1929 All Over Again? 15 comments
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David Rosenberg is Chief Economist for Canada's Gluskin-Sheff, and former Chief North American Economist for Merrill Lynch. The graph below appeared in Rosenberg's investor advice newsletter Friday morning (July 31) here.
Others have also commented on the close parallel pattern, including both Doug Kass and Harry Schiller at Real Money (TheStreet.com) here.
I think many will agree with me that the economic resume for 2009 has major differences from 1929-30. For that reason alone there should be limited expectation of continuation of the remarked similarities to date in the above graph. I emphasized "limited expectation" because I do not want anyone to infer that I meant "rejection".
There are some significant parallels in the two time periods. Among these are the worldwide nature of the collapse, multigenerational deflationary pressures, massive insolvency issues in financial systems around the world, dramatic reduction in industrial production and drying up of international trade.
What Is Different Now?
There are significant differences, as well. There is massive sovereign interference with contraction now, orders of magnitude larger than anything conceivable in 1929-30. In the U.S., stimulus and government investment in the private sector is in the trillions of dollars when everything is added up. China is pouring its national reserves into stimulus and commodities on a scale relative to GDP that is several times what the U.S. and others are doing, Factors such as these will make the trajectory of this 80-year cyclical minimum much different from the last one. It is more likely to resemble the rolling recessions of the past 20 years in Japan than the 1930s of the U.S. Both had enduring pain, but the magnitude and depth of suffering is drastically different.
Rosenberg recognizes the possible correlation to the Japan experience. He points out that Japan has had a 20-year bear market with four large rallies with gains in excess of 30%.
My view is that the future will hold an experience that will probably have a mixture of flavors from many historic cuisines. I give low probabilities to a repeat of the Great Depression, as well as "V" shaped recovery to sustained 3%+ positive GDP growth. Something like the Japanese experience of the past 20 years has a higher probability.
But I think we will paint a new, original canvas. It may have recessions more frequently than experienced over the past 25 years. (We had four, counting the current one). It may have lower U.S. GDP growth potential, say closer to 2% rather than the 3%+ potential of the past two decades. It will probably see the G-12 move toward equality in economic power and many aspects of living standards with the G-8. (Note: I have divided the G-20 into two groups.)
What About Stock Valuations?
Rosenberg comments on the valuation of stocks with much skepticism. He says:
It is amazing that anyone would go long an equity market with a reported P/E multiple of 700x but that is indeed what we have on our hands. The end of the recession and the onset of a sustainable recovery, as we saw in 2002, are not the same thing. So this could still end badly but we will await confirmation signs that this is more than a very flashy bear market rally before shifting gears.
To understand how Rosenberg makes the statement about PE, you must recognize a key word - reported - as in "reported P/E". U.S. corporations keep two sets of books: One set is "reported earnings" upon which taxes are paid. These are the earnings that are stated according to GAAP (Generally Accepted Accounting Principles). Analysts like to use a second set of numbers reported by corporations, called "operating earnings". This allows corporations to exclude expenses that they designate as "non-recurring", such as acquisition costs, costs associated with payroll reductions (cost of firing people), etc.
Here is a table using S&P data (Standard & Poor's) with their latest results and estimates (as of 7/23) for "as reported" and "operating" earnings for the S&P 500 and the P/E ratios calculated by the author:
These numbers can be compared to recent actual results:
Before this crisis really got underway in the second half of 2007, there were usually not major differences between operating and reported earnings. Since then, they have often come from two different planets.
Analysts often like to use operating earnings, making the claim that they better represent ongoing business activities. However, when operating earnings differ substantially from reported earnings quarter after quarter, that argument must be questioned. Sooner or later, the two sets of books must come into close agreement or the accounting practices of corporations must receive closer examination. When do two sets of books with grossly different results become fraud?
This issue was discussed by David Pauly this week on Bloomberg.com, giving several examples of big impacts that analysts chose to omit when using the operating earnings for Intel (INTC), Google (GOOG) and others. Read the entire article here.
By the way, I don't show Rosenberg's stated 700x P/E ratio. His value may represent data from his own analysts (not the S&P) or may represent a different date than 7/23. For example, sometime in the first quarter the S&P estimates must have gone from negative P/E, through infinity and then on to a very large positive P/E.
In July, http://www.chartoftheday.com/ published the follow chart:
I do not know on what date the last data point was taken, or what the source of the data is, but I think this graph overstates the situation as I understand it today. This is definitely what the situation would have looked like in the first quarter of 2009, if the reported earnings at that time were projected for the entire year. Today I would expect the 2009 data point to be much higher, based on the current S&P estimates.
Shouldn't the Market Lead the End of the Recession?
There has been a lot of discussion regarding how the stock market responds to GDP. Rosenberg has another informative graph that relates to that question in his mid-day newsletter, also Friday, here:
Look at this graph in sections. In the first section there is a positive correlation between movement in stocks and GDP from 1965 to 1977, albeit with a delay, GDP lagging stock movement. For 1978 and 1979 there was a pronounced negative correlation, as was the case also from 1984 to 2000. From 1980 to 1983, a positive correlation existed. From 2001 to date we see a return of positive correlation.
In any of the time periods there were short periods of contrary relationships. For example, in 2001 to 2002, the stock market turned back down to a new low about nine months after GDP bottomed.
The Bottom Line
It is always interesting to compare current conditions to possibly similar past periods. I do it all the time and it often provides valuable insight. However, making many generalizations can lead one astray. I do not want to diminish the value of what David Rosenberg has to say. He is one of the best economic analysts in the world and I read his posts every day. I do encourage the reader to try to use his own brain as well as the thoughts of the writer and look for any value to be added.
Not only should we ask what could be repeated, we should also ask what things could be different this time.
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Concerning the last graph comparing GDP growth to the S&P which used YoY percent change, it is obvious that beginning in the late 1980's that the area under the curve for the S&P growth exceeded GDP growth.
do i assume the S&P corporations have been able to grow profits at a faster rate than GDP growth? or should i just assume that stocks prior to the late 80's were a better buy?
with a larger and larger percentage of stock market transactions being part of programmed trading, i wonder if computers are now determining the market levels.
One observation. In 1929 there was much less proactive government action. It was years before Roosevelt started the massive capital and infrastrucuture investment. This time round billion of dollars was being injected literally within weeks. The recovery path relative to 1929 should be different and the -1% GDP data for Q2, relative to -5.5% Q1, implies a Q3/Q4 recovery, which would be years ahead of the 1929 crash timetable.
The federal government went from about 5% GDP to 10% GDP during the thirties. That and all government is multiples higher now. We were far more solvent and self-sufficient then. I know that markets are often known to signal the economy but we are in uncharted territory not only fiscally but with a captive MSM and market manipulation.
We came out of "prosperity" with appalling debt. We are digging deeper much faster now. Statistics are gamed more than ever. I trust my lying eyes over the spin from our "leaders."
Besides some of the obvious & often repeated end of cycle factors, there are two others that are once in history -
Peak Oil
Peak Population (Total & Aging)
We are much more dependent upon mechanized production and transportation of food than in the 1930's.
Most people don't have a family farm and Parents or Grandparents to fall back on anymore.
If the government spigot slows at all, the riots and unrest in the cities and suburbs will be massive.
We can't hop in the Model T and putter out of town to Grandpa's farm or be squatters somewhere. Many, many more people and much fewer resourced (including how to survive without a supermarket and indoor plumbing).
Yikes.
For part of my childhood (I was born in the middle of the Great Depression) my family lived without indoor plumbing near the Canadian border, with winter temperatures occassionally reaching 40 below (Fahrenheit). We not only survived, we had a great life.
In economic hard times today, many extended families can provide much better support systems because of larger houses and smaller families (on average). When I was a child, my grandparents lived in 1000 square foot homes and had 11 children between them - not much opportunity for moving back in with mom and pop (grandpa and grammy, from my perspective).
However we come out of the latest economic cycle, life will go on, people will prosper in whatever ways they can, including engaging in fulfilling activitiies that may have a different perspective on wealth creation and what is really valuable in a life's experience.
"Misrepresentation in corporate earnings statements is rife; according to S&P, of the 197 SPX companies to report this quarter, only a quarter have actually earned the number reported in the headlines. Fully 63.5% stuffed "one-off" or "extraordinary" items in their income statements, while only 24 of the 197 had reported earnings that were higher than headline operating earnings."
Macro Man then goes on to say:
"So in valuing equities moving forward, what concept of earnings should we use? Pick a number, any number. Looking at 2010 earnings estimates yield an incredibly broad range of forecasts. If you believe the crack-smoking bottom-up guys who strip out everything that could be construed as a "loss", you get a resounding $74 pr share. Not bad!
Taking the same approach (stripping out the quarterly "one offs"), but from a top-down framework, yields a substantially less rosy result: earnings of just $46 per share. And actually counting all the turds for what they are on a top-down basis yields 2010 EPS of just $37 per share."
Caveat Emptor!!! Read the entire post to get the whole story.
Waiting another 3 or 4 weeks won't make a significant difference to an investor. Not waiting could make a difference.
Check back in 20 days.
On top of that, the currrent TTM number for E presents an unusual situation, because so many banks and others took huge write-downs in Q4 2008, leading to negative E in that quarter. That negative E will remain in the TTM calculation until it is replaced by 2009's Q4, which will not be known until Q1 2010.
Also making the current situation flimsier than normal is the fact that a fair number of companies that contributed to Q4 2008's negative earnings are no longer in the S&P 500 index, having been replaced in the index. While S&P replaces companies (32 from Q4 2008 to the present), they do not go back and restate prior quarters' earnings to reflect the companies that are in the index now. So it can be argued that the Q4 2008 E is not very representative of the current index.
Putting all this together, I think that the S&P 500's current astronomical PE (as calculated by S&P), which will go negative (or NMF) in Q4, is of limited value in evaluating whether to be long in the market at this time. Perhaps the best answers to Rosenberg's question about why anyone would go long a market with a reported PE of 700 are (1) because the PE is not representative, and (2) because the market is going up.
seekingalpha.com/artic...
Maybe PE's have less to do with the stock market than crowd psycology. Maybe the pattern established in 1929 to 1932 repeating may be more likely than you think.
I have to say that MacroMan's blog is a daily "must read" for me, as well. Even though my world is nothing like his (trading ForEx at a hedge fund), I usually glean a "big picture" nugget, or two (plus, the man DOES have a way with words..)
Another great article!