Merrill’s economist David Rosenberg left the firm yesterday (planned for several months). And he went out swinging. David has maintained from the beginning that the recent rocket rally off the lows is just a suckers’ rally, and he reiterated that view as he walked through the doors.
Some excerpts from his swan song, which was published Thursday:
Market likely to peak the end of the week [Yesterday]. Just as the clock is winding down on my tenure at Merrill Lynch, the equity market is winding up with an impressive near-40% rally in just nine weeks. For those that were still long the equity market back at the March 9 lows, a good ‘devil’s advocate’ exercise would be to ask yourself the question whether you would have taken the opportunity, if the offer had been presented, to have sold out your position with a 40% premium at the time. What do you think you would have said back then, as fears of financial Armageddon were setting in? We haven’t conducted a poll, but we are sure at least 90% of the longs at that point would have screamed “hit the bid!”
Are we at risk of missing the turn? Fast forward to today, and within two months optimism seems to have yet again replaced fear. Are we at risk of missing the turn? What if this is the real deal — a
new bull market? This is the question that economists, strategists and market analysts must answer.
Risk is much higher now than it was 18 weeks ago. The nine-week S&P 500 surge from 666 at the March lows to 920 as of yesterday has all but retraced the prior nine-week decline from the 2009 peak of 945 on January 6 to the lows on March 9. We believe it is appropriate to put the last nine weeks in the perspective of the previous nine weeks. To the casual observer, it really looks like nothing at all has happened this year, with the market relatively unchanged. But something very big has happened because the risk in the market, in our view, is much higher than it was the last time we were close to current market prices back in early January, for the simple reason that we believe professional investors have covered their shorts, lifted their hedges and lowered their cash positions in favour of being long the market.
Employment, output, income, sales still in a downtrend. Considering what transpired from an economic standpoint, the decline in the first nine weeks of the year was rather appropriate in the midst of the worst three-quarter performance the economy has turned in roughly 70 years. The rally of the past nine weeks appears to be rooted in green shoots. While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend.
Need to see an improvement in the first derivative. We have evidence that the consumer, after a first-quarter up-tick that was front- loaded into January, is relapsing in the current quarter despite the tax relief (didn’t we see this movie last year?). Not until improvement in the second derivative morphs into improvement in the first derivative with respect to the important economic data will it really be safe to declare what we are seeing as something more than a bear market rally, as impressive as it has been.
This is a bear market rally that may have run its course. The investing public is still holding tightly to their long-term resolve, but much of the buying power at the institutional level seems to have largely run its course, in our view. That leaves us with the opinion, as tenuous as it seems in the face of this market melt-up, that this is indeed a bear market rally and one that may well have run its course. We have “round-tripped” from the beginning of the year and there is real excitement in the air about how these last nine weeks represent evidence that the economy will begin expanding sometime in the second half of the year.
Growth pickup will likely prove transitory While it is likely that headline GDP will improve as inventory withdrawal subsides and fiscal policy stimulus kicks in, our view is that whatever growth pickup we will see will prove to be as transitory as it was in 2002, when under similar conditions the market ultimately succumbed to a very disappointing limping post-recession recovery. So yes, there may well be some improvement in the GDP data, but it is based largely on transitory factors. We strongly believe it is premature to totally rule out the end of the vicious cycle of real estate deflation – residential and now commercial – that we have been experiencing since 2007. Balance sheet compression in the household sector will continue to pressure the personal savings rate higher at the expense of discretionary consumer spending. This is a secular development, meaning that we expect it will last several more years.
Chances of a re-test of the March lows are non-trivial. To reiterate, it seems to us likely that the risk in the market is actually higher today than it was back at the same price points in early January, and we say that with all deference to the stress tests (which given the less-than-dire economic scenarios, along with the changes to mark-to-market accounting, were destined to reveal healthy results). While the consensus seems gripped with the burden of trying to decide if there is too much risk to be out of the market, we actually still believe that the chances of a re-test of the March lows are non-trivial, especially if the widely touted second-half economic rebound fails to materialise…
The data flow is less relevant this cycle than in the past. This was not a manufacturing inventory cycle, which makes the data flow less relevant than in the past. Real estate values are still deflating and the unemployment rate is still climbing; these are critical variables in determining the willingness of lenders to extend credit. And as we just saw in the Fed’s Senior Loan Officer Survey, while there may be a ‘thaw’ in the financial markets, banks are still maintaining tight guidelines. In fact, the weekly Fed data are now flagging the most intense declines in bank lending to households and businesses ever recorded.
The best case is that this is a bear market rally. All of this has not precluded an elastic band bounce from an egregiously oversold low in the S&P 500, and perhaps we will even test the 200-day moving average of 960 (as the 10-year note yield and NASDAQ just did). But we still do not believe what we are seeing fits the hallmark of a new bull market. In our view, the best case is that this is a bear market rally, but one that clearly has more legs than its predecessors this cycle.