Roubini(Gloom) vs. The Street (Great fundamentals for this rally)

Dr. Doom (Roubini) expresses fears of excess liquidity on the "dollar carry trade" i.e. such low dollar interest rates are propelling this boom- the low interest rates and the high liquidity are leading to another bubble.

"So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions"

Street says No rather emphatically and focuses on the fundamentals and says go long stocks since corporates will spend now as they overreacted last time they set budget.

Key defining characteristics of the 7-month and 62% rally have been:
(i) Its “prove it” nature: up on earnings surprises, flat-lining otherwise ;
(ii) Textbook relative sector performance. Financials and Consumer Discretionary up the
most, Energy and the defensives lagged ;
(iii) Lower quality higher beta stocks outperformed ;
(iv) Equity investor underweight positions have unwound but there have been little or no new
inflows into equities

Is this a bear market liquidity-driven rally? We don’t think so.
A positioning unwind can entail a significant rally even in the absence of a perceived change in fundamentals. This in our view would qualify as a bear market rally. In our view, the large unwind of equity investors underweight position was a key driver of the rally, and so on this measure the recent rally qualifies.
But it fails the fundamentals test in that it took place in response to repeatedly better-than-expected earnings. As to being liquidity driven, liquidity can drive equities two
ways—directly through inflows into equities or by liquidity-induced improvements in the
fundamentals or earnings. On the first count, inflows into equities have been limited so it is not as if the liquidity found its way into equities. On the second count, earnings improvement on cost cuts can hardly be attributed to liquidity.
Our take remains that the rally reflected excessively pessimistic expectations of corporate earnings causing investors to cover short
and underweight positions on much better than expected earnings delivery.
What’s priced in: Yesterday’s earnings; not a cyclical recovery yet. On a trailing multiple of
20, equities look expensive. But given that earnings snapped back in H1 2009 from off the
cliff levels of Q4 2008, a better gauge of where we are is provided by more recent earnings.
S&P 500 Q2 EPS came in at $16 or an annualized $64. Our fair value multiple of 16.4 implies
1050 on the S&P 500, around where we are today. So the market has nearly priced in last
quarter’s earnings. Q3 earnings are up sequentially by 6% and seasonally adjusted by 11%.
Thus, Q3 earnings are not yet priced in, let alone a cyclical recovery in earnings going forward

The key drivers and themes for equities the street sees are:
(i) Production to catch up with sales. The large gap between final sales and production
creates strong pressure for a cyclical recovery.
Buy Industrials (Capital Goods, Transportation), Consumer
Discretionary (Autos, Consumer Durables & Apparel), Materials and Tech (Semiconductors,
Hardware)

(ii) Corporate (not consumer) spending the key. Corporate budgets were last set at end-2008, when expectations for the economic outlook were very low. On an imminent increase in enterprise spending, buy Tech (Software and Hardware), the Industrials (Capital Goods), and advertising (Media in Consumer Discretionary).

(iii) Unemployment to peak. Policy uncertainty in a variety of spheres will likely keep the labor market recovery slow, but a peak in unemployment seems near. Buy the Financials (Universal Banks and quality Regional Banks) as a peak in unemployment should be a catalyst for marking a turning point in write-downs. Buy the Temp staffing agencies, which typically
benefit at this point in the cycle, but should do particularly well this time around .
(iv) Equities are cheap on normalized earnings. In a baseline of gradual recovery, equities are
very cheap. Buy the sectors which are cheapest on normalized earnings: Financials (-20%);
Industrials (-10%); Materials (-5%) .

next time : My view!