Richard Bernstein asks a very good question in a wide-ranging interview with Bloomberg. Now that the so-called green shoots are dominating the news coverage and the S&P 500 is up a massive 34% from its March lows, one might think we are due for a pretty Robust V-shaped recovery. Is that what the future holds?
Bernstein doesn’t think so. He thinks the recovery will be more muted than most people think. For this recovery to have any legs Bernstein believes we need to move away from the “credit-induced” dynamic of the previous 5 to 15 years. This necessarily means that financials will not be leaders in a sustainable bull market because we will have a lot less leverage in the system. This also means that the core earnings power in the sector is a lot less than people think. Bernstein thinks the financial sector has got way ahead of itself – a view I am beginning to share after today’s junk rally. Nevertheless, he does hedge himself a bit by saying they are fully (not over)valued at present levels. He believes industrials are a group to watch for an actual sustainable rally.
As to the bailouts and the government plan, Bernstein believes that the government is attempting to keep the excess capacity in the financial sector alive. His basic point is that bubbles create overcapacity (think tech stocks). This is the case in finance. The sector must shrink. In my own, there are only two ways a sector in over-capacity can perform. They can have poor earnings (Bernstein’s first point) or they can seek heavy risk taking and reach for yield. One of these two outcomes in financial services is likely unless the sector is rationalized. Hence the reason for consolidation through merger, nationalization and liquidation. Bernstein warns this looks nice in the short run but will lead to a Japanese scenario in the longer term. We are not going into free fall Bernstein says. That is a big change from the view just a few months ago. However, longer-term, the lack of consolidation in places like financial services necessarily means a Japanese outcome of lower than expected growth.
Risk taking has shot through the roof of late, argues Bernstein. As I see it, if we aren’t getting a V-shaped economic recovery (which I don’t believe we are), we are certainly getting a V-shaped market recovery. Quite frankly, a 34% up move led by a weak financial sector, should give anyone pause. I certainly called this last month. However, the ferocity of the uptick is a bit over the top and makes me worried about downside risk. Now that the stress tests are out and all is fine and dandy, thoughts about buying the rumour and selling the news come to mind. Let’s see where we get to over the next week.
The clip of Bernstein at Bloomberg is below. Note, the latter half of the clip is of Dick Bove of Rochdale Securities as well. This is a piece I covered in my last post “BofA, Citi, Wells and GMAC biggest losers in stress test leaks.”