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Submitted by Tyler Durden.
Yesterday, in a must read post, Gluskin Sheff's David Rosenberg played the devil's advocate and presented a much needed experiment in contrarianism, attempting to unravel what it is that bulls may be seeing in the economy and the market (an analysis which may have to be revised after today's pro forma 400K in initial claims and deplorable retail sales update). While we don't know if anyone was converted into the permabullish fold as a result, it certainly was useful to have a view of what "sliding down the wall of satisfaction" means currently . Today, Rosie is back to his traditional skeptical self with today's publication of the "Laments of a Bear", which is yet another must read inverse view of everything that yesterday was not. Our advise to readers: be aware of both sides of the argument and make up your own mind. Plus at the end of the day the only thing that really matters is what side of the bed Bernanke wakes up on…
From Gluskin Sheff's Breakfast with Dave
Lament of a Bear
Yesterday, we highlighted the bull case for equities, primarily based on the view that the stock market is cheap by historical standards and that the high bar for expectations is far lower than it was this time last year.
Today, we provide a counter view, even as we tip our hat to the bulls, who have been more right than wrong since early October last year, but prior to that were dreadfully wrong from the late-April recovery highs.
As it now stands, the S&P 500 is basically where it was at the close on the first business day of the year and smack-dab in the middle of the 2011 min-max range. It's still a see-saw battle.
To be sure, the near-term backdrop is being constructively underpinned by positive seasonal and technical factors. Tactically, it is probably not a bad thing to have some toes in the risk pool, and our investment team began to add some beta a few weeks back — even in the challenging 2011 environment, having the risk-on trade on for the first few weeks/months was a pretty good alpha- generating thing to do.
But in the secular bear market we are in, and as the evidence from the 2011 experience (even much of 2010 before the onset of QE2) illustrated, rallies are to be rented, not owned. For the most part, we remain quite cautious and skeptical even as we join in this traditional early-year rally.
That said, valuation is at all times a case of beauty being in the eye of the beholder. Yes, classic trailing and forward P/E ratios are very low, but on a cyclically smoothed real earnings basis, the market is at best fairly valued and actually overvalued on a Tobin Q basis (market value versus replacement cost).
And as for sentiment, it is a mixed bag. As I debated Jim Paulsen at the CFA forecasting dinner in Charlotte this week, I realized how much emphasis the uber-bulls place on sentiment and confidence, citing how depressed the surveys are — "if only we got a little confidence boost…".
To be sure, the economics community is less effusive than they were heading into 2011, but is a 2.1% consensus real GDP growth forecast really that downbeat? Or, say, $107, or 10%, growth for corporate earnings out of the analyst community? The Investors Intelligence survey, as we said earlier, is over 50% in terms of bullish sentiment. Consumer confidence is at an eight-month high. The NFIB small business sentiment index is at a 10-month high. The IBD economic optimism index jumped 11% in January, up five months in a row, to stand at its best level since last February.
So by what measure exactly is sentiment truly washed out, as the bulls claim?
To be sure, 2011 was a flat year for the market in a period that saw positive profit growth undercut by a compression in the P/E multiple. In 2012, we may yet again have a flat year — with intermittent volatility — but the with tables turned: multiple expansion offset by an earnings contraction.
Indeed, it can hardly be said that the consensus of forecasts is bearish when it points to a record $107 of operating earnings for this year. But what is key is these EPS estimates are coming down and until that process stops, the overall backdrop for equities will be rather challenging. Low valuations among the traditional P/E metrics may provide a cushion to the downside, but the downward path in analyst earnings revision ratios will limit the upside.
As we said, rent the rallies. This is no time for dogma on either side of the debate.
As for Q4, here is the reality. The bottom-up consensus view is now +7.1% YoY, which is way off the +15% forecast when the quarter began. This is the slowest trend since the third quarter of 2009, just as the economy was escaping from the grips of the most severe recession in seven decades. And if you haven't noticed, in terms of corporate guidance, the ratio of negative pre-announcements to positive ones is now at 3.5x, the highest this has been since the Great Recession was celebrating its first birthday in Q4 2008 (a typical ratio is more like 2.3x). Against this background, the consensus has sliced the Q1 earnings growth forecast to +5.4% on a YoY basis from 10.2% three months ago.
The Bloomberg consensus is for sequential contraction in U.S. corporate earnings for Q4 of 2011 and Q1 of 2012. So there may not be a recession in GDP — GDI (Gross Domestic Income) may be something else however — but it may be the case as far as corporate earnings is concerned.
And in the end, it is profits that investors pay for, not GDP, which is the domain of the economics community. The hurdles for corporate earnings for 2012 are numerous and building:
- Recession in Europe — affects 20% of revenues of U.S. corporations
- Slowing in Asia — China's import growth was sliced in half to 11.8% YoY in December and its inbound traffic is somebody else's export receipts
- Margin squeeze from stubbornly high oil prices
- Stronger U.S. dollar impact on foreign-sourced profits
- Reduced tax benefits
- Higher employment expenses and lower productivity growth.
- Crimped pricing power (as per the latest NFIB survey)
- Profit margins coming off six-decade highs … no more room for expansion
- No yield curve for the banking sector to ride off of, limited ability to squeeze more earnings from loan loss reserves
The key to success will remain much as it was last year. Focus on companies and sectors with earnings visibility, non-cyclical characteristics and a demonstrated ability to provide dividend yields with payout growth. The pundits at Standard and Poor's are forecasting a record of at least $252 billion of dividend payouts this year, surpassing last year's $241 billion.
That means avoiding luxury-goods retailers like Tiffany's, which just posted disappointing sales results and cut their profit guidance. Its Fifth Avenue store posted negative YoY sales and others are bound to follow as financial sector layoffs mount and bonuses are pared back.
It is difficult to believe that with a 2% yield in the broad market that the dividend theme is somehow a crowded trade or an old story now just because it worked so well last year. It worked well for the right reasons. In a market meat grinder, at least you have the dividend tailwind at your back (but avoid the traps — 101 companies also cut or suspended their dividends in 2011). Telecom has a 6% yield, Utilities at 4.2% (and 15% price appreciation last year) and Health Care at 3%.
Bristol-Myers, Home Depot and Con Ed are all examples of companies in a challenging "market" that generated double-digit returns last year, with the help of the dividend stream (not to mention AT&T lifting its quarterly payout by a penny to 44 cents a share or Ford resuming its dividend policy for the first time since 2006). Even the gold miners have a "yield" in today's environment where the boomers are craving more income in the total return of their portfolios. What about McDonald's? A fast food restaurant that is largely non-cyclical, has a global brand, earnings stability and a nice 2.8% dividend yield to boot (having just boosted its quarterly payout 15% to 70 cents). Look — even bears are carnivorous.
On a final note in this chapter, we find it extremely fascinating that as everyone gets excited over the start to the year in equities, the action in Treasuries is serving up a big fat non-confirmation on any view that the risk-on trade is being built on any lasting cyclical momentum. Sorry — but that is the message from the Treasury market where the yield on the 10-year note has been dragged back below 1.9% after yesterday's very robust auction. The other message is that secure income is increasingly becoming a scarce commodity.
And it is against that backdrop that we are seeing a growing trend towards diversified ways to play the "boomer-driven income theme". Three examples showed up in yesterday's WSJ alone (and all in Section C):
- U.K. Debt Continues to Shine (the country is a surrogate for troubled Europe
- fiscal austerity is a reality and the debt/GDP ratio is lower than in [MU)
- A Market Builds for Single-Family Rentals (our global macro fund PM has been paying attention to this for a while now)
- Storage REITS Enjoy a Boom (talk about a creative way to generate yield in a nearly recession-proof industry)
