http://zerohedge.blogspot.com/2009/05/shooting-shoots.

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Friday, May 1, 2009 Shooting The Shoots
Posted by Tyler Durden at 2:36 PM
Must read from David Rosenberg, who is on fire today, even taking on
Larry Kudlow now.

It’s time to set the record straight

We acknowledge that we have felt like salmon swimming upstream. And,

we constantly preach that everyone should keep an open mind and about
the dangers of being perma-bears at the low (not our intention!) – but
it’s time to set the record straight.

Big money investors have been on the sidelines

We have talked to so many bewildered clients about the massive equity

market rally from the March lows that we’ve lost count. Few, if any
(especially in the hedge fund community) seem to be celebrating the
fact that the S&P 500 has rallied 30%, which tells us that big-money
investors have been on the sidelines through this entire move. From
our lens – and you can see this clearly from the twice-monthly NYSE
data – the buying power for this market has actually come from severe
short-covering as the bears head for the hills.

Few market-makers share enthusiasm of most economists

We don’t really share the view that the recovery, if and when it
comes, will be sustained. We understand the historical record that
even in the face of monumental fiscal and monetary easing, it takes a
good four years for the economy to work through the aftershocks of a
collapse in credit and asset values. While most economists are now
waving the pom-poms, we find very few marketmakers who share their
enthusiasm.

By and large, this rally has been a clear technical event

Gaps get filled rapidly and the primary source of buying power seems
to be coming from a huge short-squeeze, and perhaps some pension fund
rebalancing, which always seems to happen after the market makes a new
low. To be sure, there is always the chance that the dry powder (money
on the sidelines) is put to work and investors chase this rally. And
nothing says that the S&P 500 cannot go as high as the 200-day moving
average of 970 over the near term. We have seen these kinds of rallies
in the past There were four of these kinds of rallies from 1929 to
1932; a half-dozen in the 19-year-old Japanese bear phase; and no
fewer than 40,000 rally points in the Nasdaq that were fun to play in
the 2000-2003 bear market – but the fundamental downtrend was
obviously still intact.

Stock market not good at predicting inflection points

The stock market bottomed for good in the spring of 2003 because at
that time, we were on the cusp of a 4%+ real GDP growth rate over the
ensuing four quarters. The reason the rally of late 2001 to early 2002
failed was because the market realized the recovery would be delayed.
Let’s just say that a 21% rally in the S&P 500 from Sept 2001 to
January 2002 was not a bounce that was pricing in a 1.5% GDP growth
rate for the ensuing four quarters, which is what we ended up with.
We can look at the situation in reverse. Did the 20% slide in the S&P
500 in the summer accurately predict the 4-1/2% GDP growth trend we
were going to see the following year? No. And even in this cycle, the
equity market was peaking just as the recession started in the fourth
quarter of 2007. So, this notion that the equity market is telling us
anything meaningful about the economic outlook, as Larry Kudlow would
have us believe, is open for debate. The stock market’s track record
is just about as good as the economics community at predicting the
inflection points in the business cycle – and that’s not very good.

The market, as a whole, cannot be considered cheap

While there are some good blue-chip companies trading at low

multiples, the market as a whole can hardly be considered cheap. That
may have been the case two months ago, but no longer. As for the
earnings landscape, it has become fashionable to talk about how the
vast majority of companies are beating estimates in their 1Q results,
but the bar was set extremely low to begin with after that epic 4Q
operating and reported loss on S&P 500 EPS. In the meantime, earnings
forecasts are being trimmed steadily for the balance of the year. In
fact, forward P/E multiple of 15x operating and 30x on reported EPS
are not that compelling. So, we do not have a strong valuation
argument. We do not have a strong earnings argument. The seasonals
("sell in May”) are about to become less compelling too.

New lows in S&P won’t happen as soon as we thought

We would, at the same time, acknowledge that if the terms of

engagement have changed, the Obama economics team and the Fed have
made it exceedingly difficult for the shorts to make money in this
market. Tail risks, notably in terms of the banking system, have been
removed. This, in turn, does mean that even if we break to new lows in
the S&P 500, it probably will not happen as soon as we had thought.

Government will do whatever it takes

At the March 9 lows, there was a real feeling of possible bankruptcy

in the financial system. But it is now abundantly clear the government
will not allow any big financial institution to fail. The end of mark-
to-market accounting rules and the super-steep yield curve have
returned most of the banks to profitability. Uncle Sam can be relied
on to remain the capital provider of last resort, even for those banks
that do not pass the coming stress test (which has been delayed, in
part because the government wants to assess how to deal with the
fallout of those particular institutions). More and more taxpayer
money is being thrown at the credit crisis, and now we hear that $50
billion will be allocated toward easing debt-service strains among
those households that took on second mortgages during the housing
bubble. And, until recently when the green shoots started to appear,
there was growing talk of yet another fiscal blockbuster coming down
the pike to underpin the economy.

Green shoots can turn into a dandelion or a beanstalk

We are more impressed with solid roots than we are with green shoots.
The economy and the capital markets are being held together by tape
and glue, in our view. Private sector activity is contracting and will
continue to lose its share of GDP as the government’s influence rises
on a secular basis. Tax rates will inevitably rise, as they are
already doing at the state and local government level. The public
sector is now involved in the mortgage market, the insurance sector,
the banking industry, and of course, the automotive business.

Economy transforming into an early 1980s European model

As economists, strategists, analysts, and the media, focus on the

noise – which is what green shoots really are: a blip in a fundamental
downtrend – a dramatic transformation of the economy toward a
1970s/early 1980s European model is unfolding. That post-Mitterrand,
pre-Thatcher model, if memory serves us correctly, was one of low-
potential real GDP growth rates, low-fair-value P/E multiples, low
rates of return on capital and a sclerotic economic system. Economy is
not in free-fall but is hardly stabilizing.

Now let’s get to the economy and those fabled green shoots

There is no doubt that the economy is no longer in free-fall, but it

is hardly stabilizing, even if the data have improved from deeply
negative trends at the turn of the year. There are pundits claiming
that because initial jobless claims have managed to come off their
recent highs, the end of the recession is in sight. That is a fairy
tale, in our opinion.

Slack still being built up in the labor market

Given the looming wave of auto sector layoffs, we expect claims to

break to above 700,000 this summer, which would be a new record. So,
jobless claims do not appear to have peaked yet. In fact, the
relentless surge in continuing claims signals that an ever-increasing
amount of slack is being built up in the labor market. There has never
been a peaking out in gross claims without there being a confirmation
from a similar turn in the continuing jobless claim data. Moreover,
initial jobless claims have topped the 600,000 threshold now for 13
weeks in a row, and that is the real story.

To suggest that claims have stabilized above 600,000 and that this is
a good thing is ridiculous. It would mean that by this time next year,
the unemployment rate could potentially reach 15%. The reason is
because employment losses do not end until claims actually break below
400,000. No recession ever ended until claims broke below 600,000, and
on average, recessions only end once claims drop below 500,000 (when
the last recession ended in November 2001, as an example, claims were
450,000).

Job losses will not end until the end of the year

Employment is one of the four critical ingredients that go into the

recession call, not jobless claims, and at over 600,000 on claims, we
lose payrolls at a monthly rate of around 600,000. That is hardly what
we would call a stable economic backdrop. We do not see job losses
ending before the end of the year. Industrial production and real
manufacturing/trade sales are two other components that go into the
NBER recession-determination model, and our forecast suggests that
they too will not bottom conclusively until 2010.
Real organic personal income decrease is unprecedented

What really caught our eye is the fourth horseman of the recession
call – real organic personal income. This metric peaked in October
2007 and was early in predicting the official onset of the recession,
which began in December of that year. This measure of household income
– it nets out government benefits – slipped 0.5% in March and has
declined for five months in a row (and six of the past seven). Over
that stretch, it declined at over a 6% annual rate, which is
unprecedented (the data series go back to 1954).

Expect consumer spending to lag because of lost income

Since August of last year, the consumer sector has lost $266 billion
of organic income (in nominal dollars at an annual rate) as job losses
mounted, hours worked cut back, and full-time positions shifted to
part-time. This lost income – not to mention $20 trillion of
evaporated net worth – will likely bring long lags in dampening
consumer discretionary spending. We realize that one of the bright
spots in the 1Q GDP report was the +2.2% print on real consumer
spending. But let’s face facts: The bounce was concentrated in January
after a record 30% plunge in retail sales (at an annual rate) in the
final three months of 2008. We already know that sales were down in
both February and March and that the statistical handoff with respect
to consumer spending is negative as we head into the second quarter.

The government does not create income; it redistributes it

We mentioned tape and glue above because the only component of

household income that is rising is government transfers (mostly
jobless benefits), which rose 0.9% in March and by more than 12% on a
year-over-year basis. The government share of personal income at 16.3%
is higher today than at any other time in the past six decades (and
that covers the LBJ Great Society social benefit transfer of the
1960s). But keep in mind that the government does not create income –
it distributes income by borrowing from today’s bondholders and
tomorrow’s taxpayer. Not until we begin to see real incomes rise
without the crutch of Uncle Sam’s checkbook will it be safe to call
for the end of the recession. And again, we see this as more a 2010
story than a 2009 story, although very clearly the markets are
suggesting the latter (insofar as they are signaling anything about
the economic outlook).

The worst is over

In any event, the economy has certainly passed its worst point of the
cycle even if we do not yet see the bottom that many others do at this
time. And it may very well be that we overstayed our bearish call on
the equity market and that the lows were turned in on March 9. Many
pundits who have been around far longer seem to believe that, and they
could be right. But there is no sense crying over spilled milk, even
after a 30% run-up in the S&P 500 and a 100 basis point surge in the
10-year note yield from the lows. It just broke above its 200-day
moving average, and there is nothing but empty space on the chart to
3.8% – that is an observation, not a forecast, by the way.

Lessons learned from the Great Depression

With all that in mind, we thought it would be instructive to look back
to the experience of the 1930s. A credit collapse, asset deflation and
massive decline in economic activity were finally stopped in their
tracks by massive doses of fiscal and monetary stimulus. The S&P 500
bottomed in the summer of 1932 and the trough in GDP occurred shortly
thereafter. But if history is any indication, the depression did not
end for another nine years. Even after the massive relief efforts and
government intervention from the New Deal, we closed the 1930s with a
15% unemployment rate and consumer prices deflating at a 2% annual
rate.

Focus on SIRP — safety and yield at a reasonable price

Because the attention now has shifted to the green shoots, as was
likely the case after the 1932 low as well, we highly recommend that
investors focus on the big picture, which is that the aftershocks of a
credit collapse and an asset deflation of this magnitude last for
years, even with public sector support. Now go back to that June 1932
low in the S&P 500 (below 5) and the initial surge was breathtaking –
the market roared ahead by 75% in just the first three months. But
guess what? For buy-and-hold investors, by the end of 1941, the S&P
500 was at the same level as in the fall of 1932. Nine years of
nothing, unless you are the most astute trader around.

Folks who chased the rally after the market broke out of the gate
woefully underperformed those who stuck with their focus on generating
cash flows from the fixed-income market. The yield on long Treasuries
fell from 3.8% to 2.5% (Fall of 1932 to the end of 1941) while Baa
corporates did even better – rallying from 7.1% to 4.4%. So from this
point forward, unless you are comfortable that you have the discipline
as to when to get out, the lesson of the last post-credit crunch/asset
deflation/depression seven decades ago is to retain your focus on SIRP
– safety and yield at a reasonable price. Passive buy-and-hold
strategies are destined to fail, in our view.