Archive for April 11th, 2011

Valuation Changes During the Current Bull Market (Bespoke)

Monday, April 11th, 2011

Prepared by Bespoke Investment Group

There is always a lot of attention paid to the price changes that sectors have experienced during the current bull market, but there’s not much focus on the changes in their valuations.  Below we take a look at both using a scatter chart that shows the percentage change in both price and P/E ratio since March 9th, 2009.  As the price of the sector rises, earnings need to rise just as much or else the P/E ratio will increase.  It’s common for P/E ratios to expand during bull markets, but a sector becomes more attractive if it can keep its valuation down as its price increases.

In the chart below, the farther to the right on the horizontal axis and the farther down on the vertical axis, the better.  In the case of the Industrials and Consumer Discretionary sectors, both have risen by a similar amount, but the P/E ratio has expanded much more for the Industrials sector than for the Consumer Discretionary sector.  In fact, the Consumer Discretionary sector has seen the second biggest gain out of all ten sectors during the bull market (behind Financials, which isn’t shown in the chart because it had a negative P/E ratio at the start of the bull), yet it’s the only sector that has seen its P/E ratio actually decline over the same time period.  The Industrials sector is up just a few basis points less than the Consumer Discretionary sector, but its P/E ratio has risen the most of any sector.  The Energy sector has seen its P/E ratio expand the second most of any sector, yet it ranks in the middle of the pack in terms of bull market performance.  Along with the Consumer Discretionary sector, only one other sector — Technology — has seen its P/E ratio expand by less than the overall S&P 500 and its price rise more than the S&P 500.

Below is a table showing the actual P/E ratios for sectors at the start of the bull market as well as currently.  It is noteworthy that the Consumer Discretionary sector, while it has seen its P/E ratio decline since the start of the bull market, had the second highest valuation of any sector on 3/9/09.  The Industrials sector had the second lowest P/E ratio at the start of the bull market, while it has the highest P/E ratio now.

 

Copyright © Bespoke Investment Group

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The Return of the Carry Trade?! (Saut)

Monday, April 11th, 2011

The Return of the Carry Trade?!

by Jeffrey Saut, Chief Investment Strategist, Raymond James

April 11, 2011

“The mid-March G7 currency intervention on the Yen has given carte-blanche to Japanese investors to once again deploy capital abroad and seek yields wherever they may be found. And on cue, all the higher-yielding bonds and currencies (Indonesia, Hungary, Turkey, Australia, New Zealand …) have soared. This influx of liquidity (and the balance sheet of the Bank of Japan has just grown by approximately US$275bn) has also helped push risk assets higher across the spectrum. The question of course is how sustainable this increased appetite for risk will prove to be in the face of rising oil and commodity prices, and of diverging monetary policies. Putting it all together, it seems obvious to us that we are approaching some kind of a tipping point. The concomitant rise in commodity prices and risk assets does not seem to be compatible. Neither does the rise in commodity prices, equity prices, and inflation expectations (whether from TIPS, consumer surveys, ISM surveys …) and overly easy central banks. Finally, the recent surge in certain currencies (AUD, CHF …) to two standard deviations above their purchasing parities should also have economic consequences. So the current situation does not seem stable from a bottom-up perspective. And from a top down perspective, it seems obvious that the recent period of exceptionally easy fiscal and monetary policies is an outlier and should come to an end. This is already occurring in Europe and in China. The next step is for the US to follow suit.”

… GaveKal

We have long admired the prescient folks at the GaveKal organization for their ability rotate the “investment prism” 180°, giving them the ability to view things from a different perspective. Said “different perspective” often reveals net-worth changing ideas unforeseen by many conventionally focused strategists on Wall Street. GaveKal’s views can be gleaned tomorrow (4/12/11) at 4:00 p.m. in a conference call with portfolio manager Steve Vannelli by dialing (877) 216-1555 (Code: 722117). That said, in our opinion the G-7 intervention was meant to prevent a stronger yen from hurting Japan’s exports, braking capital flows into Japan, not necessarily encouraging outflows. There may be an increase in the carry trade in both dollars and yen, but I don’t think this is the main factor behind the rise in commodity prices and increased demand for risk assets. In the short-term, central bank policies matter a lot for currencies. However, the U.S. is not going to raise rates anytime soon, implying a somewhat softer dollar. You’re hearing inflation concerns among some of the district bank presidents, but that is very much a minority view. The Fed sees higher oil prices as a negative for growth, not a catalyst for a higher trend in underlying inflation; but officials will be watching inflation expectations, the trend in core inflation, and wages. The Fed, in fact, wants higher inflation (2%, not sub-1%). To be sure, the Fed will not tighten because everybody else is.

Nevertheless, we think interest rates have seen their cycle “lows.” While that does not mean they will rise in the short-term, over the longer-term it is tough to envision why they won’t. Indeed, recently there have been large “capital calls” in regions that have typically been our natural lenders. As stated, Europe needs more of its capital at home to bail out the PIIGs. The Middle East needs its capital to pay off dissidents. Japan clearly has a capital call and the Federal Reserve is preparing to exit QE2. Accordingly, it is difficult to see how our cost of capital (interest rates) can’t keep from rising. However, that does not mean it has to happen in the next quarter or two. It also doesn’t mean that GaveKal’s observation regarding “the return of the carry trade” can’t play in the short to intermediate-term as well.

Yet, that wasn’t the case last week as stocks stalled their way through the week, leaving the D-J Industrial Average (DJIA/12380.05) better by a mere 0.03%. The week, however, was not without its milestone, for the DJIA notched a new reaction high, thus confirming the D-J Transportation Average’s (DJTA/5228.30) new reaction high of a few weeks ago. Accordingly, another Dow Theory “buy signal” was recorded. It was the third such signal of the past 10 months, suggesting the path of least resistance remains “up.” Still, the stock market “feels” as if it needs to consolidate its gains, and rebuild its internal energy, before moving higher. That implies more of the churning action we experienced last week. In fact, as is often the case, the indices tend to expend so much energy in achieving a Dow Theory “buy signal” they need to rest a bit before reenergizing. On a very short-term basis, the downside should be contained in the 1320 – 1325 zone [basis the S&P 500 (SPX/1328.17)]. Failing that support brings 1305 into play, which would be a 38.2% retracement of the recent rally. Whatever the near-term outcome, we believe it would take some major “news shock” to break the SPX below the massive support now visible at 1275 – 1300.

Of course such a “shock” could come from the Middle East, causing crude oil to vault even higher. To us, this is the biggest risk to the economy. If oil prices were to stabilize, even at these elevated levels, we think the economy will be just fine. However, Brent crude oil traveled above $126 per barrel last week, with a concurrent rise in WTI to $112.79 per barrel; that brought retail gasoline prices to $3.75 per gallon. Due to such energy machinations many economists reduced their GDP estimates last week; while lower growth may be in the cards, even slower growth should still allow earnings to exceed current expectations. Indeed, last week saw a solid retail sales report, initial employment claims fell, German factory orders were strong, and the ECB and PBOC raised interest rates. Moreover, last Friday’s BLS report confirmed that employment is starting to recover at a faster pace. All of this data doesn’t sound all that weak to us.

Speaking to energy, we have been writing about the La Nina weather pattern, combined with more volcanic ash in the atmosphere than anyone can remember, since last August. Our conclusion was that the 2010 – 2011 winter was going to be wet and colder than most expected. Our investment strategy was to WAY overweight the energy complex. Recently, however, we have recommended selling partial positions (not all) to rebalance those overweight positions back to their intended allocations. Our worry is that some of the climate factors causing the wicked winter will be fading this summer. While we expect a stormy spring, and droughts in the South, things should be better by mid-summer. That does not mean we won’t have a worse than normal hurricane season . Still, readers are advised to rebalance our overweighting energy recommendation as the summer season approaches.

Of course, that includes our recommendations on the Canadian Oil Sands, despite our enduring belief that over the longer-term the Oil Sands are likely the best energy investment around. Last week, however, the Alberta government announced a draft for the Lower Athabasca Regional Plan. In this new framework, the government outlines new conservation and recreation areas, which in some cases cut into previously existing oil sands leases. As our Canadian Oil Sands analyst (Justin Bouchard) writes:

“Impact to current oil sands leases is minimal – for the most part, there are very few leases which are impacted by the new regional plan, and in almost all of the cases where existing leases are impacted, it is minimal.”

“No impact to existing producing projects – existing projects are untouched as are areas with any near or medium term development plans.”

For further information, please see our Canadian analysts’ comments.

The call for this week: Over the weekend things have indeed heated up in the Middle East with Gaza-based Hamas launching anti-tank missiles and hitting an Israeli school bus, a responding Israeli air strike, Egyptian talk of war if Israel attacks Palestinians in the Gaza, Egypt ready to resume diplomatic relations with Iran, more demonstrations in Egypt’s Tahrir Square, and talk that Israel might combine with Libya. Yet, crude oil is actually down, increasing our sense that rude crude is at/near an upside inflection point. If true, after another few consolidation sessions, it would surprise the most if the SPX rallied above its reaction high of 1344 for another leg up. We are positioning accounts accordingly. And don’t look now, but our fundamental energy analysts had some VERY positive comments on 5.4%-yielding EV Energy Partners (EVEP/$56.24/Outperform).

P.S. I’m in New York City all week; subsequently this will be the only investment strategy commentary for the week.

Copyright © Raymond James

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Global PMI Scorecard: Global Growth Still Strong but Moderating

Monday, April 11th, 2011

Manufacturing PMIs

The manufacturing PMIs for March indicate that the pace of the robust global manufacturing sector has moderated. My GDP-weighted PMI for the major economies fell to 56.0 from 58.2 in February.

The pace of expansion in the US eased slightly to a still robust 61.2 in March from 61.4 in February. The pace in the Eurozone also eased to 57.5 from 59.0 in February and easing was widespread. Greece, on the other hand, has seen a moderation of the contraction in its manufacturing sector. The UK’s manufacturing sector moderated relatively sharply from a robust 61.5 to 57.1.

As expected, the expansion in Japan’s manufacturing sector was halted as the impact of the terrible disaster is being felt. After registering its second consecutive month of expansion in February, the manufacturing PMI dropped from 52.9 to 46.4. The huge turnaround in Australia’s manufacturing sector in February came to an abrupt end in March with the PMI falling to 47.9 from 51.1. China’s manufacturing PMI rebounded from 52.2 in February to 53.4 in March, mainly due to seasonal factors. Taiwan failed to follow mainland China, though. The manufacturing sectors in emerging economies generally followed the weaker trend with South Africa (RSA), Russia and India the exceptions.

Sources: Markit; Li & Fung; Kagiso; ISM; Plexus Asset Management.

Sources: Markit*; Li & Fung**; Kagiso***; Plexus Asset Management****; ISM*****.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****.

Where the still relatively robust global manufacturing PMI numbers were likely to lead to improved global industrial production growth through end June, this year a hiccup is facing global industrial production in coming months, especially in light of the tragic events in Japan.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****; I-Net Bridge

The immediate outlook for industrial metal prices is therefore cloudy.

Sources: Markit*; Li & Fung**; Plexus Asset Management****; ISM*****; I-Net Bridge.

Non-manufacturing/Services PMIs

The JPMorgan Global Services PMI for March got hammered as it dropped to 54.0 from a robust 59.3 in February.

The ISM non-manufacturing sector in the US eased from a very robust 59.7 in February to 57.3 in March. In the Eurozone the robust services sectors of France and Germany upped the pace again, but elsewhere in the Eurozone the PMIs came in mixed. Spain again fell back into contraction while growth in Ireland’s services sector moderated sharply, finding itself on the brink of contraction.

March was characterised by a significant rebound of the UK services sector as the PMI rose to 57.1 from 52.6 in February. Japan’s services sector took a huge smack as the PMI dropped from 49.8 to 35.3 on the back of the disaster. The contraction in Australia’s services sector again deepened with the PMI falling to 46.5 from 48.7 in February.

In the emerging economies the robust expansion in India’s services sector has moderated slightly. China’s non-manufacturing PMI surged to 60.2 from 44.1 in February – in line with the seasonal pattern.

Sources: CFLP; Plexus Asset Management.

The rate of expansion in Russia’s services sector has steadied while the expansion in Brazil’s has accelerated.

Sources: Markit; CFLP; ISM; Plexus Asset Management.
*Japan is off the screen due to the disaster’s impact on the numbers.

Sources: *Markit; **CFLP, Li & Fung, Plexus; ***ISM, Plexus; ****Markit, Plexus Asset Management.

 

GDP-weighted/Composite PMIs

On a GDP-weighted/composite basis where the manufacturing and non-manufacturing/services are both taken into account, the growth in global economic activity decelerated sharply in March, taking the JPMorgan Global Composite PMI index from a robust 59.4 in February to 54.7. That compares to 58.3 in January and 57.1 in December last year.

Sources: *Markit; **CFLP, Li & Fung, Plexus; ***ISM, Plexus; ****Markit, Plexus Asset Management.

Sources: Markit; Li & Fung; ISM; Plexus Asset Management.
*Japan is off the screen due to the disaster’s impact on the numbers.

Summary

US economy: GDP-growth accelerating

My GDP-weighted ISM PMI for the US leads US real GDP growth by a quarter. At this stage it continues to indicate first-quarter GDP growth in excess of 3% on a year-ago basis and may even touch 3.5%. If the current robust manufacturing and non-manufacturing PMIs hold up through end June, the year-on-year GDP growth could reach 4% and beyond in the second quarter, barring any fallout from the Japanese disaster, that is.

Sources: ISM; FRED; Plexus Asset Management.

Eurozone: GDP growth to gain momentum in Q2

The PMIs during the fourth quarter of 2010 indicates that GDP growth in the first quarter is likely to come in at approximately 2.5% compared to a year ago and, barring any fallout from the Japanese disaster, to accelerate to 3% in the second quarter.

Sources: Markit (various internet sources); I-Net; Plexus Asset Management.

China: Still going strong!

As I expected, my calculated GDP-weighted PMI for China spiked in February, due to the reversal of the seasonal weakness induced by the Chinese Golden Week. The non-manufacturing PMI for March surprised me on the upside, though. Where I thought that the somewhat weaker trends in January and February were indications that the stricter monetary policies pursued over the past 12 months have started to bite, it seems to me that the PBoC needs to do more to slow the economy.

Sources: CFLP; Plexus Asset Management.

From a forecasting point of view the CFLP manufacturing PMI gives a better picture of underlying GDP growth due to lower seasonality. China’s year-on-year GDP growth of 9.8% in the last quarter of 2010 was in line with my estimate of 10% based on the manufacturing PMI’s trend in that quarter. It is evident to me that China’s year-on-year GDP growth in the first quarter is likely to come in at approximately 10%.

Sources: Dismal Scientist; Li & Fung; Plexus Asset Management.

Japanese economy: To get worse before recovering?

How the Japanese economy will perform over the next few quarters as a result of the disaster is virtually impossible to say. We will have to take our lead from the trend in the manufacturing and services PMIs. In the following graph I have assumed that the manufacturing PMIs for the next three months will come in as follows (March was 46.4): April 40; May 45; and June 50. In this scenario it seems to me that GDP growth in the first quarter will register approximately -1% on a quarter-on-quarter annualised basis. In the second quarter the GDP is likely to shrink by 2% to 3% on the same basis.

Sources: Dismal Scientist; Markit; Plexus Asset Management.

UK economy: Continuing to gain traction…

From my reading of the GDP-weighted PMI the UK grew by approximately 2.0% in the first quarter on a year-on-year basis compared to 1.6% in the fourth quarter of 2010. It is evident that growth in the second quarter will accelerate to approximately 2.5% to 3.0%, barring any fallout from the Japanese disaster.

Sources: Markit; Dismal Scientist; Plexus Asset Management.

Conclusion

While both global manufacturing and non-manufacturing/services PMI numbers continue to be relatively strong, the onset of a declining trend is something to watch closely. The population of black swans in the global pond has now been expanded by the terrible natural disaster in Japan. The geo-political situation in the Middle East and North Africa is not improving, lending support to higher oil prices and increasing price pressures in the global economy. The PBoC has again tightened its monetary policy. The potential contagion of the debt crisis in the Eurozone and the impact of austerity measures on the Eurozone economy are still major uncertainties. These black swans and how they will unfold are likely to influence and prescribe the policies of central bankers globally.

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Soros: ECB Rate Hike “Inappropriate” in Debt Crisis

Monday, April 11th, 2011

Billionaire investor George Soros talks about the ECB’s decision to raise its benchmark lending rate on Bloomberg TV with Michael McKee and Sara Eisen.

Source: Bloomberg (via You Tube), April 9, 2011.

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