Are global sharemarkets completely ignoring the growing economic storm clouds as they stage their dizzying rally?
Yes, according to Gluskin Sheff chief economist David Rosenberg. In his latest note, he points out that markets frequently divorce themselves from economic realities for lengthy periods of time, as they fall under the thrall of factors such as sentiment, technicals, fund flows and valuations.
The key driving force this year, he says, has been an expanding price to earnings multiple, “as the markets seem to believe that the massive expansions of global central balance sheets will end up saving the day for dilapidated sovereign government balance sheets and woefully undercapitalised European banks”.
But a quick look at the fundamentals tells a different story. The US sharemarket has experienced one of the most powerful surges since the recession ended (the S&P index has climbed 25% since its October low), at a time when US companies have just reported poor earnings results. According to Rosenberg, the year-on-year trend in operating earnings per share is now below 6%, and if you take out Apple then “growth has basically vanished altogether (down to a mere +2.8%).”
And US corporates appear less than upbeat about their future. According to Rosenberg, corporate guidance over the past three months is the lowest since August 2009. Only 44% of companies beat their revenue targets (the weakest since the first quarter of 2010), and only 64% beat their profit estimates (the lowest since the third quarter of 2008).
Some point to a recovery in the US housing market as justification for surging sharemarkets. But Rosenberg dismisses this argument. “The bright signs from housing are really a commentary on the balmy weather skewing the seasonally adjusted data and there is certainly no sign of any recovery in prices.”
Even more importantly, he argues that markets are ignoring the rapid climb in oil prices as tensions over Iran’s nuclear program escalate. The West Texas Intermediate (which is a benchmark for US oil prices) crude oil price is now trading at close to $US110 a barrel, while the Brent crude oil price (which is the European benchmark) is now trading more than $120 a barrel.
And this surge in oil prices is about to hit the consumer. Forward contracts suggest that petrol prices will break through the $4 a gallon level in coming months. Already, the nationwide average petrol price has risen 37 cents in the past month. Rosenberg notes that every one cent rise in petrol prices at the pump siphons about $1.5 billion from consumer wallets. The past two times that the Brent oil price hit current levels were in 2008 (which resulted in a recession) and in 2011 (when the US economy virtually ground to a halt).
Even though Saudi Arabia is pumping oil at the fastest rate in 30 years, strong demand from the emerging markets is pushing prices higher. According to Rosenberg, “it will not be very difficult to see oil retest $150 a barrel, and we are talking WTI here, not Brent”.
Rosenberg argues that even though there was a heavy issuance of US bonds last week, 10-year bond yields remain below 2%. “At a time when energy prices are spiking, this is a clear sign that the bond market is treating this as a deflationary shock rather than a durable increase in inflation.”
According to Rosenberg, the surge in petrol prices is coming at a time when real incomes in the US are being squeezed, and there is little room for consumers to dip into savings because the personal savings rate is at a low level.
“On a year-to-year basis, real after-tax incomes are running fractionally negative and in the past that was either associated with an economy in recession, about to head into recession or just coming out of recession. So perhaps there is no contraction in real GDP just yet, but there is one in real incomes.”
*This first appeared on Business Spectator.