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Friday Market Recap: Liquidity Trap

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    September 17, 2011

    Following yesterday’s non traditional Market Recap I wanted to share some highlights from a recent research note by Dave Rosenberg of Gluskin Sheff. I found his summary of the US economy to be very enlightening to say the least.

    Since “Rosie” references the 10 year yield a number times let’s first look at a historic correlation with the SPX.

    As discussed in a recent post (Credit VS Equity The War Is Waged) credit and equity are far apart. Credit has a proven track record of forecasting economic contraction while equity failed miserably ahead of and during the 2008 recession.

    Below are a few key quotes from “Rosie’s” report.

    “You know you’re in a depression when interest rates go to zero and there is no revival in credit-sensitive spending.”

    “The economy is in a depression when the banks are sitting on nearly $2 trillion of cash and yet there is no lending going onto the private sector. It’s otherwise known as a ‘liquidity trap’.”

    “When almost half of the ranks of the unemployed have been looking for a job fruitlessly for at least six months, you know you are in something much deeper than a garden-variety recession. True, we can’t see the soup lines; the soup lines are in the mail — 99 weeks of unemployment cheques for over 10 million jobless Americans.

    “Basically, in a depression, secular changes take place. Attitudes towards debt, discretionary spending and homeownership are altered for many years,or at least until the scars from the traumatic experience with defaults and delinquencies fade away. That is why we saw existing home sales slide to 15- year lows and new home sales to record lows despite the fact that mortgage rates have tumbled to their lowest levels in modern history. There is no economic model that would tell you that declining mortgage rates should lead to lower home sales.”

    “In a recession, everything would be back to a new high nearly three years after the initial contraction in the economy. This time around, everything from organic personal income to employment to real GDP to home prices to corporate earnings to outstanding bank credit are still all below, to varying degrees, the levels prevailing in December 2007.”

    “The reality is that the Fed cut the funds rate to zero, as was the case in Japan, to little avail. Then the Fed tripled the size of its balance sheet— again with little sustained impetus to a broken financial system. Government deficits of nearly 10% relative to GDP, or double what FDR ever ran during the 1930s, have obviously fallen flat in terms of providing any lasting impact to the economy.”

    “The markets are telling us something valuable when (after a period of unprecedented government bailouts, incursions and stimulus programs) the yield on the 5-year note is south of 1% and the 10-year is down to 2%. Instead of contemplating over how attractively priced equities must be in this environment, market strategists and commentators would bring a lot more to the table if they tried to decipher what the macro message is from this price action in the Treasury market.”

    “If the Treasury market is correct in its implicit assumption of a renewed contraction in the economy, then we could well be talking about corporate earnings being closer to $75 in 2011 as opposed to the current consensus view of over $110. In other words, we may wake up to find out a year from now that whoever was buying the market today under an illusion of a forward multiple of 10x was actually buying the market with a 15x multiple.”

    Images: Flickr (licence attribution)

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