Archive for October 29th, 2012
Apple (AAPL): Anticipated Future Price Action
Monday, October 29th, 2012
An article written by Ali Meshkati on his Zenpenny site provides his take on the potential price action for Apple (AAPL) in the coming weeks. He notes:
“10-28-12: The best case scenario with AAPL going forward is a period of sideways chop. Those highs at $700 won’t be challenged for some time. The low created on Friday will likely be broken within the next few weeks, following a move up to $630 – $640 to convince the convincible that the iPhone 6 & 7 mean a $1,000 stock price in the near future.
The path that AAPL is likely to take has been revealed in the not to distant past. Check out box A. A high volume reversal that resulted in a gap and eventual failure.
While I don’t expect a gap up here, I expect a retrace of a portion of the recent losses that should give AAPL enough new blood to make heads roll in the weeks ahead.
$520 – $550 remain the likely target for a solid buy point.”
(click chart to enlarge)
From The Blog of HORAN Capital Advisors
Source: Zenpenny
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“The White Hurricane” (Saut)
Monday, October 29th, 2012
by Jeffrey Saut, Chief Investment Strategist, Raymond James
“Unseasonably mild and clearing” was the weather forecast going into the Ides of March back in the year of 1888. And it was true, as temperatures hovered in the 40s and 50s along the East Coast. However, torrential rains began falling, and on March 12th, the rain changed to heavy snow, temperatures plunged, and sustained winds of more than fifty miles per hour blew. The “Great White Hurricane” had begun! In the next 36 hours, some 50 inches of snow would blanket New York City, and the winds would whip that snow into 40- to 50-foot snowdrifts. Telegraph and telephone lines were snapped, fire stations were immobilized, New Yorkers could not get out of their homes, 200 ships were blown aground, and 400 people would die before the storm was over. The resulting transportation crisis led to the construction of New York’s subway system.
I revisit The White Hurricane this morning because it potentially looks like another 100-year storm is heading pretty close to Manhattan. While in modern day it shouldn’t cause the horror seen in 1888, it is still a force to be reckoned with. If, by chance, the storm heads up the Hudson River it could cause the partial evacuation of New York City. So in addition to dealing with the Benghazi scandal, Syrian atrocities, Euroquake, the “fiscal cliff,” a stalled U.S. economy, softening earnings momentum, waning revenues, a dysfunctional government, the nastiest campaign I have ever seen, and who Taylor Swift should date next, Wall Street now has to contend with the potential of being flooded out. What is fascinating, at least to me, is how well the equity markets have held together despite the deluge of dour news. Indeed, while I was laid up with the flu most of last week, the S&P 500 (SPX/1411.94) was also “laid up,” locked in a trading range between roughly 1407 and 1420 the past three trading sessions. As stated in my daily reports (The Morning Tack):
“About the most constructive thing I can say concerning the recent action is that the SPX has been trying to hold around the intraday lows (@1407). The quid pro quo is that it has not been able to travel decisively above the 1418 ‘pivot point’ I was using as a downside ‘energy level’ for three weeks (read: on a short-term trading basis we should have held above 1418).”
Unfortunately, studying the attendant SPX chart shows that the downside consolidation pattern of closing prices are clustered near the weekly “lows,” which is not suggestive of an imminent rebound (see chart on page 3). Instead, this looks like it could lead to a temporary breakdown below the often mentioned 1390 – 1400 support zone. While it may not happen, if it does I think it would be a “false breakdown,” like the one we identified last year on October 4th (@1075). That expectation is because while the stock market’s internal energy is no longer fully charged, it is also not used up. Further, the McClellan Oscillator is still moderately oversold, the number of SPX stocks above their respective 50-day moving averages (DMAs) has fallen from 85% to Friday’s 44.2% (approaching oversold levels), many of the market indices tested (and held) their respective 200-DMAs last week, the bearish sentiment is pervasive, the NASDAQ is fully oversold, and we saw buying on weakness last Friday.
Clearly, slowing earnings have been the overriding boogie man. Yet while the earnings season remains sketchy, with only 60.7% of all stocks reporting beating estimates and 44.8% bettering revenue estimates, the economic reports have been strengthening for the past few weeks. Last week, of the 14 economic reports released, eight were above expectations, five below, and one was in line. Such metrics lifted Bespoke Investment Group’s Economic Diffusion Index to its highest level since March 2011 (see chart on page 3). The highlight of the week was Friday’s GDP report, which caused our economist Dr. Scott Brown to write:
The headline figure was a bit better than expected. Consumer spending growth was moderate, but a bit less than expected. Business fixed investment was weak, but less than anticipated (structures down and equipment and software flat). Inventories failed to add, and net exports subtracted only modestly. Government spending surprised to the upside and was concentrated largely in defense. Real personal income growth was weak. Core PCE price inflation remained below the Fed’s 2% target. These figures will be revised and revised again.
Of particular interest to me was that Nominal GDP rose 4.8%, versus the estimate of +3.9%, driven by a 2.8% reading from the Price Deflator (vs. +2.1%E). That was the second biggest gain since 3Q08! This is not an unimportant point, for our economy actually needs more inflation. Last week, however, that higher inflation rate was not reflected in the three major commodity indices I monitor, nor was it reflected in gold prices. Nevertheless, our Canada-based precious metals analyst, Brad Humphrey, thinks an inflection may be near and writes:
For investors looking for an attractive entry point into Gold and Gold Equities, historical patterns, the current macro backdrop and a more positive view towards gold equities suggests the next strong rally in Gold and Gold Equities is just around the corner (following the quarterly reporting period). Although approaching a US election we doubt any asset class will be trading in its “typical” fashion, given gold is off some $90/oz since October 1 and heading for its first down month since the beginning of the summer. We felt it was worth reviewing where gold may be heading based on the historical rally/retreat patterns. As we have experienced over the past several years, we continue to expect gold to trade in a -/+$200/ozpa range for the next several years, so the recent move is not out of character. We continue to view the current macro backdrop as supportive for gold prices and we do not anticipate any significant pullback as long as real rates remain at low levels (currently negative – and will likely remain low until at least 2015/2016).
While there are many mutual funds, closed-end funds, and ETFs that play to the metals theme [one of my favorites is the Van Eck International Investor Gold Fund managed by my friend Joe Foster (INIVX/$19.18)], for individual stock ideas please refer to our Canadian research reports.
This week we are treated to a plethora of economic releases punctuated by Friday’s employment report. The consensus unemployment number for October is 7.9% (vs. last month’s 7.8%) with nonfarm payrolls estimated to rise to 124,000 from the previous month’s 114,000. Of course to me it really doesn’t matter what the numbers are, for while many whine the numbers are being manipulated for political reasons, I have opined that the government’s numbers are always wrong, which is why the subsequent revisions have such a wide variance to the original reports.
In conclusion, last week we saw more good housing statistics, reinforcing our belief the housing recovery is sustainable. But because of their YTD parabolic price increases our fundamental analysts have downgraded many of the homebuilding stocks. However, one of the second derivative housing “plays” that we have featured all year has been 3.6%-yielding Rayonier (RYN/$48.87). Last week our fundamental analysts had this to say:
We reiterate our Strong Buy rating on Rayonier following 3Q results, as we believe RYN shares offer one of the most compelling risk/reward profiles in our REIT coverage universe. We view Rayonier as a special situation within REITs, driven by compelling growth prospects for its performance fibers business and a growing dividend (+33% since 2009), which also offers investors a unique way to play improving residential construction activity.
The call for this week: It’s been said when you get a headline, a picture, and a lead story about “anything” appearing on the front page of a major newspaper, the end of that theme is near. Over the weekend the front page of Barron’s had all three of those metrics along with the byline, “Money managers turn surprisingly bearish.” Moreover, the only sector that has been smashed in this pullback has been Technology, while most of the other macro sectors merely consolidated. Hence, if technology can bottom (its seasonally strong period is October – December), it could set the stage for decent tech price-performance into year-end, potentially carrying the stock market along for the ride. This morning, however, the markets will be closed due to the hurricane. If they were open, based on the current preopening futures, it looks like the 1390 – 1400 support level would come into play with the potential of a breakdown below 1390 a possibility as hurricane Sandy heads to town, so batten down the hatches and rig for heavy weather…
P.S. I am traveling to Ohio this week, and then off to Europe for two weeks to see institutional accounts.
S&P 500 – Five Minute Intervals 10/22/12-10/26/12
Tags: Canadian Economy, Saut
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SIA Equity Leaders Weekly Report (October 29, 2012)
Monday, October 29th, 2012
by SIA Charts (siacharts.com)
For this week’s SIA Equity Leaders Weekly, we are going to take a closer look at the U.S. Dollar Currency exchange and also looking at the 30-Year Interest Rate again. With the continued recent market channeling/indecision, is important to keep track of key relationships that may be affecting or signaling the movement in the markets.
U.S. Dollar Index Continuous Contract (DX2.F)
With the strength of U.S. Equities over the past couple of months, both the NASD.I and the SPX.I have moved on to new 52-week highs and the DX2.F has responded inversely with a 6% negative move. This broke through a prior support level and is moving towards another one at $77.56, which also corresponds with the rising trendline. Should this break, further support can be found at $73.07. This is a level that for the DX2.F, should be material, as it has failed to move below this level over the past decade on four prior attempts.
Resistance is overhead at $82.34 and again above that at $84.83. As we have been monitoring this chart closely, the SMAX has weakened further to a score of 4 out of 10 on September 19th. The weakening U.S. Dollar could explain the short-term pullback favoring the TSX.I over the SPX.I recently.
Click on Image to Enlarge
CBOE Interest Rate 30-Year (TYX.I)
We continue to monitor the U.S. CBOE 30-Year Yield very closely as it has now twice attempted to break through the downward trend line and resistance level recently, but has failed to move up through it. A move up through the downwards trend line could have TYX.I meet resistance at 3.113%. With further resistance found at 3.272%.
Support is now found at 2.875% from the recent move. Further support is found at the low from last month at 2.682% should the weakness continue.The SMAX has not changed with a score of 4 out of 10 showing weakness against the asset classes of Equities, Bonds, and Cash.
Click on Image to Enlarge
Important Disclaimer
SIACharts.com specifically represents that it does not give investment advice or advocate the purchase or sale of any security or investment. None of the information contained in this website or document constitutes an offer to sell or the solicitation of an offer to buy any security or other investment or an offer to provide investment services of any kind. Neither SIACharts.com (FundCharts Inc.) nor its third party content providers shall be liable for any errors, inaccuracies or delays in content, or for any actions taken in reliance thereon.
Copyright © siacharts.com
SIA Stock Bulletin: Canadian Pacific Railway TSX (CP.TO)
Monday, October 29th, 2012
SIA Charts Daily Stock Report (siacharts.com)
October 29, 2012
CANADIAN PACIFIC RAILWAY (CP.TQ) – After a sizable pullback for 6 months, Canadian Pacific Railway (CP.TQ) hit its uptrend line and has now started to close back in on its prior high from earlier on in the year.
Now in the Favored Zone of the SIA S&P/TSX 60 Report, resistance is overhead at $68.72. Support is at $58.65 and again at $54.18.
Canadian Pacific Railway (CP.TO) has had a great October thus far, now up against target resistance at $94.76. Support is now at $85.83 and again at $77.74.
Green – Favoured Zone
Yellow – Neutral Zone
Red – Out of Favour Zone
Important Disclaimer
SIACharts.com specifically represents that it does not give investment advice or advocate the purchase or sale of any security or investment. None of the information contained in this website or document constitutes an offer to sell or the solicitation of an offer to buy any security or other investment or an offer to provide investment services of any kind. Neither SIACharts.com (FundCharts Inc.) nor its third party content providers shall be liable for any errors, inaccuracies or delays in content, or for any actions taken in reliance thereon.
Copyright © siacharts.com
Market P/E Ratios Continue to Trend Lower (Horan)
Monday, October 29th, 2012
by David Templeton, CFA, Horan Capital
The Chart of the Day charting service recently noted the valuation or P/E for the S&P 500 Index is at levels last seen in the early 1990s. Importantly for investors though is valuation alone does not make a particular equity attractive. As the below chart notes, valuations can certainly get cheaper. Chart of the Day noted in the commentary to the below chart:
“[The] chart illustrates the price to earnings ratio (PE ratio) from 1900 to present. Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). Since the early 2000s, the PE ratio has been trending lower with the very significant but relatively brief exception that was the financial crisis. More recently, the PE ratio has moved slightly higher. It is worth noting, however, that even with this recent uptick, the PE ratio still remains at a level not often seen since 1990.”
Source: Chart of the Day
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These ETFs are a Good Place to Look for Income (Morningstar)
Monday, October 29th, 2012
Eye-popping yields are scarce for many bond ETFs, but Morningstar’s Sam Lee points out some attractive funds that focus on corporates, emerging markets, and Europe.
Securities mentioned in this video
ELD WisdomTree Emerging Markets Local Debt
HYS PIMCO 0-5 Year Hi Yld Corp Bond Idx ETF
VGK Vanguard MSCI Europe ETF
PCY PowerShares Emerging Mkts Sovereign Debt
Source: Morningstar, Inc.
Copyright © Morningstar, Inc.
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Looking Past the U.S. Election, Looking Past Wait-and-See (Sonders)
Monday, October 29th, 2012
October 26, 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
by Michelle Gibley, CFA, Director of International Research, Schwab Center for Financial Research
Key Points
- The market appears to be in a “wait-and-see” mode in advance of the elections, but looking beyond November 6th is important for investors. The election is only one piece of the puzzle, and certain aspects of the political landscape likely won’t be much clearer after Election Day.
- Earnings season has been somewhat disappointing, even though there was a relatively low bar to hurdle. We see more signs that the slowdown in the United States may be ending, however, with strength in housing particularly noteworthy.
- European policymakers continue to drag their feet, although there is likely some comfort that the ECB has attempted to take the worst-case scenarios off the table. Chinese growth remains sluggish and despite the possibility of a near-term rally, longer term pressures remain.
As for the election, it appears likely that party leadership in Washington will continue to be split. The House is likely to remain under Republican control, while the White House and Senate are very close calls. Assuming no single-party sweep, some measure of gridlock could remain regardless of who wins the presidency. Regardless of how the election turns out, uncertainty regarding both the fiscal cliff and long-term debt and deficit reduction plans will likely remain.
In spite of the election uncertainty, the coming fiscal cliff, continuing dithering in Europe, the slowest rate of growth in China since 2009, and tensions rising in the Middle East, the stock market continues to be near five-year highs—despite the recent pullback. Notably, the weakness over the past couple of weeks appears to have worked off some of the excessive optimism (a contrarian indicator) that had developed. According to Ned Davis Research, as of October 23rd, sentiment had moved into the neutral zone from the extreme optimism zone, which we view as a positive development to set up the market for another possible move higher.
Are the clouds parting?
Third-quarter earnings season has thus far somewhat disappointing despite relatively low expectations. Companies have mostly met or exceeded bottom-line expectations but revenue growth has been more disappointing. This is not surprising given the global slowdown over the past several months. With continued massive corporate cash balances on the sidelines, however, a few small holes in the dam of continued cautiousness could lead to the floodgates being opened. Animal spirits continue to be a potential powerful force behind the economy that could be unleashed if some uncertainty wanes.
Helping push businesses in that direction could be improving US financial conditions; characterized by easier credit access and a more receptive equity market. One broad measure of financial conditions comes from the National Financial Conditions Index, released by the Chicago Federal Reserve, which is now showing its lowest (most attractive) reading since June 2007.
Financial Conditions Support Business and Consumer Expansion
Source: FactSet, Chicago Federal Reserve. As of Oct. 23, 2012.
After the economy again flirted with stall speed for the third consecutive year, there are signs that the mid-year slowdown may be coming to an end, and growth may accelerate. The manufacturing sector, for example, saw a sizable midyear slowdown, with the Institute for Supply Management’s Manufacturing Index falling into territory depicting contraction. The most recent reading, however, was above the key 50 level and some regional surveys also are showing further improvement. The Empire Manufacturing Index, although still in negative territory, rose to -6.16 from -10.41, while the Philadelphia Fed Index moved into positive territory for October by posting a reading of 5.7 after -1.9 in the previous month. Additionally, industrial production for September rose 0.4%, after falling 1.4% in August, while capacity utilization ticked up to 78.3% from 78.0%—all marginal improvements but moves in the right direction.
More important may be the improved health of the consumer. Data from September started with a bang as retail sales posted a surprising jump of 1.1% month-over-month, while excluding autos and gas, the gain was still a solid 0.9%. Heading into the critical holiday shopping season, we view this positive momentum after a negative reading in the summer as a good sign; and reflective of much-improved consumer confidence and sentiment. Additionally, gasoline futures prices, according to ISI Research as of October 18, are down about 20 cents, which could provide a further boost for consumers.
Retail Sales Rebound?
Source: FactSet, US Census Bureau. As of Oct. 23, 2012.
The recent strong housing trends are likely also boosting confidence. While the housing market is still not robust in an absolute sense, it appears the upward trend is too strong to ignore. New-home sales jumped another 15% in September to their highest level since July 2008, while the more forward looking building permits reading kicked 11.6% higher, also the best level since July 2008.
Finally, the National Association of Homebuilders’ Housing Market Index (HMI) rose to 41, which, while still below the level of 50 that indicates more builders view sales conditions as good than poor, is the best reading since June of 2006. The recent year-over-year percentage increase in the HMI has been at record highs. And while probably not strong enough to overcome a potential fully loaded fiscal cliff should it come to fruition, housing improvement in our view can help the economy in many ways. It can help further solidify banks’ balance sheets; provide confidence to consumers as houses are typically their largest asset; allow people to relocate for a better-paying jobs; and help the construction industry as more homes are built.
With the Federal Reserve continuing to explicitly target the housing market through the buying of mortgage-backed securities via its latest round of quantitative easing, it should help to keep mortgage rate at or near record lows for some time.
Eurozone muddles through
Faced with even greater challenges, the European Central Bank (ECB) has been able to thwart worst-case scenarios in the eurozone and buy time with the promise of potential sovereign-bond purchases. This has resulted in relief in peripheral government bond markets, benefitting Spain in particular. Spain’s fundamentals, however, continue to worsen. Home price declines have accelerated, falling 2.4% in the third quarter from second quarter and bad loans have risen to a record 10.5% in August from an upwardly revised 10.1% in July. Banks are reining in activity, meanwhile, after deposits fell 8.7% from a year ago in August, and bank loans dropped 5% in August versus 2011.
The Spanish government’s fiscal deficit target of 6.3% for 2012 may be missed and Spain’s economy contracted in the third quarter for a fifth-straight quarter. Despite these negatives, Spain’s government is projecting a 0.5% decline in gross domestic product (GDP) in 2013, smaller than the International Monetary Fund’s (IMF) 1.3% forecasted contraction, and the Bloomberg consensus of a 1.4% decrease. A late-November election in the Catalonia region may be a referendum on secession, which could have negative consequences. Economic realities may thwart dreams of separation, however, and we view secession as a low-probability event.
In summary, because the relief in Spain’s government bond market is based primarily on improved sentiment and not fundamentals, the country’s bond market is vulnerable to renewed pessimism, making yields potentially volatile with a possible upward bias. It may take yields moving higher before Spain asks for aid. This may be greeted positively by markets, however, as it would remove an uncertainty.
Even Germany’s economy struggling
Source: FactSet, IFO national Institute of Research, German Federal Statistics Office, Eurostat. As of Oct. 23, 2012.
While the ECB has taken the eurozone out of crisis mode, economic growth is likely to remain weak. Despite some improvement in September, a sustained economic recovery is not yet in view; even in Germany, viewed as an economic stronghold. German business confidence as measured by the Ifo survey dropped to the lowest level in more than two-and-a-half years in October, and the preliminary eurozone composite purchasing manager index fell to 45.8 in October, the lowest in more than three years.
While austerity in many countries is a headwind, we are also focused on the European banking system, which we still believe is in need of more capital. Germany, the Netherlands and Finland are resisting allowing the European Stability Mechanism (ESM) bailout fund to be used to recapitalize banks for “legacy” problems. These countries want the ESM to be used only for problems that occur after eurozone-wide bank supervision, which is not expected to start until sometime in 2013. Additionally, bank deleveraging has barely started—of the $2.8 trillion base case the IMF estimates that European banks need to deleverage from the third quarter of 2011 to the end of 2013, only $600 billion has been completed through the second quarter of this year. A hobbled banking sector is unlikely to expand lending in our opinion, which could keep a lid on economic growth.
While eurozone stocks have the potential for a “catch-up” rally, we urge investors not to be complacent about the risks—volatility could increase again and challenges remain. We outline our neutral stance on eurozone stocks in our article.
Has China bottomed?
Investors seemed to take solace from China’s recent economic data, with China’s third quarter GDP figure of 7.4% meeting the Wall Street consensus estimate, and data for September showing somewhat of a rebound in the economy. However, we are even more skeptical than usual about these government figures, with the trend being the main source of our consternation. We’re taking our cue from commentary from companies, with the ISI Research company survey falling to levels not seen since 2009 and earnings reports from US multinationals indicating either uncertain or slowing outlooks in China.
China’s bounce would be off a significant slowdown
Source: FactSet, national Bureau of Statistics of China. As of Oct. 23, 2012.
That said, there is some signs of inflection, and it appears that worst-case scenarios in China may have been averted. Glimmers of hope include an improvement in infrastructure construction, a bounce back in purchasing managers indexes (PMIs), money supply, rail volume and electricity consumption. Additionally, new stimulus could accompany the coming leadership transition that begins the same week as US elections.
We are concerned about the recovery in China, as we believe speculative excesses could make the recovery more difficult and slower than many expect. There continues to be the expectation of a turn in China just around the corner, with 19 of the 24 economists surveyed by Bloomberg forecasting a rebound in GDP in the fourth quarter, two expecting flat growth, and only three anticipating a further moderation. While past underperformance, a bottoming of economic data and new stimulus could result in a several-months-long rally in investments tied to China, we believe any rallies should be treated with caution. A difficult recovery and high expectations could present headwinds, and a rally in China-related investments may be short-lived. Read more in our article Is the Worst Over for China?
Global divergences
Preliminary readings on economic growth in October show divergences—a rebound in China and deterioration in the eurozone; while the United States is expected to have improved. Overall global economic growth appears tepid, however, but it’s not falling apart either. Positively, central banks globally continue to have a bias toward easing monetary policy, with inflation generally subdued.
Does that mean investors should avoid international investments? We think not. Investing internationally still provides a diversification benefit for portfolios over the longer term and it is rare for a country to be the top stock performer for more than a year. Trends can change and markets can move in unpredictable ways, making an “all-in” into any one asset class a precarious proposition.
Read more international research at www.schwab.com/oninternational.
So what?
Earnings season in the United States has been disappointing and global economic growth remains slow. But there are signs of hope as US economic indicators have been trending higher; excessively optimistic sentiment has been worked off; and we’re closer to a resolution of the election, and a potential fix to the fiscal cliff. We believe this is setting up for a renewed uptrend in stocks after some continued near-term volatility, but urge investors to maintain a diversified portfolio because no one can predict the future.
Tags: Bill Gross
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SEC Weighs Bringing Back Fractions in Stock Prices
Monday, October 29th, 2012
By the trader
Smaller spreads was supposed to make things better, but it took regulators some 10 years to understand that by decreasing the spread, the market would get less efficient, at least if you trade more than 100 shares. We have always argued that by decreasing the spread, many functions of the “natural” market maker would dissapear, as there is no spread to motivate the trader being in the market, providing the nescessary liquidity. We are not arguing for the old times to return. Technological advances are great, but only if the market benefits. The development over the past years, with Broken Markets, is now slowly being acknowledged by the regulators. Irrespective of what the academics tell you, liquidity is not better, trading impact is higher etc. One of our suggestions is starting off by applying a spread in relations to the company market cap. There are many more suggestions, but first let’s see if the SEC finally starts realising the market is broken. From WSJ.
For some stock prices, the new math might look a lot like the old math: Regulators are thinking about bringing back the fraction.
The move would at least partly undo an 11-year-old rule that replaced fractions of a dollar in stock prices, like 1/8 and 1/16, with pennies. The idea of that change was to trim investors’ trading costs: One-cent increments can lead to narrower gaps between the prices at which brokers buy and sell shares—potentially reducing their opportunity to shave off profits.
Those championing the fraction’s return say it would spur securities firms to buy and sell more shares of some companies by making it more profitable for them to do so. Opponents say fractions would increase trading costs for investors with little or no benefit to companies.
Discussions are still in the early stages and it is unclear what the Securities and Exchange Commission will ultimately decide. Furthermore, any change would affect only some smaller companies. “People are increasingly raising this idea with us directly,” SEC Chairman Mary Schapiro said in an interview. “We will look at it, but there are obviously trade-offs.”
Full article here.
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GDP: The Warning Signs from Exports
Monday, October 29th, 2012
Via Lance Roberts of Street Talk Live,
Over the past several months we have been discussing that this is no longer your “father’s economy.” What we have meant by this is the economic environment today is vastly different than that which most of our parents grew up in. We recently discussed in “Debt: Driving Our Economy Since 1980″ that: “From the 1950’s through the late 1970’s…the U.S. was the manufacturing and production powerhouse of the entire global economy post the wide spread devastation of Europe, Germany and Japan during WWII. The rebuilding of Europe and Japan, combined with the years of pent up demand for goods domestically, led to a strongly growing economy and increased personal savings. However, beginning in 1980 the world changed. The development of communications shrank the global marketplace while the rise of technology allowed the U.S. to embark upon a massive shift to export manufacturing to the lowest cost provider in order to import cheaper goods.”
The importance of this shift in the U.S. from away from being the epicenter of global production and manufacturing to a service and finance based economy should not be overlooked. This transition is responsible for the issues that are impeding economic growth in the U.S. today from structural unemployment, declining wage growth and lower economic prosperity. The four-panel chart below gives you a visualization of this transition showing the year-over-year change in the data, with the exception of the personal savings rate which is linear, prior and post-1980.
What does this have to do with GDP and exports? Well, just about everything, as I will explain momentarily, but first let’s take a look at the recent release of the first estimate of third quarter GDP for 2012. The headline release showed an increase in economic growth to an annualized rate of 2% which was an improvement from second quarter growth rate of 1.3%.
For the third quarter the contributions to the percentage change in real GDP were:
- personal consumption expenditures rose from 1.06 to 1.42
- gross private investment (business investment) contracted from 0.9 to 0.7
- government consumption exploded from a#ff0000;”> -.14 contraction to a .71 contribution
- net exports (exports less imports) declined from a .23 contribution to a #ff0000;”>-.18 detraction.
It is net exports that are most concerning. Since 1980 the global community has become very small due to advances in technology and communications. Globalization has made the U.S. very sensitive to changes in global economy due to the increasing demand for the products and services that we sell abroad. As we said previously: “Exports have made up roughly 40% of corporate profits since the end of the last recession. The recent announcements by CAT, FDX, NSC, UPS and others, all discussed the rising weakness with international trading partners – primarily in the Eurozone and China. Not surprisingly we saw a decrease of $0.3 Billion in exports in 2Q GDP. This was a 110% decrease from the previous estimate of a $3.1 billion increase. This decrease in exports is very important as it relates to current forward earnings estimates and the belief that the U.S. can remain decoupled from the rest of the world.“
Since the first quarter of 2012 exports, as a percentage contribution to real GDP, has fallen from .60 to #ff0000;”>-.23. As stated above, exports are a much more important share of economic growth than either housing or automobile manufacturing. Furthermore, spending on equipment and software, which corporations have used to suppress employment and costs and increase profitability have been a significant contributor to the economic fabric as well. The chart below shows exports, equipment and software spending, automobile manufacturing and residential investment as a percent of GDP.
What is important to note here is that each time exports, as well as equipment and software spending, have turned down the economy has either been in, or was about to be in, a recession.
The continued drag on exports due to the worsening recession in the Eurozone, and the slowdown in China, is putting continued pressure on corporate profit margins. In turn this keeps businesses on the defensive to protect profit margins which stifles employment and investment. This is quite apparent as private domestic investment (business investment) has collapsed from a 3.72 percentage contribution in the fourth quarter of 2011 to a .07 percent contribution in the latest release.
While personal consumption expenditures showed a fairly strong gain in the latest report – it is very likely, given the latest retail sales report not being nearly as strong as reported, that the initial estimate of 2% growth in the third quarter will be revised down in the next two months.
Furthermore, another sign that the headline may be quite ephemeral, is that real final sales in the third quarter shrank on an annual basis once again from 2.17% in the first quarter to 1.94% most recently. Historically speaking, whenever real final sales has fallen below a 2% annualized growth rate, once again, the economy was either in, or about to be in a recession as shown in the chart below.
As David Rosenberg pointed out “In fact, netting out the government sector, real GDP came in at a 1.3% annual rate in the third quarter and on the same basis the pace was 1.4% in the second quarter. Perhaps not a recession in the private sector but whatever cushion there is, it is extremely thin. There is no margin for error here.”
That is an extremely important point. With exports declining which is impacting corporate profit margins, employment conditions deteriorating, and business spending contracting – these are all the necessary ingredients to spin out a negative economic growth rate at some point in the not so distant future. For investors this is becoming a much more critical issue as stock prices have already begun to revalue future profit growth expectations. Our previous calls for a recession in early 2013 are beginning to look much more probable.
Copyright © Street Talk Live
Distinction Without a Difference (Hussman)
Monday, October 29th, 2012
by John P. Hussman, Ph.D., Hussman Funds
In recent weeks, market conditions have fallen into a cluster of historical instances that have been associated with average market losses approaching -50% at an annualized rate. Of course, such conditions don’t generally persist for more than several weeks – the general outcome is a hard initial decline and then a transition to a less severe average rate of market weakness (the word “average” is important as the individual outcomes certainly aren’t uniformly negative on a week-to-week basis). Last week, our estimates of prospective market return/risk improved slightly, to a level that has historically been associated with market losses at an annualized rate of about -30%. Though that improvement falls into the category of a distinction without a difference, at least we can say that conditions are not the most negative on record.
Over the course of the coming cycle, I expect that we will easily observe conditions among the many favorable clusters in the historical record, where we will not face the syndromes of hostile conditions we’ve seen recently (e.g. overvalued, overbought, overbullish, yields rising). Valuations, though rich, are nowhere near where they were in 2000, and even the tepid valuations of early 2003 provided ample opportunity to accept market risk without the need for significant hedging. Unlike 2009, the next cycle will not unexpectedly present us with the need to capture Depression-era data in our approach (which we’ve addressed). Even without significant undervaluation, there are many combinations of market conditions that have historically been associated with strong subsequent market returns, on average.
So there’s little doubt that market conditions will provide investors with a strong basis to accept risk at various points over the coming market cycle. The difficulty today is not only that valuations are rich, but that on our metrics, present market conditions cluster among those that have produced strikingly negative market outcomes on a blended horizon from 2-weeks to 18-months. Wall Street’s beloved forward-earnings multiples only seem reasonable here because profit margins are the highest in history (largely as a result of steep government deficits and depressed savings rates). Once we normalize for profit margins – which is necessary because stocks are very long-lived assets – valuations are elevated, and are coupled with a variety of historically hostile, overvalued, overbought indicator syndromes. Moreover, while our economic concerns do not significantly feed into our concerns about the equity market, we continue to view the U.S. economy as being in an unrecognized recession that started about mid-year.
Recession? The advance estimate for third-quarter GDP was released last week, showing a slow but above-consensus figure of 2% growth at an annual rate (paced by a 13% surge in defense spending). Surely, this is inconsistent with concerns about recession, isn’t it? No – not if we examine the historical pattern of data revisions early in previous recessions – a point that Lakshman Achuthan of ECRI also emphasized recently on Bloomberg.
Recall that in 2001, with the U.S. economy already in recession for months, Q1 GDP growth was initially reported at 1.2%. That figure was actually revised slightly higher a few months later, but based on final revision, Q1 2001 GDP is now reported at -1.3%. As a side-note, Q2 2001 GDP was positive, while Q3 2001 was negative. The 2001 recession did not contain two consecutive quarters of negative GDP growth. Contrary to what many analysts suggest, that is not how the National Bureau of Economic Research (the official arbiter) defines a recession in the first place.
The heavy revision of GDP figures is not the exception but the rule. In the first quarter of 2008, as another example, with the U.S. economy already in recession for three months, Q1 GDP was reported at 1% growth. That figure was later revised to -1.8%. Just like 2001, the following quarter was reported at positive growth. The economy then collapsed in the second half of 2008, but by the time that was evident in GDP figures, the stock market had already plunged. The upshot is that early GDP figures are often reported positive even after a recession is already well in progress, and waiting for two consecutive quarterly declines in GDP is a poor way of gauging recession risk, because that pattern sometimes doesn’t emerge until much later revision, if at all.
Based on the most leading economic signal that we infer from dozens of economic variables (see the note on extracting economic signals in Do I Feel Lucky?), the best we can say about recent data is that the signal is negative but the pace has not worsened, which suggests that at least over the next 4-5 months, the character of the recession is likely to be moderate, and not the sort of off-the-cliff collapse we saw in 2008. Again, this falls into the category of a distinction without a difference, as investors completely ignore the existence of a recession anyway, leaving them vulnerable to its eventual recognition.
Though our measures of economic prospects are holding fairly steady at negative levels, there are numerous risk factors that could accelerate this weakness, and not many that promise an abrupt improvement. So downside risks predominate here, in my view. First, simply because of the math of quarterly GDP figures, even if Hurricane Sandy was to cause a one-day net loss of activity across one-third of the country, the impact would slow Q4 GDP growth by about -1.5% at an annual rate. Beyond that, economic outcomes are likely to be sensitive to a variety of factors including European debt and banking strains, weakness in China and Japan, and fiscal policy decisions in the U.S.
Over the weekend, Germany’s der Spiegel published an article quoting ECB head Mario Draghi saying “I explicitly support this proposal” – the proposal being that of German Finance Minister Schauble, asking European governments to permanently surrender sovereignty over their own national budgets, and hand control over to EU leadership in Brussels. Draghi added “If we want to re-establish trust in the eurozone, countries must pass a part of their sovereignty to the European level.”
Investors should allow this to sink in, because this sort of “fiscal union” is the precondition for Germany to accept greater responsibility than it already has for bailing out its neighbors. Even then, Germany has already disavowed any responsibility to absorb the cost of a Spanish banking bailout, insisting that any funds provided from the European Stability Mechanism (ESM) will have to be repaid, and will represent additional debt of the Spanish government.
If it is not clear that European governments will unanimously agree to surrender their fiscal sovereignty, then it is also not clear that the euro will survive in its present form. My own impression is that the least disruptive outcome would be a split across central/peripheral lines, with stronger countries like Germany and Finland leaving first and redenominating either to their prior national currencies or to some sort of “euro forte”, and abandoning the existing “euro faible” to other grossly indebted countries, which could then inflate as they please.
All of this follows a very clean line of developments over the past two years, though that clean line is constantly blurred by rhetoric to the contrary, which investors have misguidedly celebrated in hope that eventual German bailouts and unconditional money printing will make the whole European crisis go away. What we are left with is the continued likelihood of a massive restructuring of European banks, particularly Spanish banks, as well as further haircuts to the debt of Greece and possibly Portugal, Ireland, Italy, and – if it takes banking sector bailouts onto itself – Spain as well. Bad loans in Spanish banks jumped to 10.5% of assets in the most recent report –not far from the “adverse scenario” that was assumed to be highly improbable in the European banking stress tests. As an analyst at Nomura put it, “you can’t assign a 1% probability to a scenario that already looks realistic.” To the extent these realities aren’t dealt with in a deliberate and orderly way, they will have to be dealt with in an abrupt and disorderly way not long from now.
On the subject of deficits, the situation in Japan seems increasingly strained. The gross debt/GDP ratio in Japan is now about 225%, and net debt (which excludes debt held by the government itself for monetary, pension and other reasons) is about 130%. During the entire post-war period, Japan has enjoyed a significant trade surplus, which has allowed it to run growing government deficits. Meanwhile, household savings have declined from nearly 15% in the 1990’s to next-to-nothing today. Needless to say, that large and persistent trade surplus has enabled economic dynamics that normally would not be sustainable. But over the past year, Japan has fallen into a trade deficit, which has deepened recently due in part to tensions with China. We are now observing an ominous combination of a significant trade deficit, a deep government deficit, non-existent household savings, a steep debt/GDP ratio, and a contraction in both manufacturing and service sectors according to the latest purchasing manager’s surveys out of Japan. While Europe remains our primary source of concern, I am concerned that both China and Japan are likely to have a more destabilizing impact than is widely assumed.
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
Fund Notes
As of last week, our estimates of prospective stock market return/risk remain negative, with present conditions clustering with historical instances that associated with annualized market losses near -30% on average. Of course, we would expect to exit this particular cluster much sooner than a year from now, so while we allow for deep potential market losses based on prior instances of overvalued, overbought, overbullish, rising-yield conditions similar to what we’ve observed in recent weeks, our discipline remains to evaluate conditions period-by-period as they change, and to alter our investment position in alignment with the expected return/risk tradeoff that we estimate.
Generally speaking, we view market risk as much more attractive in conditions that join reasonable market valuations with an early firming in market internals, breadth, trend-following measures, and other features of market action. While we were able to remove 70% of our hedges in 2003 in response to such conditions, we missed a similar opportunity in 2009 because we were forced to consider Depression-era outcomes, and in that data, our existing methods based on post-war data would have allowed what we viewed as unacceptable drawdowns. It’s tempting to assume that trend-following methods alone would have provided a quick fix, but even popular trend-following approaches such as the 200-day moving average crossover strategy would have allowed drawdowns of about 40% in Depression-era data, even assuming zero slippage or trading costs, as would numerous strategies that have performed well in post-war data. In any event, having addressed that “two data sets” issue, I don’t expect similar challenges in the cycle ahead, even if we are faced with identical evidence. It would be a mistake to misinterpret that “miss” and to disregard current risks on the belief that our views are inherently defensive.
I do remain firmly defensive here, based on evidence that has repeatedly supported a defensive stance in a century of market data, but I also believe just as firmly that the coming cycle will present conditions that have repeatedly supported an aggressive stance.
Put simply, my view is that the present is a terrible time to accept a significant amount of market risk. I certainly can’t provide a weighty argument to support the view that the market will advance or decline over the next week or the next month. But there is strong precedent for extended market losses and bear markets following overvalued, overbought, overbullish, rising-yield syndromes – say, Shiller P/E above 18, S&P 500 at multi-year highs, 8% above its 200 day moving average, close to its upper Bollinger bands (2 standard deviations above 20-period averages) on weekly and monthly resolutions, Treasury yields above 20-26 weeks earlier, and low bearish sentiment relative to bullish sentiment, all of which were observed in late-1972, July-August 1987, in 2000, in 2007, and early this month.
Strategic Growth Fund remains fully hedged, with a staggered-strike position where the put option side of our hedge is now close to present market levels. We expect this to help us to weather any major market decline. In the event that a market decline moves those puts “in-the-money”, we can expect some day-to-day “give and take” in that market declines would be expected to benefit those positions, while market advances back toward those strikes would tend to reduce the value of our index put options. Of course, we will adjust our option strikes, as well as the extent of our hedges, as valuations and market conditions change. As always, day-to-day fluctuations in the Fund are also affected by the performance of individual holdings, and the extent to which they outperform or underperform the indices we use to hedge.
Meanwhile, Strategic International remains fully hedged. Strategic Dividend Value continues to be hedged at about 50% of the value of its holdings. Strategic Total Return continues to carry a duration of less than 2 years (meaning that a 100 basis-point move in interest rates would be expected to impact the Fund by less than 2% on the basis of bond price fluctuations), with less than 5% of assets in precious metals shares at present.
