Weekly Update: Don't get too greedy
Housing is finally helping (more below), which is great because exports are starting to hurt. All the homebuilders stocks hit 52-week highs last week—that’s only happened one other time during the last 18 years. The recovery in home prices should carry over to other parts of the economy. Strains on municipal finance should ease, lowering muni yields relative to U.S. Treasuries. Consumer balance sheets should strengthen (more below), lifting borrowing and spending. Construction-related employment should pick up. Focusing the latest round of quantitative easing on housing was very clever since the sector already is improving and tends to have a relatively large multiplier effect on the economy generally and employment particularly. It’s also clever in that if QE3 doesn’t work, then every disappointing monthly employment report could push stock prices higher as investors bet the Fed will raise the ante on monthly MBS purchases. Chairman Bernanke and his ECB counterpart Draghi believe higher stock prices help the economy. (When asked in February what’s the first statistic he looks at in the morning, Draghi replied “stock markets.”)
What if QE3 fails to boost economic growth and employment? We will worry about that later as the current below-trend P/E ratios on the S&P 500 give us cover for an additional rally. Using estimated 2013 earnings of $110 for the S&P puts the forward P/E at 13.3 times—JP Morgan notes that high yield, a leading indicator for equity P/E, currently argues for a P/E of 17 or higher. A 15 times forward P/E on projected 2013 earnings implies 1,650 on the S&P. There is a potential analogy to 1985, when many believed the problems that drove the 1982 double dip were still in place—then it was inflation and high unemployment. It was not until inflation broke that investors got constructive. The rally from 1985 to mid 1987 was all P/E multiple expansion as earnings-per-share languished (as seems to be the case now, with Q2 profits growing at their slowest year-over-year rate in three years and analysts forecasting a slight decline in Q3). Our 1985 moment may be housing. But can we get to S&P 1,600 or higher without retail participation? Bank of America’s Merrill Lynch clients were net sellers of $2.1 billion of U.S. stocks last week, the largest level of net sales since October 2011, suggesting profit-taking after the S&P hit a new post-crisis high. We have gone 15 weeks without a 4% correction. Since the bull market began in 2009, we’ve never gone 16 weeks without one.
Moreover, the global economy is stumbling—September’s preliminary Eurozone PMI dropped to its lowest since June 2009 and there’s growing weakness in China and in manufacturing at home (more below). Do you really think we’re going to shoot forward? Do you really think we’re going to crash? I have been suggesting for months that the S&P would reach 1,450-1,500 in the third quarter, then we should regroup. I have also suggested there is a good chance the economy enters recession next year, but so what? To many, it feels like we’re in one already and if we get one, it’s going to be mild. But what if this powerful QE3 empowers an improving housing market, which takes up employment? All roads lead to jobs. How long will investors wait to find out if all of this worked? Probably long enough to allow the “Don’t fight the Fed!” rally to continue. For now, the lower-than-historical-average P/E provides downside protection, continued improvement in housing is not priced into stocks, record profit margins are unlikely to slip badly in the next recession thanks to productivity and this is not priced into stocks. The Fed is attempting to inflate, which is bullish for stocks and commodities, and it is as risky to bet against the Fed as it is to try to guess when the can gets too heavy to kick down the road. We may very well experience a 5% or so correction. Since late July, the bulk of the rally has occurred on five days around major central bank remarks/meetings. Strip out those days and the market has been net unchanged. I would rather it wasn’t like that if I’m going to be bullish. I would prefer a steady march up. So we’ll stand aside during this rally, using any correction to average in. Remember, don’t get too greedy.
Housing waking up … August existing home sales and single-family starts rose solidly, with declines in supply and rising rents for multifamily units buttressing the uptrend in prices. A separate gauge of builders’ sentiment rose above 50 for the first time since February 2007, with broad-based gains in all four regions of the country and a buyer’s traffic at its highest level since May 2006. The data suggest housing’s recovery is accelerating and that sector could provide a tailwind for the economy in 2013.
… and consumers are benefiting Lifted by increases in both stock and house prices, Q3 consumer net worth is set to surge almost 14% quarter-over-quarter to 26% above its recession low. Since 2007, consumer debt has declined by almost $1 trillion, largely a byproduct of housing’s collapse. Now that home sales are recovering and prices have turned up, charge-offs are back to mid-2008 levels and debt service ratios are at mid-1990 levels. This bodes well for future credit demand and spending.
Here’s a positive for the ladies The gap between earnings of male and female workers has declined significantly over the past 30 years. The Bureau of Labor Statistics reports that in 1979, median weekly earnings of full-time female workers were 63.5% of male workers' earnings, implying a gap of 36.5%. In 2011’s second quarter, the gap shrank to a low of 16.5%.
Keep an eye on China The Chinese HSBC Flash PMI marked an 11th straight monthly pullback in manufacturing, the longest consecutive below-50 streak in the report’s eight-year history. Though this is just the preliminary report for September, the data amplified existing concerns about China’s slowdown. Given that China has been the leader in the global economy/stock market moves for the last four to five years, could this be signaling a recession next year?
More blah The Conference Board’s leading indicators slipped in August, the Markit flash PMI for September was expansionary but unchanged, and two regional manufacturing gauges, Philly and New York, remained in contraction territory. The biggest negative in a better-than-the-headline Philly gauge was the deterioration in shipments, which fell to the lowest level since the recession. There is such a wide gap between expectations and current conditions that it supports speculation that businesses are in a wait-and see mode until there is greater clarity regarding the economic-political landscape and fiscal cliff.
Contrarian negatives Leuthold Group’s proprietary sentiment work shows that investor sentiment has never been more complacent heading into the traditional worst months seasonally (September and October) since it began tracking in 1975 … The S&P is now as far above its 200-day moving average or extended to the upside as it was at its tops in 2010 and 2011, but not quite as extended as it was at the March 2012 high … The latest weekly Investors Intelligence survey shows that the percentage of advisors expecting a correction has plunged from a recent high of 41% during the week of May 8 to only 21% this past week. Remember, we’re not supposed to be greedy.
Are you better off? If the S&P closes above 1,443 at next January's inauguration, it would make Obama’s presidential term the second most profitable for stock investors since 1928, trailing only the +162% rebound off the Great Depression lows in FDR’s first term.
Cover for Bernanke Nominal output is equal to money supply multiplied by money velocity. When the rise in money supply is offset by decline in money velocity, nominal output growth will be weak. Despite a near tripling of the Fed’s balance sheet, money velocity in the U.S. has fallen to a 50-year low. Hence, Bernanke’s bold move.
I’m going to make sure my Anthony is provided for Forty-six states and Washington, D.C., allow pets to inherit assets, excluding Kentucky, Louisiana, Minnesota and Michigan, according to the American Society for the Prevention of Cruelty to Animals. For pet owners planning for the possibility that they will predecease their pets, an option is a “retirement home.” Upon the owner’s death, their estate pays into an endowment of between $50,000 and $100,000 for each cat, dog or bird. Larger animals such as a horse require between $100,000 and $210,000.