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http://zerohedge.blogspot.com/2009/05/shooting-shoots.htmlFriday, May 1, 2009 Shooting The ShootsPosted by Tyler Durden at 2:36 PMMust read from David Rosenberg, who is on fire today, even taking onLarry Kudlow now.

Its time to set the record straight

We acknowledge that we have felt like salmon swimming upstream. And,we constantly preach that everyone should keep an open mind and aboutthe dangers of being perma-bears at the low (not our intention!) butits time to set the record straight.

Big money investors have been on the sidelines

We have talked to so many bewildered clients about the massive equitymarket rally from the March lows that weve lost count. Few, if any(especially in the hedge fund community) seem to be celebrating thefact that the S&P 500 has rallied 30%, which tells us that big-money

investors have been on the sidelines through this entire move. Fromour lens and you can see this clearly from the twice-monthly NYSEdata the buying power for this market has actually come from severeshort-covering as the bears head for the hills.

Few market-makers share enthusiasm of most economists

We dont really share the view that the recovery, if and when itcomes, will be sustained. We understand the historical record thateven in the face of monumental fiscal and monetary easing, it takes agood four years for the economy to work through the aftershocks of acollapse in credit and asset values. While most economists are nowwaving the pom-poms, we find very few marketmakers who share theirenthusiasm.

By and large, this rally has been a clear technical event

Gaps get filled rapidly and the primary source of buying power seemsto be coming from a huge short-squeeze, and perhaps some pension fundrebalancing, which always seems to happen after the market makes a newlow. To be sure, there is always the chance that the dry powder (moneyon the sidelines) is put to work and investors chase this rally. Andnothing says that the S&P 500 cannot go as high as the 200-day moving

average of 970 over the near term. We have seen these kinds of ralliesin the past There were four of these kinds of rallies from 1929 to1932; a half-dozen in the 19-year-old Japanese bear phase; and nofewer than 40,000 rally points in the Nasdaq that were fun to play inthe 2000-2003 bear market but the fundamental downtrend wasobviously still intact.

Stock market not good at predicting inflection points

The stock market bottomed for good in the spring of 2003 because atthat time, we were on the cusp of a 4%+ real GDP growth rate over theensuing four quarters. The reason the rally of late 2001 to early 2002failed was because the market realized the recovery would be delayed.Lets just say that a 21% rally in the S&P 500 from Sept 2001 toJanuary 2002 was not a bounce that was pricing in a 1.5% GDP growthrate for the ensuing four quarters, which is what we ended up with.

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We can look at the situation in reverse. Did the 20% slide in the S&P500 in the summer accurately predict the 4-1/2% GDP growth trend wewere going to see the following year? No. And even in this cycle, theequity market was peaking just as the recession started in the fourthquarter of 2007. So, this notion that the equity market is telling usanything meaningful about the economic outlook, as Larry Kudlow wouldhave us believe, is open for debate. The stock markets track record

is just about as good as the economics community at predicting theinflection points in the business cycle and thats not very good.

The market, as a whole, cannot be considered cheap

While there are some good blue-chip companies trading at lowmultiples, the market as a whole can hardly be considered cheap. Thatmay have been the case two months ago, but no longer. As for theearnings landscape, it has become fashionable to talk about how thevast majority of companies are beating estimates in their 1Q results,but the bar was set extremely low to begin with after that epic 4Q

operating and reported loss on S&P 500 EPS. In the meantime, earningsforecasts are being trimmed steadily for the balance of the year. Infact, forward P/E multiple of 15x operating and 30x on reported EPSare not that compelling. So, we do not have a strong valuationargument. We do not have a strong earnings argument. The seasonals("sell in May) are about to become less compelling too.

New lows in S&P wont happen as soon as we thought

We would, at the same time, acknowledge that if the terms ofengagement have changed, the Obama economics team and the Fed havemade it exceedingly difficult for the shorts to make money in this

market. Tail risks, notably in terms of the banking system, have beenremoved. This, in turn, does mean that even if we break to new lows inthe S&P 500, it probably will not happen as soon as we had thought.

Government will do whatever it takes

At the March 9 lows, there was a real feeling of possible bankruptcyin the financial system. But it is now abundantly clear the governmentwill not allow any big financial institution to fail. The end of mark-to-market accounting rules and the super-steep yield curve havereturned most of the banks to profitability. Uncle Sam can be relied

on to remain the capital provider of last resort, even for those banksthat do not pass the coming stress test (which has been delayed, inpart because the government wants to assess how to deal with thefallout of those particular institutions). More and more taxpayermoney is being thrown at the credit crisis, and now we hear that $50billion will be allocated toward easing debt-service strains amongthose households that took on second mortgages during the housingbubble. And, until recently when the green shoots started to appear,there was growing talk of yet another fiscal blockbuster coming downthe pike to underpin the economy.

Green shoots can turn into a dandelion or a beanstalk

We are more impressed with solid roots than we are with green shoots.The economy and the capital markets are being held together by tapeand glue, in our view. Private sector activity is contracting and will

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continue to lose its share of GDP as the governments influence riseson a secular basis. Tax rates will inevitably rise, as they arealready doing at the state and local government level. The publicsector is now involved in the mortgage market, the insurance sector,the banking industry, and of course, the automotive business.

Economy transforming into an early 1980s European model

As economists, strategists, analysts, and the media, focus on thenoise which is what green shoots really are: a blip in a fundamentaldowntrend a dramatic transformation of the economy toward a1970s/early 1980s European model is unfolding. That post-Mitterrand,pre-Thatcher model, if memory serves us correctly, was one of low-potential real GDP growth rates, low-fair-value P/E multiples, lowrates of return on capital and a sclerotic economic system. Economy isnot in free-fall but is hardly stabilizing.

Now lets get to the economy and those fabled green shoots

There is no doubt that the economy is no longer in free-fall, but itis hardly stabilizing, even if the data have improved from deeplynegative trends at the turn of the year. There are pundits claimingthat because initial jobless claims have managed to come off theirrecent highs, the end of the recession is in sight. That is a fairytale, in our opinion.

Slack still being built up in the labor market

Given the looming wave of auto sector layoffs, we expect claims tobreak to above 700,000 this summer, which would be a new record. So,jobless claims do not appear to have peaked yet. In fact, therelentless surge in continuing claims signals that an ever-increasingamount of slack is being built up in the labor market. There has neverbeen a peaking out in gross claims without there being a confirmationfrom a similar turn in the continuing jobless claim data. Moreover,initial jobless claims have topped the 600,000 threshold now for 13weeks in a row, and that is the real story.

To suggest that claims have stabilized above 600,000 and that this isa good thing is ridiculous. It would mean that by this time next year,the unemployment rate could potentially reach 15%. The reason isbecause employment losses do not end until claims actually break below

400,000. No recession ever ended until claims broke below 600,000, andon average, recessions only end once claims drop below 500,000 (whenthe last recession ended in November 2001, as an example, claims were450,000).

Job losses will not end until the end of the year

Employment is one of the four critical ingredients that go into therecession call, not jobless claims, and at over 600,000 on claims, welose payrolls at a monthly rate of around 600,000. That is hardly whatwe would call a stable economic backdrop. We do not see job lossesending before the end of the year. Industrial production and real

manufacturing/trade sales are two other components that go into theNBER recession-determination model, and our forecast suggests thatthey too will not bottom conclusively until 2010.

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Real organic personal income decrease is unprecedented

What really caught our eye is the fourth horseman of the recessioncall real organic personal income. This metric peaked in October2007 and was early in predicting the official onset of the recession,which began in December of that year. This measure of household income it nets out government benefits slipped 0.5% in March and hasdeclined for five months in a row (and six of the past seven). Over

that stretch, it declined at over a 6% annual rate, which isunprecedented (the data series go back to 1954).

Expect consumer spending to lag because of lost income

Since August of last year, the consumer sector has lost $266 billionof organic income (in nominal dollars at an annual rate) as job lossesmounted, hours worked cut back, and full-time positions shifted topart-time. This lost income not to mention $20 trillion ofevaporated net worth will likely bring long lags in dampeningconsumer discretionary spending. We realize that one of the bright

spots in the 1Q GDP report was the +2.2% print on real consumerspending. But lets face facts: The bounce was concentrated in Januaryafter a record 30% plunge in retail sales (at an annual rate) in thefinal three months of 2008. We already know that sales were down inboth February and March and that the statistical handoff with respectto consumer spending is negative as we head into the second quarter.

The government does not create income; it redistributes it

We mentioned tape and glue above because the only component ofhousehold income that is rising is government transfers (mostlyjobless benefits), which rose 0.9% in March and by more than 12% on a

year-over-year basis. The government share of personal income at 16.3%is higher today than at any other time in the past six decades (andthat covers the LBJ Great Society social benefit transfer of the1960s). But keep in mind that the government does not create income it distributes income by borrowing from todays bondholders andtomorrows taxpayer. Not until we begin to see real incomes risewithout the crutch of Uncle Sams checkbook will it be safe to callfor the end of the recession. And again, we see this as more a 2010story than a 2009 story, although very clearly the markets aresuggesting the latter (insofar as they are signaling anything aboutthe economic outlook).

The worst is over

In any event, the economy has certainly passed its worst point of thecycle even if we do not yet see the bottom that many others do at thistime. And it may very well be that we overstayed our bearish call onthe equity market and that the lows were turned in on March 9. Manypundits who have been around far longer seem to believe that, and theycould be right. But there is no sense crying over spilled milk, evenafter a 30% run-up in the S&P 500 and a 100 basis point surge in the10-year note yield from the lows. It just broke above its 200-daymoving average, and there is nothing but empty space on the chart to

3.8% that is an observation, not a forecast, by the way.

Lessons learned from the Great Depression

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With all that in mind, we thought it would be instructive to look backto the experience of the 1930s. A credit collapse, asset deflation andmassive decline in economic activity were finally stopped in theirtracks by massive doses of fiscal and monetary stimulus. The S&P 500bottomed in the summer of 1932 and the trough in GDP occurred shortlythereafter. But if history is any indication, the depression did notend for another nine years. Even after the massive relief efforts andgovernment intervention from the New Deal, we closed the 1930s with a

15% unemployment rate and consumer prices deflating at a 2% annualrate.

Focus on SIRP safety and yield at a reasonable price

Because the attention now has shifted to the green shoots, as waslikely the case after the 1932 low as well, we highly recommend thatinvestors focus on the big picture, which is that the aftershocks of acredit collapse and an asset deflation of this magnitude last foryears, even with public sector support. Now go back to that June 1932low in the S&P 500 (below 5) and the initial surge was breathtaking

the market roared ahead by 75% in just the first three months. Butguess what? For buy-and-hold investors, by the end of 1941, the S&P500 was at the same level as in the fall of 1932. Nine years ofnothing, unless you are the most astute trader around.

Folks who chased the rally after the market broke out of the gatewoefully underperformed those who stuck with their focus on generatingcash flows from the fixed-income market. The yield on long Treasuriesfell from 3.8% to 2.5% (Fall of 1932 to the end of 1941) while Baacorporates did even better rallying from 7.1% to 4.4%. So from thispoint forward, unless you are comfortable that you have the disciplineas to when to get out, the lesson of the last post-credit crunch/asset

deflation/depression seven decades ago is to retain your focus on SIRP safety and yield at a reasonable price. Passive buy-and-holdstrategies are destined to fail, in our view.