Weekly Update: The Media, The Positives, The Negatives, The Profit Cycle, etc.

If you're at all surprised by this week's weakness in stocks you haven't been watching my recent videos. Which is perfectly fine as long as your surprise isn't combined with intense worry. If it is, then you might want to take the few minutes a few times each week and take them in. My aim is to put short-term market volatility into what I believe to be its proper light.

The media has to sell its stuff, therefore the fact that scary stuff evokes a stronger physiological response in humans than does light and cheery stuff---and that humans have a perverse penchant for taking the bates that enhance those physiological responses (fears)---means that when the likes of famed investor Carl Icahn say "the market has a day of reckoning coming", or when his pal Donald Trump says "the bubble's about to burst", the media will plaster those quotes into every headline from here to Timbuktu!

Reminds of the time a few years ago when I teased a blog post with:

"At approximately 4am last Thursday I was woken from a deep sleep by the deafening sound of an extremely anxious five-foot long diamond back rattlesnake, coiled at the foot of my bed.  I froze, our eyes locked, his blood-red forked tongue slithered in the direction of his gaze as he positioned himself to strike. I".

That post broke the all-time record for hits to my blog site.

Bespoke Investment Group made the point last week while recognizing that when an indicator that was very recently viewed as a harbinger of terrible things to come for the Eurozone banking sector/credit markets---and plastered from here to Timbuktu in the financial press---did a positive 180, a media accounting of the bullish development was nowhere to be found:

"It’s important, in our view, to note that the CoCo market (aka contingent convertibles; bonds that can be turned into equity) has exploded higher in price and therefore return over the last few weeks, and is now back to an entirely normal level (chart). Despite the impressive recovery, we see no charts of CoCos in our Twitter feeds, scans of news sites, or on the television; the credit rally has been stealthy and out of the purview of commentators that drive page views via fear."

Hmm...

Now, the above was not me setting the stage to drown you in positivity about markets and the economy. In fact, per my video commentaries, I haven't been at all positive on the very near-term prospects for stocks.

As for the intermediate-term I see the risks fairly balanced. As follows:

Positivity:

Trend is presently higher

Cyclical sectors have assumed leadership

Impressive breadth

Dovish Fed

Dovish foreign central banks

Commodities rebounding

Sentiment sour

High short interest

Hedge funds way behind

ISMs (manufacturing and services surveys) signal expansion

Weakening dollar

Negativity:

Profit margins peaked

Charts looking toppy

Lower highs

Rich valuations

Tighter Fed going forward

Global uncertainty

Election year with termed-out president

Great Britain referendum

As for the long-term I see folks driving new cars, sporting new sneakers, texting on new phones, seeing new places, trying new restaurants, making new Facebook friends, listening to new music, going to new movies, opening new stores, building new homes, taking new meds, drinking new coffees, investing for the future, etc. That is, for the long-term I'm crazy bullish on owning global franchises!

Speaking of global franchises, I have a sneaking suspicion that the days of the U.S. equity market outperforming its foreign peers are near their end, for the time being. Why? Well, for a few reasons: One, notice under "negativity" above that "Tighter Fed going forward" was not followed by "Tighter foreign central banks going forward". Nope, most of our trading partners are many months behind us in terms of what I'll call the monetary policy cycle. I.e., they're desperate to inflate their local asset prices.

And, per the chart below, they're behind us in the profit cycle as well. Notice how the S&P 500 (top panel) has seen profit margins that have recently surpassed their high of 2007 (9.52%) and are presently trending lower. Versus the MSCI Europe, Australia and Far East and the MSCI Emerging Markets Indexes (panels 2 and 3 respectively), which have room yet to run before reclaiming their higher watermarks (9.28% and 12.83% respectively).          Click each chart, wait a second, then click again to enlarge...



And notice how prices (purple line) tend to follow margins (i.e., U.S. stocks may catch down):



And notice the recent trends in GDP (U.S top panel, Eurozone panel 2, Emerging Markets panel 3):



Although I suspect that, given much anecdotal data (the generally leading indicator stuff), the U.S. trend in GDP will slope noticeably higher throughout the balance of 2016. Which would, one would expect, bring (on strong) the Fed headwind---which, however, would, one would expect, be somewhat quelled (ultimately) by the better corporate results that would accompany a better economy.

And take a look at valuations (price to earnings ratios [S&P 500 blue, Developed Non-U.S. green, Emerging Markets red]). I.e., U.S. stocks (in the aggregate) look relatively pricey:



And how about dividend yields (same color codes as previous chart):



Again, I see potentially good things for our non-U.S. exposure going forward, relative to the U.S.. That said, we'll remain very diversified---of course!

Have a great weekend!

Marty

Market Commentary (video)

Market Commentary (video)

Today's TV Segment (video)

It's difficult not to stray just a bit from purely market/economic content herein (as I have of late [it's the season]), particularly when I hear directly from our clients that their delightful, bright and still impressionable children whom I've come to know  through the years---either in person or through their parents doting anecdotes---are being duped by political wolves in dogooders clothing, as they emerge into young adulthood .

Sure, a free college education for all sounds beautiful, but to truly believe that it's doable---that an education can in fact by some miracle ever be free---is to engage in the kind of magical thinking that we adored those years ago as the sparkles of our eyes sat on the knees of costumed jollymen and shared their hearts' desires. 

Today, sadly, the sparkles (in some) have given way to a bent-browed intensity---anger even---that says an education is a right that one should not have to pay for! Well, if indeed we go so far as to set our young adults onto the knee of Washington, while they'll surely, initially, hail the kings who upheld their "rights"---and for a time cast their votes accordingly---as they grow into productive, tax-paying members of society they'll come to know once and for all that there is no such thing as a free education. Like the day they realized that their shopping mall wishes were not magically met by the man with the beard---that it was Mom and/or Dad who ate the Christmas Eve cookies they placed by the fire, drank the milk, and paid for the red wagon---they'll come to know that an education worth having will never be free. Although there'll be no loving affection for the ones who fostered their naivete this time around, for it'll be them who are paying the bill! And, as my favorite breathing economist, Don Beaudreaux, instructs below, they'll pay it in more ways than one.

Pass this on to anyone whom you believe believes the free education fallacy, along with this link to Don's blog Cafe Hayek (where they'll receive an absolute wealth of education for the cost---a few minutes a day!)...

There Ain’t No Such Thing As Free College Education

by DON BOUDREAUX on APRIL 22, 2016

Here’s a letter to a high-school student from Kansas City who e-mailed me this morning:

22 April 2016

Mr. Parker J________

Dear Mr. J________:

Thanks for your e-mail, and good luck writing the essay for your high-school newspaper!

You ask “What … could be the possible effects of making public universities free to attend? Would the benefits outweigh the costs?”  My answer is simple: it is impossible to make universities free, and any attempts to perform this impossible feat will create more costs than benefits.

Universities – whether private or public – are built of land and materials, and they require for their daily operation not only non-human resources such as electricity, books, computers, printers, projectors, lighting, elevators, and office furniture, but also lots of human labor: professors, administrators, and staff.  Each of these resources, both non-human and human, could be used in ways other than to supply classroom instruction and research at the collegiate level.  So to use these resources in colleges is to sacrifice those goods and services that we’d enjoy if these resources were not used in colleges.  These sacrifices are real costs, and they must be borne by someone.

Government can certainly shift more of these costs from students onto taxpayers.  But such a shifting does not eliminate these costs.  Indeed, such a shifting of costs away from the most direct users of colleges (students) onto other people (taxpayers) will cause students to use collegiate resources more carelessly.  (Think of what you’d order at a restaurant if you knew that the restaurant will pick up the tab for whatever you order as opposed to you knowing that you must personally pay for whatever meal you order.)  The result is that colleges become more costly.

Government can hide these higher costs, but you and your fellow students will pay these costs eventually in the form of higher taxes when you enter the workforce and in the form of economic growth made slower because of the increasing waste of resources that “free” college entails.  (By the way, because I’m a tenured college professor, government attempts to make college “free” will likely cause my income to rise.  The reason is that such a policy will result in government funneling more and more taxpayer dollars into higher education.)

A final note: a big part of the cost of college – for many students the singlebiggest part of the cost – is not tuition and expenses.  It’s the income that students forgo by attending college rather than working.  So even if by some miracle a Pres. Sanders makes all of the vast resources that colleges now use free, each and every college student will still unavoidably bear the significant cost of foregone income.

In short, neither colleges nor college attendance can possibly be made free, and attempts to make them appear to be free will only make them more expensive over time.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

Look Around

Look left, look right, then look around...

When I look left I see a mammoth power-hungry establishment that seems somehow adept at convincing a large swath of the populace that it stands equipped to better their lots by slicing mammoth power-hungry establishments down to size. Hmm...

When I look right I see, well, ditto! Hmm...

A client told me recently that when the campaigns began revving their engines her son played her a few Trump on the stump videos and said "mom, this guy makes sense!". Since then the son has changed his mind, Bernie Sanders---"a true champion of the people"---is his man.

A complete 180 you say? I think not! "Power hungry" defines both of these gentleman (and, of course, the rest of the field). The young man, in his admirable quest to cast his best vote, exposes a lack of peripheral vision that is the side effect, the curse actually, of years of intellectual feeding through the elders, instructors and media outlets of his life, all of which who bend to the faulty---and utterly pernicious---notion that society's thriving is a top down, planned, affair.

When I look around I see what Matt Ridley sees.

From his 2015 book The Evolution of Everything:

To put my explanation in its boldest and most surprising form: bad news is manmade, top– down, purposed stuff, imposed on history. Good news is accidental, unplanned, emergent stuff that gradually evolves. The things that go well are largely unintended; the things that go badly are largely intended. Let me give you two lists. First: the First World War, the Russian Revolution, the Versailles Treaty, the Great Depression, the Nazi regime, the Second World War, the Chinese Revolution, the 2008 financial crisis: every single one was the result of top– down decision-making by relatively small numbers of people trying to implement deliberate plans – politicians, central bankers, revolutionaries and so on. Second: the growth of global income; the disappearance of infectious diseases; the feeding of seven billion; the clean-up of rivers and air; the reforestation of much of the rich world; the internet; the use of mobile-phone credits as banking; the use of genetic fingerprinting to convict criminals and acquit the innocent. Every single one of these was a serendipitous, unexpected phenomenon supplied by millions of people who did not intend to cause these big changes. All the interesting things are incremental, says the psephologist Sir David Butler, and very few of the major changes in the statistics of human living standards of the past fifty years were the result of government action.

It is a fair bet that the twenty-first century will be dominated mostly by shocks of bad news, but will experience mostly invisible progress of good things. Incremental, inexorable, inevitable changes will bring us material and spiritual improvements that will make the lives of our grandchildren wealthier, healthier, happier, cleverer, cleaner, kinder, freer, more peaceful and more equal – almost entirely as a serendipitous by-product of cultural evolution. But the people with grand plans will cause pain and suffering along the way.

Beware the grand planners!

Weekly Update: What the Market's Thinking, Emerging (and endless) Opportunities, and Prince on "The Planet Earth"...

I’m thinking you’ll appreciate a little brevity this week (with regard to markets) and some musing beyond the noise.

So, the worst start to the year gave way to a most impressive rally. Impressive, not only in terms of magnitude, but in terms of inclusion. Meaning, virtually all boats rose with the tide. Here’s a look at the S&P 500 (bold green line), along with its 10 sectors, from this year’s bottom (for now) on February 11:   

Click each chart, then click again, to enlarge...



Which brings the S&P to a smidgen above (2.3%) where it started the year:



So, two months from the bottom (red circle) and we’re back to square one on the year:



Well, yeah, but not really when we think about what the market’s "thinking" now versus what it was thinking on January 1. On January 1 the market was thinking that the Fed was going to raise interest rates 4 times this year (cuz that’s what they said), and it was thinking that the economy was going to deliver very poorly (cuz that’s what economists said).

Here’s the Fed’s own “dot plot” (a dot for each member’s fed funds rate projection for 2016), featuring projections from prior meetings:



In terms of what economists said, here’s Citigroup’s economic surprise index, which, while tailing off lately, shows the economy clicking along a bit better than economists expected to begin the year:



Plus, the sectors are telling a little different story. Here’s Jan 1 to the Feb 11 bottom:



The out-performers as of 2/11 were the supposedly safer stuff: Utilities (green), staples (white), and telecom (blue).

And here’s Feb 11 to current:



Hmm… The out-performers from the bottom have been energy (grey), materials (lt blue), financials (yellow), consumer discretionary (lt orange) and industrials (purple).

Looks like maybe the market sees a better economy ahead!

But should it with the economic surprise index rolling over the past few weeks? Or could it be that the rest of the world’s looking up (of late), which would be good news for U.S. exporters in those economically sensitive sectors? China (red), Eurozone (green):



Hmm…
I’ll keep you posted…

Now let’s go beyond the noise and onto what truly matters in the long-term scheme of things:

Grasping the long-term scheme of things requires, as they say, a 30,000-foot view. A, essentially, rising above the noise and, more importantly, a rising above our own fears and biases.

Like it or not, the U.S. is a very small place. Its citizens make up a mere 4% of the world’s population. Yet its great companies are major suppliers to the 96% who live outside its borders. The U.S. is advanced, its people---their lifestyles---are the envy of the world. I.e., the world wants what the U.S. has, and U.S. companies indeed want to satisfy the world's desires.

The vast majority of the other 96% reside in nations we call “emerging” (think China, India, Brazil, Mexico, etc.). That fact alone (that most of the world’s population is “emerging”) makes me wildly optimistic over the prospects for our clients’ portfolios in the many years ahead. Consider the fact that roughly 90% of the world’s humans under the age of 30 live in the emerging markets! Not only are the emerging economies emerging, their people are emerging into the most productive---and consumptive---years of their lives! The opportunities for U.S., and non-U.S. (that’s why [you clients] a good fourth of your equity exposure is dedicated to foreign enterprises), companies are utterly---and endlessly---enormous!

Ah, but here’s the thing, taking full advantage of the opportunities the world has to offer can mean taking heavy doses of Pepto-Bismol during the inevitable periods of turmoil and market volatility. The question one has to consider is, what can happen that would forever quell a person’s desire for a richer life? When one concludes that, yes, the world is forever a volatile place, yet through it all people will---as they always have---persevere, one can sleep at night knowing that the produce of the companies whose stocks he/she owns will, through it all, find its way to a world of forever desiring customers. And, thus, he/she will ultimately be rewarded (dividends and share price appreciation) for his/her own perseverance.

All that said, if you’re a client, and you’re taking Pepto-Bismol when the market gets rocky, I insist that you call me immediately! We either need to put markets into their proper perspective, as they relate to your particular circumstances and current allocation, or adjust your allocation to a mix that keeps you out of the medicine cabinet. Life’s too short!!

Speaking of the world, and life too short, here's the incomparably talented Prince on The Planet Earth...