Weekly Update: It's a 'My Cousin Vinny' market
The above is how David Tepper described the market this week on CNBC. I listen to David (and not just because we went to Carnegie Mellon University together). The last time the hedge-fund manager was on CNBC in 2010, he was similarly bullish and the subsequent run became known as “the Tepper Rally.’’ David notes the economy is getting better, equity risk premium (the excess of the expected return of equities over the risk-free interest rate) is near historical highs and $400 billion of cash is looking for a place to go. The Fed could even taper QE purchases and that won’t have much of an impact on the rally, he said. If the Fed doesn’t start pulling back, he thinks the market could go into hyper drive and that investors who continue to short equities “better have a shovel to get themselves out of the grave.’’ David calls the evidence favoring stocks overwhelming, a reference to the trial scene in the 1992 movie (it’s a riot if you haven’t seen it). You were fifty feet away, you made a positive eyewitness identification and-and-and-and-and-and-and YET, you were not wearing your necessary, prescription eye glasses? The percentage of stocks making new 52-week highs is at its highest level in almost 25 years, likely reflective of a robust trend and broad participation. Strategas Research notes such trending markets can persist for long periods of time—there were no 10% corrections between 1962-1966, 1984-1987 and 1990-1997.
While the percentage of bullish retail investors has doubled over the past few weeks to 40%, that’s still well below extremes indicative of investor euphoria, which would be bearish, and highlights a still fair amount of skepticism, which is bullish. That is a lucid, intelligent, well thought-out objection. The Institutional Strategist notes the S&P 500 has retraced all of its losses from the financial crisis and is just poking its head above water. One way to look at this is there was essentially no gain in stocks over six years. The other way to look at it is there should be few long-term shareholders with losses who need to sell. This lack of sellers is an important dynamic—the latest figures show there are fewer willing short-futures- contract sellers as prices continue to escalate, indicating fewer investors are willing to call a top to the ongoing rally. Yardeni Research says the mean of the monthly forward P/E of the S&P since the data start on September 1978 is 13.7, and conjectures the recent valuation-led rally may simply be a reversion to the mean (the P/E rebounded from 12.1 on Nov. 14, 2012, to 14.4 as of midweek). This cycle’s bull-market trough P/E was 10.2 on Oct. 3, 2011, while its peak was 15.1 on Oct. 14, 2009. Reverting above the mean to 2009’s peak would put the S&P at 1,744, and cyclical reversions to the mean regularly overshoot to the upside or downside. After an 8% uninterrupted rally over the past month, the trend and momentum are certainly higher for the broad indices, and Miller Tabak says complacency appears to be growing. The CBOE Put/Call ratio 5-day average is at its lowest since March 2012. Perhaps we are in a 1995 type melt-up; otherwise, odds of a correction are excellent.
I spent a part of this week in Chicago, where it’s true people really do smile at you. However, in a room filled with hundreds of advisers at a retirement seminar, the sentiment was sober. One speaker (a former doctor and financial advisor to Erskine Bowles of the Bowles-Simpson commission) talked about the cost of health care going forward and basically said, don’t try to extend your life. Have fun while you can. You was serious about that? Another talked about the probability vs. safety-first approach to retirement investing. The probability-based approach is the standard x percent in stocks and y percent in bonds. The safety-first goal was to have a minimum amount to cover your needs and, once you get there, protect that portion (with haven-like investments including dividend-paying stocks), and then asset allocate to the market. Yet another speaker warned declining productivity threatens future stock returns. Returns, he noted, are driven by dividend growth, which are driven by earnings growth, which are driven by productivity growth. And because productivity tends to peak in the 20-to-35 age range and decline in the 45-to-60 cohort, productivity is likely to decline for years as baby boomers age and retire. This, he said, will likely lower the typical 60/40 stock-bond portfolio return to 4.5% from 7.6% historically. I’m not sure I buy the declining productivity argument. As we wrote last week, 86 million millennials—Did you say, ‘yutes?’—are just entering the workforce, easily outnumbering the 77 million boomers starting to exit it. As we’ve also noted, we may be on the verge of a manufacturing renaissance driven by new technology such as 3D printing and new domestic energy sources such as recovered natural gas. So go ahead and adjust your expectations to a 4.5% return. That way, if some of these black swans come along, it’ll be a positive surprise to the upside. Under-promise and over-deliver—isn’t that what Vinny did?
Consumer mood brightens The University of Michigan’s initial sentiment gauge for May rose much more than expected to a six-year high, with expectations, current conditions and employment components all rising. April retail sales also surprised, with core sales (ex-gasoline) rising 0.5% on gains in apparel, general merchandise, online sales and electronics. March and February also were revised up, putting the near-term trajectory on more solid footing and dampening worries about the impact of higher taxes and sequestration-driven cuts. In addition to April’s pickup in jobs, consumers appear to benefitting from record-low interest rates—household financial obligations as a percent of income have declined to the lowest point since 1980, largely due to the decline in mortgages and mortgage rates.
It’s too early to worry about inflation April consumer and producer prices reflected no signs of inflation pressures, with year-over-year increases in both core rates just 1.7%. Headline CPI and PPI increases were even lower because of declining energy costs, which on the margin should provide a boost to consumer spending over the back half of the year. Headline and core import prices also fell, reflecting weak global demand and the impact of the weaker yen—Japanese import prices fell 0.6% in April, their biggest one-month drop in five years.
Small business optimism back to pre-election levels The monthly NFIB gauge rose in April by the most since October 2010, to its highest level in six months. Though the level remains low by historical standards, the latest increase is one of only 19 other increases of at least this magnitude since 1986. All 19 cases were either during expansions or at the very end of recessions. If this historical pattern holds, the expected spring/summer slowdown resulting from the fiscal cliff deal and sequestration could be limited. Within the report, hiring intentions and job openings rose, while taxes, red tape and poor sales remained top concerns.
Housing blahs April housing starts fell more than expected, led by the volatile multifamily sector. Single-family starts also slipped and remain flat this year. Some of April’s decline was blamed on poor weather. Indeed, permits for future construction rose sharply and drove April’s 0.6% increase in the Conference Board’s leading indicators, which more than reversed March’s decline. May’s NAHB sentiment gauge also rebounded to an above-consensus 44 on improvements in present and future sales, and buyers’ traffic. While the gauge remains below its cycle high and the 50 level that’s considered a sign of normalization, Goldman Sachs expects housing-related spending to add a full point to GDP in 2013.
Manufacturing blahs Industrial production fell a more-than-expected 0.5% in April, with manufacturing output down 0.4%, also notably below forecasts. March and February also were revised down. Vehicles and electronics led the decline in durables, while the drop in non-durables was led by petroleum and apparel. Alongside a softer trend in most manufacturing surveys in recent months—both the New York Empire and Philly Fed surveys for May unexpectedly slipped back into contraction territory—this adds up to a picture of a weak start to second-quarter manufacturing activity, consistent with the odds that Q2 GDP growth will slow notably relative to Q1.
European blahs Preliminary data showed GDP in the 17-nation euro zone fell a worse-than-expected 0.2% in the first quarter after shrinking 0.6% the final three months of 2012, making the current recession the longest of the post-war era. The German economy, Europe’s largest, also expanded less than forecast after contacting in the prior quarter, while France slipped into a recession and Italy’s contraction exceeded estimates. The first-quarter performance reinforces pressure on the ECB to come up with further measures to try and support euro-zone growth.
Dim ‘Grand Bargain’ hopes … The IRS is in the news for reasons only tangentially related to revenue. Unfortunately, this revelation reinforces the consensus that Washington in 2013 is unlikely to restructure longer-run fiscal policy to support growth and reduce debt. As has been the case for a decade, alluring politics inhibit smart policy, Renaissance Macro observes. Political scandals don’t affect markets or economies … until they do. Whether the IRS story morphs into something meaningful to markets depends on facts few of us possess. Who knew what and when will remain a subtext unless and until official investigations determine this is not a scandal implicating a full-blown political crisis.
… and dimmer What the IRS scandal doesn’t do, the mostly upbeat Congressional Budget Office updated budget projections most likely will. According to the CBO, the U.S. deficit is shrinking much faster than previously thought, with the deficit expected to be $642 billion for the fiscal year ending Sept. 30. If the forecast holds, it would be the smallest annual budget shortfall since 2008 and represent 4% of GDP. For comparison, the 2009 deficit was 10.1% of GDP. The CBO also lowered the estimated 2014 deficit to $560 billion, which would represent 3.4% of projected GDP. With the debt ceiling showdown now pushed back to fall, based on these projections, this makes it even less likely Congress and the White House will feel the need to reach a "Grand Bargain" and/or long-term sequestration fix.
Speaking of yutes As I mentioned before, I saw my boy graduate from Clemson. Loved the Southern cooking, and always make sure to get some shrimp and grits (the real thing). No self respectin' Southerner uses instant grits.