Weekly Update: Life is like the "Seinfeld" show

07-25-2014

No traveling for me this week. Instead, I am spending several days sitting in CPA Continuing Education seminars, and my mind is wandering. I am in a room with 200 people. The presenters are speaking English. The audience seems interested. But to me, they are talking about nothing … a seminar about nothing. Are you a “Seinfeld’’ fan? It just celebrated its 25th anniversary. Even though the last show aired in May 1998, it can still be found worldwide almost any time of the day as we channel surf. It still makes us LOL. Nearly every day, something reminds me of Larry David’s brilliant show—even the Fed! The market has gone almost two years without a 15% correction, and while there has been some speculation policymakers may move sooner on rates than the market is expecting (though not at next week’s meeting), history suggests the prospect of tightening should not be what would cause such a large correction to take place. In 1994, when the Fed tightened fast and unexpectedly, neither of which is anticipated now, the stock market adjusted “only” 7.5% and “only” for 21 weeks. The average adjustment after an initial rate move has been a loss of 5.6%, while the average increase from the trough to the time the tightening cycle ends has been 18.2%. “That’s gold, Jerry! Gold!”

Yet the individual investor remains skittish, even as this market up-cycle enters its fifth year. A full two-thirds declare themselves bearish or neutral, according to the AAII. The latest Investors’ Intelligence data shows the percentage of letter writers classifying themselves as bulls falling to a nine-week low, and domestic equity fund flows have been negative 10 straight weeks. Market sentiment keeps going up, then down, up, then down. “Yada, yada, yada.” Part of this growing unease has been the increasingly visible role of activist investors and the frothy levels of M&A activity—there have been 344 deals (Festivus “feats of strength”) totaling $2.3 trillion since Feb. 6, equivalent to $5.3 trillion annualized, a third greater than China’s entire reserves or a quarter of the entire Wilshire index. The raw materials for both phenomena are the same—a combination of over-capitalized companies and a lack of long-term confidence required to engage in capital spending. This is forcing companies to seek to grow earnings (and even capex) through acquisition or leaving them wide-open for pressure from activists. Add to this cocktail a sense that the shot clock on free money has started, and there is a chance we ain’t seen nothin’ yet. “Not that there’s anything wrong with that.”

Since the 1930s, no bull market has ever ended without a recession, and there are no signs one may be imminent. Average hourly earnings growth of 4% tends to mark the “late” stage of an economic expansion, and that metric is currently running at only 2%. Moreover, when wage growth did hit 4% in the last three cycles, the expansion still lasted another two years on average. And in the last two recoveries, wages didn’t begin to reaccelerate significantly until the unemployment rate declined to around 5.5%. It’s at 6.1% after falling fairly rapidly over the past 12 months, and an expected increase in the participation rate could moderate its rate of decline going forward. In addition, the number of long-term unemployed has been falling rapidly—another source of downward pressure on wages. All this suggests wages may continue to grow at a subdued pace, potentially helping the current expansion to easily last another 3-to-5 years. “Aw, it’s gold, Jerry! Gold!” Strategas Research also observes that in years in which large caps have returned at least 5% more than small caps, as is the case so far this year, the broader market has had a median price return of 20% in the following year. Economic statistics were good this week (more below), and the market made another new high. And now I’m off to vacay—“Serenity Now!”

Positives

“You telling me there's not one condo available in all of Del Boca Vista?” Existing home sales rose in June at their highest pace in eight months, with condos again leading the increase. Cornerstone Macro notes condo sales as a share of single-family sales have increased from 11% to nearly 14%, mirroring a similar shift in starts and helping explain why housing’s recovery has been so-so. On balance, single-family construction is almost 3 times more stimulative to a local economy than multifamily. Unlike the message sent by June’s negative new-home sales report (below), existing sales, a three-month string of increases in pending sales (which tend to lead existing sales) and rising builder sentiment suggest housing has stabilized and will be a second-half contributor to GDP.

“Giddy up!” The Kansas City and Richmond Fed manufacturing indices rose more than expected in July, joining the New York and Philly Fed surveys that showed significant improvement in July activity. The separate Markit flash PMI slipped for the first time in three months, but at 56.3, it was still very robust. And June durable goods orders surprised to the upside. The increases were broad-based, with nondefense capital goods orders ex-aircraft rebounding 1.4%, reversing May’s 1.2% decline.

“I would drape myself in velvet if it were socially acceptable’’ China's PMI of 52 was much stronger than expected, beating the highest estimate from 21 economists and representing the second-highest reading since 2011 and the highest since January 2013. Chinese confidence also hit a record high, driven by rising sentiment in smaller cities, according to a Boston Consulting Group survey. The outlook also is improving in Europe, where flash PMIs came in better than expected and Germany's Services PMI hit a 3-year high. More evidence of a globally synchronized recovery against a backdrop of very accommodative central banks—this is bullish.

Negatives

“I’m unemployed and I live with my parents” June new home sales plunged 8.1% while May’s initial 18.6% increase was slashed to just 8.3%, putting annualized new-home sales for Q2 behind Q1’s weather-beaten pace. RDQ Economics dismissed the volatile and revision-prone nature of the new-home series as a mockery, citing a preponderance of other indicators—existing home sales (above), NAHB confidence and both housing starts and permits—that suggest housing is improving. In fact, RDQ said it’s inclined to disregard the new-home sales report altogether.

“No soup for you!” The Fed's survey of consumer finances shows just how poor a position those under 35 were left following the financial crisis—and why they have been slow to enter the home-sales market. The median home price in the National Association of Realtors' housing affordability index is $215,000, so the implied down payment is $43,000. But the median household net worth for those under 35 is just $9,300 and, for 35-to-44-year-olds, $42,000—still short of a down payment under the affordability index.

“Who told you to put the balm on?” Food price inflation is becoming a problem for the fast food industry. Milk prices are up 27% this year, and coffee prices are not far behind, rising by about 25%. Starbucks’ food costs relative to its total sales are higher than just about any other restaurant chain.

What else

“You know how to take the reservation; you just don't know how to 'hold' the reservation” The TSA security fee on airline tickets jumped this week from $2.50 to $5.60 on nonstop flights and from $5 to $5.60 on connecting flights, though layovers of four hours or longer count as a new flight. The increases are the latest in a rash of new charges air travelers are confronting, from baggage fees to fuel surcharges to “better seat’’ fees. Airline fee-related revenue has soared from a combined $2.45 billion in 2007 to $31.5 billion in 2013, according to industry statistics.

“All right, Bubble Boy ... the correct answer is ‘Moops’ ” As economist Robert Shiller recently pointed out, Google Trends show increased searches for "stock bubbles" despite its being extremely difficult to prove we are in one right now, ISI notes. Unless pricing power or margins start to decline, many of the popular indicators pointing to stretched valuation (such as Shiller’s cyclically adjusted P/E, price to sales, etc.) could prove misleading. Besides, history shows us bubbles can last a long time and that it is difficult to time their demise.

“Oh, I'm stressed” Polls in the closely contested U.S. Senate elections and Obama’s approval rating suggest Republicans retain an edge to win a majority in the Senate come November. Obama’s approval has remained remarkably constant but is low, and that means a rough overall political environment for Democrats. Of the eight most competitive Senate races, six of which are currently held by Democrats, the polls are within three percentage points using the RealClearPolitics average in every one of those races.


 
 
 
 
 
 
 
 
 
 
 
Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.
Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.
The Empire State Manufacturing Index gauges the level of activity and expectations for the future among manufacturers in New York.
The Federal Reserve Bank of Kansas City surveys manufacturers in its district monthly to gauge the level of their activity.
The Federal Reserve Bank of Philadelphia gauges the level of activity and expectations for the future among manufacturers in the Greater Philadelphia region every month.
The Federal Reserve Bank of Richmond surveys manufacturing and services businesses monthly to gauge their level of activity and expectations for the future.
The Germany Services Purchasing Managers Index (PMI) is a monthly gauge of the level of services activity in the economy.
The Markit Composite PMI is a gauge of manufacturing and service activity in a country.
The National Association of Home Builders/Wells Fargo Housing Market Index is a gauge of how well or poorly builders believe their business will do in coming months.
The National Association of Realtors' housing affordability index measures whether or not a typical family could qualify for a mortgage loan on a typical home based on median incomes, median home prices and average mortgage rates.
Federated Equity Management Co. of Pennsylvania
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