Mish at Global Economic Analysis referenced an interesting article written by economist Dave Rosenberg titled “What Growth is the S&P; 500 Pricing in? Here are some highlights:
Based on past linkages between earnings trends and the pace of economic activity, believe it or not, the S&P; 500 is now de facto discounting a 4¼% real GDP growth rate for the coming year. That is what we would call a V-shaped recovery. While it is possible, though in our opinion a low-odds event, it is doubtful that the economy is going to be better than that. So we have a market that is more than fully priced for a post-recession world — any further gains would suggest that we are moving further into the “greed” trade.
We realize that the market has to climb a wall of worry and that it will often price in a lot of bad news, but for the first time ever, it has rallied nearly 50% amidst a two-million job slide since March. That is either whistling past the graveyard or at the lows the market was indeed pricing in a full-fledged depression.
Think about that last comment. Whatever the market was pricing in at the March lows was obviously a pretty bad outcome, but isn’t that what we saw in the end? To be sure, the government established a floor under the financials, but when you go back and think about the fresh lows posted in late 2002, it was about earnings and the economy, not about financials.
In the four months after the recent lows in March, employment plunged by two million, which is as much carnage as we saw in the entire 2001 recession — and we are talking about the entire cycle including the jobless recovery that spanned from March 2001 to June 2003! We will guarantee you one thing — it is doubtful that the two million folks who lost their jobs are going to be heading to the malls, dealerships or restaurants anytime soon. And while that is only a sliver of the 130 million U.S. workforce, change does occur at the margin.
Usually, government plays a small role, but this time around, it may be the only actor in the play, and what multiple does that deserve is a very good question, especially now that Uncle Sam’s generosity is supporting a record of nearly 20% of personal income. The fact that we have now resorted to ‘Cash for Clunkers’ to support consumption is a very sorry state of affairs.
While the hosts on the CNBC show we were on yesterday afternoon claimed that the bounce in July auto sales was evidence of pent-up demand, we would simply have to disagree. If there was pent-up demand we wouldn’t need the subsidy to begin with — it just goes to show that there will always be people who will be willing to accept free money.
Reuters did some nifty work and showed that in this last leg of the rally, which started on July 10th, CCC-rated stocks have surged 26.4%, BB-rated stocks are up 19.3%, while AAA-rated stocks have risen 9.5%. Look — when China is up 80% year-to-date, India 60%, and both the Kospi and Hang Seng up 40% — and dare we say, the SOX index up 60% in less than six months — it’s probably safe to assume that we have a huge speculative junky market on our hands. And, we know from the 2000-2001 and 2007-2008 experiences, they don’t tend to end well.
We mentioned how bullish the latest Market Vane Sentiment reading was, and now we have the latest data-point on the Investors Intelligence poll. The envelope please:
• Bulls: 47.2% versus 42.2% a week ago
• Bears: 25.8% versus 31.1% a week ago
The bull/bear spread widened by over 10 percentage points this week; a nightmare for the technical analyst (from a contrary perspective).
There you have it. This does not mean that stock prices can’t climb any higher but, based on Dave’s analysis, I have to wonder how much upside potential remains given the not very encouraging economic conditions.
Following the market trends, we will deal with an eventual turn-around effectively via our exit strategy. What concerns me more is that millions of investors have become complacent and think that happy days are here again. They will get caught unprepared in the upcoming trend reversal (whenever it occurs) without a plan to protect their portfolio from a repeat disaster.