Tower Private Advisors
- Ripping stocks
- Bond yields and inflation
- Recession end and stock performance–original stuff, believe it or not
Capital Markets Recap
Here’s a look at equity returns for the week from an expanded list of indexes. Main regional indexes are highlighted in blue.
Pundits are chalking the moves in the equity markets to expectations of a Republican victory in November or better housing news or capital spending (see This Week, below) or vernal equinox or whatever else they can dream up. Fact is, everyone was all beared up. After the Hindenburg Omen became the hot item–Glenn Beck featured it, along with a picture of the fated dirigible, and Bloomberg launched a Hindenburg Omen function–even though few could agree on what it was, and even when they did agree it had historically given false signals. And everyone knew that September was historically a terrible month, and wouldn’t this year be terrible, too. And futures traders were net short. As an old German-accented client used to say, “and . . . and . . . and.” Market participants were too bearish, and the worst didn’t come to pass, so the market went up. Or as Ned Davis likes to say, “when everyone expects something to happen, the market rarely cooperates.” Well, he said something like that.
It’s important to understand the biases behind those who take positions or make pronouncements. For example, David Rosenberg–oft quoted everywhere–will rarely be positive on stocks. Certain blogs will always be bullish/bearish on stocks. Brian Wesbury, once on the Bush Council of Economic Advisors, now an economist for First Trust securities, is always bullish on the economy. Certain political entertainers with radio shows are presently painting a very gloomy picture for America–and rightly so in many aspects. The question is, will the same ones–some in the preceding list–who talked about the “Death Cross” in the major indexes in the summer–and what that portended–mention the opposite, the “Golden Cross,” along with its bullish portents, that is forming in the same indexes, as shown in the chart below? I suspect not; it doesn’t fit with their view of things. If you don’t want to click on the hyperlinked definitions of the crosses. The Death/Golden Cross occurs when a shorter-term moving average crosses below/above a longer-term definition. In the chart below, I’ve used the 50-day moving average crossing above/below the 100-day moving average, but one could look at the 200-day, instead. It just didn’t fit with my bias–that, and commentators would have looked pretty dumb mentioning it.
Here’s a look at the remaining indexes, unenhanced but for the addition of 52-week low and high figures.
Remember, back in April, when your 301(k) was on its way back to becoming a 401(k) and the floor fell out from under the market? The way we remember it, the blame was widely assigned to worries about Europe. As more proof that you can’t trust the bobblehead dolls on financial television, the troubles in Europe are far from over, and, in fact, they’re boiling over, as this graph of Credit Default Swaps on Greece, Ireland, Portugal, and Spain–displayed below the S & P 500–illustrates. Default insurance premiums on Irish debt are at all-time highs, while Spain and Portugal are close. Instead of tanking, stocks are roaring ahead.
The whole inflation thing needs a little attention. For the first time, the Federal Open Markets Committee explicity said, in its statement released this week, that deflation is a threat, and thus the need for QE2, aka Quantitative Easing, Round II. Our intrepid Senior Investment Officer, who shall remain nameless until the next sentence, thought that perhaps it was a reference to an oceanliner. (You were kidding, right, Kevin T. Noll?) The sentence in the Fed’s statement that drew attention to deflation was this one:
The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accomodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.
Quantitative Easing is what a central bank does when it can’t lower interest rates any further–and probably what they should have done before they got this far (that’s not an argument for what follows, just that marginal returns began to diminish several percentage points ago). In short, the central bank buys securities. They do that by cranking up the printing press, increasing the supply of dollars, lowering their value, ushering in inflation. With inflation comes a fear that prices will rise and you rush out and buy them. Well, you do, don’t you? Buying fixed-income securities raises their prices and pushes down their yields, lowering interest rates. With lower interest rates comes easier financing for all the things the American consumer wants to buy. You are clambering to buy stuff, right? waiting for interest rates to fall? A funny thing happened on the way to the forum, however, and that is that consumers decided that it was time to hunker down. The Savings Rate is up to 5.9% (savings as a percent of disposable income) from a 0.8% 2005 low. In a word, the consumer is deleveraging, and lower interest rates will amount to pushing on a string.
To be fair, there are other mechanisms that transfer the effect of lower interest rates to the economy. With lower interest rates . . . (all other things equal, of course) . . .
- Present value discount rates are lower. That means future streams of cash flows are more valuable. Dividends and interest payments are cashflows; thus, the values of stocks and bonds improve.
- The cost of capital falls, making it easier for businesses to justify investments
- Capitalization rates, used in valuing commercial properties, are lower; thus, property values improve
- Business expenses improve as interest costs fall
Exhibit #1 on that last point is a bond issue the Microsoft came out with this week. The issue had three tranches (‘love using that word):
- $1 billion yielding 0.875% due September 25, 2013
- $1.75 billion yielding 1.625% due September 25, 2015
- $1 billion yielding 3.00% due October 1, 2020
- $1 billion yielding 4.50% due October 1, TWO THOUSAND F O R T Y !
With that sort of wood–$5 billion of cash alone on the balance sheet–you’d increase your dividend, too. Who cares about the bondholders. Unfortunately, the dividend boost went from $0.13/quarter to $0.16/quarter.
Back to inflation . . . the Treasury Inflation Protected Securities market is getting a bit whacky, as the graphic below shows. With interest rates on nominal (read: non-inflation adjusted) Treasury securities so low, taking out an inflation premium has resulted in a negative yield on the 5-year TIPS. In short, over time, buyers of the 5-year TIPS are willing to accept a negative yield in the expectation that the inflation compensation will make up for it.
- Nike saw its stock hit an all-time high. It beat analyst estimates by a little bit . . . 13%. Its sales in China jumped by 10%.
- Petrobras completed its add-on share offering, raising $70 billion, which it will use to “boost production to 5.38 million barrels a day by tapping deposits trapped under a layer of salt beneath the ocean floor” (Bloomberg.) The Brazilian government, too, expects to increase its holdings to 55% of the company. That and dilution (the shares were priced 2% below yesterday’s close) have pressured the stock this year.
- Netflix seems to have figured out how Americans think. In an interview with The Hollywood Reporter, the CEO, Reed Hastings, was asked if subscribers in the U.S., who pay $8.99 for one subscription plan, would be irritated by the $7.99 that Canadian subscribers pay. His response:
“How much has it been your experience that Americans follow what happens in the world? It’s something we’ll monitor, but Americans are somewhat self-absorbed.” (source: Minyanville)
If you didn’t catch the earlier Phwew-the-recession’s-over-post–or even if you did, here’s more to chew on. The first chart below shows the performance of the stock market following the date of the recession’s end for the last four recessions.
‘Doesn’t look too bad. After the typical end date the market has a modest upward bias, and were it not for the 2001 episode–think 9/11–the composite results would have been a lot better.
Unfortunately for you, it’s not possible to invest at the recession end date. Instead, you can invest at the date the end of the recession was announced, which is what the chart below shows.
Lousy housing data. Increase in jobless claims. Strong durable goods orders.
We had five housing data points this week. On their face, three were positive; two were largely unchanged. The NAHB Housing Market Index–the monthly survey of builder sentiment–was unchanged. The survey remains 82% below its 2005 high. Housing Starts appeared to be quite strong, growing by 10.5% versus a consensus guess of 0.7%, but it turns out the bulk of the strength was in Multi-family Starts(+32.2% MoM; +55.3% YoY), not what signals a robust housing market. And the pipeline of starts, Building Permits, were unchanged. Even there, the only strength was in multi-family permits (+9.8%), not single-family (-1.2%). Existing Home Salesgrew by 7.8% in August, the first month since the first-time homebuyer credit expired. Growth was pretty even between Single Family and Condos/Co-ops. But there was a cloud behind that silver lining, too: the sales occured at average prices (-)2% below July’s prices. New Home Sales were unchanged from the revised figure for July.
Initial Jobless Claimsrose by 12,000, the first increase in a month, and that seemed to be some impetus for equities futures to sell-off a bit. The monthly nonfarm payrolls report confirms that no one is hiring, and jobless claims confirm that layoffs continue.
Leading Economic Indicators grew by 0.3%, but most commentators suggested that the LEI was only consistent with sluggish growth. Today’s Durable Goods Report was, however, very positive. The Headline change was a decline of (-)1.3%, but when lumpy transportation goods orders are excluded, the Ex-Transportation index grew at 2.0%, which was better than the revised -2.8% drop in July. When orders for defense goods are excluded, too, Non-Defense Capital Goods Orders ex-Aircraft orders grew by a big 4.1%, far better than July’s -5.3%. Better still, when orders for black appliances are excluded–okay, just kidding.
Key indicators to watch
- CaseShiller Home Price Index (July) – Tuesday
- Q2 GDP – second and final revision – Wednesday
- Initial Jobless Claims (weekly) – Thursday
- Personal Income, Spending, and Saving (August) – Friday
- ISM Manufacturing (September) – Friday
- University of Michigan Consumer Confidence (final September) – Friday
- Dallas Federal Reserve Manufacturing Activity (September) – Monday
- Richmond Federal Reserve Manufacturing Index (September) – Tuesday
- Chicago Purchasing Managers Index (September) – Thursday
- Milwaukee Purchasing Managers Index (September) – Thursday