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El-Erian Reiterates Skeptical Views As Stocks Grind Higher (And More Bulls v. Bears)

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Bloomberg reports that former Harvard Fund Management CEO, now Pimco CEO Mohammed El-Erian does not buy the idea that US is returning to normal any time soon. El-Erian in particular took issue with some of Larry Summers’ sunnier prognostications:

El-Erian likened Summers’s view of the economy to a three- stage rocket attempting to escape Earth’s gravity to reach space, with government spending programs marking the first boost to economic growth, inventory reductions the second, and consumer demand the final booster stage.

Summers “has this concept of ‘escape velocity,’” El-Erian said at a meeting of financial market professionals in Toronto today. “We don’t have enough to achieve escape velocity.”

El-Erian, who co-heads the world’s largest bond fund manager with Bill Gross, has said the U.S. is facing a sustained period of annual growth of about 2 percent where credit and jobs are less plentiful than in the past, a scenario he called the “new normal.”…

El-Erian’s ideas about a “new normal” have been shared by Lawrence Fink, chief executive officer of New York-based asset manager BlackRock Inc. BlackRock will become the world’s largest manager of bond funds when it completes the purchase of Barclays Global Investors this year.

The “new normal” includes a higher level of government intervention in the economy, with new rules requiring higher capital levels for businesses and stricter reporting requirements, El-Erian said. That will drive up business costs, he said.

El-Erian’s take is wildly upbeat compared to the October 5 report from David Rosenberg, former North American economist for Merrill, now safely ensconced in his native Canada at Gluskin Sheff. Rosenberg is admittedly has a dour outlook, but he also reads the data very closely and with a well honed sense of historical patterns. Some snippets (hat tip reader Scott, no online source):

Nonfarm payrolls in the U.S. slid 263,000 in September, but the details were even more sombre. The Household Survey showed a massive 785,000 plunge in September, and employment on this score has now slid by 1.2 million in the past two months….the Household survey leads the cycle and typically bottoms and peaks before the Payroll survey do…. never before has a recession ended with civilian employment declining this much (on average, it goes down around 70,000 or almost negligible the month the recession ends)….

There were absolutely no redeeming features in the data. The private nonfarm diffusion index sank to 31.9 in September from 34.9 in August (the manufacturing diffusion index fell to 22.9 from 28.3 in August) which means that for every company adding to their staff loads, more than two are cutting back. The labour force contracted by 571,000 and has plunged now by 1.1 million since May. That again is a sign of the labour market seizing up, which is very disturbing when you consider all the government efforts to stem the tide last quarter – from housing subsidies, to cash-for-clunkers, to mortgage modifications…

It is so difficult now to find a job that a record 36% of the ranks of those unemployed have been searching with futility now for at least six months. In “normal” recessions since 1950, this ratio peaked at just over 20%…..the chances that we see a 13% peak unemployment rate this cycle is far from a ludicrous proposition at this point; and just in time for the mid-term elections.

Yves here. I have been arguing unemployment would peak at over 11%, simply based on Reinhart/Rogoff’s norms for severe financial crises (some of those countries had better responses than ours, and none were faced with a synchronized global downturn, so relying on precedent here would seem to be optimistic). Back to Rosenberg:

The share of the unemployed who are not on layoff is at record 54.3% as of September. In prior recessions, this ratio would barely pierce the 40% mark. In number terms, we are talking about 8.5 million Americans who have lost their job due to permanent shutdowns, a figure that is double what you typically see at the peak of the recession….I think there is a nontrivial chance we see zero percent real GDP growth in Q4 (consensus is around 3%)….

the employment/population ratio (the “employment rate”) has fallen to a quarter-century low of 58.8%; it peaked at 63.4% in 2007. To get back to a cycle high, we need to create more than 10 million jobs. Before that happens, deflationary pressures are going to trump whatever inflationary risks arise from the Fed, Congress and the White House.

The last time the ratio was this low was back in December 1983. Back then, household debt per capita was $9,900; today it is six times larger at $58,000. At the margin, one has to wonder what is going to be paid for first. The debt-service payments coming out of the paycheck are looking increasingly vulnerable. Default rates are extremely likely to worsen for the foreseeable future; groceries will not be sacrificed; however, credit will.

This is all sobering stuff. Rosenberg issued an equally downbeat piece later in the week that commented on valuations (again via Scott). Key factoids:

On an operating (“scrubbed”) basis, the trailing P/E multiple on the S&P 500 has expanded a massive 10 points from the March lows, to stand at 27.6x.

While we will not belabour the point, when all the write-downs are included, the trailing P/E on “reported” earnings just widened to its highest levels in recorded history of nearly 140x, which is three times the levels prevailing during the height of the tech bubble….

Bullish analysts like to dismiss the actual earnings because they are “depressed” and include too many writeoffs, which, of course, will never occur again.

The consensus is usually overly-optimistic, which is why so many analysts love to do their analysis on “forward” earnings since the market almost always looks “attractively priced” on that basis. The reality is that the forward P/E multiple is now at 16.2x after bottoming at 11.7x at the market lows. The multiple has not been this high since February 2005 when the economic expansion was already nearly four-years old! Today’s stock market, on this basis, is now being priced as if we are late in the cycle — forget this mid-cycle valuation stuff.

Reader Dwight pointed to an outbreak of bearish calls today on CNBC:

Risk of Double Dip, Investor ‘Bloodbath‘ (from Carl Icahn)

Dollar Fall Can ‘Destabilize Markets’ Like 2008 (Art Cashin of UBS)

Dow Will Fall to 6,300 by Year End (John Lekas of Leader Capital)

Of course, one could cynically note that this equal opportunity programming started on a Friday afternoon before a long weekend.

Jesse, generally of the downbeat persuasion based on fundamentals, but not afraid of a tactical long, points out that mutual funds are now heavily invested: Mutual Funds Are at Cash Levels Not Seen Since the 2007 Market Top.
But Barry Ritholtz argues in “The Most Hated Rally in Wall Street History,” that the fact that so many are skeptical means the equity rally has further to go.

Just remember: for mere mortals and pros, market timing is rarely a winning strategy.

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8 comments

  1. fresno dan

    “Yves here. I have been arguing unemployment would peak at over 11%”
    I agree, but what drives me insane about the unemployment numbers as currently reported is that as people lose their unemployment benefits, they are no longer counted. Even more worrisome, a number of analysts have pointed out that employment growth will only equal, if that, normal labor force growth. Some are talking a decade of real unemployment of 10%.

  2. kevinearick

    Everyone that cannot outwit a computer is going
    to go down the hole. The system will speed up at
    the rate of 10x until talent is paid appropriately.

    The difference between a blackhole and a magnet
    is a blackhole has an expanding boundary. The
    mistake everyone is making is assuming that the
    blackhole will not grow out to their position,
    until it’s too late, which is why the boundary
    grows.

    Capital better wake up soon. Paper profits are no
    match for a blackhole of this dimension.

  3. Hugh

    Still not a fan of El-Erian and the folks at Pimco. Rosenberg is much closer to the mark. The fundamentals don’t lie and they are awful and getting worse. I would take the Household numbers with a grain of salt though. If I remember correctly, they can be off plus or minus 400,000 a month. Still the Bureau of Labor Statistics is estimating that their job loss numbers for this year are low by 800,000 because their model continues to overstate new firms creating new jobs.

    I just looked it up the Nobel Prize in Economics will be awarded on October 12. Maybe Obama has a shot at that one too.

  4. Perfect

    Why is it so hard to figure out the actual job loss. That is an important number to total accurately. Who should we believe?
    BLS Revision Nightmare: March 2009 Payrolls Overstated by 824,000 • Birth-Death Model Falsely Boosting Jobs Reporting in Recession Environment • Monthly Jobs Loss of 263,000 (Payroll Survey) versus Monthly Employment Decline of 710,000 (Household Survey) • September Unemployment Rates: U.3 = 9.8%, U.6 = 17.0%, SGS = 21.4%
    http://www.shadowstats.com/

  5. RueTheDay

    The consensus view that U3 will peak at a little over 10% in Q1 2010 and then slowly fall is patently absurd. Since the downturn started in December 2007, the consensus view has always been that unemployment will peak a percentage point or less over wherever it happened to be when the forecast was made. Just look at Romer’s estimates from when they were crunching stimulus numbers or the Fed’s baseline and “more adverse” scenarios from the stress test days if you want a laugh. I agree with 11% being the minimum peak, with 12-13% not being unreasonable at all.

  6. Sherparick

    Michael Mandel in his Business Week Blog looks under the headline number and finds trouble in an increase in the non-oil part of the U.S. Trade Deficit, with a decline in U.S. Tech exports and in increase of U.S. Tech imports. http://www.businessweek.com/the_thread/economicsunbound/

    This is happening despite the decline of the dollar against all currencies except the Yuan/Reminbi. Consitent with Mr. Rosenberg’s analysis of permanent layoffs, apparently U.S. corporations are utilizing the Recession/Depression to accelerate the outsourcing of manufacturing and out-sourceable service jobs, particularly the higher income jobs. Calculated Risk documents that credit continues to contract, particularly to businesses outside the crony-capitalist network. For much of 2007 the world stock markets bubbled along despite all the warning signs that Ponzi finance schemes built on the foundation of the U.S., U.K., Irish, and Spainish real estate bubbles were collapsing with those markets.

  7. Vinny G.

    That three-stage-rocket analogy is so clever and insightful… But let me guess, once it achieves escape velocity, the final destination of that rocket is… the surface of the Moon, just like that 75 million dollar satellite NASA crashed there the other day…

    Vinny G.

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