FYI | Oct 04 2010
(This story was originally published on Thursday, October 1, 2010. It has now been re-published to make it available to non-paying members at FNArena and readers elsewhere).
"In this cycle, interest rates in most of the developed world are at record lows, so we've had huge levels of fiscal stimulus, government debt has gone through the roof, and the best that has come out of that is reasonable growth that we're not sure is sustainable".
(Insync Funds Management chief investment officer Monik Kotecha)
By Rudi Filapek-Vandyck, Editor FNArena
I thought I'd still open this week's editorial with a snapshot of what is actually happening in the US economy, courtesy of Glushkin Sheff's Dave Rosenberg who's always useful in keeping things “in perspective”.
The chart above is by far not the worst one I could have chosen (“worst” as from an economic viewpoint), but at least the “stand still” implications from recent “present situation”-surveys by the Conference Board fit in with the overall picture that has emerged in terms of market projections.
Nobody seems to be talking US economy anymore, as hedge funds and traders have jumped on the “reflation trade” in August. Ever since the Federal Reserve started hinting at more quantitative easing the world has experienced a flash back to March 2009.
We tend to forget these things and for all we remember it was short covering in US financial stocks that put a rocket under global equity markets in March 2009. But the Fed was there too. In fact, in March 2009 the Federal Reserve started its initial quantitative easing program, keeping liquidity in the banking system, and bond yields down, so that the US recovery could take shape.
As I write these lines, there is a wild debate going on around the world, with many an economist arguing “QE” didn't work the first time, and it won't work the second time around either. But that's not something today's traders will pay any attention to. All they know is that “don't fight the Fed” has become a very well-established truth on Wall Street.
After all, it “worked” in March 2009, with global share markets putting in a 50-60% rally, and it has already “worked” since August with global share markets up between (roughly) 6-9%.
And so it is that the world has reverted to what “worked” in 2009: sell the US dollar, buy everything else.
Yet, what hasn't genuinely “worked” this month is that equities have simply ground higher on ultra-light volumes, while agricultural products, base metals and the precious metals have enjoyed a true renaissance of the reflation trade.
This is why copper is now above the price peak of April this year, but crude oil and equities are not.
This is debate number two around the world. Why is the reflation trade this time around not working to the same extent?
All answers seem equally valid.
The least one can conclude is that this reflation trade is temporarily disconnecting financial assets from economies and data. This is not necessarily a 100% negative. Under a positive scenario, this disconnect allows economic realities in the US, Europe and in Japan to catch-up while investors are temporarily doing their own thing. Under more sinister scenarios, however, financial markets will simply look to stretch the boundaries of what can and what is possible, in terms of price upside, but ultimately attention will have to be paid to fundamentals.
In the meantime one might as well completely disregard economics, it's not what is driving markets (even though many a commentator and market bulls are putting in best efforts to somehow make it fit).
It's probably no secret that I am very sceptical when it comes to forecasts regarding the US economy. Two years ago I travelled around the country, arguing the US was facing years and years of sluggish growth. I have yet to see any evidence that my predictions back then will not be correct.
Let's have a quick look at what has transpired post the economic meltdown of 2008 in the US. Many an economist has felt the need to compare the post-2008 recovery with those of previous crises and recessions. A few conclusions can be drawn.
– In terms of jobs creation, the current recovery doesn't seem to differ much from the recessions of 2001 and 1991 with the difference that “household employment” is much lower, which is a significant negative
– Strictly taken, the unemployment rate in the US is at present actually lower than at similar times post 2000 and 1991, but, again, this does not take into account that the overall participation rate is substantially lower (hardly a positive thus)
– Consumer spending remains weak and it also remains weaker than at comparable times in the past (it is at around similar levels post 1991 but back then there was a visible recovery from lower levels, this is not the case this time)
– The recovery in manufacturing certainly looks like a surprise
– What has really surprised is the resilience in corporate profits
– The housing market may well be in its worst condition ever
– The same worst condition assessment applies to the overall government debt situation (including states such as California)
The old adage is that when we put three economists in a room to discuss the above factors we will end up with three different explanations (four if one of them graduated from Harvard), but I'd be willing to stick my hand up and suggest the surprises in manufacturing and in corporate profits are linked to the emergence of new growth engines in China, India, Brazil and other emerging economies.
This divergence between the world's number one developed economy in the US and the upcoming stars of tomorrow (Brazil et cetera) is also starting to be reflected in earnings forecasts. Quantitative strategists at BA Merrill Lynch (no relationship with QE policies at the Fed) reported this week the ratio between downgrades and upgrades to company earnings forecasts is improving in Emerging Markets, but deteriorating in many developed countries.
In simple terms this means stockbroking analysts are issuing more upgrades to forecasts in Emerging Markets but gradually more downgrades in the US. As I have pointed out repeatedly in the past, this is important because history shows that rallies without earnings upgrades cannot last.
BA Merrill Lynch analysis suggests that equity markets supported by positive earnings revisions perform substantially better than those who do not have such support.
On BA-ML's observation, the ratio between upgrades and downgrades has again turned negative in the US after a positive swing in August. For Australia, the ratio was negative in August and it has remained negative in September.
This is in line with my own observations. I also suspect that once stockbroking analysts decide to update their currency assumptions, the ratio in Australia will turn even more negative. Add the fact that in terms of ratings for individual companies the gap between recommendation downgrades and upgrades has widened significantly this month, plus the fact that everybody is expecting the RBA to add further interest rate pressure on the economy overall,..
In case anyone still wonders why the Australian share market continues to underperform, I'd say most of the answers can be found in the paragraphs above. And if these trends do not reverse for the better, any rally will ultimately receive punishment because of the lack in underlying fundamental support.
(In case you read this story through a third party channel and you cannot see the chart on top I apologise, but technical limitations are to blame.)
P.S. I – All paying members at FNArena are being reminded they can set an email alert for my Rudi's View stories. Go to Portfolio and Alerts in the Cockpit and tick the box in front of 'Rudi's View'. You will receive an email alert every time a new Rudi's View story has been published on the website.
Rudi On Tour 2010 – Some dates have changed.
YOU ARE ALL INVITED!
Your editor will be roaming the country in the coming weeks to conduct presentations to investors about his latest views on financial markets and about how to better use the info, data and tools on the FNArena website.
These presentations offer the unique opportunity to catch up with your editor in person and to ask questions directly.
Investors should note not all of these events are free, and they are all organised by one of FNArena's commercial associates.
The first series of presentations will occur on invitation from MINC Trading, with your editor contributing personally to opening day sessions of multiple day seminars on the Gold Coast, in Brisbane, in Sydney, Melbourne, and Perth.
Your editor will also provide the closing presentation on the “BULLS VS BEARS” one-day seminar organised by the Australian Investors Association (AIA) on Friday, 12 November at the Tattersalls Club, 181 Elizabeth Street, Sydney. (Other speakers include Steve Keen, Robert Vagg and Shane Oliver).
Finally, your editor will fill 100 minutes presenting and answering questions about the theme “The Market Always Knows Best, Or Does It?” to members of the Australian Technical Analysis Association (ATAA) on Monday, 15 November, also in Sydney.
While the AIA and ATAA presentations are for members, access to both events is possible after paying fees to the organisers.
The schedule for the four day seminars organised by MINC Trading is as follows:
Day One – Taking the fear out of the Stock Market
Day Two – Introduction to Options as a Trading and Investment Tool
Day Three – Trading Strategies to Profit from an Uncertain or Trending Market
Day Four – Long Term, Low Risk Income Generation Strategies
The current roster is as follows:
Sydney – 4-7 Oct
Perth – 11-14 Oct
Gold Coast – 16-17 Oct
Brisbane – 18-21 Oct
Melbourne – 6 Nov
Important: your editor will only present during the first day's session. All sessions start at 7pm. Fees to attend are $40 for one day, $100 for all four days.
To express your interest: send an email to info@fnarena.com
