The Return of the Brothers Grimm

With the rosy views a fair number of Wall Streeters are pitching, the brothers Grimm seem to be making the trek to Wall Street.
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Fairy tales are supposed to be the province of the young. Not anymore. The brothers Grimm wrote their first volume of them in 1812. And now, nearly 200 years later, they seem to be making their way to Wall Street.

Here's the story. If I told you that the overseas uprisings are almost kaput, that rising oil prices (now around $100 a barrel) are hardly a big deal since the price is still well below its July 2008 high of $147, that European debt woes are history, that our housing and job problems should soon take a decided turn for the better amid an improving economy, that inflation fears are way overdone and that higher interest rates are simply out of question in a struggling economic environment, what would you tell me? Probably, that I ought to rejoin the real world.

In other words, leave the fairy tales to the brothers Grimm.

Well, these rosy views, in a nutshell, are what a fair number of Wall Streeters are pitching. Some of those euphoric signs: heavy leveraging by many hedge funds to be as fully invested in stocks, a lively pace of corporate buybacks a growing risk appetite, very low institutional cash reserves and inflows of nearly $25 billion worth of U.S. equity mutual funds the past couple of months (although there has been some recent outflows due to the riots in Egypt and Libya and the rising price of oil).

You may be one of those struck by the euphoric wave, but it's worth knowing that one of the more respected investment and economic minds around, David Rosenberg, the chief investment strategist and economist at Glusken Sheff, a leading Canadian-based wealth management firm, is hoisting cautionary flags. In a weekend note to clients, he kicked off with six of them: declining home prices, contracting bank credit, listless jobs market, soaring oil prices, accelerating spending cuts and tax hikes at state and local government levels and policy tightening overseas.

Granted there are tailwinds, such as quantitative easings, strong corporate balance sheets, manufacturing renaissance and the lagged impact of last year's stimulus announcement. But Rosenberg notes, "If I was keeping score, headwinds are in the lead by six to four."

It also seems clear to our worrywart that the tenor of the global economic recovery is undergoing a bit of change here, and not for the better unfortunately. But U.S. growth projections, he observes, have almost doubled to nearly 4 percent for current quarter GDP even though data on new home sales, real estate prices (resale values are down to 2002 levels) and durable goods orders offer some cause for pause.

Rosenberg also takes issue with what he regards as another fairy tale -- the emerging view that Saudi Arabia can just step in and replace Libyan oil, which strikes him as totally off base. The reason: Libya's crude is a perfect feed for ultra low sulfur diesel. The oil the Saudis would use to replace it is not. Apparently, you need three barrels of Saudi crude to get the same number of barrels of diesel sulfur you get from one Libyan barrel. Further, Saudi crude is very high in sulfur and the refineries that process the Libyan crude cannot remove the sulfur.

Rosenberg also raises the question of what happens if we lose Libyan crude (an estimated 1.8 million barrels a day) and strategic stocks are not released? Then, as he sees it, $150 a barrel oil would certainly not be out of the question. And that, he points out, is not factoring in Algeria, which has also experienced recent protests.

Rosenberg figures the rent rise in oil from $80 to $100 a barrel will subtract 1 percent off real GDP growth. He went on to note that about half of this quarter's fiscal stimulus from the payroll tax cut has been wiped out by what's happening at the gas pump.

Another economic revelation that he believes is worth thinking about centers on the Federal Reserve Bank of Chicago's monthly National Activity Index (NAI) that covers the entire economy and is viewed as close to a GDP proxy as you can get. The index has been negative for eight straight months and came in below zero in five of the last six months. The NAI swung from 0.18 in December to 0.16 in January. One has to view these numbers with alarm since Rosenberg says anything below 0.70 and the chances are good the economy is heading back into a recession.

"Illusion is the most dangerous thing," wrote Ralph Waldo Emerson. As far as Wall Street goes, so too may be the return of the brothers Grimm. But just maybe they never left since fairy tales are a good part of what Wall Street is all about.

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