Archive for October 16th, 2012
Tuesday, October 16th, 2012
by Lacy Hunt, Hoisington Asset Management
Entering the final quarter of the year, Lacy Hunt and Van Hoisington (H&H) describe domestic and global economic conditions as extremely fragile. Across the globe, they note, countries are in outright recession, and in some instances where aggregate growth is holding above the zero line, manufacturing sectors are contracting. Of course, new government initiatives have been announced, particularly by central banks, in an attempt to counteract deteriorating economic conditions.
These latest programs in the U.S. and Europe are similar to previous efforts. While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies. To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, in their view, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.
H&H go on to break down every branch that Bernanke rests his QE hat on from the Fed’s inability to create demand, to the de minimus wealth effect, and most importantly the numerous unintended consequences of the Fed’s actions.
Can all the trillions of dollars of reserves being added to the banking system move the economy forward enough to eventually create a higher level of aggregate spending? Our analysis of the aggregate demand curve and its determinants indicate they cannot. The unintended consequence of these Federal Reserve actions, however, is to actually slow economic activity.
The unintended consequences of QE3 could also serve to worsen and undermine global economic conditions already under considerable duress. When the Fed actions lead to higher food and fuel prices, the shock wave reverberates around the world, with many foreign economies being hit adversely. When prices of basic necessities rise, the greatest burden is on those with the lowest incomes since more of their budget is allocated to the basic necessities such as food and fuel. Thus, a jump in daily essentials has a more profound negative impact on living standards in economies with lower levels of real per capita income.
Three studies show that the impact of wealth on spending is miniscule—indeed, “nearly not observable.” How the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling.
The other element that is required for the Fed to shift the aggregate demand curve outward is the velocity or turnover of money over which they also have no control. During all of the Fed actions since 2008 the velocity of money has plummeted and now stands at a five decade low.
The consequence of the Fed’s lack of control over the money multiplier and velocity is apparent. The monetary base has surged 3.3 times in size since QE1. Nominal GDP, however, has grown only at an annual rate of 3%. This suggests they have not been able to shift the aggregate demand curve outward. Nor, with these constraints, will they be any more successful in shifting that curve under the present open-ended QE3.
Increased aggregate demand and thus rising inflation is not on the horizon.
Full H&H report below:
Copyright © Hoisington Asset Management
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Tuesday, October 16th, 2012
Consuelo Mack WealthTrack – October 5, 2012
CONSUELO MACK: This week on WealthTrack, five star fund manager David Winters takes on the investment crowd and parries and thrusts his way through the stock bears and inflation deniers. Wintergreen Fund’s Great Investor David Winters is next on Consuelo Mack WealthTrack.
Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Central bankers are clearly worried about global growth. From the U.S., to Europe, to Asia, we have seen unprecedented levels of easing in recent weeks. By independent research firm ISI Group’s count, there have been more than 250 stimulative policy initiatives announced over the past 13 months. The firm also points out that we are less than 100 days from the famous fiscal cliff in the U.S., when numerous Bush era tax cuts expire and automatic spending cuts take effect if Congress and the White House can’t reach a budget compromise. If they don’t, estimates are that GDP growth could be reduced by as much as 3.5%, sending the economy into recession.
Meanwhile, stocks have rallied strongly this year largely because of all of those central bank actions, which have given some investors confidence that the world will continue to muddle through the challenges of a widespread economic slowdown. Individuals, however, are still not participating in large numbers. Retail investors continue to favor bonds over stocks- a winning move for them until this year, and a trend we’ve been tracking for months.
This week’s guest disagrees with such bearishness and believes investors are missing several attractive opportunities around the world. He is Great Investor David Winters, portfolio manager of the five-star rated Wintergreen Fund, which he has been managing since he launched it in 2005. The go anywhere, invest in anything value-oriented fund has outperformed its category and the markets since its inception. Wintergreen is a sponsor of WealthTrack but David is clearly here on his own merit. I began the interview by asking David about what he considers a major investor misconception, phrased by great bond investor Bill Gross at PIMCO as “the cult of equity is dying.”
DAVID WINTERS: I think it’s wrong. I think the notion that stocks are never going to go up again creates an enormous opportunity for the few of us left who are working on equities and actually do the work, and I think it’s a misconception that’s forced the public even further from the equity market and institutions, and the reality is there’s this enormous disconnect between price and value which creates future opportunities.
CONSUELO MACK: So there is a shift on both the institutional level and the individual level away from stocks and, as you know, the new term for stocks is that it’s the risk asset, and Treasuries are the risk-free asset, another perception which you strongly disagree with.
DAVID WINTERS: Well, you know, people think it’s been such a bad period for 10 years that this is going to be forever like this, and so in that timeframe, Consuelo, rates have come down, and the only way to have made money was, except certain well-selected securities, has been to own bonds. So people now have their money in 20 basis points and 18 basis points securities, you know, Treasury securities. People lose purchasing power on a daily basis. I think inflation is very real. You have food prices going up, fuel prices going up. You need to get your hair done. Prices go up, and if you have your money not growing over time, you get crushed. So here you’ve got the public believing and institutions believing equities are dead. They believe that putting all your money in bonds when rates go up and you have the impact of inflation. We think what’s perceived as a risk-free asset is actually an incredibly risky asset.
CONSUELO MACK: So cash, in fact, and cash equivalents you told me is one of the riskiest assets now. Let me ask you, because if you were to talk to Federal Reserve chairman, Ben Bernanke, he would basically say that inflation is very mild. It’s benign, and it’s under our target rate, and yet, again, another misperception.
DAVID WINTERS: For most individuals, their cost of living is going up, and this circles back to this ‘equities are dead’ fallacy, because if you own the right businesses with a global footprint that grows free cash flow, has a nice yield, those businesses become more valuable over time, and they have the ability not only to raise prices but to sell more units, and so the well-selected equities, which is what we do at Wintergreen Fund to the best of our ability, it protects you from inflation, the erosion of principal which is really, I think, the biggest risk out there.
CONSUELO MACK: So it’s interesting, because you just mentioned that we had come through a decade which is called the lost decade, and so when people look at the market indices, and they’re saying, you know, the S&P and the Dow are below what they were at their height, their peaks from 2007, whatever it was, but when I look at Wintergreen’s results, and you look at individual securities, in fact, that many people haven’t lost money. They’ve made money. So this kind of disconnect again, between the market and individual securities, historically, I mean, how big is the gap as far as you’re concerned?
DAVID WINTERS: I’ve never seen anything like this and, you know, part of it is you have so many people who’ve had a bad experience, and there is relatively few of us who’ve had a good experience so that we remain optimistic, constructive, and believe that you take advantage of this disconnect. There’s companies out there which trade at massive discounts to their asset value that are well run with good management.
CONSUELO MACK: Give us some examples of investing in Wintergreen.
DAVID WINTERS: Well, you know, one that I’m talking about it Canadian Natural Resources.
CONSUELO MACK: A long-time holding of the Wintergreen Fund.
DAVID WINTERS: Right, and in this environment it’s certainly gotten beaten up, but if you look at what recent transactions for oil assets have been and what CNQ trades for, it trades at one third of those recent trades, and the oil’s in Canada. It’s a great country, rule of law, and so there are a number of examples where we can take advantage on behalf of the Wintergreen investors that they can own these assets at a really low price with bright future. That’s the other thing, is that people extrapolate what’s happened, that things will never get better, and we know from our own lives that the country is so much better than it was 20, 30, 40 years ago, and I think the future’s bright. And the other big misconception is that people have repatriated their money home, whether the U.S., to Canada, to Japan, but really the big opportunities are international.
CONSUELO MACK: That’s a very interesting point, because certainly if you talk to a number of other value investors, the theme has been that the U.S., the big brand name U.S. companies are the best value in the globe and, therefore, invest with the big name U.S. companies.
DAVID WINTERS: Well, we think there’s… you know, we’ve actually bought more in the U.S. in the last year or so because the market is in the state it’s in, but there are so many great companies all over the world, whether they’re in Monterrey, Mexico or Zurich or Kuala Lumpur, and I think most investors don’t have the flexibility of thought to be willing to look everywhere, and today we think that, you know, I feel like a kid in a candy store with $100 in my pocket, and my parents aren’t watching.
CONSUELO MACK: That is a great image. I can you see you as a little kid. I have to admit, ever since I started interviewing on WealthTrack, you have had this same kind of optimism about the kind of companies that you’re finding, and one of the things that you always say you’re looking for a trifecta, and that bears… it’s really important for our viewers to understand, you know, what do you mean by a trifecta? What do you look for in the companies that you invest in?
DAVID WINTERS: Well, I’m a value investor, global value investor, and I’m fortunate to know how to do all kinds of things, you know, liquidations, bankruptcies, activism, but what we’ve really learned as time has evolved, that you need three things. One, you need a company with good underlying economics, and hopefully economics that are improving and that again takes the risk out.
CONSUELO MACK: So a good growing business.
DAVID WINTERS: Yes, and then you got to have management who’s focused on all shareholders, not just themselves and that who wants to create value, and the third thing is a low price, and today there’s lots of low prices, and so I think that this is a great time. And I don’t know what the market’s going to do in the short term or securities prices, but if you use the trifecta as a filter and you really get in and do the work, I think you take out the risk, and you create a lot of upside.
CONSUELO MACK: But why are there more opportunities today? I understand the price equation of it, but I mean, looking over your 20 some odd years of investing, you know, why are there more opportunities today, aside from the fact that the market has been down over the last 10 years or whatever? Is there something else going on?
DAVID WINTERS: I think there’s a number of things going on. As we started the conversation, you have the death of equities. People really believe market’s never coming back, that business is never going to grow, that if you plant another crop as a farmer, it’s never going to, you know, and it’s just not true.
CONSUELO MACK: Right, eternal drought.
DAVID WINTERS: It’s just not true, and the reality is most of the companies in the Wintergreen portfolio are doing really well, and you just have less competition.
CONSUELO MACK: So that’s an important point, is the notion that there’s less competition. So in fact, as we see people not only withdrawing from equities but also switching to passive indexes instead of in a way from active managers, has there been a real marked decline in the number of people doing stock analysis? I mean, is that another part of this change in the markets?
DAVID WINTERS: Yeah, I think basically there are fewer people doing the work, and people’s timeframes have been compressed, and they don’t want any price fluctuation, and if you go back to the essentials, you go back to what Benjamin Graham wrote in “The Intelligent Investor” in 1949, it was Mr. Market. Today we say Mr. or Ms. Market, and you take advantage of the fluctuations, but what’s happened, because it’s been so difficult, is people have just fled and so it’s like being a fisherman with lots of hungry fish, and there’s no more fisherman around.
CONSUELO MACK: David, let me ask you about the macro environment, because we are looking at a lot of uncertainty. You know, it just seems like there’s a crisis du jour, whether it’s political or economic, and so how, as a portfolio manager, do you deal with those macro uncertainties?
DAVID WINTERS: Well, you’ve got to I think select what’s really important and also what you can control, and most of it as individuals, we can’t control, but what we can control is how we react, and if we react by saying, “What can I do to find an opportunity in this mess?” that’s, I think, been the key way that we’ve thought about it, and there are a lot of problems in the world, but there’s a lot of good things in the world, and so what we focused on is what’s good and how can we make money for the Wintergreen investors by focusing on these opportunities.
CONSUELO MACK: The companies that you’re investing in, they’re multinational companies. They do business all over the world. I mean, what’s the sense from the managers that you talk to about what their feeling is about the prospects for business globally?
DAVID WINTERS: Well, I think there are certain examples where things are slowing down, yet the well-run companies continue to invest for the future and figure out what they’re going to do when the sun comes up tomorrow morning, and I think a well-run company doesn’t give up or worry about this quarter. They build for tomorrow, and so we’ve tried to find those types of managers who are focused. I give you a little example. The Schindler elevator and escalator company announced that they built their first foreign company, elevator company, building a factory in India. So the Schindler company, they haven’t stopped. They’re getting more orders. They’re busy, and I think ultimately not only are they doing well now, but when things do improve, they will have laid the groundwork to sell more elevators and escalators and more maintenance. So that’s where we’re focused.
CONSUELO MACK: You are so optimistic again, and you seem to be focused where the growth is occurring. One of the major areas, again, that’s in the headlines is China, and China, they’re saying that its growth is slowing. It’s had a housing bubble. What’s your view of China and the opportunities that are still there for companies?
DAVID WINTERS: You know, people worry about China, and many people have never been there. And I was there for a month earlier in the year, and I can’t tell you I know exactly what’s going to happen, but I do know that you’ve got a lot of people, and they all want to look good. It’s just a basic human emotion, and the Chinese are just like everybody else. So you know, that’s why we like Richemont that owns Cartier. You know, we like Swatch that sells low, medium and high-end watches. You know, our largest position is Jardine Matheson, and it’s a Bermuda-based company, but they’re in Hong Kong, and they have great businesses, and they experience that things are slowing down a bit, but they keep investing for the future.
Nestlé. Nestlé just bought or is in the process of buying Pfizer’s infant milk formula business. You know, in China it’s the one child policy. People love their children. They will do anything for their babies, and if they need infant milk formula, Nestlé will sell it to them, and so I think that there’s so much we can’t know and we don’t know, but what we do know and what we focus on at Wintergreen is what’s the knowable, and how can we make money off of it, and we know that as the Chinese get richer, there are certain things that they’re going to do, and so I don’t know about this quarter. I don’t know about the politics, but I do know they want to eat better, and they want to have a good time, and they want to look good.
CONSUELO MACK: So there are some markets that you’re not investing in right now. I mean, you’ve basically avoided Euro zone companies, and you’ve avoided Japanese-based companies. So talk to us about where Wintergreen isn’t right now and why.
DAVID WINTERS: Europe’s in a big mess, and I think that ultimately however this plays out, they’re going to print money just like we have, and you’ve got this construct which ties everybody together at least for now, and it’s going to be like a giant tax on the corporations and the people. So we’ve looked, and we’ve owned a lot of European companies in the past, and we’ll probably own them in the future, but right now we just don’t need to be in the middle of the storm.
And Japan, you know, I love Japan, but they have such issues that they haven’t been able to grapple with, that it’s a tough place to invest and produce returns. So again, the day will probably come when we’ll back in Europe and back in Japan, but right now, there’s other places to invest where the weather is better, and we think there’s more money to be made.
CONSUELO MACK: Let’s talk about some of the places that you are investing, and one of the kind of hallmarks of the Wintergreen Fund’s portfolio is that you are invested, have large positions in a number of tobacco companies, so BAT and Altria and Philip Morris. So tell us about…
DAVID WINTERS: Well, you know, we don’t advocate smoking, but the cigarette companies are huge free cash flow generators, and especially the international ones, BAT and Philip Morris. Philip Morris raised its dividend 10% yesterday. It yields 3.8%. So you get paid to wait and also governments get a lot of tax dollars from these companies, and then there are certain companies like Altria, which is a U.S. company, that’s a complete special situation, because they own 27% of SAB. They have a little wine business. They have a liquidating finance business. Yields five percent, and something eventually is going to happen these excess assets. So we like companies where there’s very little risk, and there’s a lot of upside. And another example would be Berkshire Hathaway, and everybody talks…
CONSUELO MACK: Right, not tobacco, but railroads which you’re a major fan of railroads, right?
DAVID WINTERS: Absolutely, and Berkshire put in a buyback 110% of book, and we added to the position at I think 112% of book, so we have two percent down side really and a lot of upside, and so that’s why, again, we get so excited about the market today. The market, investments, individually well-selected investments, because the risk/reward, because of what’s happened, and the way that people perceive it- equities are dead, bonds are riskless, never invest internationally again- they’re the wrong lessons. So for us at Wintergreen, it’s like, okay, come on.
CONSUELO MACK: The last time I talked to you, we talked about Google. What’s your view on Google right now?
DAVID WINTERS: We still own it and, you know, it’s really a media company, and everybody uses it basically, and they’ve got lots of cash and free cash flow. You know, we don’t love what they did with the high vote- low vote stock, but it’s not an expensive company.
CONSUELO MACK: Not expensive.
DAVID WINTERS: Not expensive, and they have this fabulous business that it doesn’t appear that anybody can ever catch that, and that may change, but for now, as somebody used to invest in newspapers, television, et cetera, I think Google’s the best media company out there.
CONSUELO MACK: Apple. Do you have a view? And I look at Apple, and I see what a huge impact it’s had on the S&P500 index and the NASDAQ and what a spectacular performer it’s been. What’s your view on Apple?
DAVID WINTERS: It’s a great company and, you know, they went from being almost broke to being this huge success, and they make fabulous products, and they have lots of cash, and you can do the analysis.
CONSUELO MACK: A hundred billion dollars in cash.
DAVID WINTERS: And you can strip out the cash and see what you’re paying for it. The problem with an Apple or most of the technology companies, is the product cycle is so short, and I can’t tell you whether the next product is going to be widely received. So if we don’t know, we don’t participate.
CONSUELO MACK: So what’s the best idea in your portfolio now? Do you have one?
DAVID WINTERS: I don’t know if it’s the best, but it’s one that I think is- it’s newer, and I think it really fits us- is MasterCard, and why we like MasterCard is every time the card is swiped, they get a little fee, and there’s an enormous amount of transactions every day. Seventy percent of the business is global, and I think it’s 85% of the world still does every transaction in cash.
CONSUELO MACK: Which amazed me when you told me that statistic.
DAVID WINTERS: And even if it’s higher or lower and small transactions in out-of-the-way places, over time people are going to use plastic. It’s just more convenient.
CONSUELO MACK: Cash, what role cash plays in the Wintergreen portfolio? It’s always played an important role. So what are the cash positions now and why are you keeping them wherever they are?
DAVID WINTERS: Cash has come down actually, because we’ve been a buyer. We found a lot to do because of what’s going on.
CONSUELO MACK: And it’s come down since when?
DAVID WINTERS: Oh, I don’t know. This year. We probably are 12% in cash, and we’ll probably continue to move things around a little bit, buy and sell. We always want to have cash, because it gives us the ability if something awful happens or if something great becomes available even without anything awful happening, that we can be a buyer, and we don’t have to liquidate something else. We run the money as if it were- and it is- you know, I have essentially all my own money up. My niece has all her own money up and so on, and you know, and my best friends. So we really try to be very, very careful, and you want to be in a position to be a buyer when others are sellers, and there are so many sellers.
CONSUELO MACK: So around 12% now, so in kind of the historical scheme of things, is that midpoint to what you normally are or…?
DAVID WINTERS: Probably mid, yeah, and it could drift lower. I mean, it depends on prices really, and what opportunities those three great misconceptions give us, because there are very few people doing security analysis, thinking long term and investing long term, so we’re in the minority now, which is good.
CONSUELO MACK: Good to be in the minority. So David Winters, thank you so much for joining us from Wintergreen Fund. We really appreciate your being here.
DAVID WINTERS: Great to be here.
CONSUELO MACK: At the end of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: think like a contrarian and selectively invest against the crowd. David Winters just mentioned that he is in a minority by doing individual security analysis, and thinking and investing long term. Current investor sentiment is anti-stock and anti-active management so maybe it’s time to re-consider some long-term oriented, actively managed global stock mutual funds for your portfolio. Among Morningstar’s favorites are the ones run by this week’s guest David Winters and recent guest, Matthew McLennan; they are the Wintergreen Fund and First Eagle Global Fund. Both have earned five star ratings for their performance and management.
I hope you can join us next week, our guest will be another Great Investor, but one who has generated his share of controversy by making huge bets in financial stocks and other unloved securities in recent years. A rare interview with Morningstar’s fund manager of the last decade, Fairholme Fund’s Bruce Berkowitz, is in your future. If you would like to watch this program again, please go to our website wealthtrack.com. It will be available as streaming video or as a podcast. You can also see additional interviews with WealthTrack guests in our new and improved WealthTrack Extra feature. And that concludes this edition of WealthTrack. Thank you for watching. Have a great Columbus Day weekend and make the week ahead a profitable and a productive one.
Tuesday, October 16th, 2012
October 12, 2012
by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
and Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research
and Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research
- Concerns about a possible US recession remain elevated in light of the pending “fiscal cliff,” resulting in some lackluster stock market action. We believe the market needed to digest recent gains and remind investors that equities typically climb a “wall of worry.”
- The fiscal cliff and uncertainty around tax and regulatory policy appear to be influencing business decisions to the detriment of economic growth. The Fed is aggressively trying to fight these powerful headwinds, but its ability to make a large impact may be limited.
- While worst-case scenarios for Europe may have been taken off the table by the ECB, Spain’s reluctance to ask for aid is causing consternation. And although we see continued weak growth in China, signs indicate the global slowdown may be turning around.
Stocks have taken a breather over the past couple of weeks, following impressive gains this year. As we’ve seen throughout this year, stocks often climb a “wall of worry” and we believe the path of least resistance for stocks longer-term remains up. There remains ample cash on the sidelines, investor sentiment is not much worse than uncertain, and the Federal Reserve remains aggressively easy. We suggest using pullbacks to add to positions as needed to bring or keep equity allocations in line with long-term goals. Since 1925, the S&P 500 has risen more than 12% during the first three quarters of the year (as it did this year) 31 times, according to Ned Davis Research (Oct. 12, 2012). The median gain for the fourth quarter in those instances has been 4.9%, and the S&P 500 finished in positive territory 81% of the time in the fourth quarter.
Third-quarter earnings season is upon us and expectations have been relatively dour, with analyst expectations for earnings growth falling to -2.1% from +6.6% at the start of the year, according to Wolfe Trahan & Co. (Oct. 3, 2012). Additionally, according to Strategas Research Partners (Oct. 2, 2012), for every five earning pre-announcements for the quarter, roughly four have been negative, which is the highest ratio since the third quarter of 2001. Lowered expectations, however, can lead to better performance. When the pre-announcement ratio has been above 2.1, the average monthly gain in the month following quarter end has been 2.1%, while when it has been less than 2.1, stocks have actually fallen 0.2% (according to Thomson Research (Sept. 30, 2012)). Company outlooks for the coming year will be of utmost interest, and we believe that estimates for the fourth quarter and 2013 should come down, which could cause volatility in the near term.
US economic growth remains sluggish and recession risk is rising as the fiscal cliff approaches. We’ve heard major multinational companies, especially those involved in shipping and delivery, express elevated concern about global economic growth. Recent reports also indicate that businesses are holding off on capital spending. We continue to hear anecdotal reports that executives are waiting for the election results and some resolution to the fiscal cliff before making major spending decisions. Unfortunately, their concerns about growth can be self-fulfilling, as decreased demand can lead to economic contraction.
We continue to believe that we’ll avoid a recession in the near term, although fourth-quarter growth could be weak. We were encouraged to see the Institute for Supply Management’s (ISM) Manufacturing Index move back above 50, to 51.5, after being below the dividing line between expansion and contraction for three months. Even more encouraging was the new orders component, which jumped 5.2 points to 52.3, while the employment component rose to 54.7. The weightier ISM Non-Manufacturing Index came in at a better-than-expected 55.1, up from 53.7, while new orders rose to 57.7. Additionally, auto sales continue to improve and are up roughly 65% since the lows in 2009, according to ISI Research.
Auto sales continue to improve
Source: FactSet, U.S. Bureau of Economic Analysis. As of Oct. 8, 2012.
Stronger auto sales are adding heft to consumer spending, which is vital to the US economy. Retail sales improved by 4.8% in July and 6.1% in August, according to Thomson Reuters, and the important holiday season is expected to generate a 4.1% rise in sales from the year before, according to the National Retail Federation. This is not robust, but also is not indicative of a recession. Along with improved balance sheets and a better housing market, the consumer is helping support economic growth.
Consumers continue to reduce debt
Source: FactSet, Federal Reserve. Includes mortgage and consumer debt, auto lease payments, rental payments, homeowners insurance, and property tax payments. As of Oct. 8, 2012.
The jobs picture also doesn’t indicate robust growth, but it doesn’t indicate a recession either. ADP reported that private payrolls rose by 162,000 in September, while the Department of Labor said 114,000 jobs were added, although readings for the previous two months were revised higher and the unemployment rate, tied to the “household survey,” fell to 7.8%, its lowest level since January 2009. In support of the lower unemployment rate, jobless claims fell sharply in the latest week, albeit from a large revised adjustment emanating from a single state.
Election and fiscal cliff now in focus
With the election less than a month away and the fiscal cliff looming at the end of the year, markets appear to increasingly have their eye on Washington. The partial paralysis evident by businesses poses a further risk to the economy but there remains a possibility of “uncertainty fatigue.” At some point, business leaders may grow weary of restraining themselves due to tax and regulatory uncertainty, and “animal spirits” and pent-up demand could win out.
Eurozone less pressing, but unsolved
A more severe debt crisis persists in the eurozone. The lifeline from the European Central Bank (ECB), in the form of potential purchases of sovereign debt, has bought time and, in our view, reduced extreme downside risks. The ECB, however, cannot act alone—countries must ask for assistance. Since this requires committing to unpopular austerity measures and oversight by outsiders, it’s natural for countries like Spain to drag their feet.
Despite the relief in Spain’s government debt market, it may still require a bailout. Since the relief is based primarily on improved sentiment, not fundamentals, Spain is vulnerable to renewed pessimism, making yields volatile with a possible upward bias. Yields may need to move sharply higher before Spain asks for aid. This could be greeted positively by the markets, however, because it would remove an uncertainty.
Meanwhile, the real economy in the eurozone still has headwinds, as European banks remain hobbled and likely still need more capital. While the permanent bailout fund—the European Stability Mechanism (ESM)—could recapitalize banks in theory, progress toward a eurozone-wide banking union, a precondition for any recapitalization, has stalled. Eurozone banks need to shrink their balance sheets (deleverage); with the International Monetary Fund (IMF) estimating the amount of deleveraging could be anywhere from $2.8 trillion to $4.5 trillion by the end of 2013, depending on policy-makers’ actions. A hobbled banking sector is unlikely to expand, which could keep a lid on economic growth.
While eurozone stocks have the potential for a big “catch-up” rally, we urge investors not to be complacent about the risks—volatility could climb again and challenges remain. We outline our neutral stance on eurozone stocks in our article.
We’ve been noting the problem of high expectations for China since July, and our concerns have since intensified. We believe there is an increased chance China has a “hard” landing—where economic growth slows too much and feels like a recession. A hard landing may not show up in official figures, but could be felt in other ways. We believe the overhang of speculative excesses and a possible need to transition China’s economic growth model could result in a difficult economic environment that could persist longer than most expect.
A major problem in China is the amount of speculative capacity in China. The belief by businesses that growth would stay robust and that any slowdown would be followed by a snapback resulted in sustained high levels of production and investment. In fact, after the global financial crisis, investment in new capacity grew at a faster pace than China’s gross domestic product (GDP).
As a result, the IMF has estimated that utilization of production capacity in China was at 60% at the end of 2011, down from 80% before the global financial crisis (“IMF Country Report on the People’s Republic of China, July 2012″). Since that time, new capacity in some sectors continued to be added in 2012, despite the slowdown.
We believe there could be fallout from excess capacity because we doubt economic growth will return to the high pace envisioned when capacity was put in place. The implications are many:
- Reduced need for spending to build new capacity;
- Price and profit pressure due to supply in excess of demand;
- Potential for a rise in bad loans for banks and an increase in accounts receivables for companies as cash flows decline; and
- Possible job losses for factory workers at plants with excess capacity.
We aren’t suggesting a crash in China’s economy and stimulus could reaccelerate growth in coming months. A new era of slower growth in China, however, could have profound implications for investors, reducing growth prospects for US multinationals, cutting demand for commodities over the medium-term, and lowering growth for emerging market economies as a whole. We remain cautious on both the Chinese and emerging market equities.
Global slowdown behind us or worsening?
Headlines don’t always tell the whole story. While the IMF cut growth forecasts for most global regions in early October, there are signs of improvement under the surface. Global economic growth may be sluggish, but it’s not falling apart.
Global economy may have improved in September
Source: FactSet, Bloomberg. As of Oct. 9, 2012.
Global purchasing manager indexes (PMIs) for September indicate the global economy overall may have improved during the month. A number of countries reported figures above the 50 level that separates expansion and contraction, and many economies posted slower rates of decline in September relative to August. Overall, the JP Morgan Global Composite PMI rose 1.6 points to 52.5 in September, on the strength of services, which added 2.0 points to 54.0; while manufacturing also improved, gaining 0.8 points to 48.9.
Global trade also remains subdued, but there is improvement here, too. In September relative to a year prior, South Korea’s exports fell 1.8% and Taiwan’s exports grew 10.4%; better than August’s 6.2% decline and 4.2% fall, respectively. Elsewhere, leading indicators of global growth have also improved, with the Baltic Dry Index rising over 30% since mid-September, and the CRB raw industrials spot price index gaining 12% since end of July.
Developed market economic data better than feared
Source: FactSet, Bloomberg. As of Oct. 9, 2012
Meanwhile, expectations appear low and economic data have surprised to the upside in advanced economies. This mix of “better than feared” and the improvement in the data (even if still not rosy) has boosted stocks, as the trend is often more important than the level. Additionally, reduced extreme downside risks in the eurozone and global central bank liquidity have also helped.
There could be even more upside for global stock markets if economic growth continues to improve; although China’s slowdown and subsequent recovery, as well as uncertainties with regard to the US fiscal cliff could mean a bumpy road ahead. China constituted roughly 10% of world GDP in 2011 but accounted for a larger percentage of growth in some sectors (for example, roughly 40% of some construction-related commodities). As a result, China’s transition could create a multiyear shift in sector leadership, reducing prospects for some sectors, while creating new markets for others.
Read more international research at www.schwab.com/oninternational.
It appears to us that US growth remains in stall speed and recession risk is elevated heading into year-end thanks to fiscal cliff uncertainty. However, we are encouraged by some positive US and global economic data recently. After a period of lackluster action and amid continued investor skepticism, stocks have the potential to move higher as excessive optimistic sentiment is worked off, but volatility could rise as we head toward the end of the year. We continue to suggest investors maintain a diversified portfolio, add to stocks amid pullbacks as needed, and maintain exposure to fixed income securities for fixed payment needs.
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Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly.
Past performance is no guarantee of future results.
Investing in sectors may involve a greater degree of risk than investments with broader diversification.
International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.
The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinions are subject to change without notice.
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Tuesday, October 16th, 2012
by Guy Lerner, The Technical Take
A composite indicator constructed from the trends in yields on the 10 year Treasury bond, gold and the CRB Index suggests that inflationary pressures have decreased. The indicator is shown in figure 1, a weekly chart of the SP500. I last discussed this indicator and its significance in this recent article.
Figure 1 SP500/ weekly
This indicator is not meant to be an oscillator type of indicator that rises and falls with prices. However, since 2010 or rather in this era of central bank intervention, inflation pressures (when the indicator is above the upper blue line) tend to coincide with intermediate term tops in the equity markets. See the gray vertical lines on the chart. Inflation pressures preceded the 2010 and 2011 market tops, and I have no reason to doubt that the current dynamics will be any different.
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Tuesday, October 16th, 2012
A rare interview with Morningstar’s Fund Manager of the Decade. Great Investor Bruce Berkowitz discusses The Fairholme Fund’s controversial concentration in financial stocks and other unloved securities.
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