Enjoy the Sucker's Rally, Says Merrill's Rosenberg

From The Business Insider, March 19, 2009:

Merrill's economist David Rosenberg, who was well ahead of his peers in calling the meltdown, reiterates his view that this is a sucker's rally.

Why?

A bunch of reasons, the most compelling of which is that even the $1.2 trillion of debt the Fed is buying pales in comparison to the $8 trillion of private sector debt that is choking the economy.

David Rosenberg:

[The Fed's purchase of $300 billion of Treasuries] is equivalent to nearly 20% of this year’s bond borrowing requirement. As a stand-alone event we think this is worth 75-100 basis points of interest rate reduction (so today’s post-meeting 50bp rally takes us between one-quarter and half-way there). We also believe that the risk to this program size is clearly to the upside...

Fed’s announcement less bullish for equities, in our view.
But the equity market, which had already been enjoying a classic short-covering rally accentuated by quarter-end pressures, also reacted very positively to the Fed’s announcement today and at one point the S&P 500 looked set to break above the 800 threshold for the first time since mid-February. We are of the view that what occurred this afternoon was less bullish for the equity market than meets the eye. Here’s why:

1) Fed buying bonds not stocks. The Fed announced that it is buying bonds, not stocks. This is not the HKMA, circa 1998.

2) Government cannot prevent nature from taking its course. While an additional $1.15 trillion expansion of the Fed’s balance sheet is large as a stand-alone event, it really is just a drop in the bucket when one considers that there is still almost $8 trillion of combined household and business sector credit that must be unwound in order to mean-revert the private sector-to-GDP ratio (which is still close to a record-high). Once again, the government is cushioning the blow, but cannot prevent nature from taking its course, in our view.

3) Fed does not see a flicker of light at the end of tunnel just yet. The economic backdrop highlighted in today’s press statement makes us feel that much more confident that corporate earnings are going to slide again this year (to $40 for S&P 500 operating EPS from nearly $50 in 2008). To wit: “… the economy continues to contract … Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. US exports have slumped as a number of major trading partners have also fallen into recession”. Yikes. This is with the Fed funds rate effectively at zero. But it’s pretty clear that the Fed does not see any flicker of light at the end of the tunnel just yet. Mr. Market may be in for yet another surprise.

We remained convinced this is still a bear market rally.  We will say this. We do not claim to be market-timers. There is always the chance that this bear market rally is extended. Only a fool would rule that out entirely, we think. But we remain convinced that this is all it is. Does anyone remember what happened in the opening weeks after the BoJ switched to quantitative easing (QE) back on March 19th, 2001? The Nikkei closed at 12,190 that day and went on to rally all the way to 14,529 by May 7th for a nice 20% advance. But you only made money if your timing was so impeccable that you knew to get out that day (or sell calls) because we didn’t see that level on the Nikkei again for three years. In fact, by July 11th, 2001, four months after the ballyhooed move to QE, the Nikkei was back to 12,005 as the stock market pulled a big U-turn.

We still prefer bonds to cash and stocks
While quantitative easing was successful in Japan in terms of easing debtservicing strains by dragging long-term yields lower, with the benefit of 20-20 hindsight, it is obvious that the move fell short of reversing the overall deflationary trend in the Japanese economy or the secular bear market in equities. For longterm investors who take a real business cycle view, this may be an important anecdote to consider as the Fed moves down the same path Japan did. In other words, we still prefer bonds to cash and stocks.

See also from The Business Insider:
Rogoff: Worst Over? Are You Kidding?
How Low Can The Market Go?