Monday, December 02, 2012 - The Home Stretch

The Home Stretch

By Sinclair Noe

DOW – 77 = 16,008
SPX – 4 = 1800
NAS – 14 = 4045
10 YR YLD + .05 = 2.79%
OIL + 1.19 = 93.91
GOLD – 32.80 = 1220.30
SILV - .73 = 19.31

Stocks were down today. There are many possible explanations, but the one that makes sense to me is that we just couldn't have a record high celebration with milk and cookies; not after all the pie I ate over the holiday. There are other explanations as well.

Anyway, we survived Black Friday, mainly by sitting it out. Black Friday comes with its own unofficial economic data point as the most important shopping day of the year. And we always hear the erroneous, or at least mildly misleading caveat that consumer spending accounts for nearly 70% of gross domestic product, making this large shopping day extra important. Thanksgiving and Black Friday combined brought in an estimated $12.3 billion in sales, according to shopping analytics firm ShopperTrak. Thanksgiving Day traffic grew 27% as nearly one-third of shoppers headed to stores on the holiday. About 97 million people planned to shop online or in stores on Friday, with about 140 million intending to do so Thanksgiving through Sunday. That’s down from 147 million last year. Overall spending was expected to reach $57.4 billion for the weekend, that's down from $59.1 billion last year.

Thanksgiving and Black Friday fell a week later in the season this year, leading stores to push pre-Black Friday deals and shifting consumer spending earlier. On average, shoppers would spend about $407 Thursday through Sunday, compared with about $423 in 2012. So, if you avoided shopping, don't worry, because there will be big discounts as we move into the season.

Today is Cyber Monday. These are not real holidays, but rather marketing schemes, designed to encourage sales. Cyber Monday just started in 2005. There’s no denying that the scheme has been a huge shopping success. It set records for one-day online shopping for the past three years in a row. Last year, Cyber Monday sales approached $1.5 billion; this year will likely be higher. The actual Cyber Monday deals from e-commerce sites have been posted for quite some time; it's not like the deals are restricted to today only. Retailers that offer attractive deals and make it as easy as possible for people to buy no matter where they are — whether on mobile, tablet, desktop, speaking to a call center or in-store — are going to be the winners, regardless of the date on the calendar. With all these opportunities, who needs Cyber Monday?

Today, the US Supreme Court declined to hear a legal challenge to a New York state law requiring internet retailers to collect sales tax, even if they have no physical presence in the state where the buyer is buying. So, for now at least, the New York law remains intact and the high court will not rule on whether states have the power to pass such laws. Recently, 11 other states passed laws seeking to expand their tax authority over out-of-state retailers.

New York Attorney General Eric Schneiderman argued in defense of the law that recent developments favored delaying consideration of the issue. He cited the possibility of congressional action and pending challenges to other state laws as reasons why it would be better to wait. Proposed legislation in Congress would give all states the power to enforce their sales tax laws on Internet retailers. In May, the Senate approved a bill, but it has stalled in the House of Representatives. Schneiderman also noted that developments in the retail industry that would make it easier for companies to collect state taxes could also render the dispute moot in the near future because the burden on businesses would not be so great.

Let's run through a few economic reports. Construction spending rose 0.8% in October, which was a bit higher than the 0.4% expected. All of the improvement in October was in public spending, which rose 3.9%. Private construction outlays fell 0.5%. While the trend shows the housing recovery remains intact, private nonresidential outlays have shown weakness over the past two months.

The ISM manufacturing index increased to 57.3 in November from 56.4 in October. This is the highest level since 2011. The employment sub-component of the ISM index also jumped: 3.3 points to 56.5 in November, almost enough to make us think the monthly jobs report will come in better than expected. 

This Friday, we'll see if the economy added more new jobs. That will be the biggest economic news in a while, due to its implications for Fed policy. The Federal Reserve is considering scaling back, or tapering, its $85 billion in monthly asset purchases, but will only do so if the economy is improving at a moderate pace. More than any other statistic, the jobs report is the best indicator of the health of the labor market.

In September, the Fed surprised the market by not tapering and led Fed watchers to revise their expectations for when the taper could come. Right now, most analysts believe that it will happen in March, but better than expected job growth could push up that forecast. The October job report beat expectations, adding 204,000 jobs and revised up the August and September numbers by 60,000 as well. This was despite the government shutdown and debt ceiling brinksmanship.

Analysts expect 180,000 new jobs in November and the unemployment rate to drop back to 7.2%, after it rose last month due to the shutdown. If the data beats expectations, it will increase the odds that the Fed will taper in December. If the number is weak, it will almost surely rule out a December taper and could push it even further into the spring or summer of next year.

Meanwhile, the Bank of Japan might be looking to increase it's monetary base. BOJ Governor Haruhiko Kuroda said today that he would not be opposed to adjusting policy, fanning speculation the bank could take more easing steps next year. Japan's central bank is looking to go beyond its $70-billion-a-month bond-buying operation; which based upon the relative size of the Japanese economy means that Abenomics is about 3 times bigger than the Fed's Quantitative Easing. Options include major purchases of stock-market-linked funds or other assets riskier than Japanese government bonds. The yen continued to struggle after falling about 4 percent in November against the dollar and euro. Investors have been selling the low-yielding yen to buy riskier assets in carry trades made attractive by the Bank of Japan's ultra-loose monetary policy. Today, the dollar climbed to a more than six-month high against the yen.

As we head into the last month of the year, let's take a look at where the markets are, and may be headed. Of course, I don't know where the markets are headed, and neither does anybody else but we can look at some data and make wild guesses or prescient predictions, depending on how this plays out over the next month.

The S&P 500 is up about 26% year to date, and that outpaces earnings growth. A quick refresher; when stock prices outpace earnings growth, the price to earnings multiple, also known as the P/E ratio, is expanding. So, in the S&P 500 the PE has expanded to 16.5 from 13.7 trailing Earnings Per Share, or EPS, at the end of last year. Forecasting PE is important because it can be a huge driver for future returns; it represents the premium investors are willing to pay for profits. Many investors feel that there is less multiple expansion in front of us than behind us. The PE tends to revert to its mean, but it fluctuates, and it can trend away form the mean for extended periods; which is to say, the PE could trend even higher, giving stocks a nice boost.

While stock indexes like the S&P 500 have hit all-time highs, the stocks are not currently valued at the levels that have marked the end of bull markets in the past. The PE for S&P 500 companies using trailing 12 month EPS, is right around 16, but historic ratios at the end of secular and cyclical bull markets are usually closer to 17 or 18 range. So, valuations are high but not necessarily topping. In other words, a bull market can run longer than you might expect.

There are other indicators to consider.

The percent of stocks trading over their 200-day moving average is currently at 82%. Again, a trend in place is more likely to continue than it is to reverse, at least until it reverses. At a certain point, the market gets frothy, and unlike the children of Lake Wobegone, not everyone can be above average. While this indicator has been overbought all year, it does not diminish the risk associated with such a high percentage.

Sentiment has turned extremely bullish. The bulls have reached 52.6, which is in in the overly optimistic range. The bears fell to a 30-month low of 16.5, which is extremely bearish from a contrarian’s point-of-view. Since the majority of traders are excessively bullish, who is left buying?

Last spring insiders were heavy sellers before the June correction. Upon this recent advance, the ratio of sellers to buyers has again become extremely bearish, exceeding the summer selling.

Margin debt has hit new all-time highs, surpassing levels reached in 2007-08. Such a high extent of leveraging is a sign of an overly enthusiastic marketplace.

Stock market capitalization relative to GDP has moved back up to multi-decade highs. This suggests that investment in the market is at an extremely high level. Because the market value is so high relative to GDP, any correction will have a detrimental impact on the entire system.
The S&P 500 profit margin is at a 60-year high. This is a direct result of low interest rates; a key input for capitalism. Any changes in rates, or expectations in changes could upset this “good as it gets” scenario.

It's hard to be bearish when the markets are on the edge of record highs, but that is actually a good time to be cautious, and remind yourself of the importance of risk management.