Your Weekly Update

Another spotty week for economic data, and yet the S&P 500 and the Nasdaq Composite indexes posted new all time highs. Go figure!

So what gives? My best guess is that the data suggest that the U.S. economy---despite the coming weak Q1 GDP number---is in decent enough shape to avoid recession in the foreseeable future, but not robust enough to get the Fed itching to raise interest rates before, say, the very end of this year. That keeps traders interested enough to buoy stock prices enough to entice return-hungry investors to join the party. 

While that may sound hunky-dory, trust me folks, we really need more to go on if this bull market is going to go on a lot further. As I type, 201 of the S&P 500 companies have reported Q1 earnings  and revenue results. And while a whopping 77% of those beat analysts' earnings estimates (that had been ratcheted noticeably lower), only 47% beat the estimates on revenue. And while earnings growth has come in thus far at a decent-enough 6.55% pace, revenues are essentially flat, at +0.25%. And this is with only 11 of the 41 energy companies in the S&P having reported. So, therefore, the growth rates are indeed coming down before it's all said and done.

But of course this is not breaking news---which means the reality of the previous paragraph virtually has to already be discounted in the price of your average share of stock. So then, traders/investors are either, as I suggested above, simply resigning to the fact that, in the present environment, stocks are the only game in town, and will remain so at least till the Fed begins tightening , or are, like me, optimistic over the U.S.'s economic prospects going forward---and hope that that translates into revenue gains, as well as the kind of confidence among businesses that'll lead to productivity-enhancing capital investment.

Like I said in paragraph two, I'm guessing, for now, that it's the former. However, the latter is what would make the beginning of the Fed's next tightening cycle, at worst, a correction-inspiring affair, rather than a bear market-inducing event.

Next week is going to be huge in terms of economic data.  While the first reading of Q1 GDP will be on everyone's watch list (due Wednesday), I'll be paying particular attention to Thursday's release of the Employment Cost Index (ECI). The ECI---which measures the cost of most companies' largest input---is huge as an inflation gauge, and is closely monitored by the Fed. Also, the Fed's meeting next week will be very much in focus. I don't expect any fireworks coming from this particular meeting. 

I'll get into the weeds this week by adding a paragraph under each of the indices/sectors I report on---offering my thoughts on each as well as what's behind the good, or not so good, year-to-date results.

The Stock Market:

For starters, I'll repeat last week's opening paragraph:

Non-US markets continue to measurably outperform the U.S. in 2015. Don't be surprised if that remains the story throughout most of the year. That said, there are a number of potential international hot buttons that could easily delay the narrowing of the gap between the valuations of U.S. and non-U.S. securities. That's why we think long-term and stay diversified!

Once or twice each week I update a spreadsheet that tracks a number of personally-selected valuation metrics for the S&P 500 Index, the Russell 2000 (small cap) Index, the indices that track major sectors in the U.S., as well as twenty different regions and individual countries. I then color code each as a visual to share with clients during our portfolio review sessions. 

In the following, when referencing an index that I include on my valuation spreadsheet, I'll highlight the title---which will include its year-to-date performance---accordingly. Green for attractively valued, yellow means I'm neutral, red means it's expensive. 

Note: if you happen to be reading this on an Apple device in the “reader view” you won’t see the highlights. You’ll have to exit reader view to get the visual…

Keep in mind that while, as you'll see below, I find value in various pockets of the U.S. equity market, at any moment the market can and will punish any and all sectors, regardless of how advisers/investors may feel about their present valuations or prospects.

Dow Jones Industrials:  +2.13%

The Dow is the index I quote most often on TV and in my audio commentaries. Not because it’s by any means the best market measure, but simply because it’s the one most folks identify with. It’s simply a price-weighted index of 30 select large U.S. companies. I don’t maintain valuation stats on the Dow.

S&P 500:  +3.47%

The S&P 500, which is comprised of, interestingly, 502 (due to the inclusion of different share classes of a couple of companies) companies' stocks, is a legitimate benchmark for the U.S. large cap universe.

The S&P is, in my view, very close to what I’d consider fully, or fairly, valued. I.e., In terms of valuation, I’m not crazy bullish nor bearish on the prospects for the broad U.S. market at present. We’re going to have to see a pickup in earnings to go with the inevitable pickup in interest rates if this bull market is going to make it far into the next Fed tightening cycle. An earnings pickup can come by way of greater revenues, greater productivity (or both), or yet more financial engineering (share buybacks). While I have nothing against share buybacks, the former two are what we want to see.

NASDAQ Comp:  +7.94%

Just last week, the Nasdaq finally eclipsed its all-time high set way back in the year 2000. While that may spark fear in the hearts of those who suffered the wrath of the most ridiculous of bubbles (the tech bubble explosion), there are two things that should entirely eliminate all remnants of that PTSD. One would be inflation, which if it's run at, say, 2.25% per year since 2000, the index still has quite a ways to go before besting it's old record. My calculator says 6,800+ --- it closed Friday at 5,092.

The second would be the fact that today's Nasdaq Composite is not your father's Nasdaq Composite. Roughly two-thirds of the 2001 index was dedicated to tech stocks (many of whose names I've forgotten, although I do recall they all ended in dotcom); tech stocks today comprise 43% of the index (companies that actually make money, such as Apple, Google and Cisco Systems, to name a few). Consumer services were 8.7% of the index back then, today they're 21%. Healthcare was 9.2%, today it's 16.2%...  You get the picture.

I don't keep tabs on the Nasdaq Composite's overall valuation, but as you'll see below, I closely track its sectors.

EFA (Europe, Australia and the Far East [EAFE]):  +10.78%

The EAFE Index tracks the developed world outside the U.S.. While I keep tabs on the countries that comprise the index separately, I also do the valuation exercise for the EAFE Index itself. It's presently attractive in my view.

In addition to looking relatively attractive from a valuation standpoint, much of the world that comprises the EAFE resides under the monetary policy of central banks that are pulling out the stops to try and stimulate their economies solidly into expansion mode. While I'm no fan of the notion that a country can print its way to prosperity, this is a strong signal that those economies have yet to leave the runway after that last great recession (i.e., there's lots of room to run). Plus, I recognize the inflation impact such practices tend to have on asset prices (which is one of the intended transmission effects of easy monetary policy). Where valuations are compelling, this is icing on the cake.

FEZ (Eurozone):  +7.39%

Despite the yellow valuation highlight---which is due to this year's rally in share prices outpacing forward earnings expectations---I remain bullish on the Eurozone for now. As I've reported, the zone's economies have been picking up, which, if it continues/accelerates, will put a fire under earnings expectations. Otherwise, ditto the EAFE explanation.

VWO (Emerging Markets):  +11.82%

The countries that comprise the emerging world are countries that are, well, emerging. Meaning, their citizens don't yet enjoy the advancements, nor generally the freedoms, we North Americans, Western Europeans, Australians and Japanese do, but they want to in the worst way. Thus, their economies---in terms of growth---have the potential to (and often do) outpace the developed world in a big way.

Those emerging populations are the targets of smart businesses the world over---both in terms of the opportunities to sell them goods and services as well as to put them to work producing goods and services. Inherent in such phenomenal growth potential lies, alas, phenomenal risk. So, for most clients, we go there somewhat lightly (compared to developed economies).

Emerging markets possess, by far, the most compelling valuations on my spreadsheet.

Sector ETFs:

IYH (HEALTHCARE):  +9.85%

Healthcare was not nearly my number one pick coming into this year. In fact my valuation spreadsheet had it colored red in January. However, to play a little just-in-case economic defense, I maintained my 10% exposure target in client portfolios. Since then, a pickup in the sector's projected earnings growth rate has turned it yellow (to neutral).

This year's thus far impressive run can be attributed to the surging biotech sector and a rash of M&A (merger and acquisition) activity. Healthcare (save perhaps for biotech) is not typically your major investment destination during an economic expansion---it's typically where you go when the economy is topping out and/or contracting (folks still buy aspirin when they can't afford Apple watches), hence the economic defense. 

I remain cautious on healthcare.

XLY (DISCRETIONARY):  +7.95%

In last year's year-end letter, I let readers know that---after under-weighting consumer discretionary (which turned out to be a good move) in 2014---I was becoming optimistic on the sector. Here's my last line from that commentary:

Factor in growing consumer optimism, an improving jobs/wage picture and lower energy prices, and one should feel okay about this space going forward. I’m recommending a solid 10% weighting for now.

In terms of valuation, during the course of this year I've gone from yellow to green to now back to yellow. From a cyclical standpoint, and from what I gather from the anecdotal evidence, I remain fairly optimistic on the sector going forward.

XHB (HOMEBUILDERS):  +5.48%

I came into this year very bullish on the housing space---valuations were compelling and I saw the fundamentals lining up very favorably. And, despite the recent pullback (knocking it from its number one performing sector perch), I remain very much a bull.

Speaking of the mixed data, here are a few snippets from last week's log:

MORTGAGE PURCHASE APPS continue to show strength, up 5.0% last week. Once again supporting my optimism for homebuilders/housing-related stocks going forward.

THE FHFA HOUSE PRICE INDEX shows prices rising .7% in February. And 5.4% year-over-year. One major complaint of late over housing is lack of inventory... a problem that should be alleviated largely by higher pricing...

EXISTING HOME SALES IN MARCH jumped 6.1% to a 5.19 million (or 10.4%) annual rate. This would be the best reading, in terms of the number, since September 2013. In percentage terms, it's the best reading since December 2010. The year-over-year rise in the median price of a single family home is up 7.8%, which is the best reading since last February.

As I've suggested of late, higher pricing should bring more inventory to market, which appeared to occur in March for existing homes (2.0 million vs 1.9 million in February). That said, inventories remain historically tight (when we consider how many months at present pace of sales it would take to sell every existing home currently for sale), at 4.6 months.

NEW HOME SALES came in surprisingly weak in March, at 481k versus 539k prior and a consensus estimate of 518k. This of course does not support my optimism for the sector going forward. Despite today's number, and last week's below-expectations starts and permits, what I'm seeing in supporting stats (homebuilder confidence, demographics, household formations, interest rates, a very tight rental environment, not to mention valuations [specifically the PEG ratios]---in the aggregate---for the companies comprising the homebuilder index ETF we use) keeps me bullish on the sector.

XLK (TECH):  +4.73%

Technology stocks are attractively valued in my view. The index I track sports a lower P/E than that of the S&P 500, with an expected earnings growth rate that's 10% higher. Plus, tech is a winner when companies invest (which they're in a position to), and the big tech names are very multi-national in terms of where they do their business. Hence, as other economies begin to catch up to the U.S., and as the dollar calms down,  good things may be in store for tech stock investors.

XLE (ENERGY):  +4.26%

If you had told me a month ago that last week would mark the 14th straight for crude oil inventory gains---on top of a supply number penetrating an 80-year high---that the S&P Energy Index would be up  over 4% on the year, I would've probably said "you could be right", but I sure wouldn't have bet on it.

In fact, despite the amazing freefall of oil prices, and energy stocks, leading up to the recent rally, energy is highlighted bright red on my valuation sheet. That's because earnings expectations for many of these companies have plummeted even further than have their share prices. Despite my skepticism over the recent bounce in oil, and oil companies' share prices (i.e., I'm not yet a believer), I'm not counting out energy as a viable long-term hold going forward. Therefore, while I'm not presently a buyer, I'm not a seller either...

XLB (MATERIALS):  +3.85%

Thanks to a rising dollar and a slowing China—and no doubt a few other things—commodities/materials have not been the place to be thus far in 2015. That said, after a decent run of late, the materials sector—as represented here by XLB (which is heavily weighted to chemical companies)—has done okay on a year-to-date basis. My general optimism over the economy, and housing construction, going forward bodes well for the sector.

XLP (CONS STAPLES):  +2.06%

Consumer staples sit with healthcare as a place people's money frequents even when it's in short supply. I.e., when folks are not inclined to buy cars and computers, Kraft still sells truckloads of mac n' cheese.  For defensive reasons, our typical client portfolio has roughly 10% exposure to staples, despite it showing up red (expensive) on my valuation spreadsheet. We'll likely go there in a much bigger way when the next economic contraction is threatening.

XLI (INDUSTRIALS):  -0.01%

The multinational nature of the major industrial players (and, therefore, their sensitivity to currency fluctuations), an overall decline in government investment (think aerospace and defense), the thus far absence of major capital investment on the part of businesses, and the year-to-date weak performance of the transportation sector have served to hold the industrials at bay so far this year.

In that the above, save perhaps for government spending, are cyclical affairs, there's a decent chance that ultimately the industrial sector will gain some traction. And, as the highlight implies, they're relatively attractive at these levels.

XLF (FINANCIALS):  -1.46%

Financials look compelling to me going forward. Particularly if the inevitable rise in interest rates coincides with a continued expansion. In such a scenario, borrowers are aplenty (recall my optimism over housing), and banks enjoy a higher net interest margin. Plus, I have to believe that the worst of the litigation risk is behind them.

IYT (TRANSPORTATION):  -2.80%

If I had to pick just one U.S. sector to buy at this moment, transportation would be it. While you might have guessed homebuilders, which would definitely be in the running, I'd have to go with transportation due to---by my calculations---its really cheap valuation.

So why, amid cheap valuations, a growing economy and lower energy prices, is the sector down on the year? That would be partly due to underperforming railroads suffering from less business from the energy sector and less cross international border traffic stemming from a rising dollar. Add mixed results from the airlines and UPS's Q4 miss and spotty outlook, taking Fedex with it, and you have the recipe for lower share prices in the transportation sector.

Assuming the economy remains in expansion mode going forward, and energy prices don't regain their pre-crash level anytime soon, the attractive valuation of the transportation space makes it a must have in a diversified portfolio.

XLU (UTILITIES):  -3.64%

If I had to pick one sector to avoid at all costs, at this moment, utilities would be it. After last year's amazing run, they are crazy-expensive by my calculations and are the definition of interest rate sensitive. So much so that I won't even go there as a just-in-case defensive play (they are akin to healthcare and staples in that regard) at this juncture.

Other U.S. indices/sectors on my valuation sheet that I don't report to you on weekly are: The Russell 2000, Telecom Services and REITS.

To put the above commentary in proper context, PLEASE READ THE FOLLOWING on volatility and market timing that I posted back in February:

In last weekend’s commentary I attempted to put a rough January into proper perspective by urging you to view the stock market as an “antifragile” (benefits from stress) entity. Again, periodic market downturns are an essential aspect of the long-term investing process. As I stated in our year-end letter, and several commentaries since, I expect financial markets in 2015 to exhibit the kind of volatility that will challenge the resolve of many a short-term investor. Good thing you and I think long-term!

One additional note on volatility: The past couple of weeks I’ve shared with you the very short-term results for markets and sectors. I do this with a bit of hesitation, as I in no way want to give the impression that you, nor I for that matter, should base our long-term investment decisions on short-term movements in markets or their sectors. It can, however, serve as a reference point for how the markets are, or are not, responding to the data (which is why I, as a professional, track the short-term). As you may have noticed, my beginning of the year optimism over non-US and the housing sector (to name two), and pessimism over utilities, appears to be justified by recent results. I need to strongly (very strongly!) emphasize that I was not predicting what we’ve experienced these few short weeks into 2015. My optimism or concerns are based on factors such as valuations, trends, monetary policy and cyclicality—and my comfort in making allocation recommendations rests on the view that our clients are not short-minded investors (it can take awhile, if at all, for the market to reward what I believe to be good fundamental logic) who mistakenly believe that any human being possesses a capacity for market timing. Some people get lucky from time to time, but without exception, market timers are wrong far more often than they are right. The path to long-term investment success is fraught with bumps and potholes. The ones who successfully make the journey take it slow and never over-compensate when steering through and around the inevitable obstacles along  the way.

The Bond Market:

As I type, the yield on the 10-year treasury bond sits at 1.91%. Which is up from last week's 1.87%. As you'll see below, last week was, on balance, another less than inspiring one  in terms of U.S. economic indicators. Despite the apparent weakness, yields backed up a bit. While the 10-year treasury has moved in a fairly tight range of late, the bias in the bond market may be starting to trend toward higher inflation going forward.

Like I said last month , I see bonds in general sporting a risk/return trade-off that makes going out on the yield curve not worth the risk---and I'm sticking firmly to that story.

Here are last week’s U.S. economic highlights:

APRIL 20, 2015

THE CHICAGO FED NAT'L ACTIVITY INDEX confirms that the first quarter was quite weak for the U.S. economy. Here's Econoday:

March was not a good month for the economy, an assessment confirmed by the national activity index which fell steeply to minus 0.42 vs an already weak and downwardly revised minus 0.18 in February. And the first quarter as a whole was also weak, reflected in the 3-month average which came in at minus 0.27.

The production component, also at minus 0.27, pulled down the index the most in March followed by personal consumption & housing at minus 0.13. Employment also pulled down the index, at minus 0.3 for a big swing downward vs February's plus 0.11. The only component in positive ground in March, and only barely, was sales/orders/inventories at only plus 0.01.

APRIL 21, 2015

THE JOHNSON REDBOOK RETAIL REPORT FOR LAST WEEK, due to Easter falling in early April, should be disregarded. The year-over-year comparison, given that Easter occurred in late April last year, is greatly distorted... Retail sales are expected to return to their 3%+ rate once the distortion passes.

APRIL 22, 2015

MORTGAGE PURCHASE APPS continue to show strength, up 5.0% last week. Once again supporting my optimism for homebuilders/housing-related stocks going forward.

THE FHFA HOUSE PRICE INDEX shows prices rising .7% in February. And 5.4% year-over-year. One major complaint of late over housing has been a lack of inventory... a problem that should be alleviated largely by higher pricing...

EXISTING HOME SALES IN MARCH jumped 6.1% to a 5.19 million (or 10.4%) annual rate. This would be the best reading, in terms of the number, since September 2013. In percentage terms, it's the best reading since December 2010. The year-over-year rise in the median price of a single family home is up 7.8%, which is the best reading since last February.

As I've suggested of late, higher pricing should bring more inventory to market, which appeared to occur in March for existing homes (2.0 million vs 1.9 million in February). That said, inventories remain historically tight (when we consider how many months at present pace of sales it would take to sell every existing home currently for sale), at 4.6 months.

THE EIA PETROLEUM STATUS REPORT showed crude inventories rising by a very large 5.3 million barrels last week. I find it a bit intriguing (but not necessarily bewildering) that oil prices have rallied of late against 14 straight weeks of inventory builds adding to an 80-year high. Clearly, traders see the massive cut in U.S. rig counts, among other things, ultimately leading to production cuts sufficient to turn the supply/demand tide. Ultimately, that makes sense, but for now the producers aren't missing a beat. I'm not at all convinced, just yet, that oil has found its bottom. GASOLINE INVENTORIES fell 2.1 million barrels and DISTILLATES rose .4 million.

APRIL 23, 2015

WEEKLY JOBLESS CLAIMS continue to paint a positive picture of the jobs market. Below 300,000 is, historically-speaking, solidly in expansion-mode. Last week's number was 295,000. The 4-week average---a better metric in that it smooths out the bumps---is currently 284,500. Continuing claims, always reported with a 1-week lag, were 2.325 million, with a 4-week average of 2.309 million. The unemployment rate for insured workers remains at a 15-year low of 1.7%.

MARKIT'S FLASH PMI INDEX FOR APRIL paints the same (of late) discouraging story for manufacturing. While above 54.2 is solidly in expansion territory (above 50), the trend has been on the decline. What is on the rise, and very importantly I might add, is the employment component---which speaks favorably about confidence in the sector going forward.

THE BLOOMBERG CONSUMER COMFORT INDEX shows folks losing a bit of their optimism---declining for a second straight week. Although I should add that that's coming off of a nearly 8-year high. Here's the release:

Consumer Comfort in U.S. Falls for Second Week on Finances View

By Nina Glinski

(Bloomberg) -- Consumer confidence retreated for a second week after reaching an almost eight-year high as lower- and middle-income Americans’ views of their financial well-being dimmed.

The Bloomberg Consumer Comfort Index fell to a five-week low of 45.4 in the period ended April 19 from 46.6. Sentiment of those earning less than $50,000 a year was the weakest in almost two months, while those at the highest end of the income scale were the most upbeat since August 2007.

“Heightened economic disparity may be related to countervailing trends,” Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. A well-performing stock market is boosting spirits of higher income households, while “lagging wage growth combined with disproportionate low-wage job creation” limits sentiment among lower-income individuals, Langer said.

The employment picture softened somewhat in March with payrolls advancing the least since 2013 as businesses in energy-producing states cut back. Average hourly earnings rose 2.1 percent from the same month last year, in line with the pace since the end of the recession in 2009.

Even with last week’s decline, the sentiment gauge remains well above last year’s average of 36.7, which was the best since 2007.

The measure of personal finances fell to a six-week low of 56 from 58.4. A gauge of the buying climate, showing whether this is a good time to purchase goods and services, decreased to 42.5 from 43.7 the prior week, while the index of views on the state of the economy were little changed.

Income Groups

Workers earning between $15,000 and $25,000 a year saw the biggest decline in comfort last week, dropping 5.6 points to 25.7, the lowest level since December. The measure for individuals earning $100,000 or more rose for the sixth straight week.

Benchmark stock indexes hovering near records are boosting the financial picture for households with investment portfolios, which are typically those at the upper end of the income scale

Home prices also advanced more than forecast in February, increasing homeowners’ net worth. Prices climbed 0.7 percent on a seasonally adjusted basis from January, the Federal Housing Finance Agency said in a report Wednesday.

NEW HOME SALES came in surprisingly weak in March, at 481k versus 539k prior and a consensus estimate of 518k. This of course does not support my optimism for the sector going forward. Despite today's number, and last week's below-expectations starts and permits, what I'm seeing in supporting stats (homebuilder confidence, demographics, household formations, interest rates, a very tight rental environment, not to mention valuations [specifically the PEG ratios]---in the aggregate---for the companies comprising the homebuilder index ETF we use) keeps me bullish on the sector. Econoday does a good job summing up the results:

One day up, one day down is a fit description for recent housing data. Last week's declines in housing starts & permits were a surprising blow to the outlook, reversed in part by yesterday's very strong report on existing home sales. But today it's bad news again as new home sales fell a very steep 11.4 percent to a 481,000 annual rate.

The bulk of the decline came in the largest region, the South, where sales fell 15.8 percent. The drop here does follow a 9.3 percent gain in the prior month but the latest result is not good news for the region's builders. Also contributing to the decline was the Northeast, but sales in this region are very small, as well as the West, a much larger region where sales were down 3.4 percent. Sales in the Midwest rose 5.9 percent in the month.

More new homes actually came onto the market in March, up 4,000 to 213,000 nationwide, but supply relative to sales rose sharply because of the drop in sales, to 5.3 months from 4.6 months. This reading, however, is still pretty thin and won't scale back builder plans.

Softness in sales is confirmed by price data where the median price fell 1.5 percent to $277,400. Year-on-year, the median price is down 1.7 percent while sales are up 19.4 percent, a discrepancy that points to price discounting by builders.

It's difficult to draw firm conclusions from this report because of the sample size which is often small and therefore increases volatility in the readings. But today's report echoes last week's housing starts & permits data and points to stubborn weakness in the new homes market.

NAT GAS INVENTORIES rose 90 billion cubic feet last week to 1,629.

THE FED BALANCE SHEET rose $4.3 billion last week to $4.49 trillion. RESERVE BANK CREDIT decreased by $1.4 billion.

M2 MONEY SUPPLY declined by $40.6 billion last week, after rising $78.9 billion the week prior.

APRIL 24, 2015

THE ADVANCE REPORT ON DURABLE GOODS FOR MARCH, at first blush, looked pretty good, up 4%. Strip away transportation, however, and the report looks pretty bad, -.2%. Given recent poor productivity reports I'm looking intently at capital goods orders and expectations. Both of which do not look promising going forward.. Of course, the prospects for capex in the energy sector are abysmal, which is no doubt impacting the data...