In his morning update piece, following up on his CNBC interview and providing much more clarity on the themes he touched upon, Rosenberg gives his explanation on the four factors currently in play in the market, which include i) technicals, ii) fund flows/market positioning, iii) valuation and iv) fundamentals. It is a tale of two cities, with the first two indicating a disconnect from reality as the market has likely more potential upside, while the underlying valuation/ fundamentals representing a market that has rarely been as rich.
On the technicals, Rosie sees a possible break through all the way to 1,200: That is an observation, not a forecast, by the way. Back when we hit that level last fall, it was a glass-half-empty feeling of being down 20% from the highs; this time around it is a cause for celebrating an 80% move off the lows!
In the fund flow camp, he points out that after the sideways action for the past three weeks, the break out was precipitated by only the second net 2009 inflow in mutual funds of $12 billion. The initial source of buying power in March was the dramatic short-covering and pension fund rebalancing. Now, it is the retail investor keeping the rally alive, as he is transfixed by the cheerleading puppets on CNBC. The vicious cycle would pressure the predominantly bearish fund managers (60% seeing the move off the lows as a bear market rally, and 5% buying into the V-shaped recovery concept) to chase performance, implying high odds of a further melt-up.
On the bearish side, valuation just screams overbought. The global trailing P/E multiple has surged five points during this rally to 15x. Zero Hedge discussed Rosenberg's view of mid-cycle multiples previously. He follows it up with the caveat that a 15x multiple is also rather generous when one considers that we now have an economy where large chunks — autos, insurance, mortgages, banks — are at least partially owned by the government. In a nutshell, David doesn't see the S&P $75 earnings, based on a bond implied 12.5x multiple, as achievable until 2013 at the earliest. And he concludes Look at this way — we are going to be hard-pressed to see operating EPS much better than $43 this year. A ‘normal’ first-year earnings bounce is 20%, and again this is being generous, but that would leave us with $52 EPS for 2010. We give that prospect very little chance of occurring, and we have some difficulty with the stock market going ahead and pricing in an earnings profile that is likely four or more years away from occurring.
As for economic fundamentals, while everyone is transfixed by the ISM number of 42.8, one should compare it to the ISM read of 49.1 in December 2007, when the recession began, and the 49.3 in the month before the Lehman collapse. This was not a manufacturing-led recession — the factory sector was an innocent bystander in this de-leveraging cycle. The much more ominous questions of unemployment and consumer savings are still on the table, and painting a much bleaker economic bleaker picture. In Rosie's words: The really big story is that the fiscal stimulus is assisting in the household balance sheet repair process, but is not really doing much to spur consumer spending — highlighted by the rise in the personal savings rate to a 15-year high of 5.7% from 4.5% in March and zero a year ago — never before has the savings rate risen so far over a 12-month span. Note that the post-WWII high in the savings rate is 14.6% and that is where I believe we are heading. Despite the conventional wisdom, this is highly deflationary. As for unemployment: Nothing is as important to the inflation backdrop as the labor market — wages/salaries/benefits are seven times more powerful in determining the corporate pricing structure. And the labor market, at least until the latest batch of however adjusted data, is not showing any relief whatsoever.
Rosenberg's conclusion of sorts: Long-term, we believe that the U.S. economy is in a gigantic mess and that risk-taking in the stock market is not going to be rewarded on a sustained basis. We continue to hold the view that the stock market, which peaked in 2007 just two months shy of the most intense recession in 70 years, is vastly overrated as a forecasting device and we strongly believe that portfolios will need to be cash-generating machines.
So all those who chase 200 DMA's, be careful when the greater fools start disappearing. Of course, if the greater fool is the involuntary taxpayer, there is nothing to be concerned about.