Double Helping of the Astute Mr. Rosenberg

In Wednesday's Huffington Post column, "Feeding the Ducks on Wall Street," I referenced data and reports detailing the varied list of players, many with intimate knowledge of what is occurring on Main Street's front lines, who have viewed the run-up in share prices as an opportunity to raise (and hoard) cash.

That raises the question, of course, of "Just Who Is Buying this Rally?" which happens to be the title of the following post from FT Alphaville:

Here’s an insightful question from David Rosenberg of Gluskin Sheff on the matter of the current rally in global equities.

Who is actually doing the buying?

As Rosenberg notes:

• It’s not private clients - stock funds registered net outflows of $1.33bn last week.
• It’s not corporate insiders - heck they’re selling like crazy.
• It’s not buybacks - S&P reported they were down to the lowest level since 1998.

Nope indeedy. This leaves him to conclude it must be:

Very likely it is still a combination of program trading, short coverings and portfolio managers desperately trying to make up for last year’s epic losses.

And, just to leave you with a scary fact for the weekend, he adds:

While it is now considered to be in very bad taste to say anything negative about an equity market that is seemingly on a one-way ticket north, by the time the S&P 500 was up 60% in the last cycle, claims had already fallen to 300k. And, in the cycle prior to that, claims had drifted down to 350k by the time the market had rallied 60%. The market is so overextended that it is now 20% above its 200-day moving average, which is a technical condition that has not occurred in 27 years.

Still, as I noted in my own commentary, just because the buying is of poor quality doesn't mean the market can't go up. Eventually, though, cold, hard fundamentals get in the way, as FT Alphaville -- which I gave props to several weeks ago -- reveals in another post, “This Overvalued, Overbought, Overextended Market…,” featuring the insights of the former North American economist for Merrill Lynch:

Here’s some more from Gluskin Sheff’s David Rosenberg, because his latest “Breakfast with Dave” note is just so good.

He is NOT buying this stock market - remember, bear market rallies “are to be rented; never owned…”

Imagine that six months after the depressed lows we have a situation where:

• The trailing price-earnings ratio on operating EPS is 26.5x. At the October 2007 highs, it was 18.8x. In addition, when the S&P 500 is trading north of a 26x P/E multiple on trailing operating earnings, history shows that at these high valuation levels, the market declines in the coming year 60% of the time.
• The trailing price-earnings ratio on reported EPS is 184.2x. At the October 2007 highs, it was 23.4x. In fact, just prior to the October 1987 crash, the P/E ratio was 20.3x (not intended to scare anyone).
• The price-to-dividend ratio is 53x, where it was at the 2007 highs. Again, the market is trading as it if were at a peak for the cycle, not any longer near a trough. Once again, and we don’t intend to sound alarmist, the price-to-dividend ratio just prior to the 1987 crash was 12x, and at the time, the S&P 500 was viewed in many circles to be at an extended extreme.

Bullish analysts like to dismiss the actual earnings because they are “depressed” and include too many writeoffs, which of course will never occur again. Fine, on one-year forward (operating) earning estimates, the P/E ratio is now 15.7x, the highest it has been in nearly five years. At the peak of the S&P 500 in the last cycle — October 2007 — the forward P/E was 14.3x, and the highest it ever got in the last cycle was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment). As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the U.S. dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 4.5% clip.

In other words, valuation may not be the best timing device, but it still matters. If the S&P 500 was in a 700-750 range, de facto pricing in zero to 1% real GDP growth, we would certainly be interested in boosting our allocations towards equities. But at 1,060 and over 4.0% GDP growth effectively being discounted, we will be spectators as opposed to participants, understanding that the key to success is to NOT buy at the peaks. So the strategy is to sit on the sidelines, be selective in our equity choices, and wait for the correction to come or for the fundamentals to catch up with this overvalued, overbought, overextended market. Remember, the reason why the tortoise won the race was because the hare got tired.

One more thing, when people look back at this period, they are very likely going to ask themselves why it was that they never paid attention to the volume data, which, like the bond and money market, never confirmed the veracity of this very flashy bear market rally. We reiterate, Japan enjoyed four of these 50% power surges in the context of a market that is still down over 70% from its highs of two decades ago. So remember, rallies in a bear market are to be rented; never owned. For those that never took the opportunity to get out at the lows today have this glorious chance to do so at much better prices, but the question is whether greed has overtaken their long-term resolve, especially now that Gordon Gekko is making a return to the big screen.

Comments

[masnoor h. khan]

A Radical Solution for America's Insolvent Financial System
The core problem of the United States' banking system (and maybe the world's banking system) is not liquidity but insolvency. The liabilities of the United States' banking system exceed the value of its assets. The issue is not only the toxic assets (toxic mortgage backed securities, toxic commercial real estate loans, sub-prime mortgages, alt-A loans, adjustable loans likely to go bust, increase in prime mortgage default rates, etc) but also off-balance sheet liabilities (such as expected huge unaccounted for future derivatives losses).
This means that bailouts are just beginning and will require bigger and bigger sums of taxpayer money as time goes on. The government will resort to borrowing more and more and eventually to printing money when treasury debt auctions start failing. The end result of this path is a currency collapse and probably total chaos as expected by gold bugs.
One other way to deal with this issue is to stop the bailouts and let the dominoes fall. Defaults and cross-defaults will cause many, many depository institutions (even very large ones) to collapse leading to extreme decrease in money supply as bank deposits are destroyed. Deposits of failed banks cannot be used to pay bills, make purchases and/or service debts.
Which will probably lead to even more defaults as unemployment increases and debtor's are unable to service their debts. This process will probably cause extreme deflation as businesses lower prices in a bid to survive. This will also lead to wage cuts, increased unemployment and a deflation spiral and much chaos. But probably less chaos than a currency collapse.
Is there a better way?
Here is my idea:
1) We essentially need an orderly bankruptcy and liquidation of the United States' financial system.
2) I suggest we create a government owned bank and transfer all deposits of the private commercial banking system to the new government owned bank. This "transfer" is really just new money creation. This new money will be digital cash (electronic version of physical paper cash). Very much like reserves at the FED.
3) Note that the plan will not create net new money since we will be destroying all deposits of the commercial banking system in the process.
4) All assets of the commercial banking system will be transferred to the government and auctioned off in an orderly manner over the next 10 years. The proceeds from the sale would go the United States treasury and not the commercial banks. The assumption here is that commercial banks deserve nothing since the entire industry would have been most likely destroyed any way. Even good banks would have been destroyed due to bank runs and defaults if the government had allowed the dominoes to fall. Of course bank shareholders, bank bond holders and counter parties of bank derivatives would not receive anything.
5) After the transfer FDIC protection will be removed for any private bank which wishes to remain in business or any new private depository institution or bank. From that point on the government should make it absolutely clear that there will be no more bailouts and no more conversions. This will discourage (but not completely eliminate) fractional reserve deposit banking and private money creation that results from pyramiding of government created money. This will also limit debasement of the currency that results from fractional reserve deposit banking. In fact, we can have "free banking" from that point on and not even have reserve requirements or capital requirements. All depositors who use private banks will be fully at-risk. The industry will have to set the interest rate high enough to attract depositors.
6) The new government bank will act as an electronic "piggy bank" only. All deposits will be 100% reserve and it will not make any loans. Loan making will be left to the private banking system (with no deposit insurance or a possibility of a future bailout). The new government owned bank exists only as a "safe" money storage and a payment clearing system so the public does not have to carry around physical paper cash to make purchases and pay bills.
7) Of course this plan is not without pain or cost. Cost of funds for banks and borrowers will probably rise as bank deposits are a source of very low cost money for the banks. Nothing is free. We are just exchanging higher cost of funds for removal of systemic failure risk. Economically we are recognizing that when money is loaned there is always credit risk.
8) We are just separating the payment and clearing transaction system which is absolutely necessary for day-to-day commerce (no credit risk) from the loan banking and investment system (has credit risk).

Mansoor H. Khan
http://aquinums-razor.blogspot.com/

[Don]

The theory I have is simple. While equities might have a great deal of risk, what asset class is any less risky right now?

Still, it sure smells of something dramatic. Everyone is nervous about what happens when the stimulus runs out. What or who are they going to hand the relay baton off to?

They should have let the whole thing collapse and be rebuilt, which is the natural order of things. By failing to allow the forest to burn naturally, they are guaranteeing a firestorm later.

[Marion Shaw]

I wonder how the countries that own our debt, like China, India, South
Korea, etc. would go along with Mr. Khan's proposal that "we" undertake an
"orderly" liquidation of the United States financial system? His solutions
bring to mind a famous quote from a World War I senator who was asked how he
would solve the German submarine, torpedo problem. "Very simple," he said,
" drain the Atlantic Ocean." A journalist politely inquired how he
proposed to do that and the senator replied: "I have no
idea. That is a detail and I am not a detail man."

[mls]

hi every body i like it
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