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‘Scary’ Analysis

October 11, 2012 Leave a comment

On Wednesday, I was trapped listening to CNBC because I was at one of our major consulting clients’ offices and it was on. I was struck by, and thought I would share, their insightful advice about what to do if the market has a ‘scary October.’ Their advice, phrased a number of different ways at a number of different times during the day, was to “average in,” and “take the opportunity to buy low.” So: respond to weakness in stocks by buying.

It would reasonable to consider whether that is solid advice – after all, it is much better to buy lower prices and multiples than higher prices and multiples – except for the fact that it’s the same advice they give when the market is rallying: buy. In fact, if one were to buy every time CNBC said to buy, and sell every time CNBC said to sell, over the last 15 years, I am pretty sure you’d be about 2500% long.

In this case, I don’t fault the advice itself, just the track record of the advisor. If the market actually declines an appreciable amount (2.5% off the highs does not, I think, qualify), then it makes sense to buy. Stocks are, after all, real assets. They don’t tend to perform well in inflationary periods, because of the initial shift in valuation multiples as inflation moves from low and stable to higher levels, but once valuations have adjusted, they do just fine. So far, valuations have not in fact adjusted, and remain high; so also do gross margins and corporate earnings as a percentage of GDP (which is currently near the highest levels of the last 60 years). I would buy equities after a ‘scary October,’ but not unless it’s a lot scarier than it is right now.

Stocks are doing poorly despite the suddenly whiz-bang employment picture. Today’s 339,000 print on Initial Unemployment Claims (versus a consensus of 370k) was the best since January 2008 (see chart, source Bloomberg).

Now, unfortunately, this number can’t be taken at face value. Unlike with the Employment report, all that you need to massage a weekly Claims number is for the government workers in a state to work a bit slower processing unemployment claims that week. As it happened, the BLS noted in the report that one state was responsible for most of the drop, which is not what you’d expect to see if the ranks of the jobless were suddenly thinning due to economic growth. It looks like one state (the BLS won’t say which one, but it must have been a big one; I’m guessing California, where some gas stations were closed last week and gasoline prices shot to near $6/gallon in some places, but I am not sure why the BLS wouldn’t tell which state since they typically do).

But, again, I must admonish readers to remember that the reported numbers are not as important as whatever is actually happening in the economy. If the numbers are not a good reflection of that, the man on the street will know it. They certainly know it in this case.

Now, there is certainly a possibility that employment has suddenly accelerated. But I don’t consider that a very likely possibility, since employment (as we are incessantly reminded near turns in the economy) tends to lag the business cycle rather than lead it. We haven’t seen a sudden surge in Durable Goods or purchasing managers’ reports, and seasonally-adjusted gasoline demand is the lowest it has been since 2008 (see the busy chart below, source Bloomberg, that plots the DOE Motor Gasoline Implied Demand by calendar date for the last five years. The white line represents 2012).

Total trucking miles are also at the lowest level, not the highest, since 2009 (see chart, source ATA and Bloomberg).

And, in case that’s partly a response to high gasoline prices, here are US Freight Carloads from the Association of American Railroads (with the 52-week moving average, in red. Source: AAR and Bloomberg).

That, and not the weekly Claims numbers, are what Americans feel. While consumer confidence may improve simply if things don’t get worse, that’s not the same as the way confidence will improve if ever activity – not just stock prices – starts to actually improve.

Europe continues to be the biggest threat to the global growth dynamic, but last night’s S&P downgrade of Spain two notches (from BBB+ to BBB-) was ignored by the market. Spanish yields actually declined. This is the way it should be, because we all know ratings are fairly useless generally but especially for sovereigns. As I have written previously, the only circumstance in which sovereign ratings make any sense is in fact in countries like Spain that may be unable to pay their debt because they cannot print their own currency. In any country that can print, it is impossible for there to be a forced bankruptcy; ergo, the rating of such sovereigns (such as the US) must be trying to measure not the ability to pay (which is absolute) but the willingness to pay rather than to default – even if to do so requires inflating, that isn’t a default. But if ratings have to measure willingness, they’re completely messed up. We have no way to evaluate willingness to pay. All of which is a long-winded way of saying that ratings only matter these days I think because of the risk of ratings triggers, such as when investors can only hold ‘investment grade’ paper and so need to sell bonds if they’re downgraded below that level. And I suspect this isn’t a big problem with Spain, as most conscious investors probably concluded months ago that this is not an ‘investment grade’ credit.

The election and earnings season remain the foci for the month of October. (And inflation traders also look forward to the 30-year TIPS auction, next week, which has started to put mild downward pressure on BEI already). There are plenty of other global issues still in play, but I’d expect stocks to continue to drift lower under the growing pressure of end-of-year selling to lock in lower tax rates, a weak earnings season, and increasing signs that the global slowdown is real. Will it get ‘scary’? I doubt it will get scary enough to buy.

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From May Day to Mayday

May 31, 2012 9 comments

By the time the calendar turned to May, one month ago, we already knew that the economy was weakening. The jury is still out on whether the weakening in the U.S. economy is due entirely to payback from the unseasonally good winter weather, but over the course of the month it became clear to most observers that the data were coming in soft. The exception to that rule was the inflation data, but we have been assured that worry is needless.

But back in the halcyon days of April we were just beginning to realize that the Greek “bailout” had not kicked the can down the road sufficiently far. Bankia had not failed, and Spain was not yet so threatening as it is today. And certainly, the head of the ECB had not yet taken to calling the Euro framework “unsustainable,” as he did today:

“That configuration that we had with us by and large for ten years which was considered sustainable, I should add, in a perhaps myopic way, has been shown to be unsustainable unless further steps are taken,”

Lest we forget how far we traveled in May, here is a quick summary of the way we were: (Source: Bloomberg)

4/30/2012

5/31/2012

Change
Crude

104.87

86.54

-17.5%

Gasoline

318.44

282.5

-$0.36

DJUBS Ag

160.8088

144.8983

-9.9%

DJUBS Softs

153.9553

135.8419

-11.8%

DJUBS Prec Metals

514.6371

477.9181

-7.1%

DJUBS Ind Metals

326.637

295.1249

-9.6%

Dollar Index

78.776

83.066

5.4%

S&P 500

1397.91

1310.33

-6.3%

Spanish 10y yields

5.77%

6.56%

+79bps

US 10y yields

1.92%

1.56%

-36bps

US 10y real yields

-0.35%

-0.56%

-21bps

US 10y breakevens

2.24%

2.09%

-15bps

Those are the financial market indicators, but we could go further. Initial Unemployment Claims for the last week of April were 368k; for the last week of May, the figure was 383k. That would seem to be the wrong direction. ADP was also weaker-than-expected at 133k. More concerning perhaps was the Chicago Purchasing Managers’ Report for May, which fell to 52.7 (the lowest figure since 2009) instead of rising to 56.8 as expected. The chart below suggests that the recent numbers have been weaker than the prior numbers were strong.

Stocks sank, although slowly, until the S&P reached and briefly sank below the 1300 level again. Then, for the second time this week, the market rallied on a poll showing the largest pro-austerity party in Greece leading the largest cancel-bailout party by 26% to 24.3%. Yes, that’s right: a 1% increase in the aggregate value of the equity market in the U.S. in response to a polling that was within the margin of error!

If you sold in May, I hope you went away because there weren’t many places to hide. Bonds were the clear winners, but with core inflation rising in virtually every country that is obviously a limited-time offer. Today, year-on-year core inflation in Europe exceeded expectations for the second month in a row. European HICP ex-tobacco, food, and energy rose 1.6%, matching last month’s figure and the high since 2009. (You wouldn’t know this from the widespread headlines of “Euro Zone Inflation Drops to 15-Month Low,” focusing on a headline figure that pundits hope can be interpreted as giving the ECB more room to ease. I fully expect that to happen, and for the Fed to also ease as the European disaster grows more frightening. It isn’t necessary for inflation to be falling, and it won’t matter that core inflation continues to rise. Central bankers simply won’t consider inflation to be a matter of signal importance compared to recession/depression fears.

What a month it has been. And as May draws to a close, we are plainly getting close to a mayday cry.

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