Begging for Trouble (Hussman)

Monday, August 13th, 2012

Begging for Trouble

by John P. Hussman, Ph.D., Hussman Funds

With the daily focus on European crisis and the hope of central bank intervention, one of the essential features of the investment climate – at least for long-term investors – is easy to lose in the shuffle. That feature is valuation. It’s an easy concern to overlook, because with corporate profit margins close to 70% above historical norms (largely because of unsustainably large government deficits coupled with low private savings rates – see Too Little to Lock In), Wall Street is quite happy to look at the ratio of prices to near-term earnings estimates and conclude that valuations are satisfactory. But stocks are not a claim on one year of earnings. They are a claim on a very long stream of cash flows that will actually be delivered into the hands of investors. Unfortunately, the conclusion that stocks are appropriately valued rests on the implicit assumption that profit margins will remain elevated into the indefinite future.

We presently estimate a projected 10-year total (nominal) return for the S&P 500 of less than 4.6% annually. Nothing in recent years, much less the past decade, indicates any material change in the relationship between actual market returns and expected market returns as we estimate them using a range of fundamentals including normalized earnings. Indeed, the 5.1% total return of the S&P 500 over the most recent 10-year period has been right on target (see also my July 7, 2002 comment). It’s notable that even without compelling valuations a decade ago, we lifted 70% of our hedges several months later in early 2003, at what turned out to be the start of the next bull market – something to remember for those who misunderstand our two-data sets issue of 2009-early 2010 and assume that we’ll never lift our hedges until the market is deeply undervalued.

I anticipate that a decade from now, the S&P 500 will have achieved a total return that is very weak from a long-term perspective. Remember also that you don’t “lock in” a 10-year return. You ride it out. I continue to expect that investors will have numerous opportunities to accept risk in the coming years in expectation of much better prospective returns than are presently likely.

Of course, with the yield on the 10-year Treasury bond at just 1.6%, one might argue that a prospective 10-year return of nearly 4.6% on stocks is still very good by comparison, and should be enough to prevent any substantial adjustment to lower prices and higher prospective returns. To inform that argument, I’ve added the 10-year Treasury bond yield to our standard chart below. Note that the correlation between 10-year S&P 500 returns and 10-year Treasury bond yields (which reflect both expected and actual 10-year returns, provided no default occurs) is just 0.1. There is virtually no relationship at all, with the exception of the early-1980’s, when the prospective and actual returns were quite high for both as a result of inflation shocks.

While the simultaneous rally in both stocks and bonds from the early 1980’s through the late-1990’s gave the illusion that the 10-year bond yields and forward operating earnings yields had a precise point-for-point relationship, spawning an unfortunate little cottage industry of adherents to the “Fed Model”, this model is based entirely on the relationship between stock yields and bond yields during a specific 16-year period of sustained disinflation, and there is no evidence – or even sound theory – supporting that spurious one-to-one correlation more generally.

Why aren’t the 10-year returns of stocks and bonds (prospective or actual) more closely related? The reason is simple, really. 10-year bonds have an effective duration of only about 7-8 years, depending on the coupon, which means that your ending wealth is nearly completely determined within that horizon. In contrast, stocks are very long-term assets, with an effective “duration” roughly equal to the price/dividend ratio*, which means that changes in valuation dramatically affect the terminal value of your investment even for horizons out to 30-40 years, and sometimes longer when valuations are rich and yields are low.

[*Geek’s note: You can derive this by differentiating the Gordon growth model P = D/(k-g) with respect to k, and calculating the elasticity of price to changes in the gross return: (dP/P)/{dk/(1+k)}].

Consider investors who bought stocks back in 1999 when the price/dividend ratio was 70. Those investors were assured that the value of their investment would be dramatically affected by even very small changes in yields. The S&P 500 has now underperformed Treasury bills for over 13 years – even when recent market advance is included. If the S&P 500 indeed achieves a total return of 4.6% annually over the coming decade, those investors will have achieved a 23-year total return of just 3.2% annually. But even if the S&P 500 achieves a 10% annual return over the next decade, the 23-year total return for those investors would still only work out to 5.6% annually. When investors commit funds at rich valuations, the inevitable return to more normal valuations matters, and it matters for a very long time.

The most controllable determinants of investment returns are the level of valuation at which investors choose to initiate their investment and the level of valuation at which they choose to terminate their investment. Once you choose to initiate your investment at a rich level of valuation, you require a rich terminal valuation at some point in the future – and the good fortune to sell at that point – in order to achieve an acceptable long-term return. At present, rich valuations promise a very challenging decade for stock market investors, regardless of any fleeting short-term relief that monetary policy might provide.

Keep this in mind – when the market is deeply oversold and market internals are demonstrating positive divergences and recruiting favorable breadth, it can be sensible to accept market risk despite uncompelling valuations, as we did in early 2003. But speculating in a richly valued market where internals are showing increasing divergences, and the environment features an exhaustion syndrome and other historically dangerous conditions (see An Angry Army of Aunt Minnies) – is just begging for trouble.

Begging for Trouble

Investors remain so addicted to the temporary high of monetary intervention that they continue to ignore very real downturn in global economic indicators, to an extent that we have not seen since the 2007-2009 recession. This is particularly evident in the deterioration of new orders and order backlogs, which are short-leading indicators of production, which in turn is a short-leading indicator of employment.

Trading volume has been unusually low, while a 14-handle on the CBOE volatility index also suggests unusual complacency.  It’s understandable that people are reluctant to place trades in a weakening economy, yet one where quantitative easing is widely expected. Wall Street is scared to death of being out of the market when the perceived salvation of QE3 is announced, and at the same time is increasingly encouraged by negative economic data in the belief that this will accelerate delivery. In short, investors are practically begging to be shot, mauled by dogs, and diced by a Veg-O-Matic so they can get their next fix of pain-killers.

The chart below shows the average standardized value (mean zero, unit variance) of the overall, new orders, and order backlogs components of numerous regional surveys from the Federal Reserve and the Institute of Supply Management (ISM). We observe the same sustained deterioration in economic data across the world, including Europe and China (where the absolute values are higher, but the standardized values are similarly bad). The overall pattern reflects what Lakshman Achuthan of ECRI often describes as the “three P’s” – pronounced, pervasive, and persistent. Those three P’s help to distinguish signals from noise. Presently, our own noise-reduction methods suggest that a global recession is at hand.

One problem with the widespread faith in QE3 is that quantitative easing has had very weak and temporary effects on real economic activity or employment. Regional Fed governors like Eric Rosengren (Boston), John Williams (San Francisco) and others have increasingly advocated another round of quantitative easing, feeling extreme pressure for the Fed to “do something” about the economy. But as I’ve asked before, suppose that Ben Bernanke announces that he is going to stop spitting watermelon seeds into a can. Should we all become concerned that the Fed is suddenly not doing enough to stimulate the economy? Well, only if you think that spitting watermelon seeds into a can is stimulative.

Unfortunately, the impact of QE has been almost exclusively restricted to marginal changes in interest rates that have little effect on economic activity, and provoking temporary speculative bouts in the financial markets. This ineffectiveness has been predictable, not only because of the very weak relationship between GDP growth and stock market changes (a 1% change in stock market value has historically been associated with just a 0.03-0.05% change in GDP), but also because – drumroll – with trillions of idle reserves already sloshing around in the banking system, QE doesn’t relax any constraint that is actually binding on the economy.

The typical effect of QE-induced speculative runs has been little more than to help the stock market recover the decline that it experienced over the prior 6-month period (see What if the Fed Throws a QE3 and Nobody Comes?). In effect, QE is a policy that has negligible effects on the real economy, and is effective only in suppressing spikes in risk premiums and supporting the stock market after hard declines. We should not be surprised if it turns out to be fairly ineffective in lowering risk premiums when they are already depressed, reducing interest rates that are already near record lows, or supporting stock prices that are already quite elevated. Needless to say, the Fed is virtually certain to initiate another round of QE3. But the fact that it is needless to say this should be of some concern, because it suggests that the intervention is already fully discounted.

The suspended animation of the market here is very reminiscent of the similar suspension that occurred in 2008, as the markets eagerly awaited the near-certain passage of the Troubled Assets Relief Program (TARP). If you recall, within one minute of the passage of that bill by the House of Representatives, the stock market entered a free fall. Buy the rumor, sell the news.

Given the spike in risk premiums across Spanish and Italian debt, it is clear that a round of massive bond purchases by the European Central Bank would come as quite a relief to those debt markets and the European stock market. So massive ECB purchases would almost certainly have greater short-run impact than another round of QE by the Fed. But ECB monetization of distressed European debt is a policy that is still vehemently opposed by stronger European countries, and even what has been done already dabbles at the very edge of German constitutional law.

I continue to expect that the Euro will eventually break apart, and that it would be least disruptive for the stronger countries (Germany, Finland, Holland, etc) to exit first, allowing the remaining countries to print money and depreciate the Euro as they desire. The reason is that existing contracts in Euro could still be honored, without the massive corporate and private defaults that would occur if peripheral countries had to revert back to their previous national currencies and yet have to honor contracts in a dramatically stronger currency.

In my view, it is unwise to dismiss the possibility that the stronger European countries will split off either into their pre-Euro currencies, or into a new common currency with a more restricted membership. That is essentially what the sovereign bond markets foreshadow. Government bonds in Finland, Germany, Holland and several other countries are presently sporting negative interest rates, with German yields reaching record negative levels just last week. As Ray Dalio of Bridgewater recently wrote, “we think that there are good reasons to doubt that European bank and sovereign deleveragings will be prevented from progressing to the next stage in a disorderly way, without a viable Plan B in place. This fat tail event must be considered a significant possibility.”

For the United States, the main force of policy here should be on measures to ensure that the financial system is as immunized as possible from deterioration in the European banking system. On that front, Reuters reported last week that major banks have been directed to develop plans in the case of a renewed credit crisis.

With regard to the preparation of the U.S. financial system, I remain skeptical, but am somewhat more hopeful than I was a few years ago. Part of the Dodd-Frank act was the creation of an Orderly Liquidation Authority (OLA) to resolve too-big-to fail banks (Systemically Important Financial Institutions or SIFIs). The objective is to preserve large financial firms as going concerns in the event of insolvency, while ensuring that shareholders and creditors bear all the losses and customers and depositors are protected. The mechanics: following receivership, a temporary bridge company would be created, the FDIC would write down the assets to market value, old equity would be written off, and liabilities would be transferred by seniority (senior secured debt first) until the  bridge company had 10% equity. Remaining debt would be exchanged for equity in the new company.

The JP Morgan resolution plan provides a good example of how this would work. Notably, JP Morgan’s illustration suggests that an after-tax loss of $50 billion (just 2.2% of total assets) could be sufficient to take the company to insolvency, driving the company to a negative $16 billion equity position (h/t DailyBail). How could that happen? The example presented by JPM assumes two additional driving changes: a deposit run of 20%, which would be a substantial reduction in deposits, but certainly not unprecedented in other banking crises; and a $150 billion mark-down of asset values by the FDIC upon creation of the bridge company. Now, I’ve been quite critical of the 2009 FASB ruling that removed the need for banks to mark their assets to market, but a difference of $150 billion between the reported value of assets and the value that would be recognized in a reorganization? That would represent about 80% of the equity presently reported by JPM. One hopes that this figure has no relationship to reality.

Market Climate

As of last week, our estimates of prospective return/risk for stocks remained in the most negative 0.6% of historical observations, based on a blend of horizons from 2-weeks to 18-months. Strategic Growth remains fully hedged, with a “staggered strike” position that raises the strike prices of the put side of that hedge closer to market levels, presently representing about 1.6% of assets in time premium looking out toward year-end. Strategic International also remains fully hedged. Strategic Dividend Value is hedged at 50% of assets – it’s most defensive position. In Strategic Total Return, we used the spike in yields last week to very slightly increase the duration of the Fund to about 1.8 years. About 10% of assets remain in precious metals shares, with a few percent in utility shares and foreign currencies.

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Tags: Amp, Cash Flows, Central Bank Intervention, Corporate Profit, Daily Focus, Dalio, Earnings Estimates, Government Deficits, Hedges, Hussman, Hussman Funds, Implicit Assumption, Investment Climate, Material Change, Norms, Private Savings, Profit Margins, Shuffle, Target, Term Earnings, Term Investors, Valuations
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Robert Kessler: Yields on U.S. Bonds Really Can Go Quite a Bit Lower

Saturday, August 11th, 2012

Complete Transcript:

CONSUELO MACK: This week on WealthTrack, why rock climbing government bond investor Robert Kessler says we still haven’t seen the peak of the generational bull market rise in U.S. treasury bonds and why other investment routes are much more dangerous to your financial health! Great Investor Robert Kessler is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Three years into an economic recovery, it sure doesn’t feel like one. We are even beginning to hear the dreaded “R” for recession word here in the U.S. A recent headline in the Financial Times read: “Blue-Chips Raise Recession Fears.” The FT reported that “estimates of revenue growth for the largest us companies are being scaled back sharply by Wall Street analysts, signaling a mounting risk that the world’s largest economy may enter recession later this year.”

It is a development we have talked about with many WealthTrack guests. Sales and earnings estimates are being scaled back by analysts and companies alike as the global outlook becomes murkier. Recession is already happening in Europe. The so-called peripherals- Greece, Spain and Italy- are there. Even mighty Germany is feeling the pressure from its weaker neighbors. Germany’s central bank recently estimated its economy had grown “moderately” in the second quarter. According to The Wall Street Journal, that’s “shorthand for growth between zero and five tenths of a percent.” Not exactly reassuring for Europe’s largest economy, which its finance minister rightly describes as the “Eurozone’s anchor of stability.”

So if global economies and company sales and earnings are slowing, what does it mean for the markets? That is a source of heated debate and both sides are being reflected in the stock and bond markets. On the one hand, investors have been buying dividend paying blue chip stocks for their dividend income and their financial strength. The S&P Dividend Aristocrats Index, which is made up of 30 companies that have consistently raised dividends for at least 25 years, has traded around record highs recently. How well will their prices and dividends hold up in a global slowdown?

On the other hand, yields on U.S. treasury bonds have extended their multi-decade long decline over the last year, lifting the prices of the underlying bonds, as global investors sought their safety and liquidity. It has also helped that Federal Reserve Chairman Ben Bernanke has clearly spelled out the Fed’s intentions to keep interest rates low. And he has reiterated time and again that the Fed is “prepared to take further action as appropriate to promote a stronger economic recovery.” As PIMCO bond guru Bill Gross put it, in explaining why he is holding 35% treasuries in his PIMCO Total Return Fund: “don’t underweight Uncle Sam in a debt crisis.”

This week’s WealthTrack guest has been overweighting Uncle Sam in his portfolios for the ten years plus that I have been interviewing him. It’s been an extremely profitable run and he is sticking with it. He is Robert Kessler, founder and CEO of Kessler Investment Advisors, a manager of fixed income portfolios for institutions and high net worth individuals with a concentration in U.S. treasury debt. I began the interview by asking him about his long standing and contrarian investments in treasuries. What is he seeing that Wall Street is not?

ROBERT KESSLER: I think Wall Street is seeing all the same things I’m seeing. We’re just really interpreting those things a little bit differently. I look at the interest rate environment that we’re in right now, and most people think that this is created by Ben Bernanke, the Central Bank, and zero is some artificial number. The fact of the matter is, zero is a number that exists all over Europe now, and, in fact, that number is negative in five, or six, or seven countries in Europe.

CONSUELO MACK: So this is zero interest rates or negative interest rates on government debt, short-term government debt.

ROBERT KESSLER: Short-term government. Actually, even longer term. In Switzerland, it’s minus .25. So people who have a lot of money, and they want to park it someplace, they actually have to pay the government to put it there. Now, we haven’t seen that before. If you look at the way Wall Street’s interpretation of that is, they’ll say that that’s totally artificial. That’s not reality. And the reality really is that big money right now doesn’t want to go anyplace with it. It doesn’t matter if it’s corporate money, where they’re sitting with trillions of dollars, or individuals. What they want to do with it is make sure it’s totally safe. And money has a real value. Most people don’t look at money properly.

Money is a commodity. Just like gold, or like grain, or corn, or anything else. To store it someplace, it costs you some money. So if you want to store it in Switzerland, they’re going to charge you a quarter of one percent. When we look at zero in the United States, to make this really interesting, and people say, “Well, where do you think interest rates really are going?” And now I really look at everyone and say, “I don’t know. But they certainly could go negative,” meaning that the whole treasury curve, which is two-year, five-year, ten-year, thirty-year, all of that curve could all go down to zero. And everyone thinks there’s so much out there to buy. Look at all those treasuries. Come on. We have so much debt. Someone has to support it. What actually is there is, if I don’t want to sell my treasuries and you don’t want to sell your treasuries, there aren’t that many treasuries. And that’s why rates really can go quite a bit lower.

CONSUELO MACK: I know that you hear from other people on Wall Street. And if someone on the other side were looking at you and saying, Robert, okay, so interest rates are at zero. Short-term interest rates are at zero. Investors have other choices. Zero is not a good rate. That’s what they’re saying. It’s not a good return. Therefore, even Ben Bernanke, who is keeping short-term interest rates at zero, which is a reality, and is saying that, I’m going to keep interest rates at zero probably through 2015, if not beyond; even he is saying the reason that I’m keeping interest rates so low, one of the reasons is I want people to invest in risk assets. I want people to go and buy stocks and, you know, finance the economy, where they get a higher return. I’m going to make investing in treasuries so unattractive that I want them to buy something else, and, therefore, help the economy.

ROBERT KESSLER: In the environment we’re in, which is a deleveraging, deflating environment, a real return on money may actually be negative, meaning that if inflation actually goes negative, one percent is a pretty good return. And the only reason all of this is happening is because there’s no demand in the marketplace. And as much as Japan tried to do something, you can’t create that demand. And that’s exactly what Ben Bernanke’s talking about. He’s saying, “If I get these rates low enough” … there was a Swedish experiment, which is interesting, when Sweden had a very difficult time, the Central banker said, “You know, we ought to think about going negative.” Imagine that. The rate overnight won’t be zero. It will be minus 50.

CONSUELO MACK: Right. So I pay you for the privilege of owning a Swedish government bond.

ROBERT KESSLER: A half of one percent. That will certainly induce everyone to go buy something else. And the answer is, when there’s no demand from the private sector, I don’t care how much money you produce, I don’t care how much you print- if the private sector doesn’t want to borrow it, you have no marketplace. We have what we call no velocity. No movement of money. So that’s the environment we’re in. And as to what an investor needs to look at, is not what the real return is on a treasury against inflation from last year, but where will it be next year. And next year looks like we’re going to be looking at, if not deflation, certainly lower prices.

CONSUELO MACK: Let’s talk about kind of, there are different things that you’re looking at. So one of the things that Wall Street would say is that, you know, number one, inflation isn’t going to continue to go down, because, like, it never does for any length of time, and, therefore, at least in our recent experience, and all our models are predicated on the fact that we’re going to get some inflation, and with all the stimuluses the Fed is doing, central banks around the world are doing, we will get inflation. You’re saying, no, the reality is we’re in a deflationary environment, and, in fact, you know, we’re not going to get inflation for a long time. Why?

ROBERT KESSLER: Let me give you the Japan example. The Japan example is a very good example, because we claim in this country that we would never do what Japan did.

CONSUELO MACK: Right. No one wants to be a Japan. That’s the blanket statement everyone makes.

ROBERT KESSLER: We are doing exactly what Japan did. And interestingly enough, in 1997, that’s seven years after the deep recession/depression hit Japan, an administration came in, 1997, and said, we’ve got to contract the economy. We’ve got too much stimulus out here. We’ve got to tighten things up. That will make things better. The rates on the ten-year in Japan at that point were around two percent. Within a year or two they dropped to .8, and the deficit went straight up, even though everyone wanted to bring it down.

And the reason was, you can tighten everything up, but again, if there’s no demand and people perceive that prices are coming down, cash looks very good. And now we’re talking money. And money is really important, because money takes on a tremendous value in a deflating economy. If you’re a gold bug, the argument is inflate, inflate, because that’s a terrific thing to happen. All of this stimulus is going to cause inflation. And, in fact, in this kind of an economy, it doesn’t matter what stimulus you put in, because stimulus only works if someone wants to spend the money. And the fiscal side of it, which is the government side of it, right now, looks like, as we get into the fiscal cliff that people love to talk about, the fact is that will be very contractionary on the economy. So I would argue that if we get into that position, you will see rates go even further down.

CONSUELO MACK: One of the realities that you’ve identified at Kessler Investment Advisors as well is that zero interest rates can stay zero for a long time, or go lower for a long time.

ROBERT KESSLER: I think in this particular case, there are so many people who keep saying we’ve never seen this before. We’ve never seen this exact same thing, but we’ve seen this before. And I suspect that interest rates will stay extraordinarily low until we get out of this balance sheet problem of individuals getting rid of some of the debt. It’s 25% of homeowners are underwater. You have this huge unemployment problem, and the number that came out today, the Philadelphia Fed Index, actually had an employment number that would suggest, in this month coming up on the employment news, that employment could go negative again. Now, if you stop and think about that, the argument has been quantitative…

CONSUELO MACK: You mean job growth could go negative.

ROBERT KESSLER: Job growth will go negative. If you stop and think about how serious that is, we’ve had quantitative easing one, quantitative easing two, and probably something more. None of that has helped. And it’s simply because money is going no place. And the people who have it are buying whatever sovereign they feel safest in.

CONSUELO MACK: So Robert, another reality that you have identified at Kessler Investment Advisors is that instead of what Wall Street is telling you- I’m going to make you money, and that the traditional investments that make money, like stocks, that have over the last, you know, 40 years, whatever it is, in the post-World War II period- that, in fact, that investors are saying, “No. No. No. You don’t understand. My first principle is I don’t want to lose money.”

ROBERT KESSLER: We have an enormous number of investors leaving the stock market now and going into fixed income. Obviously, they feel that that’s too volatile, and that slow transition is probably going to continue for some time. But the concept of an investor saying, “I don’t want to lose money,” it usually means I want to make a lot of money, but I don’t want to lose any money. And you have to be able to explain to make a lot of money you’re going to be at risk to lose a lot of money. I would suggest the big problem we all seem to have is we can’t distinguish between a savings account, your pension account, your IRA, and an investment account.

CONSUELO MACK: And you’re saying it’s very important to differentiate between your investing and your savings. What’s the difference?

ROBERT KESSLER: The purpose of a savings account, as we all grew up, and we saved something, is to know it will be there. So, obviously, the return isn’t important. It’s the return of the money. And so I look at a savings account or a pension account, you cannot lose there. And that’s why I’ve suggested for years that you buy a zero coupon U.S. Treasury, meaning that the treasury will pay off in a certain period of time, because you have to have that money. That’s a savings account. An investment account is, have a good time.

The odds are, these days, for the last ten years, no one has made any money in the stock market unless you happen to buy at the right time, sell at the right time, and buy… and none of us do that. We’re all random buyers, so we all make mistakes. So the average person really doesn’t distinguish between those two pockets of money, and I would suggest that’s becoming very relevant now, because suddenly, if you look at the average homeowner, let’s take the homeowner, you have a decrease of $7 trillion in the value of what they had over the last two, three, four years. $7 trillion. An enormous amount of money. And if you look at their median net worth of that same homeowner, it’s gone from $126,000, that’s the average person, down to 77. That means they lost 39% of their money, of what they really thought they had. So all of these questions become extremely relevant if we talk reality, and I think that’s what we should be talking.

CONSUELO MACK: The fact that rates are coming down all over the world gives fuel to the argument on the other side, and that is, I can’t tell you how many people have told me that somewhere around 60% of the companies in the S&P 500 now are offering dividend yields that are greater than the yields on the ten-year Treasury note, and this is a once-in-a-lifetime opportunity.

ROBERT KESSLER: And they should. And they should, because everyone has done terrible with all of these companies. So they should give you some of your money back. But the best argument I can use is that these are the same companies that don’t know what to do with the cash they have, and they’re not out there buying any other companies. There are mergers going on, but they’re not spending the money. So if they’re not spending the money, what are you spending the money for? And then at the same time, there are no big dividend payers. There are no big cap stocks that are not going to be affected by a global deterioration in the economies that we’re looking at. They all will be. And if the stock market comes down, which I suspect it probably will, they’ll come down, too.

What do you care if you’re getting 4% if it drops 40%? That is the risk you take. So you think, well, this is a terrific deal, because in the long term, four percent looks good. It doesn’t look that good if you go back to 2008. You had an AT&T that was paying a very nice dividend, and it dropped 47%. I don’t think that’s what you want. And so I suspect that if you didn’t want any of the other stocks, you probably don’t want those stocks either.

And, again, I’m back to the subject, you do not want to lose money, because in an economy where prices are coming down, there’s tremendous opportunity. Everyone thinks that I’m being pessimistic about this. If you have money, and the price keeps coming down, the money gets more and more valuable. That’s why people are parking it where they think they can get it back, which ends up being in sovereign debt or good sovereign debt.

CONSUELO MACK: So Wall Street would say this is an example of extreme pessimism, and the times of extreme pessimism are when you make the most money by buying the securities that everyone else is shunning.

ROBERT KESSLER: But that has to be the excuse that we use, otherwise you wouldn’t buy anything from Wall Street. It’s a silly argument. We’re faced with a real serious problem in this country, as it is in Europe, but in this country, especially right now, because we have a disorganized kind of Congress, we have a situation where no one can get together on what to do, and I suspect there really is a reason for that. No one knows what to do. You can take this side, or you can take this side. It really doesn’t matter. The net result is, there are no simple solutions, and we’re certainly not going to get one, from what I can see.

And so this thing is going to linger, and the question is, do you need a crisis to begin to really try to solve this? Maybe that’s what happens. Maybe you do get a crisis. But this is not being pessimistic. I’m just telling you what’s happening. And the only reason we can make money in this market is because we really don’t care about what anyone else says. The key to this market right now is to follow whatever your own instinct is. If you don’t understand it, and it doesn’t make sense, and you can’t sell your house, and all the terrible things that we all know are happening, happen, well then, why do you want to go out and buy stocks? I mean I’m not doing this just because I want to hit the stock market. But this is a very serious period of time, and I don’t think people are treating it as serious as they should.

CONSUELO MACK: So most investors, most individuals, in their retirement savings, have gone the traditional route, and they certainly do not own a lot of treasury securities. So what are you advocating? That they basically, you know, liquidate, pay the taxes, everything, and put them into treasuries? I mean, you know, what are our options?

ROBERT KESSLER: I’m going to do the same thing I did last time you were kind enough to have me on the show, I think, at the end last year, and I said, go out and buy long-term 20-year, that’s a good thing to do, zero coupon U.S. Treasuries. They will yield about 280, 2.8 percent. Nothing terrible about that. In the last six months, since I’ve said that, they have returned 11%.

CONSUELO MACK: In six months.

ROBERT KESSLER: In six months. Better than the stock market and everything else. I will make the assumption that 280, 275 is not a terrible return. If you have this opportunity that I’m talking about, that rates actually come down, because if rates come down, a lot of people feel that 30-year, 20-year treasury will come down a point; if they come down a point, then you make 25% return. Worst-case scenario? You’re making 280. Not so terrible. That’s your retirement fund. That’s your serious money.

As far as the other money goes, I would be in this wait-and-see attitude. I’m really not trying to be pessimistic, and I know it sounds pessimistic, when I’m saying negative things, but those negative things are happening regardless of what I tell you. They’re happening in Europe. And this doesn’t even count the fact that we could have an oil disruption. We could have all the usual things that seem to be on our plate all the time. So sure, I think for a retirement fund, right now I’d be out buying all the treasuries I could get my hands on. I mean, but I think when you talk about the investment money, the money that you have to invest, I think you want to stay very, very cautious.

CONSUELO MACK: All right. Very cautious at this point. So the One Investment for long-term diversified portfolio is?

ROBERT KESSLER: I would say zero coupon treasury, if it’s a retirement fund. If it’s in a retirement fund, there’s absolutely– there’s no issue about time. You’re keeping it for a long period of time. But the other money that you have is money that really has to be put to use now, and you don’t want to waste it. It’s not going to be there necessarily 20 years from now. It’s money you’re going to invest in. Well, I can’t find anything to invest in. So keep it in cash. I know I’m kind of escaping by saying that, but I don’t think there’s anything wrong with cash.

CONSUELO MACK: So, you know, you said earlier in the interview that you’re really not a pessimist, that you’re actually an optimist. So what are you optimistic about?

ROBERT KESSLER: I think that people needed to go through this change in attitude towards how they spend money, what they think of money, and that change is taking place. There’s a realism coming into the marketplace. I think that makes for a better country, and that makes for a better people in the end. It doesn’t mean it’s easy, and it doesn’t mean this is going to be a very comfortable change. But it will probably be, as it usually is, for the better. What we don’t want to see is some serious kind of crisis that makes it worse.

I think the problems in the United States are solvable, if we can get a Congress to probably do something together. There are things to do here. But you can’t have 20 million people without a job, 45 million people on food stamps, and a bunch of people without healthcare, and then say, “Well, we don’t really have any problems here, and I think we should buy some stocks.” I think that attitude is exactly the wrong attitude. I think the problem becomes you have to pick up demand, and there is no demand in our system right now, and with good reason. People are pessimistic.

CONSUELO MACK: So what is it going to take to turn around demand?

ROBERT KESSLER: I don’t know. I don’t know. It’s a process. And the process is this horrible deleveraging, this pay down the debt, and people have to consciously understand when you pay down the debt, you’re increasing the value, in this case, of the currency. Because remember, the currency can buy everything cheaper. The U.S. dollar is the place to be. I’m very optimistic about the dollar. I think that’s a great place. I think the treasury market looks terrific here. That is the country. In between, there are problems that have to be solved.

CONSUELO MACK: Well said. Robert Kessler, thank you so much for joining us from Kessler Investment Advisors. And we will have you on again, you know, in a year, and see how you’ve done, as you have done extremely well over the last seven years on Wealth Track. So thanks for joining us again.

ROBERT KESSLER: Thank you. Thank you for having me.

CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. As we did last week, we are recommending a book for summer reading. This one is the choice of guest Robert Kessler. It’s called The Great Depression: A Diary . It’s by Benjamin Roth and it was published by his son in 2010, many years after his death. Roth’s diary is a compelling and eye opening account of the Depression seen through the eyes of an ordinary middle -class American. You will recognize the policy debates about inflation, skepticism towards big government, and worries about too much stimulus, that as Kessler says were “prevalent, recurring, and in the end, all wrong.” You can make up your own mind.

I hope you can join us next week for a shocking discussion about the cost of investment fees. According to our two guests- legendary financial consultant Charles Ellis, who is exclusive to WealthTrack, and top financial advisor Mark Cortazzo- fees are much higher than you think. They’ll tell us how to fight back. If you would like to watch this program again, please go to our website, wealthtrack.com. It will be available as a podcast or streaming video no later than Sunday evening. And that concludes this edition of WealthTrack. Thank you for watching. Have a great weekend and make the week ahead a profitable and a productive one.

Copyright (c) WealthTrack.com

Tags: Blue Chip Stocks, Blue Chips, Bond Markets, Consuelo Mack, Earnings Estimates, Eurozone, Finance Minister, Financial Health, Financial Times, Global Economies, Global Outlook, Government Bond, Recession Fears, Robert Kessler, S Central, U S Treasury, U S Treasury Bonds, Wall Street Analysts, Wall Street Journal, Wealthtrack
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Earnings, Revenue Beat Rates Remain the Same (Bespoke)

Sunday, August 5th, 2012

by Bespoke Investment Group

Since last Thursday, roughly 800 companies have reported earnings, which is nearly half of the total amount of reports we’ve seen since earnings season began on July 9th.  While we’ve seen a ton of reports over the last week, the overall percentage of companies that have beaten both earnings and revenue estimates has stayed the same.  As shown below, the earnings beat rate currently stands at 59.9%, which is just a tenth of a percent below where it was a week ago.  The revenue beat rate is currently at 48.2%, which is a tenth of a percent above where it was a week ago.

The earnings beat rate has been right around 60% for six consecutive quarters now.  The revenue beat rate, however, is well below its historical average this earnings season.
We’re now at the back end of the second quarter reporting period, so we don’t expect these readings to change much from here.

Copyright © Bespoke Investment Group

Tags: Consecutive Quarters, Copyright, Earnings Estimates, Earnings Season, Investment Group, Last Thursday, Nbsp, Revenue Estimates, Second Quarter
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“Release the Kraken” (Hussman)

Monday, April 30th, 2012

by John P. Hussman, Ph.D., Hussman Funds

Over the past 13 years, and including the recent market advance, the S&P 500 has underperformed even the minuscule return on risk-free Treasury bills, while experiencing two market plunges in excess of 50%. I am concerned that we are about to continue this journey. At present, we estimate that the S&P 500 will likely underperform Treasury bills (essentially achieving zero total returns) over the coming 5 year period, with a probable intervening loss in the range of 30-40% peak-to-trough.

Why? First, with respect to 5-year prospective returns, it’s important to recognize that returns at that horizon are primarily driven by valuations – not the “Fed Model” kind, but the normalized earnings and discounted cash flow kind. Stocks remain strenuously overvalued here, and only appear “fairly priced” relative to recent and near-term earnings estimates because corporate profit margins are more than 50% above their long-term norm. Meanwhile, corporate profits as a share of GDP are about 70% above the long-term average. As I detailed in Too Little To Lock In, these abnormally high margins are tightly related (via accounting identity) to massive fiscal deficits and depressed household savings rates, neither which are sustainable.

Our projection for 10-year S&P 500 total returns – nominal – is about 4.4% annually, which is far better than the 2000 peak, far inferior to the 2009 trough, and save for the period before the 1929 crash, worse than any prospective return observed prior to the late-1990′s bubble – even in periods having similarly depressed interest rates.

Of course, rich valuations can persist for some time – predictably resulting in poor long-term returns, but often doing little to prevent short-run speculation and temporary gains. The issue is then to identify the point at which overvalued conditions are joined by sufficiently overextended conditions, and a sufficient loss of speculative drivers, to make rich valuations “bite” even in the shorter-term. This is where additional criteria come in, such as overbought technical conditions and extreme optimism in the form of low bearish sentiment, depressed mutual fund cash levels, and heavy insider selling. Presently, it doesn’t help that T-bill yields and long-term bond yields remain higher than 6 months ago, and we have signs of oncoming recession. This is particularly evidenced by collapsing economic measures in Europe, softening economic performance in developing economies including China and India, and jointly weak year-over-year growth in key U.S. economic measures such as real personal income, real personal consumption, real final sales, and reliable leading indicators from the OECD and ECRI, as well as our own measures.

The combination of rich valuations, overbought conditions, overbullish sentiment, and deteriorating leading economic evidence can still unfortunately persist for months before being resolved. But once the hostile syndromes we’ve seen recently have emerged in the data, attempts at continued speculation have amounted to playing with fire. Similar conditions have repeatedly resulted in disastrous outcomes for investors. It would be nice to be able to “time” these outcomes better. We haven’t found a reliable way to do so, and would still be concerned about robustness – sensitivity to small errors – even if we did. Yet even when unfortunate outcomes are not immediate, the fact that the S&P 500 has underperformed T-bills for 13 years is not very sympathetic to arguments that stock market risk has been worth taking overall, except in confined doses.

Tags: Corporate Profit, Corporate Profits, Discounted Cash Flow, Earnings Estimates, Fed Model, Fiscal Deficits, GDP, Household Savings, Hussman Funds, Kraken, Market Advance, Market Plunges, Model Kind, Profit Margins, Speculation, Term Earnings, Treasury Bills, Trough, Valuations
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Earnings Season Cometh (Bespoke)

Wednesday, April 11th, 2012

Tags: Aa, Alcoa, Analyst Estimates, Decline, Earnings Estimates, Earnings Report, Earnings Reports, Earnings Season, Interactive Earnings, Next Level, Quarterly Report, Report Database, Report Users, Snapshot, Stock Price, Stocks, Surprise, Time Period
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The Outlook for Earnings (Brown)

Tuesday, April 10th, 2012

by Dr. Scott Brown, Ph. D, Chief Economist, Raymond James

April 9 – April 13, 2012

The stock market has risen nicely this year, partly on improving economic data, but are such gains justified by the earnings outlook? The level of the S&P 500 Index does not appear to be out of line with earnings expectations, but there may be some pressure on profits over the longer term. As the election approaches, we may hear more about class warfare.

In the late 1990s, share prices rose more than was justified by the earnings outlook. In hindsight, the market was clearly in a bubble. In the last decade, the market rose roughly in line with earnings. However, the Great Recession sent earnings sharply lower, and the stock market followed. Since the recession has ended, earnings have more than recovered. Bottom-up earnings estimates for more than a year out, compiled from analysts’ forecasts of individual companies, still look a bit giddy, but that’s typical. Top-down estimates, provided by economists and strategists, are more moderate – and consistent with some slowing in corporate earnings relative to the last few years. That’s to be expected. Much of the rebound in earnings has reflected the bounce-back from the recession. Firms have a tendency to cut too many jobs and overly curtail capital expenditures near the end of the downturn and there’s some catch-up as conditions begin to improve.

Click here to enlarge

Part of the strength in corporate profits in the recovery has been due to the restraint in labor costs. Given the large amount of slack in the labor market, wage pressures are relatively subdued. Moreover, since the labor market slack is expected to remain elevated for some time, corporate profits are likely to stay relatively strong. As a percentage of national income, corporate profits are very high and labor compensation is relatively low. The share of national income going to profits and the share going to labor cycles back and forth over time and at some point the pendulum seems likely to swing back in the other direction, but probably not anytime soon.

Click here to enlarge

It’s hard to have an intelligent discussion about the distribution of income. One side sites “corporate greed,” the other sites “class envy.” For the most part, economists have generally shied away from income distribution issues. This is mostly a question of politics. It’s difficult to say what an “appropriate” distribution of income should be and what steps should be taken to achieve it.

However, there’s no doubting that the distribution of income has widened significantly over the last thirty years. Real wages have stagnated. A lot of that is due to the decline of union membership. In the early 1970s, 25% of private-sector jobs were union jobs. Now unions account for less than less than 7% (note that 37% of public-sector jobs are union, but many of these are teachers and the dynamics are a lot different). In the late 1960s and early 1970s, we typically had more than 300 work stoppages per year, involving millions of workers. We had 19 last year, involving 113,000 workers.

It’s unclear what role the distribution of income will take in this year’s election, but investors should pay attention.

Tags: Capital Expenditures, Chief Economist, Class Warfare, Corporate Earnings, Corporate Profits, Downturn, Dr Scott, Earnings Estimates, Economic Data, Hindsight, Individual Companies, Labor Compensation, Last Decade, Raymond James, Recession, Share Prices, Slack, Stock Market, Strategists, Wage Pressures
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Markets Gain Ground, but Remain Range-Bound

Tuesday, October 25th, 2011

by Bob Doll, Chief Equity Strategist, Fundamental Equities, Blackrock

October 24, 2011

Stocks Rise as Earnings Accelerate

Stocks managed to post their third consecutive week of gains, again thanks to perceived progress on the European debt crisis and signs of improving economic data. For the week, the Dow Jones Industrial Average climbed 1.4% to 11,808 and the S&P 500 Index advanced 1.1% to 1,238. In contrast, the Nasdaq Composite declined last week, falling 1.1% to 2,637.

Also boosting sentiment last week was some better-then-expected results on the earnings front. Third-quarter earnings season is now well under way, with more than one-third of companies having reported results. At this point, 62% of companies have exceeded revenue forecasts and 71% have beaten earnings estimates. As has been the case for some time, the financial sector has lagged the rest of the market.

Policymakers Grapple With European Debt Issues

The ongoing debt crisis in Europe remains the critical issue affecting global markets. This past weekend, representatives from the 27 members of the European Union met to discuss potential resolutions to the crisis and appeared to at least make some progress, promising a package by mid-week.

Policymakers are scrambling to find and implement programs that will save the euro and avoid a collapse of the European banking system. There are some similarities between the current European debt crisis and the financial crisis of 2008, and as with the situation a couple of years ago, it appears that the financial and economic pain will have to become severe enough for policymakers to take some unwanted but necessary steps to prevent widespread debt deflation. The parties are under tremendous pressure to solve the interrelated problems of Greek (and other countries’) debt, weakened banks and a bailout fund in need of reinforcement. Ultimately, we believe policymakers will need to implement funding packages that are effectively open-ended in order for investors and the business sector to regain confidence in the euro and the region’s banks.

Even if policymakers are able to come together on such a package, tensions could continue to escalate since any such package will not, by itself, solve Europe’s debt problems. We are hopeful that policymakers will be able to stave off full-blown debt deflation, but Europe has a long way to go before balance sheets are repaired and the foundation for better growth is in place.

US Economic and Political Uncertainty

US economic data has shown some encouraging signs in recent weeks. Retail sales figures and jobs indicators have trended to the positive, which has caused a number of economists to upgrade their forecasts for third- and fourth-quarter gross domestic product growth. The overall sense of economic uncertainty remains high, but it is looking increasingly likely that the United States will avoid a double-dip recession.

One issue that is acting as an increasing drag on economic and market sentiment is the political uncertainty and strife in the United States. There is a great deal of squabbling over the jobs-creation plans and fiscal policies in Washington, DC and the extent to which the Federal Reserve will engage in additional monetary stimulus also remains a wildcard. Time is also running out for the so-called “super committee” charged with creating a plan to reign in the federal debt. The Occupy Wall Street movement has also been gaining increased attention. It is impossible to boil that movement down to a single issue, but it is clearly a symptom of deepening social turmoil, political polarization and economic discontent in the United States.

Potential Catalysts to Break out of the Trading Range

With the market gains in recent weeks, stocks in the United States have moved closer to the upper end of the trading range they have been in since early August (represented by 1,100 to 1,250 for the S&P 500). In the near-term, we expect that progress (or lack thereof) in addressing the European debt crisis will continue to be the main driving force behind the direction of risk assets, and given the volatility of that situation, we expect markets will continue to see some significant swings.

So what will it take for market to break out of their trading range? Clearly, significant progress in Europe would help the stock market to hold a sustainable upward trend, but we also believe that continued improvements in the labor market would be a necessary ingredient. On the downside, we do not expect to see a major market breakdown below the 1,100 level unless the European system fails to stem the banking crisis.

Bob Doll is Chief Equity Strategist for Fundamental Equities at BlackRock^® a premier provider of global investment management, risk management and advisory services. Mr. Doll is also Lead Portfolio Manager of BlackRock’s Large Cap Series Funds. Prior to joining the firm, Mr. Doll was President and Chief Investment Officer at Merrill Lynch Investment Managers.

You should consider the investment objectives, risks, charges and expenses of any fund carefully before investing. The funds’ prospectuses and, if available, the summary prospectuses contain this and other information about the funds, and are available, along with information on other BlackRock funds by calling 800-882-0052. The prospectus and, if available, the summary prospectuses should be read carefully before investing.

The information on this web site is intended for U.S. residents only. The information provided does not constitute a solicitation of an offer to buy, or an offer to sell securities in any jurisdiction to any person to whom it is not lawful to make such an offer.

Sources: BlackRock, Bank Credit Analyst. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of October 24, 2011, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.

BlackRock is a registered trademark of BlackRock, Inc. All other trademarks are the property of their respective owners.

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Tags: Bailout, Bob Doll, Bonds, Critical Issue, Debt Crisis, Debt Issues, Dow Jones, Dow Jones Industrial, Dow Jones Industrial Average, Earnings Estimates, Earnings Season, Economic Data, Economic Pain, European Banking System, Financial Sector, Global Markets, Members Of The European Union, Nasdaq Composite, Necessary Steps, Quarter Earnings, Revenue Forecasts
Posted in Bonds, Brazil, Markets | Comments Off

Emerging Markets Cheat Sheet (September 6, 2011)

Monday, September 5th, 2011

Emerging Markets Cheat Sheet (September 6, 2011)

Strengths

• China’s official PMI for August was 50.9 percent, up 0.2 percent from 50.7 percent reading in July after declining since April this year. This clearly demonstrates that China is firmly in a soft landing trend engineered by the government.
• Korea’s exports went up 27.1 percent in August. Korean heavy industry exports continue to lead the growth with vessels export growing 77.5 percent year-over-year.
• Macau’s casino revenue went up 57 percent in August on a year-over-year basis. The casino companies have all reported beating sales and earnings estimates for the first half of the year.
• China revised individual income tax policy came into effect on September 1. Workers with lower than Rmb3500 monthly wages will no longer pay any income tax.
• Russian crude oil output growth accelerated 2.1 percent year-over-year to 10.28 million barrels per day in August, based on the data published by Interfax. Russia maintained its position as the world’s leading producer of oil.

Weaknesses

• Within China’s August PMI number, there are worrisome numbers: the new order index was flat versus that of July at 51.1 percent and the new export order index continued to drop in the last five months reaching 48.3 percent, down 2.1 percent from July. A reading below 50 percent indicates economic activity is in contraction mode. This will have an adverse impact to the revenue and earnings of transportation, materials, and industrial companies.
• Also in the August PMI number, the input purchasing index, a sub-index, showed an increase of 0.9 percent, to 57.2 percent. This shows inflation pressure is still in the market. The price indices for food and beverage, and non-ferrous products are above 60 percent, which makes it questionable for the central bank to loosen monetary tightening.
• Korea reported that August inflation rose to 5.3 percent, a three-year high. The market already sees corporate cost increases in Korea as in all Asian countries. The Korean government is turning to a hawkish stand on inflation control now.
• Korea industrial production grew 3.8 percent in July, the lowest pace in 10 months. As a leading export country, Korea itself is an indicator that global demand is weak.
• The People’s Bank of China has announced through the government-owned newspaper The China Daily that it will broaden the reserve requirement ratio (RRR) base to include margin deposits for bank acceptance and guarantees. In effect, this is equivalent to a 2.4 percent RRR increase. It is sucking money out of circulation and lending, but it serves the central bank better in controlling liquidity at less cost, and provides the bank more leverage at open market operations, while it is negative to the commercial banks in their loans growth and funding cost. It will also further withdraw liquidity from the market unless the central bank issues fewer notes going forward to make up the liquidity withdrawal.
• UBS cut GDP forecasts for Hungary to 2.0 percent and 1.5 percent for 2011 and 2012, respectively, from 2.2 percent and 3.3 percent. The Hungarian economy is the weakest in Emerging Europe as it continues to suffer under a debt burden (exacerbated by Swiss franc strength) that chokes off domestic demand.

Opportunities

• China’s equity markets are at a depressed level. The MSCI China Index is down 10 percent year-to-date. Its valuation is close to the low of 2008, with the price-to-book ratio at 1.6x, as indicated in the chart below. For that reason, it is widely believed the share prices of China-based companies have good support at the current level.

• Ukraine is poised to overtake Brazil as the third largest corn exporter after the U.S. and Argentina, shipping abroad 9.25 million metric tons of the grain this season. The revenues from this record export will be boosted further by corn prices rising as U.S. crop conditions fell to the lowest level since 2005.

• Morgan Stanley’s economics team expects the current account deficit in Turkey to improve as early as this month. The foreign trade numbers along with the expected rise in tourism revenues suggest a noticeable decline in upcoming current account numbers.

Threats

• China Premier Wen Jiabao this week published an article in which he said three things that the markets were focused on: first, the declining Chinese economic growth, thus the economic activity slowdown, is what is intended by the government; secondly, inflation control is still the priority for the government; lastly, China will not change the policy direction for now. Effectively, his statement dampened the market expectation for an easing stand on monetary policy. There has not been encouraging economic statistics and policies from China to drive the market. Brokers may come to the reality to reduce their corporate earning forecasts, adding more pressure to the market.
• While not entirely immune from the sovereign debt crisis contagion afflicting Western Europe, countries in Emerging Europe stack up relatively well on net debt-to-GDP ratios. This week, Fitch affirmed its BBB sovereign rating for Russia on an “exceptionally strong” balance sheet and kept its “positive” outlook on the debt.

Tags: Adverse Impact, Brazil, Casino Companies, Casino Revenue, Contraction, Crude Oil, Crude Oil Output, Day In August, Earnings Estimates, Economic Activity, Emerging Markets, Ferrous Products, Five Months, Food And Beverage, Heavy Industry, Individual Income Tax, Inflation Pressure, Interfax Russia, Outlook, Pmi, Price Indices, S Casino, Transportation Materials
Posted in Brazil, Markets, Oil and Gas, Outlook | Comments Off

U.S. Equity Market Update – “Attractive Stock Valuations Offset By Growing Macro Concerns” (Lewenza)

Monday, August 15th, 2011

Here is TD Waterhouse senior analyst, Ryan Lewenza‘s August 12, 2011 U.S. Equity Market Update report.

Highlights include:

· Q2/11 GDP growth came in at 1.3%, well below expectations for growth of 2%. Even more disconcerting was the large negative revision to previous growth estimates, with Q1 growth being revised to 0.4%. The ISM manufacturing report for July declined to 50.9, resting just above the boom-bust level of 50. These two key weak data points help to highlight the fragile state of the U.S. economy and cause us to believe the probability of a recession has greatly increased. Presently, TD Economics is estimating 1 in 3 chance of a U.S. recession in the coming months

· Despite the weak economic backdrop, U.S. corporate earnings continue to shine with 76% of companies in the S&P 500 Index (S&P 500) exceeding earnings estimates and Q2/11 earnings growing at 12% Y/Y. We still expect healthy earnings for the year, but the disconnect between slowing growth and continued rosy forward consensus estimates will need to be resolved in the coming quarters, with expectations for forward estimates being revised lower.

· The one positive of a declining market is that valuations become more attractive, thus increasing forward rates of expected return. Currently, the forward P/E for the S&P 500 is at a very attractive 12.2x (12.5x trailing), which is well below its ten-year average of 16.5x.

· We recommend investors put some money to work at current levels, focusing new money on defensive, high-quality, dividend yielding stocks. However, given the uncertainty that exists, we recommend investors go slow as they redeploy funds and maintain higher than normal cash levels.

· Given the explosive decline, the U.S. stock market is extremely oversold on a number of technical measures, with our preferred oversold/overbought technical indicator – NYSE Percentage of Stocks Above 50-day MA – being in rarefied oversold territory at just 8%. Generally speaking, below 20% indicates oversold for this indicator and one of the key reasons why we believe we could see a short-term trading bounce over the next few weeks.

· In trying to isolate the potential end to this correction we will be closely monitoring the following: 1) a steep decline in bullish investor sentiment; 2) a bottom in the Shanghai Composite, which often peaks and troughs ahead of the U.S. markets; 3) a peak in U.S. Treasury prices; and 4) a peak in the Volatility Index.

With our recommendation to put some money to work at current levels, we will be shortly sending out a detailed list of Canadian and U.S. high quality investment equity ideas.

U.S. Market Update August 12 2011

Tags: Canadian, Consensus Estimates, Corporate Earnings, Declining Market, Dividend Yielding Stocks, Earnings Estimates, Economic Backdrop, Forward Estimates, Forward Rates, Fragile State, GDP Growth, Growth Estimates, Ism Manufacturing, New Money, Nyse, Senior Analyst, Stock Valuations, Td Waterhouse, Technical Indicator, Technical Measures, U S Stock Market
Posted in Canadian Market, Markets | Comments Off

Goldman Sachs Cuts S&P Target From 1,500 To 1,450

Thursday, May 26th, 2011

by ZeroHedge.com

A month ago, when Goldman, just as we predicted, cut its GDP outlook for Q1 (to be followed by downgrades to both H2 and Q2) we said: “Some other things nobody will be able to predict: Hatzius dropping full year GDP from 4% to 2.25%; Goldman’s downgrade of precious metals, Kostin’s 2011 S&P 500 price target reduction by 20%, and Goldman getting its New York Fed branch to commence monetizing $1.5 trillion in debt some time in October.” One by one all of the predictions are starting to come true: this morning Goldman head market strategist just cut his S&P 500 outlook from 1,500 to 1,450 (granted it is not 20%…yet. There is, however, over 7 more months left in the year). In the meantime, look for the thunderous Wall Street lemmings herd to do the same. Just as we have been predicting on both. Time for CNBC to trot out Laszlo Ultrasound and to advise him to angle the predictive instrument known as a ruler a littler lower: the S&P 2,854 call in 2 years suddenly appears in jeopardy (absent QE7 of course).

From Goldman:

We have lowered our S&P 500 2012 EPS forecast to $104 from $106 and our year-end 2011 price target to 1450 from 1500. At the sector level, the largest changes in our earnings estimates are a $2 increase in Energy 2012 EPS, a $1 decrease  in Information Technology, a $2 decrease in Financials earnings and a smaller negative revision to Consumer Discretionary. We made further minor changes to other sectors that are not large enough to highlight.

And another shocker: Goldman just cut its outlook on S&P margins. A move so obvious we predited it back in November 2010.

We expect S&P margins to contract in 2012, focus on sales growth. The combination of higher commodity prices, lower global GDP growth and rising inflation raises our sales forecasts but lowers S&P 500 expected margins in aggregate. We focus on sectors and stocks best positioned to grow earnings through higher sales. We expect Energy, Consumer Staples and Info Tech to post the highest revenue growth in 2012.

In short:

Our new 3-, 6-, and 12-month price targets: 1400, 1450 and 1500

We forecast S&P 500 will grow sales by 10% in 2011 and 8% in 2012, similar to consensus. But we expect margins will peak at 8.9% this year and slip to 8.8% in 2012. Consensus forecasts margins rise to 9.6% in 2012.

Our commodities strategists forecast 20%+ gains in oil, copper, zinc

We expect a slow but sustained GDP growth environment that will tighten key supply constrained markets and drive prices higher in 2012. Persistent impact of MENA events will push Brent crude to $140/barrel by end-2012.

Stocks with fast sales growth should perform even if margins fade

Firms forecast to generate high sales growth in 2012 are better positioned to absorb rising commodity prices and still post strong EPS gains than companies with average or lackluster sales prospects.

Look for all of the other predictions noted in the first paragraph to come true.

GS Equity 5.26

Tags: Cnbc, Commodity Prices, Crude Oil, Downgrades, Earnings Estimates, GDP Growth, Global Gdp, Goldman Sachs, Jeopardy, Laszlo, Lemmings, Margins, Market Strategist, Minor Changes, New York Fed, precious metals, Price Target, Q1, Sector Level, Shocker, Target Reduction
Posted in Markets, Oil and Gas | Comments Off