The Economy and Bond Market Cheat Sheet (January 31, 2011)

Saturday, January 29th, 2011

The Economy and Bond Market Cheat Sheet (January 31, 2011)

U.S. Treasuries rallied, driving yields modestly lower. The market chopped around some this week and was roughly unchanged through Thursday, but on Friday the continuing unrest in Egypt and the surrounding region initiated a flight to safe assets such as U.S. Treasuries. Fourth quarter GDP rose 3.2 percent, just under expectations, but underlying trends remain positive. Growth of 3.2 percent is not a bad showing and is about what the economy averaged in the 10 years before the financial crisis.

Strengths

• GDP grew 3.2 percent and reinforces the idea of a sustained economic recovery.
• The Fed announced no change in policy at this week’s Federal Open Market Committee (FOMC) meeting, keeping very stimulative policies in place.
• The National Association for Business Economics sees hiring picking up over the next six months based on its Net Rising Index for employment which hit the highest level since the index was created in 1998.

Weaknesses

• Initial jobless claims rose to 454,000, well ahead of expectations and sending mixed signals on the health of the job market.
• Durable goods orders for December fell 2.5 percent on weak aircraft orders.
• The British economy unexpectedly contracted in the fourth quarter by 0.5 percent.

Opportunities

• The rise in yield on the 10-year Treasury since the October low to levels comparable to those existing in May 2010, may offer an attractive entry point for bonds.

Threats

• The economy appears to be performing better than many expected and could be a threat to fixed income markets as yields move higher in response.

Tags: Aircraft Orders, Bond Market, Bonds, British Economy, Business Economics, Cheat Sheet, Durable Goods Orders, Economic Recovery, Federal Open Market Committee, Financial Crisis, Fixed Income Markets, Fourth Quarter, GDP, Initial Jobless Claims, Mixed Signals, Open Market Committee, Quarter Gdp, Six Months, Treasuries, Unrest
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September to Remember (David Andrews)

Monday, October 4th, 2010

September to Remember

by David Andrews CFA, Private Client Strategist, Richardson GMP Ltd.

Is this the ‘new normal’ everyone is talking about these days? September proved to be anything but ‘normal’ as U.S. stock indexes capped their best month-of-September performances in seven decades. Investors ignored ongoing economic uncertainty and chose to believe another round of stimulus in the form of Quantitative Easing was in the cards. With the Federal Reserve edging closer and closer to another round of bond buying, stock markets were effectively handed a put option (floor of support) which bolstered sentiment and rewarded risk taking. In a perverse turn of events, it now seems stock markets actually cheer for weaker news on the economy only to ensure the Federal Reserve does launch their QE2. A ‘new normal’ indeed!

The September surge saw the best one month performance by the S&P 500 (+8.8%) since April 2009, and its best quarter (+1 0.7%) in a year. The Toronto Stock Exchange also surged to its own two-year high this week helped by surging investor demand for gold. The TSX rose 3.8% helped along by commodities as we saw by new highs in copper, gold and silver.

Economic data continues to give mixed signals to investors. Consumer confidence slipped again in September, but we also saw fewer U.S. workers filing claims for jobless benefits (453K), easing concerns the world’s largest economy may be retrenching further. Investors also learned the Canadian economy shrank for the first time in eleven months as July GDP fell 0.1%. The economy may have slipped more in the third quarter than the Bank of Canada had predicted this summer. Bank of Canada governor Mark Carney confirmed this week that our economy had indeed lost its momentum due to weaker U.S. demand and the over- indebted Canadian consumers. Traders have since bet that future interest rate hikes are now on hold for the foreseeable future.

Internationally, Chinese manufacturing data showed factory activity expanded at its fastest pace in four months supporting the notion China is gearing up again after its weaker second quarter performance. U.S. lawmakers took steps toward approving a bill designed to protect against Chinese imports. Could a U.S./China trade war be looming? Stay tuned.

Greenback Woes

An eight month low for the U.S. dollar helped bolster commodity prices this week. Gold is setting all time highs above $1 300/oz and Oil pushed through the $80/bbl level. Continued poor economic data out of the U.S. keeps the prospect of further Quantitative Easing (November) on the front burner for investors.

Looking Forward

We are now in the final quarter of the year. Next week, we have another full economic calendar from which the markets will take direction. All eyes will be on Friday’s U.S. employment situation report for September. Markets anticipate a modest, but positive gain of 5,000 new jobs for the month. In August, payrolls fell a surprising 54,000, so investors will get to see if the U.S. employment situation is at the very least showing signs of stabilizing. With summer over, the unemployment rate is expected to tick higher to 9.7% as more job seekers resumed their search. The smorgasbord of data will also include U.S. Pending Home Sales (Monday), more consumer confidence data (Tuesday), and the regular weekly unemployment claims (Thursday). Markets will take their cues primarily from the U.S. data, but Canada is expected to show (on Friday) it added another 1 0,000 new jobs in September. This follows the surprising gain of 36,000 new positions in August. The Canadian unemployment rate is expected to fall to 8.0%, but sadly this is unlikely to move anyone’s needle.

Third quarter Earnings Season also kicks off on Thursday when Alcoa unveils their most recent earnings results. Standard & Poor’s estimates a 31% increase in corporate earnings versus the same quarter last year. Thomson Reuters expects a more modest 24% increase but either way, Earnings Season should prove mostly supportive of stock prices. However, keep in mind 77 S&P 500 companies have already issued profit warnings; far more than last quarter. This time earnings will be scrutinized to see what effect this summer’s economic speed bump had on sales given the weak employment and housing markets. Companies have continued to focus on cost cutting but it will be interesting to observe what impact soaring commodity prices (wheat, corn, and copper) had on the bottom line. Historic low bond yields have enabled many companies to refinance debt at low rates. Lower interest expenses support higher earnings but growing cash balances also earn next to nothing and become a drag on profitability and return on equity. On a sector basis, Financials are expected to have the greatest year over year earnings growth (+48%). Industrials, Technology, Energy, and Materials are the other four sectors expected to have earnings growth that outpaces the broad index.

Question of the Week

Are Bonds in a Bubble?

A critical question for high net worth investors especially today with ‘cautious’ investors herding into bonds pushing yields to record lows. Bond investors are taking comfort the Federal Reserve (FED) is on their side. That is, the FED is expected to line up as a buyer of bonds when Quantitative Easing 2 (QE2) is launched. Keep in mind, the biggest risk bond investors are taking today is inflation risk. Those who invested in long term bonds in the 60s just before inflation surged actually lost money in real terms over the next 20 years. The goal of Quantitative Easing is to coax economic activity and revive price inflation. Quantitative Easing usually works best when done in large volume ($1 Trillion) so expect the FED to go big if they do in fact launch QE2. So while they may be acting as the bond investors’ friend today, watch out if they achieve their objective of reviving inflation. Bond investors may want to break the silo of bonds are ‘good’, stocks are ‘bad’ and consider dividend paying, blue-chip companies as an alternative.

Copyright (c) Richardson GMP Ltd.

Tags: Bank Of Canada, Bank Of Canada Governor, Buying Stock, Canadian Consumers, Canadian Economy, Canadian Market, China, Commodities, Consumer Confidence, Copper Gold, Economic Data, Economic Uncertainty, Interest Rate Hikes, Investor Demand, Jobless Benefits, Mark Carney, Mixed Signals, New Highs, oil, Private Client, Qe2, Silver, Stock Indexes, Stock Markets, Toronto Stock Exchange
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Eric Sprott: “Wither Green Shoots”

Monday, July 12th, 2010

This article is a guest contribution by Eric Sprott & David Franklin, Sprott Asset Management

With the summer now upon us, the “Sell in May and Go Away” adage has proven itself true once again. The major market indexes are all turning downward, and while they haven’t dropped enough yet to warrant panic, we certainly want to be positioned properly if this trend continues into the fall. The market tea leaves are no longer sending mixed signals either – most of the new data is decidedly bearish. So what happened to all the ‘green shoots’? What happened to the strong recovery the market rally was promising?

Economic data released over the past two weeks have decimated any remaining belief in a lasting economic recovery. Slowdowns are appearing in the US, Europe, Japan and even China. Auto sales, housing starts, employment, consumer confidence, factory orders, consumer purchase intentions – just about every aspect of the economy that can be measured, is showing decided weakness.

Of particular interest to us over the past year has been the GDP forecasts released by The Consumer Metrics Institute in Colorado (“CMI”). CMI caught our attention with their real time tracking of consumer retail sales data. Consumer spending represents 70% of GDP, and that spending can provide great insight into the workings of the underlying economy. CMI’s retail sales data has indentified a long, negative contraction in the economy based on their data set for the last 180 days. This was confirmed most notably in Walmart’s poor first quarter sales results when CFO Tom Schoewe stated, “More than ever, our customers are living paycheck to paycheck.”¹ If that sentiment applies to other large retailers, it doesn’t bode well for 2010 GDP.

CMI also predicted 2010 Q1 GDP growth at 2.62% all the way back in November 2009. It took nearly seven months for the actual US GDP data to eventually be released, but when it finally did (after three revisions, no less) it turned out that CMI’s prediction was bang on. Interestingly, when the real data came out, CMI founder Rick Davis noted that the inventory component underlying the 2.7% Q1 GDP growth figure had moved from 1.65% up to 1.88% – meaning that the bulk of GDP growth, almost 66%, actually came from inventory swings rather than consumer demand. No wonder factory orders fell out of bed this past week! With the re-stocking complete, there aren’t enough new orders to clear the fresh inventory. And if two thirds of Q1 growth came from inventory swings (or just plain re-stocking etc.), it makes us wonder what we can realistically expect from the next two GDP announcements. CMI provided the following guidance for the balance of the year, stating that “We expect GDP growth to be flat for the second quarter, but with inventory adjustment reversals absolutely killing the reported ‘growth’ number just four days before the U.S. mid-term elections.” If that turns out to be correct, it will be unfortunate timing for the elections.

An important question to ask is whether the March ’09 rally was really justified at all. Were the green shoots real? Or was the market just looking for a way to justify the effects of government-induced ‘easy money’? The stock market is supposed to be an efficient, forward-looking indicator after all – and the rally that began in March ’09 was supposed to signal a robust recovery. So where’s the recovery? From the time the term ‘green shoots’ was first uttered by Ben Bernanke on March 15, 2009, the S&P 500 rallied 36% to June 30, 2010 and by as much as 60% to April 26, 2010. If the green shoots were really just the early indications of weeds, was the market wrong to appreciate so dramatically?

Tags: China Auto, Cmi, Consumer Confidence, Consumer Spending, David Franklin, Economic Data, Economic Recovery, First Quarter Sales, Gdp Forecasts, GDP Growth, Gold, Living Paycheck To Paycheck, Major Market Indexes, Market Rally, Mixed Signals, Paycheck To Paycheck, Purchase Intentions, Retail Sales Data, Tea Leaves, Us Gdp Data, Walmart
Posted in China, Gold, Markets, US Stocks | Comments Off

Crispin Odey: Markets Giving Misleading Signals

Thursday, March 5th, 2009

Crispin Odey, CIO, Odey Asset Management, shares a wealth of insight in his 2008 year-end Letter to Shareholders reflecting, in the following excerpts, on the mixed signals the markets are sending about valuations, and commodities. Unlike his former protege and partner, Hugh Hendry, who is avoiding equities for the time being, and long long-term government bonds, Odey likens the current pricing climate in bank shares, “like trading options,” and believes there will be a bear market in bonds within 12 months. Read on:

“Keynes believed that economics was a polemical science. He made economics popular and powerful because he abstracted ideas that in the workaday world looked sensible and showed them to be dangerous if followed by everyone. Thus he changed the way that policy makers and people thought. Has there been a better time to renew the challenge?”

“Given that all of this is a long way away from being accepted we must reluctantly conclude that the world economy is not yet in a recovery position. The recession only started to get into its stride in September of last year. Most companies will have been guilty of over-trading as they have sought to cover falls in orders by accepting any orders. They will be finding themselves with customers going bust and inventory still rising. Profit numbers will be dire. The only good news is that at some point the survivors will be able to charge more for less, and margins will be higher on the other side of this hill”.

“Current investments come about from the outstanding opportunities being opened up by the pain from the falls in share prices that we have seen over the last year. This anguish is sorely felt by us all but it is also the time to be investing. We have become big buyers of the UK clearing banks. This reflects quite how cheap they are. The shares are trading like options. After Northern Rock and Lehman Brothers, many are now convinced that they will be nationalised. However, the government has realised that nothing is solved by nationalising them, and in the UK’s case, that there is everything to be gained from letting them live. In an election year who else has Brown got to blame?”

“Given that on the other side of this disaster these banks can earn multiples of their current share price, the risk/return is wrong. In many ways these purchases remind me of Marconi, when the share price fell to 10p but the lack of covenants on the £4 billion bank loan meant that it could not be bankrupted for four years. We made 450% on that trade. Hopefully these banks will fare better and for longer. Given time and distance they will be fine”.

“This is because the markets have been giving misleading signals for some time. Wheat is a typical example. There is barely any surplus supply over demand in wheat. Yet last year farmers found themselves with rising input costs, thanks to the oil and fertilizer price hikes, and then falling incomes with wheat prices that were some 60% off their highs. They had one of their worst years ever. As a result this year plantings are way down, farmers are distressed and in Brazil and Argentina facing droughts. The wheat price is likely to soar”.

“All in all I expect that within 12 months government bond markets will go into a bear market which may be long and protracted. The stockmarkets remain good value and would prosper after some worries if inflation came back and my portfolio should do quite well in that environment. However it remains hard work in the main”.

Hat tip: Jonathan Davis, Independent Investor

Tags: Anguish, Asset Management, Bear Market, Better Time, Brazil, Bust, Clearing Banks, Crispin Odey, Excerpts, Government Bonds, Hugh Hendry, Keynes, Lehman Brothers, Letter To Shareholders, Margins, Mixed Signals, Recession, Recovery Position, Share Prices, Valuations, Workaday World, World Economy, Year End
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