL.
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Next week, we’ll look at Macro Overview: Investing & Psychology
All of the above are things we have discussed over the past year — use the search function (top right) orthe category list (bottom right) for the prior posts . . .
75 months? Lessee that translates to, carry the 5, add the 2—-6 years and change.
Anyone think that anyone can predict 6 years into the future with less than plus or minus 100% margin of error?
“But the argument that government spending is the only game in town is overstating it. Private sector capex spending and hiring is slowly improving; Consumers have come out of their bunkers and are dining out, going to the movies, hitting the malls. ”
Wrong.
A data driven but ahistorical analysis.
One quibble. Nothing has changed. We’re back into the sea of liquidity; like a kid in the bath with its eye on the serenely floating rubber ducky. The trouble is that the plug can be pulled easily and rapidly and we don’t know by whom. The hidden gargantuan of derivatives connects invisibly. The obvious suspect for plug puller is Greece. Since Mark Mobius recommended the jingle mail approach as the only practical way out it’s not thinking the unthinkable. The plug can be pulled quickly by the black swans swimming unseen but instinctually we know there are more of them out there than ever. frankensteinian surgery has been done to save the financial system but we have no clear control over the beast. As all is now interconnected by global neurons life comes at you fast at the speed of Lehman.
You are extrapolating an anomalistic consumer spending report into a trend. Seems like a reach, and without a fully particpating consumer we tread water at best, collapse at worst.
Pick and choose what you wish. The market is living a lie, built on investor psychology – monkey see monkey do. Where is the rational actually coming from? No building recovery to speak of. Is it not an old axiom that you can’t have a recovery without a building recovery? Retail sales when compared to an average year are still down 50%. Lets face it some times the capitalistic model just gets broken!
“Unfortunately, most of the commentary we see about markets have been unusually ignorant, myth driven, and based on rationalizing bad decision making.”
I keep hearing this myth repeated. Got data? I’ve been long stocks for over a year, even though I’ve been looking for a correction since last June. And yes, I expect a new, lower low on the indexes. Who says “most” bearish commenters are “rationalizing” bad decisions?
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BR: To date, that would be Mr. Market . . .
BR, do you have a comment about the chances of SP500 earnings for 2010 reaching what Bloomberg indicates could be consensus earnings of very near $86 vs $90 in the trailing twelve months prior to September, 2007 (http://preview.bloomberg.com/news/2010-04-25/stocks-in-u-s-cheapest-since-1990-as-analysts-rush-to-increase-estimates.html). It’s not clear to me from the article that it’s consensus or the high end of estimates, however. If it is consensus, then we’re at a reasonable 14 p/e on forward 2010 estimates which is quite a substantial discount to the growth rate of the earnings.
I have been thinking that with earnings being so robust, it’s logical to think that the SP500 could reach levels of 2007, perhaps into the 1500’s should the earnings come near those estimates. For 2011, it’s not out of the question to see $100 eps. Should p/e multiple expansion occur, a move up could gather a pretty good head of steam. Obviously, I am assuming the sovereign debt crises around the world are more of a distraction creating a wall of worry, and don’t derail the earnings momentum.
Interesting to note the highly skeptical, bearish bent of the early comments. I’ve noticed in the comments section of The Big Picture that this kind of sentiment is something that has remained remarkably unchanged during the rally from the March, 2009 lows.
A little elaboration. The problem I have with Barry’s analysis of the data is the frame of reference that he uses to draw his conclusions from the data. Barry’s implicit assumption seems to be that this recession is only different in magnitude from any other post-WWII recession. He also seems to have a particular emphasis on the post-1980 data for comparison – a time of high and declining inflation and high and declining interest rates – the polar opposite of our situation now. (I’m guessing this is because Barry considers these data to be the most accurate and complete.)
I believe this leads Barry to the same error made by so many others back in the spring of 1930 after the economy seemed to stabilize and the stock market made a 50% recovery from the crash.
Are we that much smarter than they were back then? Do we really understand how these kind of crises play out? Do the monetary and fiscal authorities know how to deal with a world wide economy with interest rates at the zero bound? My answers are no, no and no.
For Barry’s sake, for his clients sake, for all our sakes I hope I’m wrong but I won’t be betting any money on it (and I’ll be paying more attention to David Rosenberg’s analysis which incorporates at least some history and recognition that this is more like your grandfather’s recession than your father’s.)
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BR: I have not yet developed an opinion as to whether we see a 1932-like crash (yet).
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