Weekly Update: Losing money safely
I visited Seattle this week, where I met a very pragmatic advisor and his clients. No one needed to be convinced that Treasury bonds are not an attractive investment. I also spent some time in Detroit and Kalamazoo, slip sliding along I-94. A large audience there was very relaxed about braving the elements, feeling sanguine about the market, just as in Seattle, trusting the capable hands of their advisor. Equities held in any form now account for just over 40% of households’ discretionary financial assets, with older baby boomers and those over 65 accounting for almost two-thirds of the equities owned by households. And while equities carry twice the weight of bonds, the last time the stock-bond relationship looked like it does now was in 1995’s third quarter, when the yield on the 10-year Treasury bond topped the dividend yield on equities by more than 4.5 percentage points. Today, stocks yield almost half a point more than bonds. The current yield relationship resembles that in place in the 1950s, when the Great Depression was still fresh in the minds of older investors.
At this writing, the S&P 500 was again flirting with 1,500. It moved above that level in intraday trading a few times, but last closed there in early December 2007—ahead of a 55% and 15-month slide in stocks. I’m not suggesting we are heading that way again, but the market appears to be in overbought territory, which suggests the rally is maturing even though sentiment indicators are not yet at the levels that usually warn ahead of a major top. The percentage of constituents in the S&P making a 65-day high hit 37.6% midweek, a level that typically signals imminent consolidation. The seasonal challenge of February also is approaching. And even though earnings have mildly surprised so far, with 70% of those reporting exceeding beaten-down consensus estimates and 50% exceeding revenue expectations, JP Morgan says it appears business was pulled into December from January as companies positioned ahead of the fiscal cliff and tax changes, indicating potential giveback this month and next.
Still, House Republicans lightened market worries this week, voting to suspend the debt limit through May 19, at which point the Treasury would be able to use accounting strategies known as “extraordinary measures” to continue borrowing (just as they are now) for another few months. The market loves playing kick the can. Moreover, with the S&P and the Dow at five-year highs, the Dow Jones Transportation Average, the Russell 2000, the S&P Small and Midcap indices, and the NYSE cumulative advance/decline line at all-time highs, breadth data continues to be supportive of the rally. Moreover, 92% of the S&P closed above its 50-day moving average, the highest reading in 15 months. The 90% threshold has only been hit 14 times over the past 22 years—a momentum surge that Strategas Research says suggests forward returns over the next 65 days are likely to be more than double the historical average. Finally, the VIX remains at extremely low levels, and fund flows into equities have been the strongest since late 2008. It’s the most beautiful wall of worry in my career.
Leading indicators suggest moderate pickup The Conference Board gauge rose a slightly better-than-expected 0.5% in December, and November’s initial decline was revised to no change. The showing, helped by improved jobless claims (see below), interest-rate spreads, the leading credit index and stock prices, suggests growth will improve modestly the next six to nine months.
All roads lead to jobs Initial jobless claims hit a five-year low and appear to have broken to the downside after being stuck in a 360K-390K range in 2012. While the Labor Department cautions early-year claims early are subject to seasonal distortions, ISI thinks the drop-off is indicative of accelerating payrolls in the months ahead. Still, almost four years after the Great Recession ended, the U.S. has gained only 3.5 million, or 47% of the 7.5 million jobs that were lost. But 13D Research says the balance of these jobs, and tens of millions more, are likely never coming back because they no longer exist as they have been filled by technological advances in automation and robotics.
Despite modest job and income growth, consumers are in a pretty good place Consumer household debt service is at more than 30-year lows, and consumer wealth is back. Americans’ balance-sheet wealth is up $13 trillion since 2009, to $78 trillion, and consumer net worth is on track to surpass its 2007 peak this quarter, abetted by an equity market that’s nearing new highs and the turnaround in home prices.
Disappointing December home sales point to supply issue December new and existing home sales unexpectedly declined, reflecting in part an inventory problem although other factors also played a role. For example, the decline in new-home sales was off a huge upward revision to November sales—new home sales for the year still jumped the most since 1983 and were up on the year for the first time since 2005. Existing home sales also were still strong, rising 12% on the quarter. But the supply of available existing homes hit an 11-year low in December, while the supply of new homes is near historical lows. While this lack of supply bodes well for prices and the net worth of consumers with homes—the FHFA’s home-price index was up 5.6% for the 12 months ended last November and is on track for its first up year in six years—it appears to be pricing prospective first-time buyers out of the market.
Manufacturing’s mixed messages Most regional gauges of activity, including Richmond, Philly and Empire, contracted in January, though it’s noteworthy these areas were in or close to Hurricane Sandy’s path. The Fed’s Kansas City survey also turned negative, disappointing expectations. But the national Markit Flash PMI rose more than expected on the month on broad-based improvement, including output, employment and new orders. Driven entirely by domestic demand—new export orders fell—the new orders index hit its highest level since May 2010. Next week’s ISM report could provide clarity on whether the regional weakness is just that—a regional issue.
Could corn and wheat pose inflation risk? The USDA reduced its inventory estimates for corn and wheat in response to rising demand and drought. Corn inventories as of Dec. 1, after the 2012 harvest, were down 17% from a year earlier and the smallest for that date since 2003. Estimated wheat reserves were down 5%. A recent Earth Policy Institute analysis highlights the growing danger from declining grain stocks, as demand has exceeded supply in eight of the last 13 years. A spike in food commodity prices could derail the Fed’s all-in easing if inflation expectations perk up above its 2.5% band.
A new city for me! During my trip to the state this week, I visited for the first time the Tri-Cities, including Kennewick/Richland/Pasco, the fastest-growing metro area in 2011, with a 28% increase in population over the past decade. The U.S. receives 5% of its electricity from this region, a unique area of the country. In 1943, it was part of the Manhattan Project, meant to protect our country, and produced the first full-scale nuclear reactor in our country. Plutonium, for creating the nuclear bomb, came from here. Until the late 1980s, the area housed nine plutonium reactors. In recent years, billions have been sent to this area to clean it all up.
Whatever happened to, “It’s the economy, stupid!” Obama’s Monday inaugural address was aggressive, highlighting togetherness, collective action and the federal fight against climate change but not growth, jobs, business investment or tax reform.
Regulate this The number of new regulations as of Dec. 10, 2012 on the website Regulations.gov: last 3 days-103; last 7 days-540; last 15 days-1,067; last 30 days-1,831; last 90 days-5,863. These numbers were tabulated before a wide range of new regulations were launched in 2013, from Dodd-Frank to fracking.