Archive for September 4th, 2012
As Bonds Are Proven Right Once Again, Is 400 The Next Stop For The S&P?
Tuesday, September 4th, 2012
Once again it seems Japan has a lot to teach the Europeans and Americans of the unstoppable reality that bond markets again and again are “correct in the ‘end’”. As risky- and ‘non’-risky-assets become more scarce (thanks to a central bank bid to monetize or collateralize any and all of it), so equity (and risk) markets become more and more distorted – temporarily suspending normal market relationships – until something triggers the reversion to reality. We discussed regime changes in detail regarding gold and bonds over the past 40 years in the past, but the US and European ‘survival’ tactics appear to be accelerated (and larger) versions of Japan’s balance-sheet-recession-fighting game-plan. Their analog, therefore, provides defensible insight into the bond market’s anticipation and equity market’s inevitable confirmation that it’s not different this time. The question we ask is this: “when TOPIX was at 1800, and JGBs implied it ‘should’ be 1000 (in 1999 and 2007) – how many people said it was ‘different’ then?”
Japan’s 10Y JGB yield vs TOPIX – hope cometh slow and fadeth fast…
US 10Y vs S&P 500 – we have seen one ‘hope’ era fade back to bond’s reality; will it occur again?
and will the German DAX (relative to Bunds here) also revert back to reality?
We assume the answer is ‘but, but, but, it’s different this time’…
Charts: Bloomberg
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Erin Botsford: How to Avoid the Biggest Fear of Retirees, Running Out of Money.
Tuesday, September 4th, 2012
How to avoid the biggest fear of retirees, running out of money. Erin Botsford, financial planner and author of “The Big Retirement Risk” discusses her “lifestyle driven” approach to investing.
Copyright © Wealthtrack.com
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Profit Motive: If Earnings/Margins Are Peaking, What About Stocks? (Sonders)
Tuesday, September 4th, 2012
September 4, 2012
by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Key Points
- Earnings growth has peaked, but don’t necessarily assume the same about margins.
- Present pace of earnings growth has historically been accompanied by decent market performanc.
- Margins are increasingly driven by domestic and foreign earnings, but peaking margins have historically been accompanied by strong market performance.
Investors are returning from their summer vacations and getting ready for what could be a very interesting final quarter of 2012. August was fairly quiet, which was a great relief given the fireworks of the past several years. We’re also in the lull period between second- and third-quarter earnings reports. Second-quarter earnings season was an interesting one in that it highlighted the effect on stocks of an expectations bar that had been lowered quite dramatically. Stocks, at least in the short term, often move more on relative-to-expectations rather than on absolute fundamentals.
Earnings growth has undoubtedly peaked from its torrid pace coming out of the Great Recession, but frankly, that was to be expected. As you can see in the chart below, both the plunge in earnings during the recession and the subsequent recovery from those depths were both unprecedented in history.
Earnings Growth Slowing
Source: FactSet, Ned Davis Research (NDR), Inc. (Further distribution prohibited without prior permission. Copyright 2012© Ned Davis Research, Inc. All rights reserved.), Standard & Poor’s, as of August 31, 2012.
One could argue that we’ve returned to a more normal band and pace of growth that, historically, has been decent for stock market performance, as you can see below. Interestingly, were growth to slip a bit more, we’d actually move into what has been the best zone historically for stock market performance.
Source: NDR, Inc. (Further distribution prohibited without prior permission. Copyright 2012© Ned Davis Research, Inc. All rights reserved.). March 31, 1927-August 31, 2012. Circle indicates current range.
The earnings surge coming out of the recession was unprecedented in magnitude, but not in concept. Earnings do tend to rebound quite sharply during the initial stages of bull markets, which in turn tend to lead economic rebounds. Also consistent historically has been the slowing in the pace of that growth as the bull market ages. What happens then, typically, is that in the more-mature phases of bull markets, the heavy lifting tends to come from valuations expanding, not earnings continuing to grow.
In other words, we now need to rely more on the P (prices) than the E (earnings), leading to an expansion of the P/E ratio. Fortunately, the multiple on forward earnings for the S&P 500 presently is just greater than 13, which is about three multiple points below the long-term median.
Taking it from the top down, revenue (or “top line”) growth is slowing. S&P 500 revenues are highly correlated with manufacturing and trade sales. Those are a component of the Index of Coincident Indicators and also a metric partly used to define recessions’ start and end dates. As of July, those sales are up 3.5% year-over-year, a relatively slow pace. Revenues for the S&P 500 were up only 0.3% quarter-over-quarter in the second quarter and up less than 2% versus a year ago. That’s the slowest pace of revenue growth since the third quarter of 2009.
Analysts are also still giving haircuts to their revenue growth estimates for the remainder of this year and next year. According to Yardeni Research, as of mid-August, the consensus expectation for 2012 and 2013 revenue growth is 2.7% and 4.1%, respectively.
Earnings growth, however, is expected to continue to exceed revenue growth. Thomson Reuters shows consensus is for S&P 500 earnings to rise 6.3% this year and 11.7% next.
Profit margins … more than meets the eye
Of course, when doing the math, the only way for earnings growth to outpace revenue growth is for profit margins to continue to expand. One of the better proxies for margins is overall US pre-tax corporate profits relative to US corporate gross domestic product (GDP). Rather than looking at profit margins of publicly traded companies (e.g. the S&P 500), this measure focuses on corporate-sector profits for all US companies based on national income data, a concept pioneered by BCA Research. You can see a chart of this margin proxy below.
Margins Nearing 60-Year High
Source: BCA Research, Bureau of Economic Analysis, FactSet, as of June 30, 2012. Corporate Profits are pre-tax with inventory valuation and capital consumption adjustments.
Today’s elevated margins are approaching the highly profitable years of the 1950s. But it’s important to note the key difference between economic conditions of the two eras. In the 1950s, the US economy was essentially a closed system, with foreign trade and overseas investment much, much lower than today. As such, an even better measure of today’s margins should have profits assessed in relation to both domestic and foreign sales. Unfortunately, national income accounts do not track such data, and as a result, using the more-common measures of profit margins can and likely will be misleading. As per a recent BCA report:
- “…consider a previously ‘purely’ domestic firm that starts generating foreign sales equal to domestic sales. If new foreign sales produce a similar amount of foreign profits per dollar as domestic sales, then underlying margins will remain stable. Meanwhile, when measured as total profits relative to domestic sales only, it could appear that margins have risen and should ‘mean revert.’ A similar analogy could be extended to a specific industry or to an entire economy.”
Homing in on domestic margins
A ratio that compares domestic profits with domestic sales avoids such bias. The chart below, put together with the aid of BCA, plots domestic non-financial profits as a percentage of domestic non-financial corporate GDP.
Domestic Margins Less Stretched
Source: BCA Research, Bureau of Economic Analysis, FactSet, as of June 30, 2012. Corporate Profits are pre-tax with inventory valuation and capital consumption adjustments.
When measured this way, profit margins look significantly less elevated. With globalization in full force, foreign earnings’ contributions to US profit growth should continue to expand, suggesting that margins may continue to diverge somewhat from the US business cycle, and that their upward trajectory may not be soon interrupted (barring a synchronized global recession).
As for the margin cycle’s implications for the stock market, you can see in the table below that stock market performance following margin peaks has been healthy. That said, as mentioned, we may not even be at a margin peak yet.
Source: BCA Research. 1950-2012. Profit Margins defined as total pre-tax corporate profits relative to corporate GDP.
As long as the level of profits remains fairly high, the growth rate of those profits doesn’t sink measurably, margins remain healthy and valuations remain reasonable, the stock market should behave.
Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Copyright © http://schwab.com
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Tepper, QE, and “Priced In” (Tchir)
Tuesday, September 4th, 2012
by Peter Tchir, TF Market Advisors
This is one of the most memorable clips in recent years on CNBC. The Tepper “Balls to the Walls” take on QE2. It was short, simple, and spot-on. He nailed it.
What was interesting at the time was that his belief in how good QE2 would be wasn’t universally shared. Many, myself included, questioned what further reduction of rates would do. I doubted the theory that the money would drive financial assets higher.
I thought the problems were too big for something as simple as treasury buying to “fix”. Then for the next 6 months it seemed, we watched stocks go higher and “POMO” days because the bane of existence to anyone caught short the market. It wasn’t the impact of lower rates, it was flooding the system with money, and the impact on the dollar.
Even when QE2 was announced, the market didn’t react much, because the market didn’t believe QE2 would have much of an impact, so it “wasn’t priced in”.
Priced In
That cannot be said anymore. Many doubt that another round of QE will do much, if anything for the economy, but almost no one is willing to say they don’t think it will do much for risk assets. Even operation twist seemed to help risk assets (though I believe that was actually LTRO, not OT, but hard to determine). So now everyone “knows” that QE is good for risk assets because low rates, fresh money, and weak currency, push stocks higher. That has become a widely held belief.
That is the major difference between September 2010 and September 2012. Back then, not everyone believed stocks would go up with QE, now everyone believes that. So, if and when we get QE, do NOT expect a sustained rally last time. There is no one left fighting the Fed on QE. Stocks will likely go up on the announcement, but positioning already reflects it.
It will be hard to fight money being pushed into the market, but many have already anticipated it, and even during the more surprising QE2, there were periods of weakness. Oh, and the ultimate sell-off when QE ended, which is also likely to be front-run more aggressively this time around.
Not Priced In
Now back to Europe. In spite of the recent strength of stocks, not much is priced in. The Italian stock market has clawed its way back to about unchanged on the year. It is back at 15,200 and well off the lows of 12,360 in late July. That is what everyone talks about. How much “good news” is priced in. Well, this same market was at 17,130 just in March. How much “bad news” was priced in to get us to 12,360?
Why is the consensus belief that July was right and today is wrong? Let alone March prices which almost no one seems to remember. Was the world that good back in March? Actually, maybe it was. Maybe we let ourselves become overly pessimistic about the situation and it is the July price that is an aberration?
I do not think it will take much on the part of the ECB to spark a renewed rally in Spain and Italy. It is good that I don’t think it will take much, since I don’t think we will get much out of the ECB.
My most likely scenario remains an announcement that the market views as underwhelming, where we see some selling pressure, only to turn around as the reality is that the ECB has pushed the can far enough, and then we can start seeing signs of “brotes verdes”. Will the economies be fixed? No way.
But that isn’t necessary, all that is needed is signs that the economy may have bottomed and fear and greed will take over. Pent up demand to replace things that wear out can cause some activity in the underlying economy. Some EIB projects may finally get initiated. A couple business owners who have been holding off making improvements may decide this is enough.
We could see improvement. It will be improvement from the prior month, not from the same time last year, but that is all it takes, especially when the market has been this beaten down.
I’m not sure if this is like the October 2007 rally which didn’t last long, the post Bear Stearns is saved rally in 2008, which also didn’t last long, or the March 2009 rally, which, was dramatic, and in some ways still intact. I don’t know, but I believe that the market isn’t giving enough consideration to potential ECB activity, and it is underestimating what that little activity can do.
Volumes
During the same interview, I thought this little segment, where Tepper asks Kernan about CNBC viewership is particularly interesting. The answer seems to be that the only thing that correlates with viewership is volumes.
So the financial media joins market makers, floor traders, and hedge funds as those hurt by low volumes. There are a lot of people in London today hoping that it is just our holiday that is keeping volumes low, but I personally am far from convinced that volumes spike back up.
It would be hard for volumes not to increase this week and next, but it feels that there is far more going on here than just a summer slowdown. That scares me, though not as much of the prospect that someone will decide that 60 in 60 was too intellectual for the investing audience and decide that 600 in 6 is a better approach to getting individual investors back to the markets and convincing them it isn’t just a game.
Re-Coupling
My strategy at this point, at its core, is to bet on re-coupling. Look for Europe to improve, and the U.S. to get worse. To the extent the markets like a Romney win, there is a decent chance we get some weakness as it would be hard for Democrats not to get an uptick during their convention, but really, it still comes down to Draghi and the ECB this week.
Copyright © TF Market Advisors
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Is The Fed Responsible For The Great Financial Crisis?
Tuesday, September 4th, 2012
“Recessions are a natural economic feature and their regular occurrence is healthy and indeed essential,” is how Deutsche’s Jim Reid introduces his investigation into post-Fed un-natural business cycles. Without them there is a serious danger of bubbles and the misallocation of resources as the further market participants detach themselves from the last downturn the more they tend to under-estimate risk. We,
Jim Reid, Deutsche Bank: The history of business cycles in the US
The chart below shows the duration of each economic expansion (i.e. between all US recessions) since the NBER started collating statistics from 1854. This highlights the fact that prior to the GFC the three preceding expansions were in the top five on record. We can also show that this cycle is now almost exactly average length through history.
If we re-order these cycles by duration we can show more clearly how this current US expansion compares to those through history.
We passed the median cycle length at the start of 2012 and we will be past the historical average point by the end of this month (September 2012). This expansion is now the 12th longest out of 34 since 1854.
There are those that suggest that the Fed’s inception back in 1913 has allowed for longer business cycles and for those interested we have colour coded those cycles (above) that occurred after this point, and also those post WWII when overall economy debt seemed to start a YoY increase that continues to this day. Countering the argument for longer post-1913 cycles would be the view that without the Fed helping to elongate several recent cycles, the GFC we’ve just been through might not have been anywhere near this deep and we are therefore now left in a unique situation at what is at the likely end of a multi-decade leverage binge consisting of several artificially long cycles. We are also now arguably in a liquidity trap where the Fed are less potent that they have been before in their near 100 year history.
The three ‘super-cycles’ between 1982 and 2007 were the exception rather than the norm, one where Central Banks and Governments had almost total flexibility over policy. The conditions that allowed for these long cycles perhaps started a decade earlier with the already much talked about collapse of the Gold Standard.
Unfortunately the 25-30 year build up of excess that this facilitated led to the GFC being the worst crisis since the 1930s and we have now likely moved to an era where policymakers no longer have the flexibility that defined the previous 25-30 years. Most Developed World (DW) Governments are up against their fiscal limits and are actually being forced into economically damaging austerity. We also have interest rates across the Western World that remain close to zero with little room to be lowered further. While we do have money printing, we are close enough to a liquidity trap that flooding the market with printed money doesn’t have the same immediate impact on the economy as a cut in interest rates did in the long leveraging stage of the super-cycle.
So not only are we battling with the huge structural problems that the post-credit crisis world brings, we are fighting it without much policy flexibility and are indeed being forced into a reversal of stimulus at arguably exactly the wrong time.
So it all adds up to a return to more normal length business cycles in our opinion. Indeed one could make an argument for shorter cycles than normal given the lack of policy flexibility relative to most of history.
We, like Jim, would argue that the reason the Great Financial Crisis was so deep was due to the authorities continued refusal to let the business cycle take its natural course.
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Civility (Saut)
Tuesday, September 4th, 2012
“Civility”
by Jeffrey Saut, Chief Investment Strategist, Raymond James
September 4, 2012
“Civility is the glue that holds society together.”
… Anonymous
Webster’s defines “civility” as: civilized conduct; especially: courtesy, politeness. But, there was no civility last Friday afternoon. The place, CNBC; the time 3:05 p.m.; the anchors Michelle Caruso-Cabrera and Bill Griffith; the show “Closing Bell; the guests were myself, Bill Spiropoulos, Lee Munson, and Matt McCormick. The interview started off well enough with each interviewee responding to the anchors’ questions. However, when I was asked, “Jeff, I can’t help but think we’re back to this rally situation, did we not get another signal that if the economy goes south, Bernanke is there, and the market goes higher. What do you think?”
My response was: “I think the word change from ‘could’ to ‘will’ was significant. His statement now reads, ‘The Fed ‘will’ provide additional accommodation as needed.” Bernanke’s previous statement read, ‘The Fed ‘could’ provide additional accommodation as needed.’” I then went on to say, “But all you had to do this year was to follow the chart from my friends at Bespoke Investment Group. They have a chart of the typical trading chart pattern for the S&P 500 (SPX/1406.58) in election years dating back to 1928; and, this year’s pattern has about a 98% correlation with the historic pattern” . . . and it was there that civility ended as one of the other guests interrupted me in the mid-sentence by stating:
“I love those guys over there too (meaning Bespoke). [But] we’re in completely uncharted waters. The Fed governor said today these are absolutely nontraditional [times]. There is nothing like it, and he said I will print money to jack up the Dow Jones. I don’t see how we’re in a gray area.”
If had been given the chance to respond to my interlocutor I would have said, “First, I never said we are in a gray area. Second, if these are truly uncharted waters why is the correlation between the historical stock market trading pattern in an election year, and how the SPX tracking that historical pattern, so closely?!” Indeed, as I was about to say on CNBC, before being interrupted, was that all you had to do this year was follow the historical SPX trading pattern in an election year because it called for a “top” the first week of April follow by a sell-off into the end of May and then a zigzag rally into a short/intermediate trading top late this week or early next week.
One thing my unmannerly counterpart did get right was about Friday morning’s FOMC meeting where Mr. Bernanke again inferred that there remains a Bernanke “put,” which should prevent the equity markets from declining by too much. Before the Bernanke speech my friends at the brainy GaveKal organization wrote this:
“It is a mystery why the markets look forward with such excitement to a tedious and predictable restatement of Mr. Bernanke’s boundless confidence in the power of monetary policy to stimulate growth and create employment. After all, experience has shown that the Fed simply does not have these magical powers. Almost nobody outside the Fed genuinely believes that another round of quantitative easing, or another promise to hold interest rates at zero until the Last Trumpet, will do anything to accelerate economic growth. … Additional QE today would be especially counterproductive. The US economy is no longer threatened by deflation, recession or a housing slump. In fact the biggest economic danger is the jump in oil prices – up 27% since the end of June. This is largely because of the speculation about more QE that was inspired by a series of Fed statements from early July onwards, when the probability of QE3 shot up to 70%, according to the regular Reuters survey of Fed-watchers. This oil price surge is already bigger than the 19% increase that occurred between late January and early March, contributing to the spring slowdown. Unless this oil price movement is quickly reversed or at least arrested, another slowdown is likely in the fourth quarter. But perhaps Bernanke will surprise the world today. Maybe he will not promise more QE3. He might even acknowledge that, as economic conditions normalize and oil prices inflate, QE can become dangerously counterproductive. If Bernanke did that, Jackson Hole really would be a ‘big speech’.”
I too would have liked to hear Mr. Bernanke say, “As economic conditions normalize and oil prices inflate, QE can become dangerously counterproductive.” Alas, that was just not to be. To the gasoline point, I was quite vocal about gasoline prices when they were declining. Now, however, they are rising, and they are rising materially. In previous missives I have mentioned that every penny decline in gasoline prices puts another billion dollars into the hands of consumers. Of course the reciprocal is also true and we are currently experiencing the highest gasoline prices ever for a Labor Day holiday ($3.80/gallon national average). Obviously, this is a headwind for the economy, as well as the stock market. And, maybe that’s why many of the stock market’s internal metrics have begun to weaken.
To be sure, Buying Power has been waning recently and the Advance/Decline line is not confirming the upside in the major averages. Moreover, last week “they” started running the laggards, which is typically a sign suggesting a trading top is close. Indeed, of all the indices I follow the only ones that were positive last week were the lagging indexes, namely the S&P 400 MidCap, the S&P 600 SmallCap, and the Russell 2000. Meanwhile, “smart money,” that would be commercial hedgers, are nearing their largest short sale position in eight years. Taken in conjunction with Bespoke’s election year chart, which is calling for an intermediate trading top around September 7th, I think it is time to counsel for caution. If I could script this week’s trading pattern, it would be for a decisive upside breakout above the 1420 – 1422 (basis the SPX), a level often mentioned in these comments. That breakout would be followed by a surge to somewhere between 1450 and 1477 that gets everybody excited, as well as “long” stocks, just in time for a trading peak late this week or early next week. If Bespoke’s chart continues to telegraph the future, the anticipated near-term peak would subsequently give way to a decline into mid/late October followed by another rally that carries the SPX out to new all-time highs.
The call for this week: Ben Bernanke’s word change from could to will is significant. The statement now reads: “The Fed ‘will’ provide additional accommodation as needed” instead of “The Fed ‘could’ provide additional accommodation as needed.” The implication is that QE3 is ready if needed. Certainly gold thinks QE3 is coming given Friday’s leap of about $30 per ounce followed by another $7.00 gain this morning. If past is prelude, gold’s surge is pointing the way higher and stocks should not be too far behind. Again, if I could script it, look for an upside breakout above 1420 – 1422 (basis the SPX) that is followed by a surge to somewhere between 1450 and 1477 that gets everybody excited, as well as “long” stocks, just in time for a trading peak late this week or early next week.
Copyright © Raymond James
