"Bloodletting" Economists

Economic Theory, Then & Now

The U.S. is now 234 years old, and yet over half the nation’s money supply was created since Helicopter Ben took over the flight controls four years ago.

--David Rosenberg; Chief Economist, Gluskin Sheff

It's hardly a saving grace for today's financial mess, but it HAS been gratifying to see an entire generation of muckety-muck economists abruptly lose their hubris regarding their colleagues of yore.

As epitomized by the last two Fed Chairmen, Alan Greenspan and Ben Bernanke, the prevailing mindset amongst contemporary economists has been that their Depression-era peers were little more advanced than medieval doctors, who went in for bloodletting and other harmful quackery.

The reason for that belief?

Those in charge during the Great Depression ignorantly presided over a collapse in the money supply, with a consequently ruinous effect on credit availability, debt repayment, and wages and prices generally (indeed, the Depression was characterized by a devastating deflation).

Fighting the Last War?

Fast forward to today.

"Helicopter Ben" Bernanke and the U.S. Treasury have now injected -- depending on how you count -- somewhere on the order of $10 trillion in liquidity into the U.S. economy.

And that's just since 2008.

Zero percent interest rates. TARP. Son of TARP. Federal guaranties. Bailouts. Direct equity infusions. Subsidized mortgage rates. Quantitative easing. And on and on.

The result?

No Great Depression II, but certainly not a robust recovery. And at the cost of trillions in potentially crippling, new U.S. debt.

In fact, by printing so much money, Mr. Bernanke has ushered in what economists call a "liquidity trap": monetary policy has eased so much -- in fact, to 0% -- that further easing has no effect.

In fact, it's impossible (cue, quantitative easing).

Back to the ???

So, where do we go from here?

Not necessarily 'back to the '30's.

Personally, I'd settle for the '50's.

The Bullish Scenario for Housing

Sell (Stocks) High, Buy (Housing) Low . . . Again?

Stock market investors who'd gotten in at much lower levels and were worried that a correction was overdue decided to take profits.

The sector they turned to?

The housing market, where wary Buyers burned by the last downturn were still keeping their distance -- or clamoring to get out at the bottom.

The foregoing pretty much describes what savvy investors were doing . . . in the late '90's.

Back then, of course, the Nasdaq was well on its way to its 5,000-plus moonshot, and stocks like Pets.com were fetching -- temporarily -- billions despite having no sales or earnings.

And the real estate downturn that was still fresh in people's minds?

The early '90's bear market, which was especially severe in places like Manhattan and Southern California.

Then and Now

Fast forward to today.

After rallying some 75% now from the lows set in March, 2009, here's what Gluskin Sheff analyst David Rosenberg says about stocks today:

The April data was just updated and showed the inflation-adjusted normalized P/E, premised on "bird-in-the-hand" (as opposed to consensus earnings forecasts, which is historically more than 20% higher than we get actually get — one reason why Wall Street banks are dubbed "the sell side") 10-year trailing profits, expanded to over 22x from 21x in March.This is not nosebleed territory, but it is expensive; the historical average is 16.4x. So, this implies that the market is currently 34.7% overvalued benchmarked against the historical norm. It would be nice to say that a higher-than-normal P/E is justified by low inflation and low interest rates. But frankly, real bond yields are not that far from their long-run averages; however, equity valuation is, and something is going to give at some point.

--David Rosenberg, Gluskin Sheff (4/21/2010)

Translation for non-economists: 'stocks ain't cheap anymore.'

As Yogi Berra would say, is it "deja vu all over again?"

Benjamin Franklin, Strategic Default, and Economic Recovery

Strategic Defaults Driving Retail Sales?

A penny saved is a penny earned.

--Benjamin Franklin, circa 1780

A penny defaulted on is a penny earned.

--Benjamin Franklin, 2010??

No, I have no way of knowing whether a modern-day Benjamin Franklin would have uttered the second quote. In fact, he didn't even say the first one (that hasn't stopped him getting credit for it, though!).

But the sentiment is well-placed.

More and more economists now see a connection between rising strategic defaults -- the term for owners who walk away from their underwater homes to preserve their cash flow -- and recovering retail sales.

That link helps explain a conundrum -- namely, why are retail sales improving when hiring is anemic and unemployment is still high?

Strategic Default Economics

The (partial) answer appears to be that people who've ditched their expensive mortgages have more disposable income to spend at Target, Bed Bath & Beyond, restaurants, etc.

Sometimes, A LOT more.

So, somebody who bought a home at the peak in Las Vegas (or Southern Florida, or Phoenix) for, say, $600k and has seen prices subsequently drop 40% could easily rent for $2,500 a month, instead of paying their $4,500 monthly mortgage. And live in just as nice a place.

Voila! An extra $2,000 in monthly disposable income.

Multiply that phenomenon by a couple hundred thousand people, and suddenly it's no surprise to see retail sales pick up.

Here's what David Rosenberg, former chief economist at Merrill Lynch and now playing the same role at Canadian firm Gluskin Sheff, says in today's edition of his daily market analysis ("Breakfast with Dave"):

Speaking of the U.S. housing market, we are convinced that strategic defaults by various homeowners, along with double-digit growth in tax refunds, have spurred the jump in retail sales (Easter timing helped too) of late. The economy is growing, the bulls are in a great mood, apparently we are into a new phase of job creation, and yet somehow 320,000 mortgage loans that were current when 2010 began were at least 60 days past due in March. Interesting.

--David Rosenberg, "Breakfast with Dave" (4/19/2010)

Of course, more borrower defaults ultimately means more foreclosures, which translates into more housing market supply -- and more bank write-off's.

But thanks to the Federal Reserve's policy of zero percent interest rates, banks are now booking huge profits to help offset their mortgage and housing-related losses ("Citigroup Posts $4.4 Billion Profit" -- WSJ).

They also continue to benefit from the government's unofficial policy of "too big to fail," with the implicit promise of future bailouts, if and when needed.

It all sort of recalls the chorus from a classic rock 'n roll song:

Take a load off Annie, take a load for free;
Take a load off Annie, And (and) (and) you put the load right on me

--The Band; lyrics, "The Weight"

The (financial) weight, indeed.

All Roads Lead to -- and from -- the U.S. Dollar

U.S. Dollar Down, Everything Else . . Up!

Perplexed by the action in stocks and commodities since last Spring? (I've addressed housing in many, many other posts.)

See the explanation (below), courtesy of David Rosenberg, chief economist and strategist at Toronto-based investment manager Gluskin Sheff.

It's a bit wonky -- note the references to the DXY, VIX, various credit spreads, etc. -- but very worthwhile.

The reader's digest version?

As the dollar declines . . . it's driving up everything else.

The U.S. dollar . . . has become a huge ‘carry trade’ vehicle for all risky assets. Historically, there is no correlation at all between the DXY index (the U.S. dollar index) and the S&P 500. In the past eight months, that correlation is 90%. Ditto for credit spreads — zero correlation from 1995 to 2008, but now it has surged to 90% since April. There was historically a 70% inverse correlation between the U.S. dollar and emerging markets, such as the Brazilian Bovespa, and that correlation has also increased to 90% since the spring. Even the VIX index, which historically has had no better than a 20% correlation with the U.S. dollar, has now sent that correlation surge to 90%. Amazing. The inverse correlations between the U.S. dollar and gold and the U.S. dollar and commodities were always strong, but these too have strengthened and now stand at over 90%.

--David Rosenberg, "Breakfast with Dave" (11/19/09)

I consider my financial vocabulary to be pretty extensive, but I've seen so many references to the DXY the last few weeks that I finally googled it to find out.

It turns out to be a basket of six, non-U.S. currencies that reflects the strength/weakness of the dollar.

If you read the above excerpt, you know which way it's been going.