Weekly Update: Florida is not cool
It’s actually 88 degrees here, and I would like to stay for awhile, given the 30-something-degree mornings we are beginning to see in Pittsburgh. I was traveling this week in Tampa, where I wrote with a view of the beach, which I might have been sitting on but it was too hot! I am trying to find out in my Florida meetings who will win the state’s vote (along with Ohio, one of the two most important swing states). I am getting nowhere but hear that new money in investment is being stymied by the uncertainty surrounding the election. (Speaking of the election, did you watch last night’s vice presidential debate? Biden interrupted Ryan 82 times. Women hate that … I’m just saying.) Wolfe Trahan reminds us that the fourth quarter has returned 9% on average in the past three years. This is largely because each year has suffered a spring/summer slowdown, and stimulus helped get economic prospects back on their feet during the final months of the year. This sounds familiar. Looking back to 1948, fourth quarters have generated a 4% average return and a nearly 80% hit rate of positive returns.
Yet, from an asset-allocation perspective, equities are more shunned than they have been in 27 years. Volume has fallen by nearly a third the past year and by almost half the past two years. Inflows into global equities now stand at $9 billion year-to-date compared to nearly $200 billion for bonds, even with stocks trading at their widest discount to corporate bonds since at least 1985. And equity funds have seen an outflow of $80 billion this year—$13 billion in just the past two weeks. The lack of insider buying suggests insiders are not confident of beating revenue expectations, and corporations are cutting capital expenditures, another sign of worry. Renaissance Macro notes that usually good bull phases in the market will be accompanied by cyclicals outperforming defensive names. Since QE3 was announced four weeks ago, we haven't seen it and the markets have been struggling for a catalyst. Despite this, equities have continued to outperform bonds for most of the year, remaining well ahead year-to-date. I have said for the last four years that this was the most beautiful wall of worry I have seen in my career.
With third-quarter earnings season getting into full swing, the ratio of negative to positive preannouncements has been running at 4:1, the greatest disparity in a dozen years. Such dismal pre-announcement seasons tend to augur well for the performance of stocks during the reporting period as companies generally beat lowered guidance after share prices have already fallen. However, there is risk to future earnings guidance as expectations call for 10% growth in the fourth quarter and 12% in 2013—a tall order for stretched profit margins and weak nominal GDP growth. Over 40% of corporate profit growth has come from falling corporate debt service costs—any major backup in those costs would cause earnings to tumble. The dollar also could rise, effectively tightening monetary conditions. Profit margins are one of the key drivers of economic activity. In the last 11 cycles, no economic downturn has ever started before margins peaked. However, after margins have peaked, the clock starts ticking for the next downturn. On average, U.S. recessions have started seven quarters after margins peak, which in the current cycle appears to have been 2011’s third quarter. Hmm.
Positives
Consumer sentiment hits 5-year high October’s stronger-than-expected preliminary reading, the third straight monthly increase, reflected current conditions that were close to 4 ½-year highs and consumer expectations that improved even more than the current conditions component. October’s jump in the IBD/TIPP Economic Optimism Index also beat expectations and was above 50 a second consecutive month. Bank of America notes consumer sentiment and business sentiment have drifted in opposite directions over the last couple of months—a Business Roundtable survey fell to its lowest reading in three years on uncertainty about the ramifications of the “fiscal cliff,’’ and the NFIB’s survey also slipped in September (more below)—a divergence it believes is mostly due to the fact that business leaders are more forward looking in nature than consumers. (My anecdotal survey of consumers shows that they don’t know what the fiscal cliff is.) Unfortunately, it is the business leaders who do the hiring.
A lot of people are counting on housing It appears fourth-quarter GDP increasingly will have to rely on housing to offset slowing global growth and the impact of that on domestic manufacturing (see ‘exports’ below). So far, there are signs it’s doing its part—the Fed’s Beige Book (see next item) noted that home prices and residential construction were on the rise in most districts, and banks are reporting a surge in mortgage- refinance applications, driven by exceptionally low mortgage rates—the 30-year rate hit an all-time low of 3.53% a week ago.
Beige Book paints a beige picture The Fed’s latest Beige Book was little changed from the last one, more blah—a modest, steady pace in line with subpar yet non-recessionary growth. Consumer spending was generally flat. Home prices were steady to increasing in most Fed districts, as was residential construction as housing inventory continues to shrink. And loan demand was stronger while credit standards were roughly unchanged. The one difference from the previous Beige Book: A frequent mentioning of the “fiscal cliff” as having an impact across various sectors.
Negatives
Small business hiring plans plunge The NFIB Small Business Optimism Index fell slightly in September, with the employment components weakening considerably. The only time hiring plans have been worse was in the 1991 recession, the 2008 recession and a one-month dip in March 2003 after the Iraq invasion! Overall, however, the report was mixed, suggesting conditions are not improving meaningfully, but not getting any worse. Malaise=dividends.
Growing danger of a hard landing in China Real GDP growth has slowed six straight quarters and the IMF this week lowered growth projections a second time to 7.8% this year and 8.2% in 2013. Electricity output suggests China’s economy is slowing significantly below those forecasts, and ISI’s proprietary survey of China sales remains depressed. China’s central bank this week injected $42 billion into the economy with the second-largest debt purchase in history, and one of China’s sovereign wealth funds said it would buy millions of shares in ICBC, the world’s largest bank by market cap. Wither China could very well determine wither the global markets next year.
A troubling drop-off in exports While the annualized increase in GDP since the end of the recession has been 2.1%, exports have been up 6.2% over the same period, helping to increase manufacturing employment by 217,000. However, recent data suggest that the export contribution is rapidly diminishing—with imports little changed, August’s surprise widening in the trade deficit reflected a decline exports, where year-over-year growth has fallen from 15.1% a year ago to just 1.6%. This means the onus for near-term growth increasingly must fall on consumer spending, housing and business investment, and of those three, only housing (see above) is exhibiting momentum.
What else
The labor market may be getting better but … There are reasons to think September’s improvement was statistically challenged. Deutsche Bank says if you adjust for surging employment among 20- to 24-year-olds and part-time workers, the unemployment rate would have declined just a tenth of a point to 8.0%. It also notes the drop-off included an unusually large gain in non-private employment, the biggest increase since September 2000, which was also an election year. And there was a 582,000 increase in the number of people working part-time for economic reasons. The U-6 unemployment rate, a broader measure of labor underutilization, held steady at 14.7%. And since March, part-time jobs have accounted for nearly all of the employment gains!
Surprising drop in weekly claims: more grist for conspiracy theorists This week’s unexpectedly large decline was skewed downward because “one large state” did not report all its data. The Labor Department refused to identify the state; this is extremely rare. (California is the reputed culprit.) According to the spokesman, the reason the state’s claims fell short was because it left out a pile of unprocessed claims related to seasonal factors around the beginning of the fourth quarter. Some have suggested that the numbers are being manipulated for political purposes.
My husband is in three fantasy leagues … That’s OK, dear The first fantasy football league, the Greater Oakland Professional Pigskin Prognosticators League, was formed in 1963 by an East Bay Businessman. In 2008, a frustrated spouse launched the support website Women Against Fantasy Sports, which shut down a few years later when the founder got a divorce. In 2012, according to Fantasy Sports Trade Association President Paul Charchian, the average fantasy sports enthusiast spends nine hours every week working on his team.
