Monday, August 18, 2014 - Theory and Instinct; Nobody Knows

Theory and Instinct; Nobody Knows

by Sinclair Noe

DOW + 175 = 16,838
SPX + 16 = 1971
NAS + 43 = 4508
10 YR YLD + .04 = 2.42%
OIL - .71 = 96.64
GOLD – 7.30 = 1297.20
SILV + .04 = 19.68

Over the weekend, the geopolitical hotspots did not explode. Kurdish forces made progress against ISIS militants in Iraq; Ukrainian forces made progress against pro-Russian separatists in eastern Ukraine. The ceasefire between Israel and Hamas is holding.

In economic news, the NAHB/Wells Fargo Housing Market Index showed that homebuilder sentiment rose for the third straight month in August. That should be a positive for new home construction.

Meanwhile, mortgage-finance giant Fannie Mae cut its outlook for the housing market this year and next, because rising mortgage rates, bad winter weather and consumer “conservatism” are all hitting the housing market. In its August forecast, Fannie said it expects construction starts for single-family homes to hit 642,000 in 2014, down about 8% from its July forecast of 696,000. Likewise, Fannie cuts its outlook for new single-family homes sales in 2014 by 11% to 431,000 from 486,000.

Housing affordability hit its lowest level in nearly six years in June. The National Association of Realtors reports the mortgage payment for a median-priced US home in June requires 16.3% of median household income. Even though housing affordability is still historically quite favorable by the NAR’s index, homes are not only becoming less affordable, but affordability may be even less favorable for first-time buyers. A separate index maintained by Goldman Sachs that looks only at marginal buyers shows that housing affordability is largely in line with its historic average.

The New York Federal Reserve says a new SEC rule designed to reduce runs on the money market mutual fund industry could create runs instead. At issue is part of the new SEC rule giving funds the ability to limit outflows by restricting redemptions when liquidity runs short. New York Fed economists say: “The possibility of a fee or any other measure that is costly enough to counter investors’ strong incentives to run amid a crisis will give investors a strong incentive to run preemptively to avoid such measures.”

It is Monday, and so there was some M&A activity. Dollar General made an $8.9 billion dollar, all cash bid for Family Dollar Stores. You will recall that Dollar Tree recently made a bid for Family Dollar, which works out to $74.50 a share, while today’s bid by Dollar General works out to $78.50 a share, and it’s cash.

So, for the most part, it was a typical Monday. But we are in the Dog Days of summer, and in these seemingly quiet, low volume, illiquid sessions we can see a small move quickly turn into a bigger move; a leisurely stroll turns into a gallop, turns into a stampede. The Fed 's Jackson Hole, Wyoming, symposium at the end of the week is also expected to send a dovish message to stocks, with employment and inflation nearing Fed goals, Fed Chair Janet Yellen has consistently cautioned some labor market measures still show enough slack to warrant keeping interest rates low. Heading into this year’s Jackson Hole assembly, the labor market is giving off mixed signals even as unemployment falls. About 28 percent of all part-time workers in July reported that slack business conditions or a dearth of full-time jobs kept them from finding full-time work. That’s up from a 19 percent share at the start of the downturn.

Most people are saving next to nothing, while just a few are saving a significant amount. Those who do save are saving a lot, more than $1.2 trillion a year. According to the Fed’s financial accounts data and definitions, the personal savings rate has averaged about 10% of disposable income since the recession ended, up from around 7% before the recession. That means upper-middle class and wealthy Americans are saving nearly $400 billion more a year than they used to. The Fed has been keeping interest rates low, and part of the thinking is that it forces investors to chase yield, but Americans have nearly $11 trillion parked in cash, and bank accounts, and money market funds that pay next to zero. So, the Fed might keep rates low, until we’re all willing to gamble, at which point, rates rise, and we all lose our bets.

The high share of workers who are part time for economic reasons is one reason that the Labor Department’s broadest measure of unemployment remains far above its 8.8 percent pre-recession level. U6 unemployment, which includes involuntarily part time and discouraged job seekers in addition to the jobless, is 12.2 percent, or almost double the 6.2 percent level of the main unemployment rate. Both increased by 0.1 percentage point in July from five-year lows in June.

So, what is this market worth? Robert Shiller says the stock market is very expensive right now. Shiller is the Nobel Prize winning Yale professor who helped create the cyclically adjusted price earnings ratio, which takes average inflation adjusted earnings from the past ten years. In a New York Times article yesterday, Shiller noted that the ratio is now at 25, up from 23 a year ago, and well above the historical average of about 15. The ratio has only moved above 25 three time in the last 130 years; it happened in 1929, 1999, and 2007; and of course the markets crashed. Makes sense; to justify high valuations, earnings would need to rise significantly, or prices would need to fall.

A 5 year long rally in US stocks has taken valuations higher, leaving some investors anxious, but the CAPE is just one measure of value. The S&P 500 trailing 12 month PE is right around 17.5, which is just a little above the long-term average, but not out of line. And most estimate for the next 12 months put the forward PE multiple at about 15.

Still, the bull market is getting long in the tooth; it is now the fourth longest bull market; topped only by the bull runs ending in 1961, 2000, and 1929; and of course we know how those markets finished. The lack of a meaningful correction is a severe divergence from the norm. In the summer of 2012, stocks posted greater than a 10% pullback. Since that time, all corrections have been contained to single digits. History shows that other incidents of abnormally small corrections have preceded large corrections exceeding 20%. But it doesn’t mean a crash is imminent; the markets will eventually falter, but it could be a long, long time. Meanwhile, the Nasdaq Composite made it up to a 14 year high today. Which sounds bullish, but really means that the past 14 years were lost.

Maybe stocks will fall from here; maybe stocks will rise from here. I don’t know. Maybe the housing market will go up from here; maybe housing prices will drop. I don’t know. The yield on the 10 year Treasury note was up 4 basis points to 2.42%; nobody knows why. The price of oil dropped below $97 a barrel; apparently because the ISIS idiots did not blow up the Mosul Dam; apparently because we have built up a stockpile of oil while cutting back on demand; that could all change tomorrow.

George Soros is the biggest money making fund manager around. He’s the only hedge fund manager to have earned $40 billion in profits for his investors. George Soros just turned 84. In an article from the Irish Times they quoted his son, Robert Soros, on the success and brilliance of the co-founder of the Quantum Fund. Robert said: “you know [that] the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm and it’s this early warning sign.”

Soros has admitted to relying greatly on “animal instincts”, saying the onset of acute pain was often “a signal that there was something wrong in my portfolio”. His decisions, then, “are really made using a combination of theory and instinct”.

The economic recovery is underway, or not, depending on any expert opinion of the hour. The main stumbling block to recovery is uncertainty or not, again depending. As we wait for factories to begin operating at full capacity, investors are growing increasingly frustrated at more than half a decade of prudence, pushing chief executives to loosen the purse strings. Capital spending could increase as early indicators show that industrial companies are beginning to run at higher levels of capacity than has been the case over the last five years. When factories and the like are running at less capacity on the back of lower demand there is very low capital expenditure. In the aftermath of the financial crisis companies hunkered down and re-engineered their balance sheets, diverting funds from investment to pay off debt or stockpile cash. However, even since the recession ended and the economy has picked up, many have continued to hoard cash leading to growing calls from investors to deploy cash reserves, which earns low returns sitting on balance sheets.

It is now estimated that global firms are sitting on a stockpile of $7 trillion in cash. The world’s corporate giants are poised to tap into record cash reserves and possibly embark on a long-awaited spending spree, fuelling hopes of a massive boost to the global economic recovery.

The bulk of the cash is held by 5,100 of the world’s biggest companies, which had combined reserves – cash and short-term debt – of $5.7 trillion as of the end of 2013, according to Thomson Reuters Datastream. The cash pile total excludes financial companies such as banks and insurers, who are required by regulators to hire capital.

Corporate America dominates the pack with about $2 trillion at its disposal, led by a clutch of tech titans. Apple’s cash mountain of $140bn means it has more unspent capital than any other American company, followed by Microsoft with $83bn, and Google, which has built up $59bn of reserves.

So, investors are hollering for companies to spend their cash and deliver higher returns, because cash doesn’t pay much. There are three things the companies can do: buy other companies, return the money to shareholders, or spend the money on the business and try to grow the business organically. What will they do? Nobody knows.

Tuesday, March 05, 2013 - Milk and Cookies

Milk and Cookies

by Sinclair Noe

DOW + 125 = 14,253.77
SPX + 14 = 1539
NAS + 42 = 3224

10 YR YLD + .02 = 1.89%
OIL + . 50 = 90.62
GOLD + .80 = 1576.40
SILV + .16 = 28.80

The Dow has recovered all of its losses from the financial crisis and the small”d”depression, gaining 119 percent from its low in March 2009, making this the third-strongest bull market for the Dow since World War II.

Though the Dow has erased its memories of the crisis, many households aren't so lucky: Neither jobs nor wages have regained their pre-crisis highs. Home prices are still nearly 26 percent below their level when the Dow last peaked, and about 14 million homeowners are still underwater on their mortgages.

The job market has recovered only 5.5 million of the 8.7 million jobs lost during the downturn.

With the job market weak, worker wages have stagnated. Inflation-adjusted average income is 8 percent lower than in 2007, when the Dow was at its previous high. A chart of the stock market points to the upper right hand corner, while a chart of hourly earnings is just a flat line.

Higher stock prices do tend to benefit the more affluent. This might eventually provide a lift for the broader economy, or it might just be enough to sucker Mom and Pop investors into the market again; you remember those folks who were clobbered, twice in the past 13 years; those folks who were steamrolled by the flash crash; some of them will follow their lizard brain and jump in at record highs. Maybe it will work. I hope so.

These are boom times for Wall Street traders and Corporate America but Main Street America hasn't fully recovered from the Great Recession or the small “d” depression or whatever you want to call it; and just a reminder – it was kind of caused by Wall Street.

Unemployment is still around 7.9%. Median income dropped more than 8%. Wages as a percent of the economy are at an all-time low (at least for the time we've been keeping records). The number of people on food stamps is also at a record – 46 million. If we didn't have food stamps, there would be long lines outs outside of soup kitchens. More Americans are now a doctor's bill away from the poor house; more than 48 million have no health insurance. Student loan debt has gone from just over 23K in 2007 to $26,500 for the Class of 2011; someday they'll get a job and start paying down the debt. Home-ownership is down to 65.4%, the lowest level in 15 years; and if you still own your home there's a good chance you're underwater. Surprisingly, homelessness is on the decline. And foreclosures are on the decline, though still high, the numbers peaked out.

So, nothing to worry about. Jump into the market. What could go wrong? The excesses have been washed out. The banksters that crashed the market have all begged forgiveness and changed their evil ways. Washington has punished the wrong doers so severely that they'll never consider shenanigans again. Plus, the regulators are on top of everything. If it seems like Denzel Washington is flying the plane and everything is upside down – well, it is.

In this crazy mixed up world, why is the stock market doing so well? Corporations are enjoying sky high profits; they are doing more with fewer workers. Payrolls were cut, and the remaining workers were required to pick up the slack. American workers are incredibly productive, and right now they have no bargaining power to push for higher wages. Also, the tax code favors investments in technology and capital goods expenditures, but not for human labor. Tax and trade policies also encourage US corporations to expand and hire overseas. And then the Federal Reserve has been throwing money at Wall Street and that translates to lower borrowing rates for corporations. Corporate profits are claiming a larger share of national income than at any time in 60 years. It was the best of times, it was the worst of times.

After taking inflation into account, both the Dow and the S&P are down from their earlier highs in 2000. And, on an inflation-adjusted basis, the S&P 500 is down even after factoring in returns from dividend payments.

Still, American stocks are far ahead of their foreign counterparts. The Euro Stoxx 50, a barometer of euro zone blue chips, trades at 2,683 points, off its record high of 5,464 reached in March 2000, while the FTSE 100 in London was at 6,431, compared to a record of 6,930 in December 1999.

In Asia, the Nikkei 225-share index in Tokyo closed Tuesday at 11,683.45; it reached its high of 38,916 points in December 1989. And the Hang Seng index in Hong Kong finished at 22,560, versus a high of 31,638 points in October 2007.

The Dow is a price weighted index, so they almost couldn't include Apple or Google at current prices. They swapped a few companies over the past five years. Still, it's been an impressive rebound. After the crash of 1929, it took 25 years for the Dow to get back to the nominal level it plunged from.

The biggest factor in the recent rebound: the Federal Reserve has added more than $3 trillion of monetary stimulus to the economy and more than $1 trillion of bailout loans to financial firms since the 2008 financial crisis. This was done to prevent a widespread banking crash and help the wider economy. The banks have enjoyed a windfall, the broader economy, not so much. Federal Reserve Vice Chairman Janet Yellen said Monday that the Fed should press on with $85 billion in monthly bond- buying while tracking possible costs and risks from the unprecedented program.

"Turning to the potential costs of the Federal Reserve's asset purchases, there are some that definitely need to be monitored over time," Yellen said in a speech in Washington. "At this stage, I do not see any that would cause me to advocate a curtailment of our purchase program."

Yellen, the central bank's No. 2 official, echoed Chairman Ben Bernanke's comment last week that the benefits of the Fed's historically low interest rates and near-record $3.09 trillion balance sheet outweigh any risk of financial instability.

The big question is whether the stock market can keep going up from here. 

 One determinant is whether stocks are seen by traders as relatively expensive, and therefore vulnerable to a sell-off. Robert Shiller, a professor of economics at Yale University, has built a model for gauging whether stocks are cheap or pricey. Right now, stock valuations are above historical averages, but well below the stratospheric highs they’ve reached in bubbles. According to his model, stocks are signaling that they can return about 3 to 4 percent a year. Of course, that's not guaranteed.

I repeat – not guaranteed.

But for today at least, Wall Street looked like the past 5 1/2 years never happened. What happens next depends on the Federal Reserve continuing to prop up Wall Street even as Main Street struggles; it is a dichotomy that can't go on forever. This bifurcation and the growing inequality is the dark lining behind this silvery cloud. Bernanke is a student of the Great Depression. One lesson he could still learn from the small “d” depression is that there is a difference between markets and the economy.