February 12, 2018
David Rosenberg, the chief strategist and economist at Gluskin Sheff & Associates Inc., said the decline in stocks last week was caused by a lack of liquidity more than signs of higher inflation, as some observers have suggested. Liquidity describes how easily assets can be bought and sold at stable market prices.
“This isn’t about inflation. If it were, TIPS break-evens would be sitting far higher than 205 basis points,” Rosenberg said in a Feb. 12 report, referring to Treasury inflation-protection securities. “Oil wouldn’t have collapsed 10 percent last week.”
The S&P 500 peaked on January 26 before sliding about 2 percent in the following few trading days. Selling picked up on Feb. 2 after the non-farm payrolls report showed signs of wage inflation, and continued last week with another 10 percent drop into correction territory.
“This fixation on the 2.9 percent wage growth figure that came out with the January payroll report is ridiculous considering that the average hourly earnings number for production and non-supervisory workers (over 80 percent of the workforce) barely rose last month and the year-over-year showed no acceleration at all – it stayed at 2.4 percent,” Rosenberg said.
Economic fundamentals also aren’t as strong as they initially appear, he said, citing a decline in core capital expenditures in December, a 3.9 percent drop in auto sales in January and the falling Citigroup economic surprise index, which measures how much economic data differ from consensus forecasts by market economists.
Rosenberg chided The Wall Street Journal editorial page for its economic cheerleading, including the statement that “the good news is that U.S. economic fundamentals are as strong as they have been since 2005, and maybe 1999.”
“Good grief,” Rosenberg said. “In 2005, we were heading towards the most pernicious housing bubble in history and in 1999 we were moving rapidly towards a massive tech bubble. Nice comparisons.”
Rosenberg said economic fundamentals and inflation are less important than liquidity in triggering the stock market correction.
“This isn’t about ‘fundamentals.’ This isn’t about inflation – in fact, this is the weakest argument of them all in terms of explaining what is going on in markets,” Rosenberg said. “The 1987 crash was not about inflation. The 1998 correction was not about inflation. The start of the bear market in 2007 was not about inflation. It was about liquidity. And that is the case currently.”
Crowded ETF Trades
The prevalence of passive investments, such as exchange-traded funds that track the moves of a market index, have created crowded trades that can’t be unwound without bigger swings in the market.
“This past week, there were sessions in which ETFs accounted for 38 percent of total stock trading,” Rosenberg said. “Trillions of dollars have flown into these low-cost funds, which are extremely concentrated portfolios, typically leveraged up, and now own 40 percent of the entire U.S. stock market.”
The concentration of assets in ETFs has given actively managed funds less power to prop up the market during sell-offs, he said.
“The problem, as we are seeing already, with active fund managers having lost so much market share, that when the computer programs that drive the ETFs reverse course, there are fewer buyers than there used to be to step in,” Rosenberg said. “Not to mention that active fund managers already are sitting on a record-low level of cash and the speculators in the futures and options pits are already net long the market.”
Investors are adjusting their holdings of stocks and bonds as the central banks throughout the world tighten the money supply after a decade of easy credit.
Jay Powell on Feb. 5 took over as chairman of the Federal Reserve after being nominated by President Trump and approved by the U.S. Senate. He is taking over the central bank as the Trump administration approves federal spending that may add trillions of dollars to the federal debt over the next 10 years.
“For so long, markets were comfortable that the central banks had their back and would keep monetary policy accommodative as far as the eye can see,” Rosenberg said. “But this belief system is coming under attack, with a new sheriff in town at the Fed who is unlikely to be that dovish.”