If only the numbers made sense! How nice the world---the market---would be! Right?
Well, let's explore that notion:
What if "the numbers" made sense. What if "it" were as easy as "the numbers" lining up in a manner that told the world conclusively where it stood and what to expect going forward?
Well, if the numbers foretold of a growing economy, and jobs and corporate profits aplenty---and everyone agreed---who'd sell us a single share of their stock? Can you imagine how high stock prices would go if everyone interpreted the numbers in that manner? Could we even get a price?
A market is where seller meets buyer. Where the seller possesses an item that he values less than he does what he could buy had he the cash in the buyer's wallet. Where the buyer views the item in the seller's possession as the best trade for his cash. With all the information at hand, a transaction requires two parties who essentially disagree on the value of the items exchanged.
Investor A believes Disney stock is going to pop big time on the inevitable success of its new Star Wars franchise. Investor B owns the stock and believes that Star Wars' potential is already in the price---and believes the risk is to the downside if Disney's latest bet doesn't deliver. Hence, a transaction is born.
Investor A has analyzed JP Morgan up, down and sideways, and sees the recent selloff as a huge long-term buying opportunity. Investor B owns the stock and thinks the economy is weaker than the numbers suggest and, therefore, believes interest rates---and banks' net interest margins---will remain low, and that financial stocks en masse will, therefore, underperform when the Fed doesn't raise rates in 2015. And he'd prefer not to suffer what he's convinced will be some near-term pain. In this hypothetical, A is thinking in terms of years, B is thinking months. Hence, based largely on different time horizons, a transaction is born.
Investor A believes Disney, JP Morgan, Apple, Exxon Mobile and a host of other solid U.S. companies will grow their respective businesses and, thusly, their earnings well into the twenty-first century---regardless of the near-term direction of interest rates and/or the challenges presently facing emerging world markets. And he believes that trying to time the unpredictable stock market is a fool's errand. Investor B's portfolio is diversified in the above names and a host of other solid companies but has bought into the hyperbole of some gold-toting pseudo prophet (who will profit if he can incite global panic) and wants out, like yesterday! Hence, transactions are born.
You see folks, we're only human. And as author, and general surgeon, Atul Gawande---quoting social scientist Robyn Dawes---points out in Complications: A Surgeon's Notes on an Imperfect Science (his book on the power and limits of medicine):
... human beings are inconsistent: we are easily influenced by suggestion, the order in which we see things, recent experience, distractions, and the way information is framed. Second, human beings are not good at considering multiple factors. We tend to give some variables too much weight and wrongly ignore others.
So, with regard to my friend's concern over contradictions in the marketplace, she's absolutely right, contradictions abound! They always will. And---in that the market needs buyers and sellers---thank goodness!!
Sellers have the upper hand:
Despite the chorus of analysts who've been, like myself, suggesting no bear market looms based on generally solid economic fundamentals, the sellers of late are clearly maintaining the upper hand. As noted above, the sellers possess a different opinion and/or time horizon and/or temperament than do the folks (the buyers) who are happy to accommodate their desire to sell. While no one knows how the future will unfold, history offers up a bit of evidence that suggests selling amid declining markets would not be the optimal course of action for the long-term investor.
Let's use the very volatile, and presently price-depressed MSCI Emerging Markets Index as an example:
Had you invested $50,000 into a fund that tracks that index on January 1, 2000, you would have watched the value of your position plunge by 31.47%, bringing it to $34,265 over the course of the next 12 months. UGH! Had you, understandably, had enough at that point and surrendered your shares to some risk-tolerant, and patient, opportunist, here's how her $34k investment would have fared over the ensuing 10 years (according to Morningstar):
2001: +1.45% $34,762
2002: -4.54% $33,184
2003: +62.26% $53,844
2004: +30.66% $70,352
2005: +32.95% $93,533
2006: +31.06% $122,585
2007: +42.20% $174,316
2008: -50.27% $86,687
2009: +79.11% $155,265
2010: +18.41% $183,850
Here's Morningstar's chart if you'd like to extend the illustration through last year and/or do the exercise on other asset classes: click to enlarge
As I've reported numerously in recent months, business capital investment has run at a slower than your typical expansion pace throughout the life of the present recovery. This speaks loudly about why productivity has waned of late (although last week's nonfarm productivity number for Q2 came in noticeably better than economists had predicted) and why I warned back in November of last year that the Fed having waited far into the profit cycle to raise rates could bring on a nasty correction in stocks. I should note that in the following slice of that commentary the "expanding profit margins" I referred to were primarily, if not entirely, the result of cost-cutting as opposed to capital investment.
Heres one of my charts (I apologize for its busy-ness). The dark blue line represents the P/E for the S&P 500, the light blue line represents earnings per share and the purple line represents profit margins: click the chart to enlarge
The declining P/E is warranted given higher interest rates. Accelerating profits during some of those cycles (when the market held or advanced) effectively offset the potential fallout from lower P/Es. During a Fed tightening cyclewhen P/Es are decliningand profits arent rising, stock prices will come down hard. My concern this go-round is that profit margins have been expanding, virtually non-stop (note the purple line and white arrows on the graph), for 5+ years and the Fed has yet to begin tightening. Which they generally in the past have done earlier in the profit cycle. On this observation, by itself, we should expect a significant correction to occur when the Fed begins raising rates.
However, there is a counter argument to be made that, by itself, may not avert a 10+% correction, but should provide some comfort to those who fear that the next great bear market lies just around the next turn. The U.S. economy has just begun to accelerate at a pace worthy of your typical expansion. Companies are holding large cash positions, commercial and industrial loan issuance looks healthy, commercial paper issuance is up off its low in March and commercial paper rates remain extremely low. The corporate financing gap (non-residential fixed investment vs corporate profits, i.e., the amount companies must finance for capex [capital expenditures... i.e., investing in plants and equipment]) sits ($87 billion) way below the long-term average of 2% of GDP ($350 billion). Which means theres plenty of room for capex spending going forward. Which leads to economic growth, jobs and future profits. This would be one (theres more) legitimate bull case amid the coming Fed tightening cycle.
All that said, my suspicion (a suspicion, mind you, is not a prediction) is that the Fed will induce a healthy 10-20% pull back in U.S. stocks, should they begin tightening, as expected, during the second half of 2015. But being that great bear markets are things of recessions, and that your conventional pre-recession warning signs in the U.S. are virtually nowhere to be seen, I would be surprised if the U.S. stock market begins a prolonged 20+% sell-off next year. But it absolutely could happen
Well, I bring potentially very good news: Private nonresidential construction spending (capital investment) may be on the rise. Last week's report on July's construction spending showed a major increase in what, in my view, matters much if you're hoping for a healthy bull market after the present dust settles. Here's a visual: click to enlarge
Oh, and with regard to the presidential hopefuls who hope to push the buttons of those citizens who believe our primarily service sector economy should find its way back to the smokestacks, here's a visual on construction spending within the manufacturing sector that might allay those voters' concerns: click to enlarge
Lastly---and I digress---while, alas, on the subject of politics, when your man or woman begins to sing the unoriginal refrain on China "cheating"---by devaluing its currency---in order to sell you and me affordable goods (how dare they!), here's a 10-year chart of the value of the yuan versus the dollar: click to enlarge
Like my friend said, the numbers contradict!
The Stock Market:
Non-US developed markets (EFA and FEZ below)even after their recent pummelinghave outperformed the U.S. major averages (save for the NASDAQ Composite Index) year-to-date. Given many foreign markets cheaper valuations, early-stage recoveries and, yes, accommodative central banks, I remain constructive on non-U.S.. That said, there are a number of potential international hot buttons (as we've recently experienced) that could easily delay the narrowing of the gap between the valuations of U.S. and non-U.S. securities (particularly emerging markets [VWO below]). Thats why we think long-term and stay diversified!
Heres a look at the year-to-date price changes (according to CNBC) for the major U.S. indices---and for non-U.S. indices and U.S. sectors---using index ETFs as our non-U.S. and sector proxies:
Dow Jones Industrials: -9.65%
S&P 500: -6.69%
NASDAQ Comp: -1.10%
EFA (Europe, Australia and Far East): -3.09%
FEZ (Eurozone): -4.18%
VWO (Emerging Markets): -15.44%
Heres a look at the year-to-date results for a number of U.S. sector ETFs:
XHB (HOMEBUILDERS): +5.30%
XLY (DISCRETIONARY): +3.47%
IYH (HEATHCARE): +1.67%
XLP (CONS STAPLES): -4.06%
XLK (TECH): -4.96%
XLF (FINANCIALS): -8.41%
XLI (INDUSTRIALS): -10.99%
XLB (MATERIALS): -13.44%
XLU (UTILITIES): -13.62%
IYT (TRANSP): -14.62%
XLE (ENERGY): -19.42%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.13%. Which is 5 basis points lower than where it was when I penned last week's update.
TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share decline a whopping 3.20% over the past 5 trading days (down 2.57 year-to-date). As I keep repeating, I see bonds in general sporting a risk/return trade-off that makes going out on the yield curve not worth the risk.
On Volatility and Timing:
Each week I share with you the very short-term (year-to-date) results for major indexes 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). While my beginning of the year optimism over non-US (developed markets that is) and the housing sector, and my pessimism over utilities, appears to be justified by recent results, I need to strongly (very strongly!) emphasize that I was not predicting what weve experienced thus far in 2015. Plus, while we maintained our healthcare exposure I in no way expected the gains that sector has experienced this year. Same goes for energy and materials, only in the other direction.
My optimism or concerns over a given sector or region are based on factors such as valuations, trends, supply and demand, monetary policy and cyclicalityand 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.
Last week's U.S. economic highlights:
AUGUST 31, 2015
THE CHICAGO PMI FOR AUGUST, while coming in at an expansionary 54.4, the details show a real weakening in the Chicago area manufacturing sector. Here's Econoday:
The headline for August looks solid, at 54.4 for the Chicago PMI, but the details look weak. New orders and production both slowed and order backlogs fell into deeper contraction. Employment contracted for a fourth straight month while prices paid fell back into contraction. Lifting the composite index are delays in shipments which point to tight conditions in the supply chain. Inventories rose sharply in the month and the report hints that the build, despite the weakness in orders, was likely intentional. But strength is less than convincing and this report suggests that activity for the Chicago-area economy may be flat going into year end.
THE DALLAS FED MANUFACTURING SURVEY continues to show the pain in the oil sector taking its toll in Texas. The general activity index fell to -15.8 in August, after July's -4.6.
SEPTEMBER 1, 2015
AUTO SALES have very strong of late, and August was no exception. Total vehicle sales came in at 17.8 million annualized, up from a strong 17.6 million in July.
THE JOHNSON REDBOOK RETAIL SALES REPORT came in at a weak 1.3% year-over-year last week. This report has run contrary to what we're seeing in other key consumer metrics, such as auto and home sales. Although, the latest reading for online retail sales have been strong.
THE ICSC RETAIL REPORT came in at 1.9% last week. Ditto my comment on Redbook.
MARKIT'S MANUFACTURING PMI FOR AUGUST came in at an expansionary 53, right in line with consensus expectations.
THE ISM MANUFACTURING INDEX came in at a lower-than-expected 51.1. While above 50 denotes expansion in the sector, there's no question that the strong dollar---hitting exports hard---is doing a number on U.S. manufacturers.
CONSTRUCTION SPENDING FOR JULY came in strong, up 0.7%, up 13.7% year-over-year. Here's Econoday and Bespoke (pay particular attention to Bespoke's comment, the last sentence holds huge promise for the economy going forward):
Led by strength in single-family homes, construction spending rose 0.7 percent in July while an upward revision to single-family homes added to a sharp upward revision to June, up 6 tenths and also at plus 0.7 percent. Year-on-year, total construction spending was up 13.7 percent in July.
Private residential construction rose 1.3 percent in July with construction spending on single-family homes up 2.1 percent vs a 0.5 percent gain in June that was initially reported at a 0.3 percent contraction. Spending on the more volatile multi-family category, which is much smaller in scale, fell 2.2 percent after spiking 5.5 percent in June. Year-on-year, both categories show robust gains, at 15.8 percent for single-family homes and 21.2 percent for multi-family.
Turning to private nonresidential construction, spending rose 1.5 percent in the month. In gains that belie concerns over weakness in business investment, manufacturing was very strong at plus 4.7 with power and transportation both at plus 2.1 percent in the month. But spending on public construction was negative, at minus 3.0 percent for educational buildings and minus 0.2 percent for highways & streets.
Housing and construction, which are domestic sectors insulated for global volatility, are posting some of the best numbers of any sectors in the economy right now and look to give 2015 substantial support.
As far as investment goes, its hard to beat the levels currently seen in the Amusement and recreation category. Transportation and High/street spending also continue to make new highs, in line with a more robust investment profile from state and local governments that we noted in The Closer last week. Sewage and waste disposal, while not a clean data series, is another sign that municipal spending is finally recovering after years of suppression. Finally, our favorite series? The exploding construction in Manufacturing facilities, which is indicative of significant capex and capacity expansion in the US manufacturing sector, weak ISM and Markit PMIs or no.
SEPTEMBER 2, 2015
MBA MORTGAGE PURCHASE APPLICATIONS rose 4.0% last week, up a whopping 25% year-on-year!! REFINANCES surged 17% w/w. The average 30-year rate ended last week at 4.08%.
THE ADP EMPLOYMENT REPORT showed 190k jobs created in August. While that's plenty to compensate for population growth, it's below expectations... Friday's BLS number will be telling. Other employment related data suggest the jobs market continues to tighten.
PRODUCTIVITY AND COSTS FOR Q2 show productivity growing far better than economists predicted. Up 3.3% Q/Q. Y/Y results, however, remain week, as does the forward outlook. Here's Econoday:
The upward revision to second-quarter GDP gave a strong lift to nonfarm productivity, up 3.3 percent at an annualized rate which is at the very top of the Econoday consensus and well up from plus 1.3 percent in the initial reading. This is the best performance since the fourth quarter of 2013.
The gain in productivity in turn drove unit labor costs 1.4 percent lower which is well down from the prior estimate of plus 0.5 percent and at the very low end of consensus and the sharpest drop since the second quarter of 2014. Output rose a sharp 4.7 percent in the quarter while hours worked rose only 1.4 percent with compensation up only 1.8 percent.
But year-on-year data tell a different story with productivity up 0.7 percent in the second quarter and labor costs up 1.7 percent. These readings reflect prior weakness in productivity tied to weak output in the first and fourth quarters.
And the productivity outlook for the ongoing third quarter is also soft with early GDP estimates at roughly plus 2 to 2.5 percent. For reference, second-quarter GDP came in at 3.7 percent, revised from a prior reading of 2.3 percent.
THE GALLUP U.S. JOB CREATION INDEX remained at 32 for August. Which is the best reading in the report's 7 year history.
FACTORY ORDERS for July came in below expectations, at .4%, vs .9% est. In that orders are expressed price-related, energy products are responsible for the less than expected reading. Compensating for the drop in oil, the results were actually pretty strong. Particularly in the one area that could really move the needle for the economy and corporate results going forward: capex! (as noted in the above on Factory Orders): From Econoday's commentary:
The gain in durable goods was driven by gains in motor vehicles and includes strong gains for capital goods which indicate, at least it did as of July, rising business investment and rising confidence in the overall outlook.
CRUDE OIL INVENTORIES grew 4.7 million barrels last week. GASOLINE stock declined by .3 mbs, and DISTILLATES grew by .1 mbs. Oil prices declined on the news.
THE FED BEIGE BOOK sees growth moderate to modest across the regions. Here's from the summary:
Reports from the twelve Federal Reserve Districts indicate economic activity continued expanding across most regions and sectors during the reporting period from July to mid-August. Six Districts cited moderate growth while New York, Philadelphia, Atlanta, Kansas City, and Dallas reported modest increases in activity. The Cleveland District noted only slight growth since the last report. In most cases, these recent results represented a continuation of the overall pace reported in the July Beige Book. Respondents in most sectors across Districts expected growth to continue at its recent pace, but the Kansas City report cited more mixed expectations. District reports on manufacturing activity were mostly positive, although among these, the Cleveland, St. Louis, Minneapolis, and Dallas Districts painted a somewhat mixed picture across manufacturing sectors. Only the New York and Kansas City Districts cited declines in manufacturing. Retail contacts in a majority of Districts reported that their sales and revenues continued to expand. By contrast, the Cleveland and Minneapolis Districts cited flat consumer activity since the last report, Atlanta was mixed, and Dallas reported decreased sales year-over-year. Most Districts reported increased auto sales. Among Districts with information on tourism, activity was strong in most reports.
September 3, 2015
WEEKLY JOBLESS CLAIMS continue to point to a strong labor market, as they remain below 300k. 282k last week.
THE CHALLENGER JOB-CUT REPORT also speaks to strength in the labor market. Here's Econoday:
Lay-off announcements, at 41,186, were moderate in August and far lower than the 105,696 in July which was skewed higher by a massive Army cutback. August layoffs were led by the retail sector reflecting the bankruptcy of the A&P supermarket chain. Layoff levels in this report have generally been on the low side but are not nearly as striking as actual jobless claims which are extremely low. This report will have no effect on expectations for tomorrow's employment report which is expected to be moderate to soft and in line with trend.
THE TRADE DEFICIT narrowed in July. A stat that, by itself, is utterly meaningless in the sense that us importing more goods than we're exporting is somehow a bad thing in the global scheme of things. What I am interested in, however, is the makeup of the stuff that moves to and fro. And July's report solidly confirms the notion that capex is beginning to accelerate (globally). Which is hugely positive news for the economy and the stock market going forward. Here's Econoday:
The nation's trade gap narrowed to a nearly as expected $41.9 billion in July following an upward revised gap of $45.2 billion in June (initially $43.8 billion). The improvement reflects a monthly rise of 0.4 percent in exports, which were led by autos, and a 1.1 percent contraction in imports that reflected a decline in pharmaceutical preparations and cell phones which helped offset a monthly rise in imports of oil where prices were higher in July.
Aside from autos, exports of industrial supplies, specifically nonmonetary gold, were strong in July while exports of capital goods also expanded. This helped offset a monthly decline in exports of civilian aircraft and consumer goods. Turning again to imports, other details include a rise in capital goods in what is the latest sign of life for business investment.
By nation, the gap with China widened slightly, to an unadjusted $31.6 billion in the month, while the gap with the EU widened more substantially to $15.2 billion, again unadjusted which makes month-to-month conclusions difficult. Gaps with Mexico and Canada both narrowed.
This report is another positive start to the quarter and will lift early third-quarter GDP estimates. But these will be cautious estimates as recent market turbulence pushes back conclusions and will make August's trade data especially revealing.
MARKIT'S U.S. SERVICES PMI shows the sector (85+% of the U.S. economy) remaining firmly in expansion territory. At 56.1 versus the consensus estimate of 55.2.
THE BLOOMBERG CONSUMER COMFORT INDEX unsurprisingly---given the recent global and stock market turmoil---declined to 41.4 from 42.0 the week prior.
THE ISM NON-MANUFACTURING (SERVICES) INDEX for August confirmed Markit's results. Coming in at 59.0 vs a 58.5 consensus estimate. Econoday's summary should make one feel very good about the present state of the U.S. economy:
What global turbulence? The ISM non-manufacturing index held on to the great bulk of its historic July surge, coming in at 59.0 in August vs the Econoday consensus for 58.5. Outside of July's 60.3, this is the second strongest rate of monthly growth since December 2005!
New orders are especially strong, at a robust 63.4 for only a 4 tenth down-tick. Not much effect there. And backlog orders? They're up 2.5 points to 56.5 which is the highest rate of accumulation since May 2005.
Employment edged back from July's near record level but remains very strong at 56.0. Export orders continue to expand, at 52.0 vs July's outsized 56.5 in what pessimists can hang on to as an indication of global-related trouble.
But the non-manufacturing sector, unlike manufacturing, is insulated to a large degree from global effects, as illustrated in today's report.
NATURAL GAS INVENTORIES once again grew last week by 94 billion cubic feet.
THE FED BALANCE SHEET expanded by 0.8 billion last week to $4.476 trillion. RESERVE BANK CREDIT declined by $9.3 billion.
M2 MONEY SUPPLY continued its ascent, rising by $33.1 billion last week. That's positive news for economic growth going forward.
THE BLS JOBS REPORT FOR AUGUST came in below expectations, at 173k. However, June and July's numbers were revised upward by 44k. The unemployment rate came in below expectations and hourly earnings came in above. As I've been reporting for months, the U.S. labor market is looking quite strong these days.