Weekly Update: 'Aloha' and 'Mahalo'
I was in the most beautiful state in the land this week, where it was easy to forget about all the drama in Europe and just chill. But this weekend’s Greek elections could quickly put an end to all that. There seems to be a growing sense that everyone just wants to get this over with—that even if the pro-austerity government holds onto power, as polls now suggest, the end game still looks to be a Greek exit from the euro. The bigger worry is what happens in Spain, and the sooner the Greece issue is put to bed, the sooner Spain’s problems may get the full attention of EU leaders. As we await Sunday night’s results, investor optimism is increasing as many now expect central banks to take action to help stimulate economic growth and forestall any one-off effects from Greece. The Bank of England this week announced credit-easing measures, and it’s expected Fed policymakers will extend “Operation Twist’’ when they meet next week. The markets clearly are baking in more easing. This week, the MSCI Asia Pacific Index advanced the most in five months, and at this writing, the S&P 500 was climbing and closing in on a second straight up week despite relatively disappointing manufacturing and consumer news (more below).
There are a lot of reasons to believe a run-up in equities may be at hand. Merrill Lynch’s Global Fund Manager Survey for June put pessimism at its highest among fund managers than any time since fall 2011. The same survey said cash balances in portfolios jumped to the third highest level since March 2003 and December 2008, with four in 10 investors overweight in cash, the highest percentage since March 2009’s major low. The S&P three-month earnings revision ratio rose a sixth consecutive month in April, indicating analysts are now making more upward than downward revisions to estimates, and the three-month sales forecast revision ratio rose a third straight month. Market returns historically have displayed predictable patterns based on phases of analyst revision trends. Bank of America says we currently are in the “strong/increasing” phase of the cycle, during which S&P returns have averaged 12% annually. Also, insiders are buying stocks again—the sell-to-buy ratio is just 1.9, down from an average of 7 in the March-early May period. And valuations also look attractive. The current 13 times P/E for the S&P is well below the 15 times historical average and the 16.5 times average during the 1930s.
There seems to be little doubt that Europe is going to lend money to FROB (Fund for Orderly Bank Restructuring), basically the Spanish TARP. FROB, in turn, will use the money to recapitalize its banks. The European funds could come from either the eurozone’s temporary rescue find, the European Financial Stability Facility, or from the permanent fund, the European Stability Mechanism (ESM). Both are partially backed by Spain, so Spain effectively will be participating in its own rescue! While details of the bailout are still uncertain, it is very likely that the recapitalization will shift the problem from the banks’ balance sheets to the sovereign’s balance sheet. And, to the extent that the loan from Europe to Spain will be through the ESM, that loan will be senior to all other existing Spanish debt, creating a strong disincentive for investors to buy Spanish bonds. That won’t be good for Spanish bonds, where 10-year yields briefly topped 7% this week, on par with levels that sparked bailouts in Greece, Ireland and Portugal. But it could represent the next step in the eventual creation of a Eurobond that could prove crucial to putting the crisis behind us. This is all down-the-road stuff. For now, I’m still thinking about the most hospitable and friendly people with whom I visited this week. I told one gentleman that he was so lucky to live in paradise where the weather is always perfect, except for the tsunami they suffered earlier this year. His reply was that when there is a tsunami, they go down to the beach to check it out. Don’t you just love that attitude? Until next time, “Aloha and Mahalo.”
Positives
Inflation won’t block stimulus This week’s reports on producer and consumer prices suggest that both headline and core price inflation remain under wraps, providing room for the Fed to maintain its accommodative stance or ease further when policymakers meet next week. Sharp drops in energy prices drove the declines, but food prices also tailed off. The drop-off in fuel and food have June CPIs around the world set to slow further, freeing central banks everywhere to be more stimulative.
Jobs outlook isn’t so bad Job openings and hiring expectations improved in the NFIB’s May survey, with 20% of small businesses reporting they have one or more openings, its best level since June 2008. While the overall small business optimism index edged down it still held near its highest level since the start of the last recession. Separately, Manpower said a net 11% of U.S. employers plan to increase hiring in Q3, the highest share in four years. The outlook improved for the third straight quarter and has been positive for 11 straight quarters, indicating gradual improvement in job market conditions. Both the NFIB’s and Manpower's job surveys are not signaling a growth problem.
Low rates aid housing The MBA Refinance Index surged 19% in the latest week, the most in five months, to its highest level in more than three years as borrowers moved to lock in 30-year mortgage rates below 4% and 15-year rates below 3%. The MBA Purchase Index jumped 13%, the most since March 2011, to its highest level this year. After years of being a drag, housing continues to shows signs of contributing to the economy this year and being a plus for second-half growth.
Negatives
Consumers are picky … May retail sales fell a second straight month, reflecting lower fuel prices and softer consumer spending, while the University of Michigan’s initial tally of June consumer sentiment fell to its lowest since December on concerns about jobs and the market volatility. The decline in May sales, which ex-vehicles was the biggest drop in two years, marked the first back-to-back decline in total sales since June 2010. Still, retail sales have been growing between 5% and 6% year over year, and Ned Davis Research’s proprietary broad measure of discretionary spending (including vehicles) has been growing at a fairly steady rate near 7% for 12 straight months. Also over the past 12 months, sporting goods, hobbies, books and music have increased at the fastest rate of growth since July 2000. This suggests consumers will spend when they want something, but remain cautious about splurging—and nervous about the economy.
… maybe because they’re still deleveraging The 2010 Survey of Consumer Finances, one of the most comprehensive reports on financial conditions of U.S. households, showed that inflation-adjusted median family income fell 7.7% from 2007 to 2010. During that period, the proportion of families reporting they have saved income fell to 52% from 56.4%—the lowest share since the Fed survey started in 1992. The decline in net worth was severe. The median value plunged 40% to $77,000 from $126,000 on the dramatic decline in home prices. Although wealth fell sharply, outstanding debt was little changed during the period, reflecting slow progress in the deleveraging cycle and suggesting consumers remain budget-constrained. Incomes also remain under pressure. The year-over-year change in average hourly earnings for 80% of all production and nonsupervisory workers in the private sector has fallen to 1.4%—the lowest level since the series began in 1965.
Manufacturing soft patch This morning’s disappointing reports on Empire manufacturing and May industrial production—the former came in well below consensus and barely rose, while the latter unexpectedly declined—add to the evidence of this spring’s production slowdown. But that’s likely all it is. The Empire’s decline brought it line with the average of other manufacturing indicators, such as the national ISM, Chicago PMI and the Philly Fed. While vehicle production schedules for Q3 are projected to decline from Q2, they’re still up 18% year-over-year. And this week’s business inventories data for April advanced slightly more than expected even as the inventory-sales ratio remained near its lowest on record, indicating continuing activity to keep shelves adequately stocked to meet demand.
What else
Demographics and debt damaging to developed countries The ability of developed nations to grow their way out of debt is constrained by the worst demographics in 500 years, 13D Research says. The fertility rate in Portugal and Japan is 1.3; in Greece it is 1.5, versus the replacement need of 2.1 births per woman. The workforce in these countries is shrinking and the older cohort is swelling. For most of history, until well into the 19th century, the aged 60+ cohort never comprised more than 5% in any country. In the developed economies today, it represents 22%, and three decades from now it will be approaching or passing 40% in Japan and fast-graying Europe.
How many Porsches does your CEO have? According to the National Bureau of Economic Research, companies whose CEOs engage in conspicuous spending are more likely to have a culture that enables fraud, and are also linked with weaker corporate performance and a higher likelihood of bankruptcy.
Sticky fingers in the Windy City Absolute Software, a Vancouver-based firm that offers theft-recovery services for businesses and consumers, finds that Chicago is top in the U.S. for laptop theft, followed by Houston and Detroit. The most likely airport to lose your laptop to theft is Atlanta’s Hartsfield-Jackson, followed by Miami International, Chicago’s O’Hare, Orlando and San Francisco.
