You are in the post office about to send a gift, a package full of champagne glasses, to a cousin in Central Siberia. As the package can be damaged during transportation, you would stamp "fragile", "breakable", or "handle with care" on it (in red). Now what is the exact opposite of such a situation, the exact opposite of "fragile"?
Almost all people answer that the opposite of "fragile" is "robust", "resilient", "solid", or something of the sort. But the resilient, robust (and company) are items that neither break nor improve, so you would not need to write anything on them---have you ever seen a package with "robust" in thick green letters stamped on it? Logically, the exact opposite of a "fragile" parcel would be a package on which one has written "please mishandle" or "please handle carelessly". Its contents would not just be unbreakable, but would benefit from shocks and a wide array of trauma. The fragile is the package that would be at best unharmed, the robust would be at best and at worst unharmed.
We gave the appellation "antifragile" to such a package: a neologism was necessary as there is no simple, noncompound word in the Oxford English Dictionary that expresses the point of reverse fragility. For the idea of antifragility is not part of our consciousness---but, luckily, it is part of our ancestral behavior, or biological apparatus, and a ubiquitous property of every system that has survived.
Nassim Taleb, in his latest book, Antifragile, Things That Gain from Disorder, from which the above was taken, writes about the things that get better when they experience stress. We're talking muscles, brains, emotions, economies and, yes, stock markets.
You may understand intellectually the importance of stock market corrections, bear markets even. You've heard yourself acknowledge that the market can't go up forever, that it's healthy for it to take a breather every now and again. Same for the economy, you understand that it simply can't expand forever, and when it advances for too long and has been intervened upon too much, bubbles form, then pop. You, in essence, know of this "ubiquitous property of every system that has survived". Ah, but when the developments you say are healthy begin to develop, when gloom hits the headlines, when your portfolio contracts, you become worried, you see darkness in your financial future, you fear that the market may never recover, or that you may not live long enough to experience the "good" times again. Amid a declining stock market, you abandon your wisdom.
But---despite your anxiety---you were right to begin with, corrections and bear markets are indeed antifragile. Balance sheets get clean, poorly run companies fail (if they're not, alas, bailed out that is), profligates get frugal, stuff gets cheap and crooks get caught. Yes, the market gets better when its numbers get worse.
This is me splashing cold water on your face, slapping you back into reality---just in case you're beginning to fret over recent volatility.
According to Bloomberg, in January the Dow dropped 3.69%, the S&P 500 was off 3.10% and the NASDAQ declined 2.13%. Some sectors did better than those major averages, some worse. Non-US (save for commodity dependent countries), for the most part, finished the month ever so slightly in the green. So, frankly, we ain't even close to a legitimate correction (<10-20%>) at this point. I'm guessing (just guessing) that I'll have more opportunities to evoke your wisdom in the weeks and months to come.
This week I'll update last week's themes, and add one more, earnings.
Last weekend I reported on the amazing symphony of central banks---the worldwide (save for the U.S.) easing of monetary policy. As for this past week, it was all about the U.S. central bank. The Fed held its two-day policy meeting and unanimously voted to leave interest rates as is, at zero. The post-meeting statement reiterated the members' patience, yet acknowledged the momentum in the labor market. I believe the Fed's optimism over employment spooked the stock market. I.e., while the incredible crash in oil prices is influencing the rate of inflation, it's presumed transitoryness makes for a heightened risk of inflation should oil begin to bounce as wages begin to rise.
I know, you're hearing pundits complain about the lack of wage growth. Well, believe me, they're either politically motivated, or don't understand economics. In terms of the latter: first there's the taking up of the labor market's slack, then, as the pool of qualified workers contracts, wages begin to rise. I believe, despite international weakness, despite the strong dollar, and despite the bulging bond market and skittish stock market, the Fed is very likely to push rates a bit higher in 2015. Which very well could put pressure on the stock market. And wouldn't that be wonderful, given the market's antifragility!
Last weekend I reported on the huge 10 million barrel build in crude oil inventories. Well, last week saw another huge build, 8.9 million barrels. While, as I reported, oil rigs are shutting down by the minute, U.S. producers haven't yet begun to let up on their most productive wells. Plus, and this is an important plus, refineries have slowed production (resulting in a piling up of crude inventories) as there exists a large wholesale supply of gasoline and distillates. This is unambiguously good for the U.S. consumer, as it puts further downward pressure on prices. But make no mistake, it can't last forever. Although it's likely to persist awhile with total inventories at, no kidding, an 80-year high.
You may be hearing the experts talk about how cheap energy stocks have become and how, therefore, they present a huge buying opportunity. And while I can't help but agree that, long-term, folks buying now will likely do well, the idea that oil stocks have gotten cheap, if cheap means low valuations, is simply wrong. Cheapness when it comes to stocks has virtually nothing to do with share prices by themselves, it has to do with the level of per share earnings in relation to the price per share. For example, I recently researched one the world's biggest and best oil services companies. My first look at the company, several weeks ago, showed me a price to earnings (p/e) ratio of 16, with a p/e to earnings growth (peg) ratio of a little above 1 (that's attractive). Since then the stock dropped about 12% in price and then rebounded almost back to the price it was when I took that first look, which was still like 30% below where it peaked before oil took the plunge. But the thing is---despite the share price remaining way off its high---it's not nearly as cheap as it was a few weeks ago. Due to legitimately reduced earnings expectations it now trades at a 20 p/e and 1.5+ peg ratio. So, no, energy stocks aren't as cheap as some would have you believe. Although they could very well bounce in a big way when oil looks like it's finding a bottom (or before in anticipation).
As you'll notice in this week's economic highlights the consumer remains very optimistic about his/her future. Which showed up in the consumer spending reading in last week's GDP report as well as in the big December jump in new homes sales, 11.6%. However, interestingly, retail sales have been nothing to get excited about. That'll change if this optimism, and recent momentum in the jobs numbers, holds.
Briefly on Europe:
Despite deflation, Russia and Greece, the Euro Zone stock markets (save for Greece's), when compared to the U.S., held up pretty well in January. Euro QE's biggest detractor, Germany, saw its latest CPI number turn red (deflation), which makes ECB president Mario Draghi look all the more correct in his convincing his board members to go all in on massive bond buying (QE)---which led to the area's January outperformance.
As for Russia, Putin is not, these days, supporting my theory that he's become too much the global player to keep the Ukraine situation alive for long. I've read recent reports where he's giving his super-wealthy supporters the cold shoulder, as they've upped their pleas for him to find an end to the conflict. Clearly, the Russian oligarchs get it, but the man who counts, whose popularity, they say, remains high with his citizens, doesn't. Not, it seems, as long as he has billions in reserves with which to pay the bills. Should Putin wake up and find a face-saving way to save his economy, I believe Russian and Euro Zone stocks would give him quite the rising ovation. We'll see...
As for Greece:
In Friday's audio commentary I told you about a news flash that said Greece was essentially done with reform and wasn't interested in receiving any additional bailout money. I said that I didn't believe that to be a sustainable position, and even questioned the validity of the headline. Well, as it turned out Greece's new finance minister made a statement in Greek that was misinterpreted by a reporter. Newly-elected Prime Minister Tsipras was quick to quell the rumor. He told Bloomberg:
"The deliberation with our European partners has just begun," he said.
"Despite the fact that there are differences in perspective, I am absolutely confident that we will soon manage to reach a mutually beneficial agreement, both for Greece and for Europe as a whole."
Cockiness, and a willingness to promise whatever it takes, can win you an election when your people are desperate to hear what they want to hear. But when you take the reins of a country whose debt is 175% of its GDP you really don't have a lot to work with. And you can go from rock star to goat in a hurry when the people catch on that all those promises were literally unkeepable. Just ask the once popular French president Francois Hollande:
A Harris Interactive poll published on Monday found that 92 percent of respondents said they were not satisfied with Hollande's track record, with 96 percent saying he had not held to his campaign promises made before coming to power in 2012.
According to Bloomberg, the percent of S&P 500 companies that have thus far exceeded analysts' earnings expectations (226 having reported) is a whopping 78.32. But the thing is, the bar (expectations) had been lowered measurably. Still---lowered bar notwithstanding---you'd think the market would be rallying on such news. But it's not what companies earned yesterday that counts, it's what the expectations are for tomorrow's earnings that drives share prices. And being that big companies, the components in the major averages, do a substantial share of their business abroad, they're concerned about the impact of the strong U.S. dollar, as I explained last week.
That---voiced concerns over the strong dollar---has been no small contributor to recent volatility.
Having devoted much of last week's commentary to this topic, I'll leave it here for now.
As I've been promising, the global dynamics going forward could make for a very volatile 2015. If you're prone to worry, you might bookmark this one and refer back to the opening paragraphs if or when you feel that anxiety coming on. And if you're our client there's absolutely no reason to wait for our next review meeting if you'd like to get together and confirm that your allocation matches your temperament and time horizon. In fact, if you're ever feeling anxious, I strongly encourage it. So please don't hesitate to give us a call.
Here are last week's U.S. economic highlights:
JANUAR 26, 2015
THE DALLAS FED MANUFACTURING SURVEY shows factory output essentially unchanged in December, .7 (zero is breakeven). Other components showed sluggishness during the month. Capacity utilization, shipments and new orders all moved noticeably lower on the month. While the labor market components showed continued employment increases, sentiment about future business activity fell measurably. I suspect Texas's exposure to the energy sector is influencing sentiment in the state.
JANUARY 27, 2015
DURABLE GOODS ORDERS unexpectedly dropped 3.4% in December, versus a consensus estimate of 0.7% increase. Nondefense aircraft, plunging 55.5%, and defense aircraft down 19.9% acounted for much of the decline. Outside of transportation (autos rose 2.7% btw), fabricated metals and electrical equipment posted gains while primary metals, machinery, and computers and electronics declined. The rapidly rising dollar clearly isn't helping the durable goods number.
THE JOHNSON REDBOOK RETAIL REPORT shows same store sales running at a relatively slow 3.2% pace. The report cites weather as a factor. Recent consumer sentiment indicators and improved jobs numbers would suggest this reading will improve over the coming months.
THE CASE-SHILLER HOME PRICE INDEX shows signs of life, rising .7% for the composite-20 city index. I remain optimistic on the housing market going forward.
MARKIT'S FLASH SERVICES PMI shows the service sector growing slightly, at 54 in January, versus December's 53.6 reading. Despite the relatively slow growth, respondents continue to add to payrolls, although at a relatively slow pace. This would be another indicator that we'll likely see improvements going forward, given recent reads on the consumer.
NEW HOME SALES jumped an impressive 11.6% in December to an annual rate of 481,000, which is substantially higher than the consensus estimate. Another positive for the housing sector was the 2.2% monthly increase in the median price of a home ($298,100). The year over year price increase is a solid 8.2%. The sales gain brought inventories down to 5.5 months, from 6.0 months in December, which is a negative for January sales, but motivation for builders to pick up the pace. Again, I like the sector going forward.
THE CONFERENCE BOARD CONSUMER CONFIDENCE INDEX for January confirmed that the U.S. consumer is in a very good mood these days. The 102.9 reading topped the consensus estimate (96). This is the index's best reading of the recovery. Here's Econoday's commentary:
Consumer confidence is up very sharply this month, to a January reading and recovery best of 102.9 that is outside the Econoday forecast range (93.5 to 100.0). Gains sweep most readings including a 12.7 point surge in the present situation component to 112.6. Here, the jobs-hard-to-get subcomponent shows special strength in the jobs market, down 1.6 percentage points to 25.7 percent in a reading that is a positive indication for the monthly employment report.
The expectations component also shows strength, up 7.9 points to 96.4 with the income subcomponent up sharply. Strength in expectations for future income points to a combination of strength in the jobs market, the stock market, and also the positive effect of lower gasoline prices. Inflation expectations, reflecting lower gas prices, are steady at 5.0 percent which is very low for this reading.
Another positive in the report is a jump in vehicle buying plans in yet another indication of consumer confidence. Nevertheless, readings on consumer spirits, including this report, have been far outstripping actual gains in underlying consumer spending, at least so far.
THE RICHMOND FED MANUFACTURING INDEX, like most of other recent surveys, points to slowing in the manufacturing sector, with a reading of 6 versus last month's 7. Like the Dallas Fed Index, however, employment continues to expand, but at a slower pace of late.
THE STATE STREET CONSUMER CONFIDENCE INDEX shows institutional investor confidence easing a bit, 106.7 versus December's 112.1. While the European component comes in at a strong 113.9, it nonetheless represents a 6 point drop from last month. The report blames political concerns in Europe and global deflation for January's dip.
JANUARY 28, 2015
MBA PURCHASE APPLICATIONS were flat last week, off .1%. Refinances dropped 5%. This one will be interesting to watch going forward as, clearly, the housing market is showing signs of life...
THE EIA PETROLEUM STATUS REPORT continues to show huge builds of crude inventory, another 8.9 million barrels last week. At 406.7 million barrels, crude inventory is at its highest level in 80 years! Gasoline and distillate inventories, however, declined, by 2.6 m and 3.9 m barrels respectively. What we're seeing are high wholesale supplies of gas and distillates which is causing refineries to cut back on production, which exacerbates the rise in crude inventories. This does not offer much hope for a bounce in the price of oil anytime soon. Good news for consumers!
THE FOMC ANNOUNCEMENT following its 2-day policy meeting said that the Fed remains patient with regard to raising interest rates. The market sold off heavily on the day, and I suspect the Fed's commentary regarding the improving labor market had something to do with it. The Fed has previously cited slack in the labor market as a primary excuse for keeping rates at record lows. I believe the market sees an improving labor market as a potential impetus for getting the Fed off of zero.
JANUARY 29, 2015
WEEKLY JOBLESS CLAIMS plunged 43,000 to 265,000. This was way below the consensus estimate of 300k. This has been a most volatile indicator of late. Surely, the MLK holiday played its part. But of course last weekend wasn't the only 3-day weekend since April 2000, which was the last time we saw a reading this low.
THE BLOOMBERG CONSUMER COMFORT INDEX climbed yet again last week to a 47.3 reading versus 44.7 the week prior. This is the strongest weekly advance since March 2010. The optimism-on-the-economy gauge is showing its strongest reading in almost 8 years. The recent consumer reads are extremely bullish for the U.S. economy going forward, despite the recent weakness in manufacturing.
THE PENDING HOME SALES INDEX FOR DECEMBER completely bucked the recent uptrend in the housing indicators. The consensus estimate was for a .9% increase, and the number came in at -3.7%. Final sales of existing homes did rise last week, but the trend remains relatively flat. This one doesn't at all jibe with other recent indicators. Hmm...
NAT GAS INVENTORIES fell 94 bcf last week, to 2,543 bcf.
THE FED BALANCE SHEET dropped $12.9 billion, to $4.50 trillion.
M2 MONEY SUPPLY (currency, checking accounts, savings accounts, small time deposits and retail money market mutual funds) grew by $6.9 billion last week.
JANUARY 30, 2015
Q4 GDP (advance estimate) came in below expectations, at 2.6%. The number was weighed down a bit by an increase in imports, a decrease in government spending and---the only true negative in my opinion---decelerating nonresidential fixed investments. Personal consumption was a major positive, up 4%. Here's from the BEA report:
Real gross domestic product -- the value of the production of goods and services in the United States, adjusted for price changes -- increased at an annual rate of 2.6 percent in the fourth quarter of 2014, according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 5.0 percent.
The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4 and "Comparisons of Revisions to GDP" on page 5). The "second" estimate for the fourth quarter, based on more complete data, will be released on February 27, 2015.
The increase in real GDP in the fourth quarter reflected positive contributions from personal consumption expenditures (PCE), private inventory investment, exports, nonresidential fixed investment, state and local government spending, and residential fixed investment that were partly offset by a negative contribution from federal government spending. Imports, which are a subtraction in the calculation of GDP, increased.
The deceleration in real GDP growth in the fourth quarter primarily reflected an upturn in imports, a downturn in federal government spending, and decelerations in nonresidential fixed investment and in exports that were partly offset by an upturn in private inventory investment and an acceleration in PCE.
The price index for gross domestic purchases, which measures prices paid by U.S. residents, decreased 0.3 percent in the fourth quarter, in contrast to an increase of 1.4 percent in the third. Excluding food and energy prices, the price index for gross domestic purchases increased 0.7 percent, compared with an increase of 1.6 percent.
THE Q4 EMPLOYMENT COST INDEX increased at a 2.2% over the past year. This reading, which includes wages, salaries and benefits is noticeable higher than the 1.7% hourly earnings increase noted in the December employment report. Clearly, the average worker is doing better than some would have us believe. I believe we will see wages improve going forward as slack in the labor market appears to be abating.
THE CHICAGO PMI, which covers both manufacturing and services, paints a much better picture than other PMIs of late, coming in at 59.4. Here's Econoday's commentary:
Growth in the Chicago economy is strong and picking up steam, based on the Chicago PMI which rose to a January reading of 59.4 vs a revised 58.8 in December. Growth in new orders and growth in production both turned higher while, in a convincing sign of strength, businesses in the area picked up hiring to the highest rate since November 2013. Price data show the lowest level of pressure in 4-1/2 years. This report covers both the manufacturing and non-manufacturing sectors and typically runs hot relative to other data.
THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INDEX confirms that, per virtually every other survey of late, the U.S. consumer is feeling very good these days.... The reading for January is 98.1, with the current conditions component coming in at 109.3. The expectations component came in at 91.0.