Weekly Update: Don't be a Grinch!
This week, I traveled in Miami and Chattanooga—trying to find people in warm places! In Miami, I heard lots of Spanish, which I don’t understand. Twice, people spoke to me in Spanish, and I shook my head … “I speak English.’’ Maybe that’s the problem behind Obama’s and Boehner’s closed doors. Each pretends the other is speaking a foreign language. As we all hold our breath for progress, ISI’s Washington research group suggests the odds that nothing whatsoever passes before year’s end has greatly diminished in the past week. (Meet me under the mistletoe!) Meanwhile, as we look to the New Year, central bank balance sheets are likely to accelerate, and this would be bullish for equities. (Contrary to popular opinion, the best presents come in big packages). Oh, and the Rasmussen Consumer Index rose in October to the highest reading since May and is up 24 points from a year ago, the most in its seven-year history. (I’ve got to go buy some eggnog). This morning’s jobs report was better than expected, but downward revisions the prior two months put November’s nonfarm payrolls gains of 146,000 in line with the three-month average of 139,000—still very subpar at this stage of a recovery. An unexpectedly sharp drop in the University of Michigan’s preliminary sentiment gauge for December found consumers fretting over the fiscal cliff and the potential for higher taxes. And in a Duke University survey of CFOs, tax policy was cited as one rationale for why they’ve pulled back spending—capital spending of S&P companies, ex-energy and commodity businesses, has been flat the last two quarters after rising at double-digit rates for most of the prior two years.
Time to prepare for a Santa Claus rally? Going back to 1900 on the Dow, December is the strongest month of the year, not only in terms of the average gain, but also in the fact it has been up 72% of the time. However, most of the strength is focused right at the end of December, and the month often sees a lot of crosscurrents until then. (Maybe this year, it will be some agreement out of D.C.? In 2010 and 2011, the year-end fiscal agreements to extend the 2001/2003 tax cuts and the payroll tax cut, respectively, were enacted on Dec. 17 and 23). January has also seen above-average strength. (Grinch beware!) Bulls note that the corporate sector has near record free cash flow, very low leverage and all-time high margins—historically, margins do not peak until labor has pricing power. This typically occurs eight months after the economy has returned to full capacity or 10 months after wage growth has picked up, neither of which is the case now. Relative valuation also is attractive. The high equity risk premium cannot be explained by corporate balance sheets (which are abnormally safe relative to government balance sheets) or earnings uncertainty (the spread of earnings estimates is close to its norm). Still-cautious positioning also is a contrarian positive: in Credit Suisse’s August clients’ survey, 80% of investors believed equities over the next five years will be the best-performing asset class but they are not positioned for this. The equity weightings of U.S. pension funds, at around 35% of invested assets, are well below the long-term average since 1960 of around 45%.
There is now a “near maniacal” focus on the fiscal cliff, even as the stock market seems relaxed about it. From a technical perspective, whenever the 50-, 100- and 200-day moving averages converge, this tends to be a decisive resistance or support level. This is happening in all the broad indexes. Key resistance on the S&P 500 is at 1,420, the 50-day moving average. The S&P 200-day moving average is at a new cyclical high of 1,386. And S&P 1,424 marks the 61.8% Fibonacci retracement of the pullback, and thus resistance. When I was in Chattanooga this week, I spoke before a large group of seasoned advisers, who laughed when I showed them some sobering charts of the problems our country has to face going forward. It is all about the elephant in the room, I told them—me and the rest of my fellow baby boomers for whom entitlements, including the new one (health-care reform, which is now in stone), will be very expensive. They chuckled!! The Christmas spirit has been found in the great state of Tennessee!
Positives
Service sector accelerates November’s ISM nonmanufacturing gauge unexpectedly rose to 54.7, a full point ahead of its six-month average. Moreover, increases in two key components—forward-looking new orders and order backlogs—indicated production isn’t keeping up with orders and that the pace of output could rise, providing a potential boost to sluggish manufacturers (more below). October’s surprising increase in factory orders added to this view, with sharp upward revisions to both core capital goods orders and core capital goods shipments.
Construction spending hits four-year high Aided by housing’s recovery, October’s much bigger-than-expected increase pushed construction spending up 9.6% over the past year. Sandy-related reconstruction likely will provide additional lift heading into the New Year. With the Fed helping push mortgage rates below 3.5%, the mortgage rate has now been below the appreciation rate for four quarters—a relatively rare occurrence, which last happened over six years ago. This extremely bullish condition historically has been associated with very rapid home-price gains.
Car sales spike Strong replacement demand and cheap financing lured buyers, pushing November annualized vehicle sales to nearly a 5-year high of 15.5 million, well above consensus and more than reversing October’s decline from September. October-November average sales are well above the third-quarter average, indicating the sales should add to real consumption growth in the fourth quarter. And with insurance money flowing to households impacted by Sandy, sales should remain robust in coming months.
Negatives
Manufacturing barely treading water November’s ISM gauge disappointed, dipping below a breakeven 50, signaling contraction. Fiscal uncertainties were cited—curiously, Sandy wasn’t mentioned—and several forward-looking components were troubling, with new orders and order backlogs particularly weak. The employment subcomponent fell to its lowest level since September 2009, and exports—which had been contributing to growth—dropped below 50. Since June, the index has been below breakeven four of six months.
Better not get too excited about today’s jobs report The Wells Fargo/Gallup Small Business Index tumbled back into pessimistic territory this quarter to a two-year low. One out of five owners expects to reduce headcount over the next 12 months—the most ever. Wells Fargo said the percentage of owners expecting to be in a poor financial condition and to have poor cash flow increased to 30%—both record highs. We hear from the broader NFIB survey next week, the first after the election. That gauge has been rising a bit in recent months but still remains well off the year’s highs and at recession levels.
Will student loans be the new subprime? Total student-loan debt is on track to grow from nearly $1 trillion today to $1.3 trillion over the next two years—an amount equivalent to the value of subprime loans in early 2007. At the same time, troubled student loans are surging. Student-loan balances 90 days or more delinquent spiked from 8.9% in this year’s second quarter to 11% in the third quarter, while new Education Department data shows a 13.4% default rate among loans from 2009. Credit troubles and poor employment prospects are burying former students in debt, along with co-signers such as their parents and grandparents. Rising defaults could quickly drain revenues from the federal student loan program since the U.S. government guarantees almost all loans.
What else
I miss Steve Even though ISI says Apple products remain the “gift of choice’’ for the holiday season, Apple stock plunged 6.4% on Wednesday, its largest one-day fall in four years, shedding $35 billion in value—the equivalent of Dow Chemical in terms of capitalization. Apple is down 25% from its late-September highs, with Wednesday’s downside move on volume suggesting more downside.
Dividend watch With prospects for a hike in dividend tax rates next year, at least 37 companies have announced and paid a special dividend through November of this year. This is already the highest level observed over the past 12 years. The volume of searches for the term “special dividend” is now at its highest level on Google.com since 2004.
Stocking stuffers for the 1% For the person who “has it all,” Private Wealth Magazine recommends colored diamonds, road trips to the South Pole or a moon rock.
