Posts Tagged ‘Deja Vu’
Monday, April 23rd, 2012
by John Hussman, Hussman Funds
We currently estimate the prospective 10-year total return on the S&P 500 at about 4.5% annually, in nominal terms, based on our standard valuation methodology. This may not seem bad, relative to 2% yields on the 10-year Treasury bond, provided that investors actually consider either figure to be an adequate 10-year investment return, and provided that they view 4.5% annual returns as adequate compensation for securities that have several times the volatility of a 10-year Treasury bond (especially when yields are low), and provided that investors ignore the fact that prospective market returns tend to enjoy a significant range over the course of the market cycle, so that “locking in” present prospective returns must necessarily forego any higher prospective return that might be observed in the coming decade. Even given robust growth in GDP and corporate revenues, a move to prospective returns of just 6% at some point in the next two years would likely leave investors with no return (including dividends) in the interim (see Too Little to Lock In).
Wall Street continues to focus on the idea that stocks are “cheap” on the basis of forward price/earnings multiples. I can’t emphasize enough how badly standard P/E metrics are being distorted by record (but reliably cyclical) profit margins, which remain about 50-70% above historical norms. Our attention to profit margins and the use of normalized valuation measures is nothing new, nor is our view that record profit margins have corrupted many widely-followed valuation measures. As I noted in our September 8, 2008 comment Deja Vu (Again), which happened to be a week before Lehman failed and the market collapsed, “Currently, the S&P 500 is trading at about 15 times prior peak earnings, but that multiple is somewhat misleading because those prior peak earnings reflected extremely elevated profit margins on a historical basis. On normalized profit margins, the market’s current valuation remains well above the level established at any prior bear market low, including 2002 (in fact, it is closer to levels established at most historical bull market peaks). Based on our standard methodology, the S&P 500 Index is priced to achieve expected total returns over the coming decade in the range of 4-6% annually.” Present valuations are of course more elevated today than they were before that plunge.
Suffice it to say that every P/E multiple is simply a shorthand for proper discounted cash-flow methods, because there are countless assumptions about growth, margins, return on invested capital and other factors quietly baked inside. Like price-to-forward operating earnings multiples, even our old price-to-peak earnings metric has been rendered misleading due to historically high profit margins. Of course, we knew that was happening even before the credit crisis began, and believe that numerous widely-followed valuation measures remain distorted by record profit margins here.
On the economic front, the recent uptick in new unemployment claims is consistent with the leading economic measures and “unobserved components” estimates that we obtain from the broad economic data here (see the note on extracting economic signals in Do I Feel Lucky?). Indeed, it will be difficult to get the expected flat or negative April employment print if weekly new claims don’t rise toward about 400,000 in the next few weeks. We’ve seen “surprising” weakness in some of the more recent regional surveys such as Empire Manufacturing and Philly Fed. A continuation of that trend would also be informative.
As I noted a few months ago, “examining the past 10 U.S. recessions, it turns out that payroll employment growth was positive in 8 of those 10 recessions in the very month that the recession began. These were not small numbers. The average payroll growth (scaled to the present labor force) translates to 200,000 new jobs in the month of the recession turn, and about 500,000 jobs during the preceding 3-month period. Indeed, of the 80% of these points that were positive, the average rate of payroll growth in the month of the turn was 0.20%, which presently translates to a payroll gain of 264,000 jobs. Notably however, the month following entry into a recession typically featured a sharp dropoff in job growth, with only 30% of those months featuring job gains, and employment losses that work out to about 150,000 jobs based on the present size of the job force. So while robust job creation is no evidence at all that a recession is not directly ahead, a significant negative print on jobs is a fairly useful confirmation of the turning point, provided that leading recession indicators are already in place.” (see Leading Indicators and the Risk of a Blindside Recession).
The upshot is that while I expect a weak April jobs report, we should hesitate to take leading information from what remains largely a short-lagging indicator. We’re already seeing deterioration in economic data, but it remains largely dismissed as noise. An acceleration of economic deterioration as we move toward midyear would be more difficult to ignore. My impression is that investors and analysts don’t recognize that we’ve never seen the ensemble of broad economic drivers and aggregate output (real personal income, real personal consumption, real final sales, global output, real GDP, and even employment growth) jointly as weak as they are now on a year-over-year basis, except in association with recession. All of these measures have negative standardized values here. My guess is that we’ll eventually mark a new recession as beginning in April or May 2012.
Emphatically, however, our concerns about the stock market continue to be independent of these economic expectations, as the hostile investment syndromes we’ve seen in recent months have historically been sufficient to produce very negative market outcomes, on average, even in the absence of economic strains (see Goat Rodeo and An Angry Army of Aunt Minnies). As always, I strongly encourage investors to adhere to their disciplines – including those following a buy-and-hold approach – provided that they have carefully contemplated the full-cycle risk and their ability to stick to their strategy through the worst parts of the investment cycle. What I am adamantly against is the idea that speculators can successfully “game” overvalued, overbought, overbullish markets – particularly in the face of numerous hostile syndromes, near-panic insider selling, speculation in new issues, and broad divergences in market internals, all of which we are now observing.
In the absence of hostile syndromes like we observe today, we generally have more equanimity about market prospects – recognizing the average outcome, but also emphasizing the wide range of individual outcomes associated with a given set of market conditions. The majority of our past market comments are filled with reminders that our expectations are based on average return and risk characteristics, and should not be taken as forecasts about any specific instance. At present, the outcomes that have historically emerged from similar conditions are so uniformly negative that too much equanimity would be misleading.
One way to gauge your speculative exposure is to ask the simple question – what portion of your portfolio do you expect (or even hope) to sell before the next major market downturn ensues? Almost by definition, that portion of your portfolio is speculative in the sense that you do not intend to carry it through the full market cycle, and instead expect to sell it to someone else at a better price before the cycle completes. With respect to those speculative holdings, and when to part with them, my own view is straightforward. Run, don’t walk.
Notes on banking and monetary policy
Banks continue to report seemingly pleasant earnings, as long as one doesn’t look under the hood at the drivers of those reports. Two drivers have been particularly important this quarter. One is the further reduction of reserves against future loan losses, which shows up as a positive contribution to bank earnings. For example, a decline in loan loss reserves was the source of about one-third of the earnings reported by Citigroup. The other driver is something called a “debt valuation adjustment” or DVA. You might recall that as a result of European credit strains last year, investors sold off the bonds of major banks. In the world of bank accounting, the debt was therefore cheaper to retire, so – I am not making this up – the decline in the value of the bonds was booked as earnings. Of course, the value of bank debt has recovered somewhat since then, as investors have set aside concerns about Europe (which we doubt is a good idea). One might expect that since banks booked DVA as a contribution to earnings last year, we would see the opposite effect this quarter. But one would be wrong. As Peter Tchir noted last week, “Morgan Stanley no longer includes DVA in its ‘continuing operations’ headline number. It was a loss of $2 billion this quarter. With 2 billion shares outstanding, that would have wiped out the gain. What bothers me, is that in Q3, when it was a gain of $3 billion, it was part of continuing ops.” It was the same story at Bank of America, prompting one analyst to observe “one-time items are to be ignored when negative, and praised when providing a ‘one-time benefit.’”
Tyler Durden of ZeroHedge has started referring to the Federal Reserve as simply “CTRL+P” – which is brilliant, because it really captures the full intellectual content of Fed policy in recent years. Keep in mind that when the Fed engages in quantitative easing, it purchases Treasury securities and pays for them by creating new base money. From an equilibrium perspective, the U.S. government has financed its deficit in recent years partly by issuing new Treasury debt that was bought by the public, and partly by printing money that is now held by the public (corresponding to the Treasuries bought by the Fed). Of course, the Fed can “unprint” the money, so to speak, by reversing its transactions, and selling those Treasury securities back to the public. But the Fed’s ability to do such massive selling without disruption is unproved, to say the least.
Some have asked why the Fed will ever need to reverse its transactions. Couldn’t the Fed just leave the monetary base out there and perpetually roll the Treasury portfolio forward? The answer depends on what sort of inflation we would like to observe, particularly in the back-half of this decade.
To put some structure on this question, I’ve updated our Liquidity Preference chart (1947-present), which illustrates the close relationship between nominal interest rates and monetary base per dollar of nominal GDP. Currently, the U.S. monetary base amounts to 17 cents per dollar of GDP – a level that is consistent with contained inflation only if short-term (3-month Treasury) yields are held below about 10 basis points. For more on the relationship between the monetary base, interest rates, nominal GDP and inflation, see Sixteen Cents – Pushing the Unstable Limits of Monetary Policy, and Charles Plosser and the 50% Contraction in the Fed’s Balance Sheet.
Think of it this way. The willingness of people to hold a given amount of base money, per dollar of nominal GDP, is intimately tied to the rate of return that they could get on an interest-bearing security. Higher interest rates reduce the demand for zero-interest cash. So if there is upward pressure on interest rates, and the Fed leaves the money supply alone, how do you reach equilibrium? Simple – nominal GDP becomes the adjustment variable. If there’s not enough real GDP growth to absorb the excess base money, prices rise to do the job.
Likewise, expanding the amount of base money per dollar of nominal GDP puts downward pressure on Treasury bill yields and short-term interest rates, but really only if there are no inflationary pressures in the system. Clearly, if inflationary pressures are present (suggesting that the monetary base is already too large), an expansion in the monetary base won’t produce lower interest rates. Rather, it will accelerate those inflationary pressures as nominal GDP is forced to keep up with the monetary base – even if real GDP isn’t growing at all. All hyperinflations are built on this dynamic. That said, it’s worth emphasizing that untethered money growth is invariably a reflection of untethered fiscal deficits (the central bank just buys the government debt and replaces it with money). So significant inflation is ultimately not a monetary phenomenon as much as it is a fiscal one.
In any event, the simple fact is that the Fed can sustain the current size of its balance sheet, without inflationary pressures, only to the extent that people (and banks) are willing to sit on idle, low or zero-interest money balances. In an environment of credit concerns and an increasingly likely implosion of the European banking system (where the fresh leverage taken to pursue the “Sarkozy trade” is now turning into leveraged losses), the short-term willingness to hold idle but “safe” cash balances is quite high. So in the event of additional credit strains, the ability of the Fed to go further out to the right on the Liquidity Preference curve is nearly unconstrained.
The problem is that this policy is inconsistent with any economic environment except one where credit is imploding and the Fed is running the whole show in setting short-term interest rates. As the Fed increases the monetary base, it becomes a greater and greater challenge to reverse those actions in the future. Getting into the position may be as easy as hitting CTRL+P, but getting out of the position promises to be a disruptive nightmare – not to mention the effect that these policies have in distorting financial markets, rewarding reckless lenders, punishing savers, and misallocating capital.
Notably, any exogenous pressure on short term interest rates to even 0.25% (on the 3-month Treasury yield), would effectively require the Fed to move back to the pre-QE2 monetary base in order to forestall incipient inflation pressures. Of course, the Fed could delay that outcome by boosting the interest it pays to the banking system for holding idle reserves. Then again, the Fed already has a balance sheet leveraged more than 50-to-1 against its own capital. So upward interest rate pressure would begin to induce capital losses on the Treasury securities the Fed has accumulated at low yields. Raising interest payments to banks would further strain the Fed’s balance sheet, producing an insolvent Fed while providing a fiscal subsidy to the banking system at taxpayer expense.
Needless to say, I don’t expect that all of this will end very well, but given that the full historical record captures inflation, deflation, recession, expansion, Depression, credit expansion, and credit crisis, we are prepared to respond to a wide range of possible events, without relying on the hope for perpetually high profit margins, endless monetary interventions, absence of major sovereign defaults, stability of the euro-zone, or avoidance of what we view as an oncoming recession. For now, both market and economic evidence remain negative, and we remain accordingly defensive. That will change, but we emphatically view present conditions as being among the most negative subset we’ve observed in the historical record.
As of last week, the Market Climate continued to be characterized by rich valuations and a variety of hostile syndromes (generally related to overvalued, overbought, overbullish conditions, and other variants that capture a general syndrome of “overextended market coupled with a loss of supporting factors”). This places market conditions among the most negative 1% of observations on record, particularly on a 6-18 month horizon, though shorter horizons are clearly negative as well here. Strategic Growth and Strategic International Equity remain tightly hedged. Strategic Dividend Value continues to be about 50% hedged, which is its most defensive position. In Strategic Total Return, we raised our exposure in precious metals shares to about 12% of net assets in response to recent price weakness in that sector. The ratio of gold prices to the XAU is now nearly 10-to-1, which is close to a record high. Historically, gold stocks have been treated as having “insurance” features, and their negative correlation with other stocks was accompanied by premium valuation multiples. At present, many precious metals shares have higher yields than most S&P 500 stocks, and are also significantly depressed relative to gold prices, which suggests a relative margin of defense even if gold prices were to decline substantially. This sector still has substantial volatility, which is why our exposure in terms of net assets is not aggressive (though we would likely increase that exposure on significant economic weakness). Overall, we’re comfortable shifting to a moderately higher exposure in this sector, recognizing that we may observe additional volatility as market conditions change. Strategic Total Return continues to hold a duration of just under 3 years in Treasury securities, and a few percent of assets in utilities and foreign currencies.
Copyright © Hussman Funds
Tags: Adequate Compensation, Corporate Revenues, Deja Vu, Dividends, Forward Price, GDP, Hussman Funds, Investment Return, John Hussman, Lehman, Methodology, Metrics, Norms, Price Earnings, Profit Margins, Record Profit, Robust Growth, Several Times, Volatility, Year Treasury Bond
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Monday, April 16th, 2012
From the first day of 2012 we predicted, and have done so until we were blue in the face, that 2012 would be a carbon copy of 2011… and thus 2010. Unfortunately when setting the screenplay, the central planners of the world really don’t have that much imagination and recycling scripts is the best they can do. And while this forecast will not be glaringly obvious until the debt ceiling fiasco is repeated at almost the same time in 2012 as it was in 2011, we are happy that more and more people are starting to, as quite often happens, see things our way. We present David Rosenberg who summarizes why 2012 is Deja 2011 all over again.
From Gluskin Sheff
It is incredible how things are playing out so similarly to this time last year. We closed the books on 2010 at 1,257 on the S&P 500, then hit an interim high of 1,343 on February 18th of 2011 and then corrected to 1,256 on March 16th. We later had a nice bounce off that low to 1,363 on April 29th (a higher high). Who knew then that by October 3rd, the index would roll all the way back to 1,099 and was in dire need yet again for more central bank intervention?
This time around, the S&P 500 kicked off the year at 1,257 to hit an interim high of 1,374 on March 1st. We then corrected down to 1,343 as of March 6th and then rallied our way back to 1,419 on April 2nd (again, a higher high). Only time will tell if the 1,419 close on April 2nd proves to be the peak for the year as the 1,363 high as back on April 29th of last year.
In fact, the exact same pattern occurred in 2010. Out of the gates, the S&P 500 shot up from 1,115 to a brief peak of 1,150 by January 19th. After a brief correction (as we had in early March of this year) to 1,056 by February 8th, the market soared to 1,217 by April 23rd — literally, a straight line up —just as we saw happening two weeks ago. Again, who knew then that we would be at 1,047 by August 26th? Once again, it took aggressive action by the Fed to revive the bull. This is an incredible seasonal pattern. It works for bonds too. Has anyone recognized how the yield on the 10-year T-note surged in the winter-spring of 2008, 2009, 2010 and 2011? In each of the past three years, 4% was either pierced, tested or approached. These were the peaks of the year each time. This time, the seasonal high was 2.4%. Are you kidding me? Our pal Gary Shilling may well be onto something when he says the ultimate low may be somewhere close to 1.5%.
To some extent, the bounce we are seeing reflects how deeply oversold the market was with the Dow losing 550 points over a five-day span. The AAII sentiment poll showed the bull camp shrinking 10 points in the past week to 28.1% and the bear share expanding 13.8 points to 41.6% so quite the shift here. It does not take much at all in these nerve-racking times to get investors to switch their views on a dime. So much of the move has been technical. Sentiment perhaps in some cases washed out — very quickly. It is still too early in the earnings reporting season to make a call here on the fundamentals — Alcoa is not the canary in the coalmine for the overall economy. And the economic data are still broadly mixed. Much of this rally actually is based on quite a bit of fluff like renewed expectations that the Fed is actually going to embark on more stimulus after all, following comments yesterday from two senior Fed officials:
Based on such analysis, I consider a highly accommodative policy stance to be appropriate in present circumstances. But considerable uncertainty surrounds the outlook, and I remain prepared to adjust my policy views in response to incoming information. In particular, further easing actions could be warranted if the recovery proceeds at a slower-than-expected pace, while a significant acceleration in the pace of recovery could call for an earlier beginning to the process of policy firming than the FOMC currently anticipates.
Vice Chair Janet L. Yellen, The Economic Outlook and Monetary Policy
Remarks at the Money Marketeers of New York University
Also, we cannot lose sight of the fact that the economy still faces significant headwinds and that there are some meaningful downside risks. In the headwinds department, I would include the run-up in gasoline prices mentioned earlier because that will sap purchasing power, the continued Impediments to a strong recovery from ongoing weakness in the housing sector, and fiscal drag at the federal and state and local levels. In terms of downside risks, these include the risk that growth abroad disappoints and the risk of further disruptions to the supply of oil and higher oil prices.
On the inflation front, the overall rate of increase of consumer prices, as measured by the 12-month change of the price index for personal consumption expenditures slowed to 2.3 percent in February from a recent peak of 2.9 percent last September. Even though the recent rise of gasoline prices mentioned above could interrupt this pattern, we expect this moderation of overall inflation to resume later this year.
William C. Dudley, President of the New York Federal Reserve Bank
Remarks at the Center for Economic Development, Syracuse, New York
Beyond a brief jolt to investor risk appetite, it is debatable as to what these rounds of Fed balance sheet expansion really accomplished in terms of helping the economy out. Three years of near-0% policy rates and a tripling in the size of the Fed’s balance sheet hasn’t changed the fact that this goes down as the weakest recovery ever — we’ve never gone this long without seeing a quarter of 4% GDP growth or better — or that the economy remains extremely fragile.
One thing seems sure. If the stock market were truly telling us anything meaningful about the economic outlook, then we wouldn’t be having the yield on the 10-year T-note at 2.05% and barely budging as the S&P 500 nudged even higher to close at the highs of the session in yesterday’s impressive positive price action.
Tags: Aggressive Action, Amp, Blue In The Face, Bounce, Carbon Copy, Central Bank Intervention, Central Planners, David Rosenberg, Debt Ceiling, Deja, Deja Vu, Dire Need, Fiasco, Gates, Imagination, Recycling, Screenplay, Scripts, Sheff, Straight Line
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Tuesday, April 3rd, 2012
The only European “thinktank” that has been more correct about predicting developments in the continent than any of its peers (“Greece will never default” – nuf said), has released a new briefing, this time looking at the latest European hotbed of trouble (which is not new at all, just the realization that the LTRO benefit has faded has finally set in), Spain, and specifically if its bank will be forced to seek a Eurozone bailout. OpenEurope is diplomatic about it but the conclusion is that all signs point to yes. Furthermore, as recent general strikes across the country, coupled with occasional rioting, showed, Rajoy’s agenda of enacting austerity which will be critical to receive German assistance simply to make Spain the latest German debt slave, may have some problems being enacted. Yet the biggest catalyst for the housing-heavy exposed Spanish banks is that, as Open Europe finds, of the €400 billion in loans made to residential sector, €80 billion is toxic. And only €50 billion in reserves are available. Hence the simple math: at least a €30 billion shortfall will need to come from Europe. And this assume no further declines in home price, which however are set for a record price drop this year. So… LTRO 3 anyone as the focus once again shifts to “deja vu Greece?”
From the executive summary:
- Given its size, the fate of the Spanish economy will also largely decide the fate of the euro. €80bn of €396bn (1/5) in loans that Spanish banks have made to the bust construction and real estate sectors is considered ‘doubtful’ and potentially toxic, meaning at serious risk of default, with the banks only holding €50bn in reserves to cover potential losses. Already dropping, house prices could potentially fall another 35%, meaning that Spanish banks will almost certainly face hefty losses as more households default on their mortgages.
- In such a scenario, the Spanish state is unlikely to be able to afford to recapitalise its banks, meaning that the eurozone’s permanent bailout fund (the ESM) would have to step in, shifting the cost to eurozone taxpayers.
- As domestic banks are currently the main buyers of Spanish government debt, this could also lead to major funding problems for Spain. The chances of a self-fulfilling bond run on Spanish debt would increase massively in this scenario, threatening to push the whole country into a full bailout.
- Containing spending in the Spanish regions is also key to Spain rebalancing its books. The level of unpaid debt on the balance sheets of local and regional governments has risen by €10bn (38%) since the start of the crisis (now topping €36bn). This will likely be paid off by the central government, increasing the country’s debt and deficit.
- Spain’s various reforms, particularly to the labour market, are welcome, but are themselves not enough to stop a bond run, as it will take time before they bite. The country’s long- term unemployment has now reached 9% of the economically active population, and youth unemployment reached 50.5% last month. This is threatening the long term productivity of the economy and whether Spanish society can sustain this level is unknown.
- A Spanish bailout is far from a forgone conclusion, but more work needs to be done to avoid one. Open Europe recommends:
- Spanish banks double their provisions against souring loans and commit to thorough stress tests
- Strengthen labour market reforms, particularly to relieve the welfare burden on state finances, including: end wage and pension indexation to inflation, reduce size and duration of benefits, limit collective bargaining, reduce redundancy costs and improve the business climate.
- However, these reforms will only stand the test of time if they enjoy political buy-in from across society in Spain, rather than being imposed from outside.
Full report (pdf)
Tags: Austerity, Bailout, Catalyst, Declines, Deja Vu, Executive Summary, General Strikes, German Assistance, Hotbed, House Prices, Open Europe, Rajoy, Real Estate Sectors, Realization, Residential Sector, Shortfall, Spanish Banks, Spanish Economy, Spanish State, Thinktank
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Monday, March 19th, 2012
The market is ripping. That much is obvious. What some may have forgotten however, is that it ripped in the beginning of 2011… and in the beginning of 2010: in other words, what we are getting is not just deja vu (all on the back of massive central bank intervention time after time), but double deja vu. The end results, however, by year end in both those cases was less than spectacular. In fact, in an attempt to convince readers that this time it is different, Reuters came out yesterday with an article titled, you guessed it, “This Time It’s Different” which contains the following verbiage: “bursts of optimism have sown false hope before… Today there is a cautious hope that perhaps this time it’s different.” (this article was penned by the inhouse spin master, Stella Dawson, who had a rather prominent appearance here.) So the trillions in excess electronic liquidity provided by everyone but the Fed (constrained in an election year) is different than the liquidity provided by the Fed? Got it. Of course, there are those who will bite, and buy the propaganda, and stocks. For everyone else, here is a rundown from David Rosenberg explaining why stocks continue to move near-vertically higher, and what the latent risks continue to be.
UP, UP AND AWAY!
It has been quite a move up in the U.S. equity markets. The S&P 500 just completed its fifth straight week of gains, the longest streak of the year. From the closing low of last October 3rd, the index has rallied a breathtaking 28%. So far in 2012, the Dow is up 8%, the S&P 500 is up 12% and the Nasdaq is up 17%. Breathtaking to say the least.
What accounts for all this optimism:
- The European LTRO program has obliterated financial tail risks in the region.
- The successful second bailout of Greece.
- Chinese inflation down to 3.2% has fuelled hopes of monetary ease.
- Perceptions that that the U.S. economy is reaccelerating — all the Fed had to do was change “modest” to “moderate” (plus the ECRI leading index has improved to a seven-month high).
- Tentative signs that the secular headwinds are subsiding — housing, credit, employment, local government fiscal restraint.
- Oil prices stabilizing with a calm emerging with respect to Iran.
- Technically, the market is making higher highs and higher lows — a confirmed uptrend.
- Global earnings estimates are no longer going down.
- Financial conditions are easing with corporate bond spreads narrowing sharply.
- The success evident in the Fed’s latest banking sector stress tests — bank
- stocks advanced 9% last week.
- The snapback after the early-March triple-digit decline in the Dow — the first of the year has emboldened the ‘buy the dip’ psychology.
What are the risks?
That we wake up some time in the second quarter and discover that the economy may well have contracted if not for the extremely warm weather we had in the opening months of the year, which provided a huge, if not unprecedented, skew to the data (see Weather Alert: Why the Sun Could Be Bad for Risky Assets on page 14 of the weekend FT).
Remember —January and February were both 5 degrees warmer than usual. For months usually beset by winter weather, the seasonal factors attempt to correct for this by boosting the raw data, which at that time of year are about the lowest given that many folks are snowbound. If not for the seasonal adjustment process, we would only be able to compare the data on a year-to-year basis because there is no apples-to-apples comparison between economic activity in January and what you would typically see in May. So in January and February in particular, the raw nonseasonally adjusted basis get a “bell curve” like we would in school in a tough mid-term exam. The problem this time is that January and February were downright balmy. This wreaked havoc on all the data, especially housing, employment and spending.
We estimate that over 40% of the job gains were weather-related, taking both months into account. We also know that productivity is contracting and 100% of the time in the past decade, companies responded by curbing their hiring. So taking the weather effect into account and the reversal this will have in coming months with respect to the data impact, combined with the likely cooling-off in hiring plans already evident in many surveys, and we could well see the nonfarm payroll numbers get cut in half and come in closer to 100k than 200k as we move into the spring and summer months.
This is not a disaster story at all, but recall that it was this sort of sluggish backdrop that brought at least a temporary end to the equity market rally last year and forced the Fed into more intervention in support of the bond market. Don’t write off QE3 just yet. On top of all that, we do expect to see the trade deficit continue to widen as the European recession and Asian slowdown hit the U.S. shores, and contraction in net exports is going to very likely emerge as a big headwind for the GDP data in the next few quarters. In fact, it is only now starting.
And by the time it subsides later this year, households and businesses will be preparing for next year’s massive tax grab. If logic prevails, this preparation is probably going to include a move to boost savings and raise liquidity (ostensibly at the expense of spending growth — expect the retailers to head into the 2012 holiday season lean and mean).
The weather also had a direct impact on spending by releasing more than $30 billion in recent months in terms of household cash flow from a radically lower utility bill. Absent that de facto tax cut’, and retail sales would have stagnated over the past three months as opposed to rising at what appears to be a healthy 8% annual rate. This will subside now and we have not yet seen the full brunt of $4 gasoline either — many a commentator has stated that the consumer sector is less vulnerable now and there is less of a “shock factor” this time around. We shall see about that.
As it stands, nominal spending at the pumps is at its lowest level since last June — we have not seen the draining impact on household cash flows yet. But we did see the impact on University of Michigan consumer sentiment, which surprised to the downside in a month that saw the Nasdaq head to 12-year highs and employment rip by more than 200k — going from 75.3 on sentiment to 74.3 is largely explained from the rise in gasoline prices.
The IBD/TIPP economic optimism index also slumped to 47.5 in March from the one-year high of 49.4 in February. The components of the recently released March survey data from NY Fed Empire and Philly Fed looked on the soft side, especially order books and production plans. This has also shown up in a recent reversal in President Obama’s approval ratings — so the gasoline impact, with a lag, is only now starting to rear its ugly head.
Keep in mind that even with WTI consolidating, the prices that consumers pay at the pump are on a steady march higher — up 31 cents in the past month to an average of $3.82 a gallon (nationwide) — but already nearly one-third of Americans are paying $4 or higher. What does this then do to the GDP price deflator and hence to real growth — well, just have a look and see what happened in the first quarter of 2011. It’s called stall speed, not escape velocity.
It is unclear just how stable things are in Europe. The ECB has papered over the problems for now but has jeopardized the sanctity of its balance sheet at the same time. The U.K. is seemingly on the precipice of losing its AAA rating status. Then we have Asia. India in a full-blown economic downturn and its banking system is in disarray. And the Chinese economy is now slowing down at a pace we have not seen since the 2009 hard landing. As the U.S. market has been surging, the MSCI China index sagged 2.7% in March —not a constructive signpost for the commodity complex. While this has caused the TSX index to lag the S&P 500, the Canadian dollar has managed to stay above par, in part because the rate-hike that is now being priced into the local bond market (Canadian 2-year note yields now offer a hefty 90 basis point premium to the U.S. comparable).
Back to China for a minute — the country’s A shares are down 3.3% in the past month while the H shares have gained 18%. The Chinese stock market now trades at a 9.9x forward multiple, versus a 15-year average of 12x. So the market there is well valued and the A shares (those listed in China; the H shares trade in Hong Kong) may well be poised to play some catch-up here. Something we have noticed and are definitely keying on.
As for the overall market, our CIO, Bill Webb, likes what he sees in the form of the lingering wide gap between the prevailing return on capital and the cost of capital. Screening for GARP (Growth at a Reasonable Price) and yield remains in vogue. While we are involved in those slices of the market, the major averages have managed to rally to levels above the year-end targets the consensus established at the start of 2012 (of 1,355 on the S&P 500), as was the case this time last year. The S&P 500 has actually risen as much in 2012 so far as it did at this stage in 1998 and when you consider how benevolent 1998 was in terms of fiscal, monetary and economic stability just three years after the advent of the Internet, how can anyone really compare the two years?
What we are seeing unfold really is a liquidity-induced rally that is built on a lot of hope. Neither were required in 1998 — the Fed kept a neutral policy in place for most of that year and there was no need for hope; the growth in the economy was organic and self-sustaining without unprecedented government assistance. Even then, we had a near-20% correction that summer. Nothing moves in a straight line indefinitely and while Bill and the investment team have been tactically bullish for most of this year, we are feeling the need to dial back the risk somewhat near-term given the high levels of complacency and the fact that valuation is less compelling than it was four-six months ago.
For example, the FT cites research showing that the S&P 500 is now two standard deviations above its 50-day moving average, which is far beyond the norm of even an overbought market and in the past this has proven to be a pretty good ‘chill for now indicator. Breadth has also deteriorated of late as the market has scaled new highs, which is often a technical sign that an intermediate top is at hand.
In the name of being ‘tactical’ and ‘nimble’, which is critical in today’s rapid-fire volatile backdrop, getting a little more defensive here is not a bad idea at all. We also remain long-term bulls on gold and commodities, but with the U.S. dollar breaking out and the Chinese data coming in softer than expected for the most part, we have taken on a less ebullient posture for the time being and plan to get more involved at better pricing levels once this corrective phase runs its course. The mining stocks have broken below key support levels here and over the near-term, the chart points are to be respected.
Also keep an eye on the bond market, which has become a bit unglued in recent weeks. Of course, this happens at least four times a year so hiccups like this are really par for the course. And as usual, we are hearing once again how we should all be prepared for the end of the secular bull market in Treasuries. These Wall Street reports come out at least once per year, the latest coming from UBS strategists. When will these people ever learn? In any event, it has been a rocky road as the 10-year note yield spiked 27 basis points last week to a five-month high of 2.3%. This is all part of the global risk-on trade because German bunds sold off just as much, and other assets that tend to do better in risk-off environments, such as gold, also suffered setbacks (the yellow metal lost S50/oz over the week).
Bond yields are not yet at a level to upset the equity market apple cart, especially with the yield on the banks improving so much in one fell swoop. But if we approach 3% on the 10-year note then we could start to see the stock market pay some attention — it’s not so much the level, as the change, and at a time when gasoline prices start to really pinch the consumer (driving season is right around the corner), rising borrowing costs are not going to provide a very constructive backdrop.
Tags: Bailout, Canadian, Canadian Market, Cautious Hope, Central Bank Intervention, David Rosenberg, Dawson, Deja Vu, Election Year, False Hope, Latent Risks, liquidity, Nasdaq, Optimism, Perceptions, Reuters, Rundown, Spin Master, Time After Time, Trillions, Verbiage, Year End
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Friday, May 21st, 2010
In today’s short video seasoned trader and INO.com founder and CEO, Adam Hewison, examines the crash of 1929 and the similarities to today’s Dow. This video is not meant to scare anyone, but to educate investors and traders of the possibilities that may exist in today’s market.
We could be, repeat, could be very close to a tipping point similar to that of 1930 when the Dow had ended a 50% correction to the upside. We invite you to watch Hewison’s latest video and see what makes sense to you.
As always our videos are free to watch and there are no registration requirements. If you agree or disagree with this video please feel free to comment.
Source: Adam Hewison