After three sharp down days in the market, David Rosenberg of Gluskin-Sheff declares that it’s now crystal clear why the market rallied so hard from early September, and that it wasn’t economic recovery driving the news:
With 20-20 hindsight, it is now crystal clear as to what caused everyone to hyperventilate back in early September regarding the prospects of a sustainable recovery underpinned by the Federal Reserve and its well-advertised QE2 program. Not only the Fed, but also the mid-term election that promised to replace uncertainty with gridlock — it hasn’t turned out that way. Practically everyone believed that uncertainty had been swept away in the immediate aftermath of the November 2nd election and the November 3rd Federal Open Market Committee (FOMC) meeting, which is how the VIX index (a measure of volatility in the market) managed to recede all the way back to 18-and-change.
The bulls decided to hold their breath awaiting the holy grail of sustainable recovery and reflation. The stock market rallied spectacularly, as did commodities from corn, to crude, to cotton, to copper, in hopes that asset inflation would rear its lovely head. The U.S. dollar and the long Treasury bond both declined in value because of concerns (hope is more like it) that the Fed’s actions would prove to be inflationary.
However, since the exhaustive moves of November 4th in virtually every asset class, in reality, the markets have been re-pricing what the Fed and Congress actually have precious little to offer in terms of providing any freshly-minted stimulus.
In turn, this begs the question, how well will the economy do without continued life-support from the government? There is still scant evidence of a vibrant organic recovery 17 months into the statistical GDP bounce from the lows.
At least initially, the reversal of all these risk-on trends that dominated the landscape for the past two months suggests that the pullback that became apparent after the peak in April is likely to be sustained over the intermediate term. The U.S. economy is fragile, with real GDP growth likely to slow to a 1.5% annual rate, below the consensus view of 2.6%. The negative fiscal shock we are likely to see early in 2011 could well trigger something closer to zero growth in the first quarter.
In other words, we will very likely again be debating a double-dip scenario in coming months. In the meantime, the core PPI (which removes the effects of food and energy) just came in at -0.6% in October, so evidence of any sustained inflation at the final stage of production is hard to find. The labour market picture remains confusing with a plethora of conflicting data points of late, but nothing on this file looks very promising. The housing market cannot get out of its own way. Gasoline prices are pennies away from hitting $3 a gallon. Heavy cutbacks are coming from state and local governments in the U.S. Extended/emergency jobless benefits are about to lapse at a $70 billion cost to personal income over the next five months. What can we really expect from the consumer going forward is a legitimate question — holiday shopping surveys show a marked falloff in spending plans among low-end households.
For what it’s worth, it’s still not crystal clear to us. Remember, the market started rallying on September 1 after a very strong ISM report, and then we got a string of better-than-expected data, as this chart shows quite nicely.