Weekly Update: Feeling good
I traveled in Dallas this week where I spoke to the friendliest group in memory. After receiving my presentation riddled with reasons to buy dividend-paying stocks, the lone question during the Q&A was, “So, how do you feel about dividend paying stocks?” LOL! This was a feel-good week to be sure. The S&P 500 reached its highest level in the cycle, and seems on its way to 1,500. Looking back to 1928, the median post-election-year rally to start a year was 5%, followed by a 10% correction. The S&P already is up 4% year-to-date as of Thursday’s close; 5% gets you to 1,500. If this year behaves like the previous several, the market will peak in April/May, and a 10% correction from 1,500 would lead to 1,350. What then? Steve Auth, our equities CIO, has a 1,660 forecast for year-end. How do we get there? Through a reasonable $106 earnings on the S&P times the long-term average P/E of 15.7. As of 12/31/12, the trailing 12-month P/E was 14.4 times. Could we get another multiple increase this year? Ned Davis Research points out that at this stage of the cycle, historically you would see another 0.6 multiple increase. That would take you to 1,590. Remember, the old record high was 1,565. Can we pierce that level? Do you feel good?
So far this year, we’ve been seeing the highest inflow into stocks since September 2007, but it was led by emerging-market and world funds. The advance/decline line is also at an all-time high, a healthy sign the advance is broad-based. A new bull-market high in the A/D line typically signals a minimum three-to-six month extension on the life expectancy of any bull, Leuthold Group says, because lagging breadth usually provides a forewarning lasting at least that long. But as has been a problem throughout this bull, this latest rally has been on unusually low volume, a rarity when combined with a high A/D line. There’s also the fiscal drag from this year’s tax increases and the increasing likelihood the sequester’s steep spending cuts will occur, with a potential hit to the economy of 2% or more, well above the consensus for first-half growth. Then there’s the debt ceiling. Obama says he will not negotiate over it because Congress should conform to spending and revenue laws already passed. Republicans say any rise in the debt ceiling should be matched by 10-year cuts in spending, the so-called Boehner rule.
A Washington Post poll says 58% of Americans think we should separate the debt ceiling from the debate over spending cuts. They may get their way. Paul Ryan says the Republican House caucus is considering a short-term extension in the ceiling—that is, it may kick the can, and kicking the can is all the market wants. Kick it as long as you can. If you are bullish, you expect P/E multiple expansion and think housing and autos will offset declining exports (more below). If you are bullish but worried, it may be because you are worried about inflation. The logic is China is doing better (this morning’s fourth-quarter GDP report beat expectations and showed growth accelerating), and a recovery in China goes hand in hand with rising commodity demand, which can push up inflation and, oh, no, higher inflation can hurt P/E multiples. But that line of thinking was undercut by this week’s reports on December CPI and PPI (more below). So we’re feeling good, feeling good, but … D.C. It’s all going back to D.C. Will D.C. cooperate? I loved visiting Texas. We all were feeling good. But what were we supposed to worry about? Oh, yeah. D.C.? Whew, I just woke up in a sweat.
Housing has moved from the biggest drag to potentially the biggest catalyst The NAHB sentiment index, while unchanged in January, remains at its highest level in nearly seven years and has risen 22 points from a year ago, one of the largest gains in any 12-month period in the index’s 27 years. The gauge continues to be the single most important leading indicator for U.S. equities. December housing starts surged 12%, partly on unseasonably dry and warm weather, but the gains were spread across single family and multifamily, and across all four major regions. ISI, CoreLogic and Case/Shiller surveys show price gains accelerating, with futures contracts on the Case/Shiller index suggesting a 6% increase in home prices this year. Housing could add 30 basis points to GDP this year.
Manufacturing’s soft patch appears to be ending While December headline industrial production rose in line with consensus, manufacturing output and capacity utilization were better than expected, with overall December production weighed down by utilities due to unseasonably warm weather. The improvement in manufacturing was broad-based. Motor vehicles remained the best-performing sector, but strength in the past two months also was evident in business equipment production and construction supplies. And production of computer and electronics equipment—a key proxy for spending on capital expenditures—had the largest one-month gain in eight months.
Too early to worry about inflation December’s headline and core CPI and PPI were negligible—headline PPI actually fell a third straight month. The current spread between year-over-year CPI (up 1.7%) and PPI (up 1.3%) bodes well for profit margins. Renaissance Macro expects inflation will be a non-factor this year; it tends to pick up when energy starts to outperform discretionary names and that’s not happening yet. Energy’s relative performance to the market remains muted.
Retail sales’ upside surprise may not last If you look at all the major-component trends in December’s better-than-expected results, the trend is decelerating. This is true of autos as well, which have been a great source of strength and now represent nearly a fifth of retail sales. Ned Davis’ proprietary measures of discretionary spending have slowed to the lowest levels in over two years, and general merchandisers’ sales have slumped 1.9%, the worst performance since the expansion started, driving their share to an 11-year low. Given the payroll tax hike, a growing reliance on retirement savings to pay expenses (more than 1 in 4 workers draw funds for everyday items) and a sour mood (see below), consumers may feel compelled to curtail spending if job and income growth don’t pick up.
Not feeling good The University of Michigan’s initial take on the consumer’s mood disappointed, falling to a one-year low. Factors weighing on sentiment include Washington’s ongoing dysfunction and the bite of higher payroll taxes. The strong inflows out of the gate this year have more and more pundits hailing the long overdue move out of bonds and into equities. But stepping back from these near-term good feelings, Credit Suisse reminds us investor-risk appetite arguably is as depressed as it’s ever been the past 30 years. This secular funk is reflected in the massive de-risking of investor portfolios over the course of the last dozen years, the relative valuation of safe vs. riskier assets and the tendency to look for a system-threatening black-swan event around every corner. Even in the late 1970s, pessimism wasn’t as pervasive and uncertainty about the longer-term future so great among investors and business leaders alike. Remember, we got excited about equity inflows a few years ago, then “the flash crash’’ happened and investors who had just stuck their toes back in the equity waters said, “I’m out.”
Sandy, fiscal cliff behind disappointing Empire and Philly Fed Both manufacturing gauges weakened in January, with New York’s Empire contracting a sixth straight month and Philly returning to negative territory on declines in new orders, shipments, employment and the average workweek. Each also reflected a noticeable improvement in the six-month outlook for business activity and new orders, suggesting the weakness in current conditions could have been due to uncertainty around the fiscal cliff. Still, Philly respondents cited the desire to keep operating costs low, slow sales growth and uncertainty about the health-care costs as factors restraining hiring. And only 27% of Empire respondents expect to increase their workforce, down from 51% a year ago.
Cliff II notes According to a Quinnipiac poll, Americans are opposed to cuts in Medicare spending by 70% to 25%. This is the crucial element driving federal spending over the next few decades, and there are no conceivable tax increases that can keep up with the spending rise. The average Medicare couple pays $109k into the program and gets $343k in benefits out, according to the Urban Institute. The events of the past few weeks demonstrate that these political pressures overwhelm the few realists looking for a more ambitious bargain.
Drought woes The worst drought in the U.S. since the 1930s persists, covering 61% of the nation. Only about 33% of America's winter-wheat fields were recently in good or excellent condition, the lowest level since records began in 1985. Thirty percent of winter wheat in central Kansas has reportedly already failed.
Do you believe they pay us pennies on the dollar vs. the men? ISI says hedge funds run by women outperform those run by men. The explanations are related to behavioral finance issues. Women are less likely to fall into such traps as men are.