Weekly Update: In a monumental week, you could hear a pin drop
If you are bearish, it’s likely because you think there’s a recession in the U.S. this year or that Europe is falling off the tracks. The data I gather weekly suggests the former isn’t happening, and this morning, it appears the groundwork is being laid to keep Europe going. By dropping the requirement that sovereigns get preferred creditor status on loans to Spanish banks, private lenders have been put on par with EU governments, thereby reducing yields and risk premiums for risky sovereign debt. This effectively reduces the risk of an imminent breakup of the euro and should buy Europe more time. It doesn’t address fiscal integration, structural reforms or austerity. It doesn’t do anything for growth. And it doesn’t at all address Europe’s deep cultural and political divide. The Germans believe that savings and investing are the only way to prosperity. Southern Europe and the Club Med countries, on the other hand, are accustomed to spending and borrowing. Even France is going the wrong way—its newly elected president just dropped the retirement age back to 60. What do the Germans think of France's move while they have to work until the age of 67? The cultural divide is structural and too big to be bridged, which likely rules out any possibility of a decisive, pan-European comprehensive solution to the crisis. For now, though, the can is getting kicked down the road again (but it sure is getting full). That’s more than the markets expected.
Remember when former President Clinton asked, “It depends on what the meaning of the word ‘is’ is?” A similar question arises out of this week’s monumental health-care decision by the Supreme Court—it depends on what the meaning of the word ‘tax’ is. Much will be said and written about the high court’s ruling in the next months, but I want to ask what it means for investing. I have been saying to audiences for many months that regardless of the decision, health-care costs are soaring and will continue to do so as the biggest group ever to make their way through this society (we, the baby boomers) age, and we are all going to live to be 95! The numbers don’t work. Therefore, taxes must go up, and for all of us. Tax increases are not pro growth, and therefore not bullish for the market. As investors, we want profits of S&P 500 companies to go up, which means we want consumers/businesses to continue to buy, which means we want employers to keep hiring. All roads lead to jobs. And since small businesses hire most of us, we must ask ourselves as investors whether the Supreme Court decision will remove the uncertainty that has prevented small business from hiring as they have in normal recoveries. What do you think? Know any small business people? I do.
A young adviser came up to me after a presentation in Baltimore this week and asked, “With so much uncertainty, why is the VIX so low?” In a monumental week for U.S. health care and the European Union, we hear silence, what JP Morgan calls a pin-drop morning. The VIX has barely moved. It’s at 18 at this writing—not until it’s over 30 is the VIX indicative of enough fear that could suggest a bottom. If the Supreme Court decision and the 20th EU summit since the start of the eurozone crisis aren’t enough to push up the VIX, then what is? The S&P closed last week at 1,335, about where it was a year ago at this time. At this writing, it’s moved up to 1,355 on the good news coming out of Europe, but there is much resistance at 1,350-70. Since October 1999, trailing 12-month earnings per share is up 110%, the 10-year Treasury yield is at 1.6% vs. 6% at that time, crude oil is up 276%, gold bullion is up 392% and Apple is up 3,390%. But the S&P is exactly where it was. That’s a long time to be running in place, utterly exhausting, and it really makes you wonder what’s it all about? Really gives meaning to the phrase, “to contemplate one’s navel.” The bears won’t be happy above 1,275, and the bulls won’t be happy below 1,400. And so we wait …. How am I going to make money? It always comes back to dividends. I’ve made my move, and I’m sleeping like a baby.
Positives
Housing taking center stage Virtually all the reports on housing this week represented upside surprises: pending home sales rebounded much more than expected, to the highest reading in two years; new home sales rose well above forecast for May, and both February and March saw upward revisions; the Case-Shiller report saw prices rise in 19 of 20 markets; and the supply of existing homes for sale on the market are at early 2000s’ levels. All of this confirms the housing sector continues to recover could provide a much needed boost this year.
Durable goods indicate manufacturing slowdown is temporary New orders rose in May for the first time in three months, and above consensus estimates. Nondefense capital goods ex-aircraft orders, a capex proxy, also rebounded. The report was modestly positive for real capex in Q2, though underlying durable goods orders continue to reflect broad-based softness. This week’s regional manufacturing indicators were mixed, with Chicago surprising to the upside and Richmond slipping. The ISM gauge for June should provide some clarity; it may be out by the time you read this (it's being released in the morning of July 2).
The consumer continues to deleverage May personal income rose an in-line 0.2%, with most of the income growth going into savings as consumers have been leery of buying big ticket items. Separately, the financial obligations ratio, the broadest measure of a household’s ability to make monthly payments, fell in Q1 to the lowest level in almost 20 years. It has now fallen 12 straight quarters and in 15 of the past 18 quarters. Also, U.S. consumer credit card delinquencies are lower than they’ve been in at least 11 years. Although we are likely in the later stages of the deleveraging process, households continue to improve liquidity, which is good for future spending and investing.
Negatives
Profit picture worsens The most troubling piece of the final GDP report for Q1, which showed growth holding at 1.9%, was the weakest gain in corporate profits in three years. Corporate profits from current production actually were revised down to -0.3% from 0.6% in the prior estimate, its first decline since Q4 2008. This comes as U.S. corporate guidance has rapidly deteriorated over the last month, with June seeing a spate of downward revisions for Q2 and Q3 earnings. Moreover, ISI Global notes that the dollar rose 5% year-over-year in Q2, the biggest increase since 2009 and 2000, both recessionary periods, during which earnings declined significantly. Put another way, the profit headwind from dollar appreciation in Q2 is the biggest in a non-recessionary period in many years.
Confidence slipping The Conference Board’s index fell a fourth straight month to its lowest level since January. Although the level remains well above last fall’s low and has failed to generate a contraction signal for the economy, it is historically consistent with below-trend growth. This morning’s final University of Michigan read on consumer sentiment for June also fell more than expected, on a broad-based decline in consumer’s current assessment of the economy and future expectations. Both indices show that the softening recovery in the labor market has clearly taken its toll on consumers, overriding the sharp decline in oil and gasoline prices in the past six weeks.
A sense of impending doom? Many measures of investor sentiment have plummeted in the past few months, back to levels reached in the depth of 2009. But since that time, the home builder's index is up 263%, the ISM manufacturing new orders component gauge is up 159%, the ISM manufacturing employment gauge is up 125%, the University of Michigan consumer sentiment index is up 34%, and NFIB Small Business Optimism index is up 17%. Also, housing leading indicators are at a five-year high, and a record high number of stocks pay a dividend yield greater than the 10-year Treasury, more than at the worst of the financial crisis. The vast disconnect between investor sentiment and measure of economic health is an anomaly rarely seen in history.
What else?
We better address our own debt problem At 8%, the U.S. has a higher budget deficit to GDP than Germany, France, Italy and Spain. And with gross federal debt/GDP topping 100% for the first time, the debt ratio of the U.S. is higher than Germany, France and Spain, which are projected to be no higher than 80% this year. Why have investors flocked to the U.S., then, despite our making little progress on reining in the deficit? Economically, the U.S. has better future growth potential than do the countries in Europe. And it has a superior demographic profile.
I thought a better jobs picture would take the market to its next level What is not priced into the market—an improving jobs picture, particularly with jobless claims bumping uncomfortably close to the 400,000 level again, with the four-week average hovering around 387,000 in the two latest reporting weeks. In fact, expectations for payroll growth have been on the decline. The current estimate for June’s payroll report, to be released July 6, is 87,000. This is not helping my argument.
I wonder if the Mr. will reconsider our vacay plans? When I told my New York City-based supervisor that I was planning to go on a safari vacation last year, his reply was “Oh, yes, that was a popular vacation idea here about 10 years ago.” Newsweek reports that a new hotspot is the emerald-carpeted Bwindi Impenetrable Forest, home of some of the last remaining silverback mountain gorillas, which share 97% of their DNA with humans. To keep the tourist numbers in check, the government implemented a $500 per person per day fee to visit the gorillas, and the cost is rumored to go up.
