Did you see the comments from retiring Merrill Lynch economist David Rosenberg last week? Writing just after the S&P hit 920, Rosenberg let his clients know that he thought the sucker’s rally was over. Indeed, some of our friends were suggesting that after all the short-covering money got in the market, it was setting up for at least a 5% or 10% correction from the recent surge. But Rosenberg went well beyond that.
“Risk is much higher now than it was 18 weeks ago,” Rosenberg wrote. ” The nine-week S&P 500 surge from 666 at the March lows to 920 as of yesterday has all but retraced the prior nine-week decline from the 2009 peak of 945 on January 6 to the lows on March 9. We believe it is appropriate to put the last nine weeks in the perspective of the previous nine weeks. To the casual observer, it really looks like nothing at all has happened this year, with the market relatively unchanged.”
“But something very big has happened because the risk in the market, in our view, is much higher than it was the last time we were close to current market prices back in early January, for the simple reason that we believe professional investors have covered their shorts, lifted their hedges and lowered their cash positions in favour of being long the market.”
“Employment, output, income, sales still in a downtrend. Considering what transpired from an economic standpoint, the decline in the first nine weeks of the year was rather appropriate in the midst of the worst three-quarter performance the economy has turned in roughly 70 years. The rally of the past nine weeks appears to be rooted in green shoots. While it may be the case that the pace of economic decline is no longer as negative as it was at the peak of the post-Lehman credit contraction, the reality is that employment, output, organic personal income and retail sales are still in a fundamental downtrend.”
So what does it all mean?
“Chances of a re-test of the March lows are non-trivial,” Rosenberg writes. “To reiterate, it seems to us likely that the risk in the market is actually higher today than it was back at the same price points in early January, and we say that with all deference to the stress tests (which given the less-than-dire economic scenarios, along with the changes to mark-to-market accounting, were destined to reveal healthy results). While the consensus seems gripped with the burden of trying to decide if there is too much risk to be out of the market, we actually still believe that the chances of a re-test of the March lows are non-trivial, especially if the widely touted second-half economic rebound fails to materialize.”
Which brings us to a conversation which may or may not have been overheard last night, somewhere in a quiet pub in St. Kilda.
“Hey. It’s good to see you down here at ground level, when you’re not riding your high horse,” our friend began.
“You know, I bet no one else is going to tell you this, but you’re an idiot. You should be embarrassed for yourself mate. But I know you have no shame.”
“Why do you say that?”
“It’s painful to watch. You’ve just worked yourself up over the last couple of days to accepting this rally in stocks and providing some kind of insane speculative rationale for participating in it. And the rally is over! And then you go off on some diatribe about taxes. You are such a moron!”
“Well look. You got a 57% crash on the S&P 500 in seventeen and a half months. It was a slow motion train wreck. It was a bigger peak to trough fall than the first part of the Depression Crash. But the Feds were fighting this one harder. They banned short selling. They pumped money into the bond market to force down yields and get people back into stocks. They stimulated. They legislated. And they orated. And like the Whitney woman explained, they rigged first quarter bank earnings so that bank tangible book values would improve by an accounting sleight of hand. Financial and retail stocks led the rally, but there was no substance to it.”
“She’s probably right. There’s a lot of positive momentum based on no fundamentals. She says the long-only money is going to get its head chopped off again and be pretty angry about it.”
“Good. We can agree on that. Now about you being a moron. Do you realise how big of a jerk you sounded like today?”
“What do you mean?”
“How can you write a big rant against progressive taxation and expect people to like you? You came off like an arrogant spoiled child and know-it-all American. You should indulge yourself less. Besides, should we just eat the poor or something? If the government doesn’t take care of the less fortunate, who is going to? Definitely not the market.”
“Well, it wasn’t a rant. I was only trying to make the point that the market is an institution for communicating prices and allocating scarce resources. When the government starts confiscating incomes it reduces capital formation, increases consumption, and ultimately makes the whole society poorer and more dependent on government.”
“Yeah that’s really tugging at my heart strings. So what? What about the people who need help? Who’s going to help them?”
“They’re not getting much from the government are they? Look, my point is that saying you’re for higher taxes to help the less fortunate is a moral and economic cop out. Economically, it’s easy to say when you aren’t paying the taxes. Morally, taxation is even worse than theft. It’s an effort to sub-contract the real obligations you have to help people. In fact I’d argue that when people try to foist off on the government the job of caring for the sick, the needy, and the less fortunate it actually makes people less empathetic and compassionate in their own lives.”
“You’re saying the Welfare State actually erodes the natural sense of personal obligation and empathy we have for one another? You can’t be serious. Have you been drinking?”
“That’s exactly what I’m saying. The market is a magnificent institution for conveying information. There are other institutions in life like family, Church, or community, or even government at a small local level that are there to deal with real human problems. If you want to talk personal ethics, we can do that. But believe me, I know the market isn’t perfect. When it works, more people have food, clean water, energy, and jobs. But for the other problems, I think people need to stop mailing checks to the government and start with what they can do themselves. But personal effort in your own life is much harder. It takes time, which is much more expensive than money. It’s easier to vote for a guy who tells you lies about what he’s going to do for your grandparents and the poor people you never have to see every day. People who support taxation as a way to solve society’s problems are morally lazy and ethically challenged.”
“Well why didn’t you just say that? That should really win you some new friends.”
for Markets and Money