David Rosenberg: "The Weirdest 20 Minutes Of My Life"

Chief Economist David Rosenberg comments on yesterday’s market plunge, today’s job figures and this week’s European sovereign debt chaos. Oh, in case you don’t have anything to worry about, Mr. Rosenberg has a list…

“The big story yesterday was not some possible computer glitch (though that was the weirdest 20 minutes in front of the Bloomberg in my professional life), but the fact that the contagion risks are turning into reality in the euro zone periphery.”

David Rosenberg

Thursday’s massive sell-off in the U.S. stock market was not caused by some computer blunder, Friday’s labor market report is not as positive as some make it out to be and the problems with sovereign debt in Europe is just getting started. That’s pretty much the summary of today’s edition of “Lunch With Dave”.

The chief economist at Gluskin Sheff also share his list of 10 things to worry about (just in case you don’t have any worries of your own, I guess).

But let’s start with The Big Bang of May 6th:

Mr. Rosenberg writes:

“As far as the dramatic break in the equity market yesterday, it seems appropriate to emphasize that the bear market rally that began in March 2009 is over (with a bullet!). As Walter Murphy pointed out this morning in his blog, we have impulsively broken support like a hot knife through butter. Bob Farrell points out that in panics such as this, bargain hunting is better left to a later period of testing. Considering that the bear market rally, especially in the later stages, was dominated by traders, it is important to keep in mind the liquidity risks.”

“The most popular analogy for “panic” is what happens when someone yells “fire” in a crowded theatre. The challenge in applying this to the stock market is that when you pick the back row on the aisle, you still have to find someone to take your seat before you leave the theater.”

“The big story yesterday was not some possible computer glitch (though that was the weirdest 20 minutes in front of the Bloomberg in my professional life), but the fact that the contagion risks are turning into reality in the euro zone periphery. Before the mid-afternoon meltdown, the Dow was down around 350 points, and that is where it finished the day. The roller-coaster ride is just another reason for the general public to maintain the defensive investment stance it has adopted during this bear market rally. We all know that the locals who drove the market up through most of this cycle (we are talking about the hedge funds and prop desks at the major banks) are the same ones who are dispassionately heading for the exits.”

A Highly Deflationary Brew

“While safe havens benefited, such as Treasuries and German bunds, we saw huge bond sell-offs in Portugal (+33bps), Spain (+24bps) and Italy (+22bps). Greek bond yields surged more than 100bps. The world is awash with excess capacity — in the U.S., there are simply too many vacant houses, empty apartment and office buildings, idle manufacturing plants and unemployed people. Credit is contracting. Money velocity and the money multiplier are anemic. This is a highly deflationary brew.”

“The situation in Europe is dire because there is little, if any, chance that Greece will ever accept a 3-4% annual contraction in its economy in return for the EU-IMF loan deal. Debt restructuring is the only way out, and currency devaluation to grease the skids during the fiscal adjustment is necessary. And, it is not just Greece but the entire Club Med region sharing the same problem — too much debt relative to the size of the economy and onerous debt-servicing burdens.”

“The ECB took a pass at even hinting at quantitative easing — buying government bonds outright as the Fed has done — but surely this is going to have to be part of the plan to averting another financial crisis. The banks, especially in core Europe, cannot withstand another Lehman-type collapse, and when you consider how far the debt restructuring among the PIIGS will go, it is not hard to come up with a $700-800 billion tab.”

The Banks Are Not Nearly Strong Enough

“The banks are not nearly in strong enough shape to withstand losses of that magnitude and European policymakers are well advised to come up with a contingency plan without delay because as we saw in the summer of 2008, a crisis of confidence can quickly spin out of control. In this environment, a bond-bullion barbell is going to work out just fine — as it did yesterday. To have gold rally amidst a flight-to-quality into greenback is quite a statement — and the chart of the gold price in Euro terms is just about as bullish a picture than anyone could ever draw.”

“We went into this latest leg of the credit collapse with equity market bullish sentiment at levels not seen since late 2007, portfolio manager cash ratios also at levels last seen in late 2007, the VIX index at a mere 15x, and valuation implying a return to peak earnings as early as next year!”

10 Reasons For Doing Drugs

“The complacency was amazing and I could see this so clearly in my last two trips to New York City. Back in December 2008, I recall marketing in midtown and walking along 5th Avenue, I noticed that nobody was carrying any bags or boxes and that everyone looked catatonic, as if they were on Prozac. In the last six weeks, I have been to the city twice, and both times it seemed to me that everyone was walking around looking as though they were on heroin. Smiles everywhere and a general sense that things were good, though nobody really seemed to know why. We shall see whether that bliss turns to bust on my next trip, which is hopefully next month when I get on stage with my buddy and former colleague Rich Bernstein.”

And here it is; David Rosenberg’s list of 10 things to worry about:

1. Greek default and contagion risks to European banks

2. ECB dragging its heels (á la Bernanke in 2007)

3. Hung parliament in the U.K. to add to uncertainty

4. China policy tightening and possible bubble burst in real estate

5. U.S. economy only managing 1.6% annualized real final sales growth in the past three quarters

6. Slide in Chinese stock market and commodity prices signaling an end to the global V-shaped recovery

7. Big fiscal drag will drain as much as two-percentage points off U.S. growth next year; 1.25 percentage points in Canada

8. Higher dividend and capital gains rates in the U.S. will curb investor enthusiasm

9. U.S. dollar surge will eat into U.S. large-cap corporate earnings

10. Every index is now showing a return to U.S. home price deflation

And That’s Not All, Folks!

Here’s Mr. Rosenberg’s view on today’s labor market report, described by analysts and journalists as “positive” and “better than expected”.

“So, ADP rose 32k in April and everyone got so excited over the positive sign beside the digit. Wow. So now we are only 8.2 million private sector jobs short of where we were before the onset of the “Great Recession”. This 32k increase in ADP, of course, comes on the heels of 4%-plus GDP growth in the past six months and we are very likely well past the peak of the cycle on that score.”

“While it is apparent from the ADP data that large-cap manufacturers are now hiring, it remains to be seen how far this goes with the global economic outlook looking murkier and the reversion to a stronger U.S. dollar negatively impacting export competitiveness. And, what is also apparent is that there is no hiring coming out of the small business sector with outright declines ongoing in the goods-producing segment.”

“The latest CEO survey showed company executives more optimistic about the future, but just about 3 out of 4 do not intend on boosting their staffing requirements. So is 32k the best we are going to do? Let’s hope not because, if that is the case, then it will take 22 years to recoup all the job losses incurred since late 2007.”

The Problem of Productivity

“Well, there is such a thing as too much of a good thing. U.S. productivity growth moderated but not nearly as much as expected in Q1 (remember, the pace of economic activity moderated too) — to a 3.6% annual rate (the consensus was expecting 2.6%) versus 6.3% in Q4 and 7.8% in Q3. The message here is that the recovery is being totally dominated by productivity with very little in the way of labour input.”

“Of that 4.4% rise in nonfarm business output in Q1, 80% was accounted for by productivity growth, not far off what we saw in Q4 (in the current cycle productivity is accounting for nearly 100% of output growth, compared to 50% in prior cycles going back to the early 1950s). Real compensation per hour stagnated in Q1, and this followed outright declines the prior two quarters — a whole series of other cash flow boosts from extended jobless benefits, to strategic defaults and tax credits, are helping underpin consumption. Organic income growth is just not there because of all the slack in the jobs market — that is so evident in these data.”

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The Ugly Picture

“The total pool of available labour now stands at a record 21.2 million, which is nearly eight million higher than the pre-bubble norm. So, to put today’s stellar headline figure into proper perspective, it would take another 28 months of gains like this to absorb the excess and reverse the deflationary tide that is now gripping the labour market. More than likely, this process of unwinding the idle capacity in the labour market will take at least twice as long as that. Income strategies work best in a deflationary environment, which is why bonds have begun to overtake equities on the total return ladder on a year-to-date basis. This remains a secular trend, periodic divergences like 2009 notwithstanding.”

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“Our biggest concern looking forward in the employment picture is the ever-present risk of a “double dip”. It is very likely that Q4 2009 reflected the peak for GDP growth and that the bear market rally is potentially over. Risks to confidence in the economic outlook will undoubtedly now rise materially. The resumption of the credit collapse, this time in Europe, suggests that headwinds are picking up in the global economy with negative implications for global trade flows as well as corporate earnings, which, with a lag, will also dampen hiring intentions.”

Here’s a copy of the full commentary by chief economist David Rosenberg at Gluskin Sheff.

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