Rosenberg, Lee debate outlook for U.S. stocks

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Thomas Lee, chief U.S. equity strategist of JPMorgan Chase, and David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, talk about the outlook for U.S. stocks and their investment strategies. 

Source: Bloomberg, March 23, 2012.

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2 comments to Rosenberg, Lee debate outlook for U.S. stocks

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  • Comment from Paul Sandison:

    The exchange between Lee and Rosenberg on Bloomberg raises some vital questions.

    The exchange was very limited to near term horizons by the program anchor, Trish Regan. We did not get to hear enough on Rosenberg and Lee’s views regarding the divergence between the economy and stock market levels in the long term.

    Yet even in the near-term, substantial threats to trends frequently appear very suddenly through fundamental changes that have been in the pipeline for some time but disregarded. These are apart from events that come out of the blue such as seismic events.

    The fundamental issue the stock market has evidently forgotten about is that the market is still overbought when compared with the lack-lustre economic fundamentals such as the poor overall GDP performance in Europe and the US since 2009. On the stock market side, levels since March 2009 are almost solely due to the massive Fed QE 1, QE2 liquidity injections. These were followed by the Fed’s more recent ‘twisting’ operation in 2011 and lastly the trans-Atlantic debt swaps. The latter was particularly successful in calming the markets because what was ultimately worrying the US markets was the problem in Greece and the other Southern and Central European governments that are in financial trouble.

    Furthermore, the EU pact of the 9th December 2012 gave the new ECB boss the excuse to depart from EU regulations and allow the ECB to climb out of its Austrian school monetary fortress. It began to offer European banks cheap loans with which to make money by buying bonds with a higher rate of return. This seems to have calmed the stock markets and the expectation in some quarters is that the S&P should soon reach 1600. The fact that the European fix of its sovereign financial troubles was only temporary and will return appears to have escaped the US stock market more than the European.

    In financial circles, however, the fear is of a new financial crisis, particularly in Europe. The worry is that both European and US banks will not have enough reserves to cope with the one that is judged to be down the road waiting to happen and hence both administrations have been stress-testing their banks again.

    In the US stock markets however, the pressure has been partially off, hence the limited rally in the S&P 1300s range. Although the European banks are frantically trying to build their reserve ratios, the remaining danger is still sovereign default in Europe. The gravel in the machine is that the ECB still refuses to be the lender of last resort to eurozone governments, an absurd policy which flies in the face of 140 years of established central banking practice.

    If this is not bad enough, Governments that have foolishly followed the Austrian school ‘austerity’ mantras have now found that austerity, rather than prudent housekeeping, merely results in another problem. Harsh cuts to government spending result in rising unemployment which thereby, surprise-surprise, causes tax income to decrease, thereby throwing governments into a new deficit. And so governments cut more, which results in more unemployment, and the downward spiral steepens. The negative fallout from the austerity mumbo-jumbo will become an ever greater story through 2012 and 2013.

    Poor program anchor Trish sounds so surprised that housing is still declining – she should not be. Since 2009 I have consistently reported that US housing would continue to decline until at least the first quarter of 2012 due to the continued failure of the bad real estate sub-prime and Alt-A mortgage resets until the end of Q1 2012. We are now there.

    However, while it would be nice if the US housing decline does bottom out in 2012, the likelihood of a global economic downturn in 2012 or at the latest Q1 2013 is now very strong, despite the apparent US stock market levels. One should remember that new unemployment surges would then exacerbate difficulties in the prime mortgage sector, starting a new surge in mortgage defaults down the line.

    The real accident waiting to happen this year is that China is in deep structural economic trouble, Europe is in recession and the US recovery is tepid. India, Japan and some emerging countries are doing well for the moment but taken together these economies are far too limited to be a global locomotive to pull China and Europe out of their recessions.

    There are other key indicators that Trish has lost sight of here. China has now signed a deal with Australia to buy each other’s currencies in order to effect mutual payments outside the dollar world. This is the thin edge of the wedge heralding the end to US dollar hegemony. The death-knell would be when the oil trade ceases to be conducted in US dollars.

    Due to its problems at home it is also doubtful that China will continue to buy US Treasuries to the same extent as before. The Chinese Communist party has consistently avoided allowing the expansion of a service sector – in particularly an insurance sector.

    The party knows full well that allowing citizens to decide their own health, unemployment and old-age insurance would sound the death-knell of the communist party control of the people. Communist, even European Social Democratic parties suffer setbacks when the populace begins to use individual and private insurance systems to cope with life risk. When people realise that they are much better off being able to choose economic decisions for themselves, and that the country is better off with efficient, private companies rather than cranky inefficient state-run monopolies, the demand for democracy and economic liberalisation is not far away.

    The new Chinese leadership is taking over at a difficult time when Chinese trade has declined sharply. The Baltic Dry Index is at 750 which is only 25% of what it was 18 months ago. China does not use western bookkeeping, preferring to keep the old Soviet method which is based on sector goals for production, and is regarded as consistently too optimistic in estimating growth by 2-3%. This is important to remember when considering that the present goal for 2012 is 7.5%, while inflation is at present 5.4%, leaving a projected growth of 2.1%. However taking into account the bookkeeping problem the real growth in China is 0% or lower. China is therefore presently in recession already.

    The time is therefore arriving when the Communist Party in China may be forced to allow the development of a internal service and insurance sector to replace export production serving foreign export markets. China has ready capital in the form of the very high savings ratio of Chinese families.

    When China takes this step to diversify its economy China will no longer be able to buy US Treasuries. This will throw the US into a monetary and new economic crisis. The longer that the Chinese leadership sticks its head in the sand, the more likely there will be a hunger-led revolt. These factors are not ones relegated to the distant future. Time after the debacle of sub-prime and the Lehman crash has now caught up with the world. Hunger focuses the mind and induces a very short span of time for action. The time for great risk is now.

    The last two factors are more difficult to foresee – they concern the fallout from seismic events and geo-political confrontations. Regarding the latter there is a unfortunate build up of tension in several areas around the globe, which means that observation and control is spread too thin. In situations with rapidly cascading events, foreign policy fumbling can allow a precarious situation to get out of control.

    In short, the weaknesses and threats to the world economy presently outweigh the strengths and opportunities. Like Icarus, stock markets flying too close to the sun are likely to crash vertically. The risk months this year are the last months of H1 and H2, i.e. June and December 2012. Midsummer and Christmas are times to watch very carefully.

    Whether the S&P reaches 1600 by May 2012 or not, the underlying economic fundamentals do not support the present stock market optimism. We should remember that crashes tend to overshoot before returning to the mean, and that process can take several decades, as in the case of the Great Depression, when it took the Dow 25 years to return to the same level as in 1929.

    I believe that the housing-led debacle of 2008 was a far worse equivalent of the Florida housing bubble of 1925, since it was both national and global. I think 2012-3 is likely to be the equivalent of 1929 with a peak and then a crash, both national and global.

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