David Rosenberg on Why David Tepper is Wrong
This an excerpt from yesterday’s daily commentary from David Rosenberg.
Two things happened on Friday:
First, a very successful hedge fund manager was on CNBC and (between songs, apparently) told viewers that the equity market now was a one-way ticket up. And, second, the durable goods report.
As for this very successful hedge fund manager on CNBC, he laid out two scenarios as to why he believes the equity market is now a one-way ticket up:
- If the economy sputtered, the Fed would step in and embark on more quantitative easing (QE), and that would propel the equity market higher because it will lead to P/E multiple expansion.
- If the economy chugs along, then there will be no need for more Fed balance sheet expansion but the stock market will enjoy the fruits of stronger earnings growth.
It’s a win-win!
Indeed, based on the all the emails we received on this CNBC performance on Friday, and given this investor’s recent track record, it would not surprise us at all if a lot of other hedge funds moved in that same direction. It’s quite possible. Then again, how likely is it that one man can move the market today? This is no longer the 1970s when E.F. Hutton was around.
Too bad we weren’t invited as a guest on CNBC last Friday to engage in a friendly debate with this portfolio manager because he didn’t outline the third scenario, either because he doesn’t believe it or he just plain didn’t contemplate it or he’s simply not positioned for it. That third scenario is that the economy weakens to such an extent that the Fed does indeed re-engage in QE, but that it does not work. So the “E” goes down and the P/E multiple does not expand. Maybe it even contracts since it already has spent the past number of years reverting to the mean as are so many other market and macro variables (for example, the dividend yield, savings rate, homeownership rate and debt ratios). In this scenario, the stock market does not go up; it goes down.
Is it possible that QE2 won’t work? The answer is yes. How do we know? Well, because the first round of QE didn’t work. After all, if it had worked, the Fed obviously would not be openly contemplating the second round of balance sheet expansion. If the objective was narrow in terms of bringing mortgage spreads in from sky-high levels, well, on that basis, it did help.
But it did not revive the housing market any more than the litany of other government programs, and the fact that the economy has slowed so sharply to near stall-speed in recent quarters is all anyone needs to know about the true success, or lack thereof, from the first round of QE.
The Fed has cut its growth forecast twice in the past three months and has sliced its inflation forecast three times. This was not was envisaged when the first round of QE was unveiled last year. Normally, the pace of economic activity is accelerating to over a 5% annual rate in the second year of recovery, not slowing down to below 2% — especially with all the monetary, fiscal and bailout stimulus that is in the system.
Here’s the bottom line: if not for the stimulus and the inventory swing, the economy would have actually contracted this year.
There is not enough evidence to conclude that QE will be successful in terms of giving the economy a sustained boost in a cycle of contracting credit and the lingering trauma on the baby boomer balance sheet with net worth down over $100,000 for the average household from the level prevailing three years ago. Japan’s experience with QE, and the limited success it has had, may also be used as a case in point.
Now as far as the market reaction is concerned, it was completely in line with historical knee jerk “don’t fight the Fed” responses. The Fed cut the discount rate 50bps on August 17, 2007 — the cut was intra-meeting before the market opened. Bernanke was getting ahead of the curve and was going to save the day. I got call after call that day to not fight the Fed and indeed the S&P 500 surged 2.5% and went on to gain another 10% by the October 9th high; then reality set in.
In short, Rosenberg says QE is not going to get the job done. I don’t think the Fed will announce anything intra-meeting to begin with. So we will have to wait until the next FOMC on November 2-3 to see what response is forthcoming. Moreover, economic indicators in the US are continuing to show weakness. For example, truck tonnage dropped 2.7 per cent this past month, the largest drop since March 2009. Consumer confidence fell to its lowest level since February. As a result, five-year treasury yields are at their lowest levels since during the panic in 2008.
But, could QE help lift asset prices? David Tepper thinks so and he is bullish. See the two clips below for why (30 minutes runtime). And Tepper has a good 17-year track record of over 30% compound annual returns. Watch for his comments about why he got bullish on bank stocks early in 2009 – it has a lot to do with government telegraphing their intentions. And again here, he says that the Fed is telegraphing that it wants inflation for the first time ever in his career. To Tepper, that means something.
David Tepper videos embedded below
As for Rosenberg’s reference to EF Hutton, this is what he meant (hat tip Marshall):
Also see John Carney’s post at CNBC: Bashing David Tepper’s ‘Win-Win’ Scenario: Day 2