Weekly Recap & Outlook – 03.16.12

Tower Private Advisors


  • The VIX is too low . . . really?
  • Goldman Sachs
  • Bank stress tests
  • Portugal next?

We recently hosted seminars in Fort Wayne and Warsaw, presented by First Trust Portfolios. You can click here and here to see the slide packs. Here’s a quick list of bullet-point takeaways from the first presenter, First Trust’s Chief Investment Officer, Bob Carey.

  • Stocks are quite undervalued – among other things, earnings yields (inverse of P/E) are very high.
  • Investors should favor the cyclicals sectors, like Industrials and Materials companies.
  • Discounted Cash Flow valuation methodologies suggest most undervalued sectors are Technology, Industrials, Consumer Discretionary, and Financials
  • 2012 will be the year that marks the rise of Treasury yields.

Capital Markets Recap

Check out that last one. The CBOE Volatility index is suggesting a very high level of complacency. As you can see from the chart below, such levels have spelled disaster for stocks in the past.

Not so fast, Buck-o. The problem with the VIX is that it can stay low for a long time. If one had sold stocks the first time the VIX fell below the white-line level above–back in 2004–one would have missed out on a nearly-vertical three-year run for stocks. Admittedly, it turned out badly…four years later, but that was a lot of upside to miss out on. The orange square in the chart below shows that time period.

Top Stories

This observation like many here–at least those that aren’t plagiarized–is totally unscientific, but, this week, Bloomberg’s Top Stories’ headlines included as many mentions of Portugal as they did of Greece. Now I don’t know if that’s a changing tide or just the natural moving on from the scene of the accident once the excitement dies down.

The Federal Reserve posted the results of its most recent bank stress tests. Of the largest 19 banks in the U.S., 15 of them “would be able to maintain capital levels above a regulatory minimum” in a test that assumed a 13% unemployment rate, a 50% drop in stock prices, and a 21% drop in home prices. A sentence in the same Bloomberg News article can assure you that the tests were legitimate:

“Bankers criticized the criteria the Fed used in the stress tests.”

The flunkies were: Ally Bank, Citigroup, SunTrust, and MetLife.

One of the banks that–not surprisingly–passed the stress test failed the integrity test of one of its own. Goldman Sachs was piloried in a New York Times Op-Ed piece that served as the author’s resignation letter.

What are three quick ways to become a leader [at Goldman]? a) Execute on the firm’s “axes,” which is Goldman-speak for persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit. b) “Hunt Elephants.” In English: get your clients — some of whom are sophisticated, and some of whom aren’t — to trade whatever will bring the biggest profit to Goldman. Call me old-fashioned, but I don’t like selling my clients a product that is wrong for them. c) Find yourself sitting in a seat where your job is to trade any illiquid, opaque product with a three-letter acronym.

It is featured below. Clicking on it will take you to the piece, itself.


Wall Street, naturally, could care less, as the chart of Goldman Sachs stock, below, shows. If this news is true, then, arguably, the long-term value of the company will suffer, but the stock appears unbuffetted. A more likely explanation was contained in a blogpost over at goldmansachs666.com, where an author said, “…Smith’s revelations aren’t really news at all…”

This Week

While there were a slew of economic releases this week, none of them were staggering or market moving. For the most part, economists didn’t guess too badly. Were I getting paid by the word, I would point out that economists got the Empire State Manufacturing index completely wrong. While the green eye-shade folks said the figure would come in at 17.50, the actual release was 20.21, bettering the previous figure (19.53), too. Strangely, they almost nailed the Philadelphia Federal Reserve’s version for that region. Both are feature below, and both are above both their long-term averages and the expansion-contraction demarcation line. Both of these charts reflect the expectations components of the survey; current conditions are undoubtedly different, but I prefer not to dig that deep since this version suits my personal view of the situation.

And they missed consumer confidence pretty badly. It’s a common refrain that one missed the magnitude but got the direction right. Not this week for University of Michigan Consumer Confidence. Economists expected a preliminary-March figure of 76.0, a modest improvement over February’s 75.3. Instead, they got 74.3. It may be that gasoline prices are finally hurting, although everything I’ve heard says that spikes in gasoline prices don’t hurt the economy; instead, prolonged increases do the hurting, which is prolly why the sentiment index just rolled over instead of plummeting. Here’s what it looks like.

Still, gasoline prices have a big impact on consumer confidence, as shown by this scatter plot, which features confidence on the horizontal axis, oil prices on the vertical. The R2, going back to 2005, is 35.3, suggesting that 35.3% of consumer confidence readings can be attributed to oil prices. Well, the devil is in the unexplained 64.7%, because the regression of the data suggests confidence ought to be about 10 points lower.

Otherwise, the economic news was more boring than usual. Initial Jobless Claims (i.e. layoffs) continue to decline; Small Business Optimism was unchanged–crept up a bit; economists nailed both consumer and producer inflation–would you believe the Consumer Price Index–the headline version (i.e. includes food and energy)–has fallen by 25.8% since September? (Yes, of course, it’s a conspiracy.)

Oh, and the Federal Open Markets Committee met this week and–SURPRISE–decided to do nothing, for which they released a statement that Wordle rendered as shown below:

Like it or not, the economy’s expanding*–whether it fits with your view of the world or not. There needs to be, however, a gigantic ASTERISK hitched to expanding. A Bloomberg news story talked about it recently, and it’s been bandied about amongst economists for quite a bit longer than that. While the economy’s expanding, some portion of it can be attributed to the unseasonably warm weather we’re having. That has pulled forward a lot of economic activity that depends on warmer weather. Even the economists are getting a bit heady, as shown by the Economic Surprise Index, put out by Citigroup. Featured here before, it shows economists’ estimates versus the actual releases. Its upper bound is 100, so in one sense, the indicator can do nothing but decline, but it’s showing that (its falling) the economists are starting to be too optimistic about the economy…just in time for us to hit the air pocket of pulled-forward economic activity.

Next Week

Key indicators to watch

  • Initial Jobless Claims
  • Leading Economic Indicators

Housing indicators

  • NAHB Housing Market Index
  • Housing Starts
  • Building Permits
  • Existing Home Sales
  • House Price Index
  • New Home Sales

Graig Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors


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