Market's Latest Run Appears Poised for Reversal

David Rosenberg declares, and I think rather accurately, in his June 4th commentary that 'everyone is back in the same trade' (.pdf):

• Buy stocks (massive multiple expansion — S&P 500 priced for $75 operating EPS)
• Buy commodities (still long-term bullish but a pullback is definitely overdue)
• Buy non-Treasury bonds (same story as commodities — long-term bullish on corporates, but supply is now coming in droves and being gobbled up — this is NOT the contrarian trade of six-months ago)
• Buy gold (again, in a secular bull phase, but the dollar is not going to zero and being bearish on the greenback has become far too fashionable — especially in the wake of Bill Gross’s latest missive; the Euro is saddled with problems at least as deep as the USD, if not deeper)
• And of course, sell Treasuries (that was a good trade coming off the 2% lows on the 10-year note, but what we just saw crammed into six months, which took 48 months to accomplish in the last bear market in govie bonds, was yields soaring 175bps from the low). Sentiment on government bonds is exceedingly bearish and inflation views have become too extreme for my liking. I believe there is a lack of appreciation from what history tells us about the aftershocks that occur after a cycle that was dominated by a credit collapse and asset deflation, as opposed to a garden-variety inventory-led recession. In five words: economic fragility, lingering deflation pressure.

The March-June period transcended the ‘backing away from Armageddon’ trade and recently morphed into a big reflation trade because of booming fiscal deficits and booming money supply growth. The booming fiscal deficits fall far short of offsetting the unprecedented degree of deflationary slack in the economy and are an antidote to the relentless de-leveraging taking place in the U.S. household sector, which commands a 70% share of the U.S. economy and 16% share of global GDP.

The big story of the week that was truly dismissed was the news that the personal savings rate hit a 15-year high of 5.7%, and is on a clear uptrend. It is unclear how far this can go, but I believe it could certainly test if not pierce the 15% post-WWII peak. This process is far from over as the 78 million baby boomer population, whose median age is now 52, focus on incremental retirement savings needs, which will be continuously absorbed out of increasingly scarce organic income. This will be a dead-weight drag on discretionary spending for years, not quarters, and I find too many pundits still living in the old paradigm of Americans shopping till they drop. Maybe on pasta and private-label toothpaste, but the two-decade era of U.S. consumption exceeding income growth is over.

As for the dramatic monetary stimulus, this is only inflationary once velocity begins to rise. But cash requirements in a prolonged de-leveraging cycle are likely to remain intense and the ‘dry powder’ is very likely going to be diverted towards an intense private sector debt rollover calendar for years to come. An examination of the Japanese experience suggests this process could well take years. (Keep in mind that Japan had a consumption bubble emerge alongside its real estate bubble back in the early 1990s.)

For markets, currencies, and asset classes in general, the second half of 2009 is likely to see a big shift in the other direction from what we have seen take place in the last three months, in my view. In a secular bear market, we have to take a more tactical view rather than strictly a strategic view and the latest run appears poised for a reversal.

Comments

[Dave Wrixon:]

Whether it is tactical or strategic depends on the size of the fall and its duration. As the market advances have really no fundamental foundation, then I would expect the collapse to severe, sudden and enduring.

Jun 07 06:36 AM

[Rollerball:]

I believe a reversal will be sudden, and severe, but probably not enduring. It hinges on what terms the majority "liquidity providers" (GS) can negotiate to payback TARP, and what multiple they need to drive the market to profit on that trade. Fewer gamblers are willing to up the ante, and I suspect the house is already building their shorts.

Jun 07 07:41 AM

[Prudent Man...:]

Fighting a trend is always risky, but what isn't? When that trend is based entirely upon unrealistic hope the risks are lower and the Black Swam more evident.

For those we believe the worse is over the question is the economic recession and malaise over? Where are the "help wanted" signs? Many of our largest banks haven't come near foreclosing on commercial and residential units that are over a year in arrears on payments, many abandoned. Auto dealerships, that were profitable, being forced to close by government bureaucratic Fascists.

We cannot solve our problems until we honestly and realistically face them. Government is part of these problems so who is going stop this political engine of destruction that certainly is not creative.

Jun 07 10:27 AM

[Roger Knights:]

"I find too many pundits still living in the old paradigm of Americans shopping till they drop."

We've shopped ...
... and popped ...
... and dropped.

Jun 07 01:35 PM

[Roger Knights:]

"Buy gold (again, in a secular bull phase, but the dollar is not going to zero and being bearish on the greenback has become far too fashionable — especially in the wake of Bill Gross’s latest missive; the Euro is saddled with problems at least as deep as the USD, if not deeper)"

If the euro is as week as the dollar, buying gold is a way of being bearish on both.

Jun 07 01:36 PM

[Go_TBPickens:]

Prudent Man said: "Many of our largest banks haven't come near foreclosing on commercial and residential units that are over a year in arrears on payments, many abandoned."

Is he ever right. We thought the residential housing market would be bad. Wait until Sep 09 or early 2010. Get your money in gold, T-bills or, the mattress......(!)

mcclatchydc.com/politi...

Next economic crisis looms: Commercial real estate defaults
Kevin G. Hall | McClatchy Newspapers
Apr. 29, 2009

Thousands of commercial mortgages valued at hundreds of billions of dollars are approaching a renewal date. By some estimates, two out of every three will no longer meet the original loan conditions and won't be able to refinance. And with prices for commercial properties expected to plunge, a vicious cycle may unfold much as it has in the nation's housing market.

"On the street, the rumor is it is coming and it's going to come fast and furious. Some people are predicting September," said Paul Waters, a New York-based executive vice president of brokerage operations in North America for NAI Global, a top-five commercial real estate brokerage with operations across the globe.

Forecaster Moody's Economy.com expects $375 billion in losses on the $3.5 trillion in commercial mortgage loans and securities outstanding. That's a loss rate of about 11 percent, nearly twice the rate of home mortgage foreclosures, and the forecaster thinks that about $200 billion of those commercial losses are still ahead.

"This is significant, but small compared to the over $1.1 trillion losses ultimately expected on residential mortgage loans and securities. Commercial mortgage losses will be a significant problem for many mid-sized and small banks," said Mark Zandi, the chief economist for Moody's Economy.com. "In fact, most of the banking failures that occur in the next several years will be due to losses on commercial mortgage loans."

Jun 07 02:40 PM

[ed233:]

Just because the Euro is in trouble it doesn't mean all is positive for the dollar greenback. Or is this just another "It's bad but the Euro is worse." sort of shenanigan so that the Us dollar is okay for the moment. Examine the price for an ounce of gold and look at a chart for a period of thirty years. It isn't climbing up for no reason. The dollar is in trouble and I don't care what currency it is compared with. If the dollar wasn't considered the universal currency exchange then I bet that there would have already been a run on the dollar. China will abandon the dollar, it's already starting now. Sooner or later the picture will become abundantly clear for all to see. There is only so much money you can safely print and get away with it. LOL Looking after your money.

Jun 07 02:45 PM

[Deepv:]

Not all people and businesses are "de-leveraging". Half the S&P 500 for example is net cash. HAve you looked at the b/sheet of Microsoft of JNJ etc.?
You need to look bottom up as well as top down.

Jun 07 03:37 PM

[Difu Wu:]

Great article! I agree wholehearted. Stocks are not ready for a new bull market yet. The fundamentals are simply not there: the worsening US economy will soon come to bring stocks down. Most secular bear markets lasted on average 15 years, and this one started in 2000 and is the biggest bull ever in history, so it should still have much further to fall. And yes, government is printing money like crazy, but most if not all of the newly printed money is going down the drain with failed/zombie companies "too big to fail", and to China and other countries. The average American citizen is not getting the newly printed dollars for the most part. So until China and other countries come to America with tons of US dollars to buy American products, we will have deflationary depression before experiencing the effects of hyperinflation. Foreign countries are in no hurry to bring the US dollar back to us anytime soon as long as the dollar is still the world's reserved currency, because they are productive nations and can wait until the US dollar is no longer world's reserved currency but still legal tender in the US. Gold and gold stocks are in a bubble much like the tech bubble in 2000. Gold's performance for the past 9 years is bullish, but over the past 100 years it has only kept up with inflation, no more. Sure, gold can still rally up some more, but it is bound for a significant correction. I bet the gold price will see 500 before it sees 5000. As for gold stocks, most if not all have ridiculously high P/E. GDX, the Gold Miners Index ETF, has a P/E ratio of 27.91, compared to S&P 500's P/E of 11.98. Need I say more?

Jun 07 05:02 PM

[Dean M:]

Predicting the rally will eventually reverse is not going too far out on a limb. The question is when, and I don't hear you taking the risk of trying to answer that question (rightly so since it would be pure guesswork)

Jun 07 07:13 PM

[Peter Cooper:]

Yes the prevailing wisdom is usually wrong, see:

arabianmoney.net/2009/.../

Jun 08 12:17 AM

[Mad Hedge F...:]

You bet! The market has gotten so dead here that I have started watching Suzie Ormand to get trading ideas. So I’m not supposed to run large balances on my credit card? Who knew? A hedge fund friend told me that the market is now like watching a ball tossed in the air that is at the apogee of its move, just before the free fall begins. No news, with shrinking volume and volatility. General Motors (GM) isn’t a stock anymore, so all of the news flow there might as well be a History Channel documentary. You can only sell so many out of the money short dated calls on other stocks before bumping up against risk control parameters. Even if you do make money in these conditions, it is at the expense of a Maalox addiction to fight the multiple holes in your stomach. It’s not worth it. This is why I prefer to spend my summers mountain climbing or practicing my ballroom dancing. Please see my “Sell in May and Go Away” opus at (www.madhedgefundtrader...

Jun 10 11:09 AM