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Rosenberg: 'There are numerous signs of decay beneath the surface' of this market

I spoke yesterday morning at a venture capital health care conference in Arizona, an event I have been speaking at for the past 10 years. I recall the first time in November, 2007, when I blurted out my forecast at the very beginning of my presentation:

"I'm going to do something I rarely do which is to give my forecast right up front. And here it is: by the time I'm done this presentation, the mayor of Care Free, Arizona will have changed the name of the town to Stressed Out, Arizona."

Well, the name never did change, that much is true, but by the spring of 2009 there was enough stress in Care Free, that residential properties were being sold at fractions of their original price.

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I'm not saying we are going to see a repeat this November of the events we saw that November a decade ago, but I'm getting a real tapped-out feel to this market and the economy. People are fooled into believing that that there is anything durable to recent data so heavily skewed by post-hurricane rebuild activity. Adjust for inventories and imports and what you see stripped down to the core is a 1.8 per cent growth economy in the third quarter, not the posted mirage of 3 per cent. And if not for the credit-induced rundown in the personal savings rate in the past year – to a decade-low of barely over 3 per cent – we actually are talking about a pace of consumer spending in an organic sense, as well as real gross domestic product (GDP) growth, of barely better than a 1 per cent annual rate. You read that correctly – if spending had been constrained by the trend in real disposable personal incomes, this would be little more than a 1 per cent economy.

As per Wall Street veteran Bob Farrell, it is the markets that make the news. The news does not make the markets. A question posed at this conference was: What happens to the markets if tax reform or tax cuts are delayed or derailed? It matters not. Former U.S. president Ronald Reagan cut top personal marginal rates from 70 per cent to 50 per cent in 1981 and that act did not prevent Mother Nature from taking hold. A five-quarter recession and equity bear market started that summer, at the hand of the Federal Reserve, and this time is no different.

Besides, this market is taking on old-age characteristics and there are numerous signs of decay beneath the surface.

Transport stocks have declined now in eight of the past nine trading days and are off around 5.2 per cent from the Oct. 12 peak. The 50- and 100-day trendlines have been violated and the ratio to utilities has rolled over in a material way. The financials have been lagging.

Only 45 per cent of Nasdaq stocks are trading above their 50-day trendlines compared to 78 per cent a month ago. For the NYSE, those numbers stand at 58 per cent, down from 80 per cent a month back. The equal-weighted S&P 500 index relative to the cap-weighted index has really broken down and within the consumer discretionary group, the ratio has begun to collapse. High-yield spreads have widened out nearly 40 basis points from their nearby lows and the yield curve is flatter today than any other time since November, 2007.

Need I say more?


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I recall exactly this time last year, speaking at the same conference, the morning after the election, I quipped "I had a slide show premised on Hillary winning, but instead of a re-do based on Trump's victory, I'm only going to flip the charts upside down."

All kidding aside, I emphasized that investing around politics and who resides in the White House is a little too speculative for my liking. While it is true that the U.S. stock market has defied gravity, at least up until very recently, it would be very hard to pin this on Donald Trump. The sector that was supposed to do worst under a Trump Presidency – technology – has done best, by a country mile (up 37 per cent year-to-date).

If America First is working, why have the small-caps underperformed by 700 basis points this year? Why is the DXY dollar index down more than 7.5 per cent? If the Trump reflation trade had more believers than dissidents, why has the long bond yield fallen 25 basis points this year? And instead of steepening, as is normally the case in a pro-cyclical reflationary backdrop, the exact opposite is happening as the spread between 10-year Treasury yield and two-year Treasury yield has flattened 55 basis points this year to just a 70-basis-point spread. Like the savings rate, where it was in November, 2007, at the peak of the cycle.

Yesterday's Wall Street Journal ran with a headline: Earnings Continue to Drive Stocks to Records.

That is such a joke. This has been much more a multiple, or shall we say speculative, based rally for the past year than earnings related. Go back to November, 2016. The consensus view among the analyst community was that operating earnings per share would clock in at $132.91 for 2017 and $148.36 for 2018. Today we sit with the bottom-up consensus forecast at $131.20 for this year and $145.52 next. So consider that the alleged Trump Rally over the past 12 months occurred with profit forecasts actually going down, not up.

This is why this is called the Potemkin Rally instead of the‎ Trump Rally. And why it is that I'm humming The Bear Went Over the Mountain these days (it's not because I long for the days when my sons were little kids).

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

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