David Rosenberg's Wall of Worry

From David Rosenberg
Thanks to Zero Hedge for the head's up
11/12/10

At a time when sentiment is wildly bullish and economists are taking up their numbers, it is time to remind investors that the best time to have put on the risk-on trade was three months ago when everybody was wringing their hands and knuckles were turning white. At the summertime lows in the S and P 500, Market Vane sentiment was closer to 40% versus 54% today, and the VIX index (a measure of volatility in the equity market) was closer to 30x than 20x.

It does not take much to turn fear into greed — just a few comments at a Jackson Hole symposium. The mid-term elections in the U.S., the unveiling of QE2 and the apparent end to double-dip risks are all in the market now. But concerns linger and here they are:

• Post-election political gridlock is not good. There is no guarantee that a lame-duck Congress will move to extend either the Bush era tax cuts or extended jobless benefits. And, the clock is ticking on the debt-ceiling file.
• China’s inflation rate has accelerated to 4½% and there is risk of more rate hikes coming as a result — see Inflation Leap Sparks China Overheating Fears on page 3 of the FT.
• Economists are placing bets on a Q4 pickup in U.S. GDP growth based on faulty seasonals with oil import data — we are not sure this effect will be as large as some believe.
• Widespread discounting and promotional activity suggests that the holiday shopping season will disappoint and the retailers have loaded up on inventory and staffing this year.
• There is tremendous dissention on the Fed regarding QE2, which may mean that this is Bernanke’s last kick at the can.
• Municipal bonds have been getting clobbered as default and liquidity concerns come to the fore.
• Sovereign default risks in Europe are clearly back on the table — Angela Merkel has made it clear that the EU’s pocketbook isn’t going to be there and that investors are going to have to take a haircut in the next bailout go-around. See Bailout Fund Stands By For First Big Test on page 4 of the FT and Irish Debt Woes Feed Eurozone Contagion Fears (Spanish-German bond yield spreads have widened out to new highs this week). Risk premia is clearly on the rise; the fact that Spanish GDP stagnated in Q3 has only made matters worse in this respect.
• The wink-wink weak U.S. dollar policy is being met with resistance abroad and it looks as though Brazil is set to again take action to reverse the Real’s gains.
• A negative Cisco surprise in both 2000 and 2007 proved to be leading indicators of the equity market.
• The view that the U.S. economy is out of the woods has not been confirmed by the Household employment data, chain store sales or home prices, all of which have come in soft lately.
• Oil prices have approached the $90/bbl mark and the latest surge has more to do with speculative investor demand than any acceleration in global economic activity. Moreover, when oil was first at this level in October 2007, the recession was only two months away and the bull market in equities ran its course.
• A 1%-plus yield on the 5-year Treasury note reveals a U.S. economic backdrop that is fraught with structural headwinds.
• Didn’t the Fed just use the words “slow”, “weak”, “depressed” and “constrained” to describe various aspects of the U.S. economic environment? You can look this up in the opening salvo of the November 3 post-FOMC meeting press release.
• The rally in gold to new all-time highs in virtually every currency is testament to the lingering concerns over the integrity of the global monetary system.
• Currency wars typically lead to trade wars and protectionism is coming our way soon (see Leaders Warn on Doha Deadlock and Failure on US-Korea Accord Hits Trade Hopes on page 2 of the FT). This is bullish for hard assets like commodities and precious metals.
• Fiscal support for the economy is soon to subside and in a major way — see Top Earners May Face Big Hit on page A4 of the WSJ as well as Liberals Press Obama Not to Extend All Bush Tax Cuts on page A5.