As the economy sinks closer and closer to double dipping David Rosenberg asks an important question: where will the positive shock come from that puts a long-term bottom in markets? Mr. Rosenberg notes that most of the major previous market bottoms coincided with some form of government intervention – monetary or fiscal policy:
“The question that must be answered is what the catalyst will be this time around — if at all. Policy rates are at zero. The deficit is at 10% of GDP and there is little public appetite for more fiscal largesse. If oil prices do come down sharply — a de facto tax cut — it would likely only come about if China heads into an economic downturn, which would carry with it its own set of complicated economic and geopolitical repercussions.
Maybe, just maybe, we will have to wait for a bottom that is premised on a market that simply gets so cheap that it won’t even need the helping hand of Uncle Sam to precipitate a firm and durable bottom to feed off. That, in turn, could mean a trough multiple of 10x on a forward earnings estimate of $70, rather than a 15x multiple on some consensus $95 EPS forecast that so many cling to. Look at the good news from this maths — at least we don’t break below the March 2009 low!”
The problem today is similar to the problems in Japan in the 90’s. Monetary policy has been rendered useless as debt reduction (balance sheet recession) makes the quantity or price of money a meaningless variable in the demand-for-borrowing equation. We’re clearly now hitting a wall with regards to the passage of further fiscal stimulus. Austerity appears to be the strategy of choice as we talk ourselves off the edge of the cliff. So what catalyst creates the next major bear market bottom?
I have long maintained that a true economic bottom will likely not be put into place until the private sector finishes the deleveraging cycle (or at least begins to reach a level of significant debt reduction combined with sustained income growth). By my estimates, that is unlikely to occur before 2012 – some estimates say it could take even longer. If I am right it’s unlikely that the economy can sustain a recovery (one that isn’t a creation of the public sector – as we’ve seen over the last 18 months) for several more years.
For the markets, this could mean an equity market environment that is also similar to Japan’s – sideways trading characterised by large market fluctuations that effectively take us nowhere. If I am right about the macro outlook (that sustained private sector recovery is not on the horizon) it likely means that Mr. Rosenberg is right with regards to his outlook on equity prices. Only dirt cheap valuations will give equity investors reason enough to take on the risk of owning equities in an environment of very weak economic growth. And if Robert Shiller’s 10 year trailing PE is an indication it likely means that level of equity valuation attractiveness is well below current levels.
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