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
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.
