Posting Schedule

A bit of a change this week.  During summer hours we normally don't post on Friday.  I've put something up today but will be traveling on Monday.  Unless we need to break in, the next post here will be Tuesday.

Bonds-A Real World Example.

Longer term readers of this blog know what I think of bonds right now.  If you don't know or want a refresher on the subject go here and most recently here.  If you want to see what people smarter than me think about bonds go here and here.   

The blog Zero Hedge yesterday showed a real world example of what happens to bonds when interest rates suddenly move higher.  Here's a real world chart of  some of the bonds Apple Computer {AAPL} recently sold.

Here's part of their commentary regarding the bonds:

"....Fast forward to today, or rather a month ago when on April 30 AAPL announced that in lieu of repatriating its $100 billion in offshore cash it would instead sell $17 billion in 3-30 Year bonds, a move which some speculated is an interim top in the bond market. They were right.

What followed was a quick and painful, for some, lesson in duration and bond math (and a reminder of what happens to both dividend stocks and rate-sensitive prices in a rising rate...supposedly...environment):

What happened? Well, Treasury yields soared. Which means that all linked instruments with duration exposure, such as the above AAPL bonds, got doubly crushed:

• The 10 year which priced at +75 (and par of course) has lost nearly 5 points of notional in less than a month.
• The 30 year (at +100) - down nearly 8. All of this in under one month.

Biggest winner here - Apple which raised hundreds of millions more by coming to market then and not now.  The losers? Those who bought the bonds. But don't worry: these are just paper losses, and paper losses never become real losses...."

To be fair Zero Hedge thinks that when rates begin to rise it will also not be good for stocks.  We'll see about that.  In general that is a correct statement, but I don't know from these levels whether stocks can't continue to rise if bond yields  reverse only slightly on their first move higher.  Meaning that I'm not sure a move from a 2% to 3% ten year bond yield kills the market's rally.  Bond math however tells me what this kind of move does to bonds.  Hint:  It's not good.   Remember, some version of this fate will likely happen to all bonds when yields begin to rise.

Link:  Zero Hedge.com:  Remember those Apple bonds.

*Long AAPL in certain client accounts and indirectly through various ETFs owned in client and personal accounts.

A Few Quick Thoughts.

Thought 1:  People are always looking for contrary indicators that the last person is "in" the markets and thus a top is in place.  This headline yesterday from USA Today....

.....along with the commercial run by a certain financial insurance giant that admonishes us that "It's time to start investing again" might qualify.  The counter argument to that is we still see massive amounts of money flowing into bonds.  This is what Lipper {a company that among other things tracks money flows into the markets} said about money flows in the latest reported period, the week of 05.22.13:

For the week ended 05/22/2013 ExETFs - All Equity funds report net inflows totaling $2.469 billion, with Domestic Equity funds reporting net inflows of $0.472 billion and Non-Domestic Equity funds reporting net inflows of $1.997 billion... ExETFs—Emerging Markets Equity funds report net inflows of $0.840 billion...  Net inflows are reported for All Taxable Bond funds ($3.206 billion), bringing the rate of inflows of the $3.852 trillion sector to $6.798 billion/week...  International & Global Debt funds posted net inflows of $0.552 billion...  Net inflows of $1.839 billion were reported for Corp-Investment Grade funds while High Yield funds reported net inflows of $0.376 billion…  Money Market funds report net inflows of $15.422 billion…  ExETFs—Municipal Bond funds report net inflows of $0.053 billion.  

So by my calculation using these figures, roughly 2.5 billion went into equity funds with non-domestic funds taking in about 2 billion of that.  Meanwhile all bond funds reported inflows of just over 6 billion dollars and money market accounts took in nearly 15.5 billion.  Ex out the money markets and that means that for every dollar that went into equities, $2.40 went into bonds.  I'll believe a long term top is in when these bond and equity numbers reverse themselves.  Notice also that the majority of those dollars invested in equities went abroad.

Thought 2:  Speaking of that above mentioned financial insurance giant, "the one telling us it's time to start investing again", I hope they were telling us the same thing back in 2009 as the market is up about 140% since then.

Thought 3:  The fact that I'm saying that these indicators have a higher probability of not being the end of a cyclical bull market doesn't mean that we won't see a correction or corrections over the next several   years.  In fact it wouldn't surprise me if we didn't enter a corrective phase sooner rather than later.  Here's a couple of reasons why it might occur:

1.  Markets are very over bought in the longer and intermediate time frames we measure.

2.  Stocks have run up over 20% since last November.  A move of that length and duration at some point needs to take a breather.

3.  Rising interest rates could at some point put a short term lid on the advance.

4.  Seasonal factors.  I know we've beat the seasonality thing to death and also discussed why it might not occur this year, but it's hard to ignore the fact that we have now entered the teeth of that period and harder still to ignore the fact that Wall Street will slow down as summer beckons.  This will become more pronounced after July 4th through Labor Day.

5.  Any hint from corporations that the 2nd half of the year will be tougher going than Wall Street currently expects.  We're going to get a look into that over the next six-eight weeks.  Companies that know for sure that things are tough will likely begin pre-announcing such news in the next two weeks or so.  Then we have earnings after June 30th.  

Now for the record I'm not saying for sure that a correction is coming.  I'm just saying that it wouldn't surprise me if it occurs.  Also remember that stocks can correct by time as well as price, meaning that it could be we get to Labor Day and stock prices are more or less right where they are now, having basically done nothing in the intervening months.  Only time will tell.  We'll have the defensive pages of the playbook handy in the event we begin to get more nervous about things.

Thought 4:  Rising interest rates.  Quietly in the past month interest rates have begun to creep higher.  Expect to hear more about this if this continues.  Low rates have been the mother's milk of this rally and the economic recovery.  In the event we're seeing signs that the low interest rate era is over, then we could be entering a new dynamic phase of the markets.  My thoughts on this will have to be in another post.  However, I do wonder about all that money that's still pouring into bond funds in search of yield.  I looked at the prices of a few popular bond funds these last few days.  The average of these is down nearly 2% for May so far.  That's a huge decline in a low interest rate environment.  Something to ponder as we likely sit near generational interest rate lows.  Again,  more to come on this in the event rates keep going higher.

Oh and for what its worth, the Chicago Blackhawks played one heck of a game last night, coming from sown 3-1 in their series against the Detroit Red Wings to capture a very exciting game 7!

an tSionna {The Dow}

An inflation adjusted view of the Dow Jones Industrial Average adjusted for inflation courtesy of Chart of the Day.com.  

Here's what they say about this:

For some long-term perspective, today's chart illustrates the inflation-adjusted Dow since 1900. Of interest is that the inflation-adjusted Dow has traded within the confines of an extremely long-term upward sloping trend channel over the past 113 years. It is also of interest that the secular bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s. Also, while the market action from the inflation-adjusted record high of 1999 to the financial crisis lows of 2009 was severe, the magnitude of this decline was much less than what occurred with the bear markets that concluded in the early 1930s and early 1980s. More recently, the non-inflation-adjusted Dow has continued to trade in all-time record high territory. However, the inflation-adjusted Dow still trades below both its 1999 and 2007 peaks -- albeit not by much (just 3% to go for a new all-time, inflation-adjusted record high).

Link: Chart of the Day.com: Dow adjusted for inflation.

*Long ETFs related to the Dow Jones Industrial Average in certain client accounts.

Memorial Day

Happy Memorial Day!

In our town of River Forest one of the highlights of our year is the Memorial Day parade which runs right down our street passing in front of Global HQ.  To honor this day we fly two American flags between now and the 4th of July.

The flag you see off to the side of Global HQ was carried by my brother-in-law who flew Harrier jets for the Marines in Afghanistan. We honor his service as well as the services of all prior family members and all others who are serving or who have served in our armed forces.  This year with a heavy heart we'll also fly this flag to honor Anne Smedinghoff, River Forest native and US diplomat killed this spring in Southern Afghanistan.   

Rest in peace Anne and God Speed!

Happy Memorial Day everybody!

Most Highly Segregated Cities In The US

Link to a list of the 21 most highly segregated cities in the US via Business Insider.com.  By this measure Chicago is the 4th most highly segregated city in the US.  This won't make you a dime today but I think longer term the economic stagnation and decline of roughly 40% of the population is a huge problem.  Nobody seems to know how to address it and it's getting worse.

Link:  Businessinsider.com 21 Most Segregated Cities in US; Census Maps 2013

Long Term Investments

Some interesting notes from Blackrock regarding dividends and the S&P 500.

-409 S&P 500 companies were paying dividends as of 04.30.2013.  

-More than 60% of these companies had a yield higher than the 10 year treasury.

-S&P 500 dividends increases have historically outpaced the rate of inflation by 1%-1.5%.

So let's think about this.  If you did nothing but buy an ETF based on the S&P 500 today you would be buying an instrument that pays you a dividend yield greater than the 10 year treasury with a growth component over time.  If you never sell that ETF you will never pay tax on its appreciation.  Let's make an assumption and say that from today's levels, price appreciation of the S&P 500 is just 3% over the next twenty-five years- a rate well below its historical average.  Your money from appreciation will approximately double.  $100,000 will be slightly larger than $200,000.   If on the day that money doubles and assuming our current tax code is in place then, you pass away {or "step off" as a friend of mine says}.   If your estate is under five million you will have never paid a dime of capital gains taxes on this investment, although you will have paid taxes over the years on the dividends.    Remember also that we are using in this example a rate of return below the historical 5-6% return that stocks have increased. 

What are your options today?   What are the options most of us have?  In the main here's what I see.

Well for one thing there's real estate.  My gut feel has been that excess cash from investors has been going into this since the 2008 crash, especially those who might be interested in a second home and have the ability to purchase such an asset.  Vacation markets have had great bargains over the past five years.   Somebody with excess cash in a taxable account might have been tempted to buy that retirement or second home, reasoning that even if they never made a dime on the place it was something they could use or at least wouldn't go away.  Like the stock market though these places have also rebounded in price today.

There's also annuities.  Don't get me started on these.  Someday I'll do a series on how big a rip-off I think these are.

Then there's bonds.  It is hard for me to understand why anybody would put anything other than nominal amounts of money in bonds or CDs today with yields being so paltry.  At best if bond prices never move higher from here you will lose money and purchasing power from the corrosive effects of income taxes and inflation.  If yields start to move higher you will lose principal value until maturity.  Billions of dollars however still are flowing into bond funds.

So equities via ETFs today can give you income that's competitive with bonds and an appreciation kicker.  What's the trade off?  Well stock markets have and will continue to experience declines.  Even if the secular bear market is over and we're going into a better economic place there will be periods of market volatility.  We're seeing an example of this today.  Japan is down before our open about 7%.  US stocks are poised to lose between 1-2% at our open.  Stocks have historically seen price declines of 5-20% even in good times.  That's just the natural volatility of things.  However.......

Volatility is not necessarily risk.  It is the price you pay for being in a completely liquid investment such as stocks or ETFs.  ETFs are subject to volatility risk and market declines like every other instrument.  They are in general not subject to single stock risk-the risk that an event such as a bad earnings report or an unexpected event such as an accident or a product failure will immediately and perhaps permanently impair your principal.  The reason that I say in general is because it is possible in some ETFs for certain components {think Apple in the QQQs} to become such a large part of the index that it's price decline will hurt the ETF's performance.  But I know of no single stock event, even an individual stock going to zero that will completely wipe out the principal value of any ETF that I research.  That cannot be said for common stocks.  There may be something out there in the future lying in the weeds that can do this trick to some sort of ETF in the future, but I think that's unlikely given the way most of these are currently configured.  Also ETFs went through their own trial by fire in 2008-09 and for the most part held in there in regards to busting out and going away.  Even levered ETFs {disclosure here, I use some of these in certain strategies we employ for clients} for the most part survived and are thriving today.

In my view volatility is not risk if you have time.  Over time if the US and world economies continue to grow, the natural order of things should bail out prices.  You may have had to wait over five years  during the previous bear market but the markets are now at new highs.  That means even if you picked the worst time ever to buy say a general US stock market ETF, which in my mind is is September, 2008, if you held on during that time you've been made whole and then some.   Note though that the same cannot be said of individual stocks or certain sector ETFs.  Owners of individual bank stocks for example and financial ETFs have for the most part not recovered these highs, either have all foreign markets.  Perhaps the next time we see an event of that magnitude things will be different but so far that has not been the case.

Volatility is risk if you don't have time.  Here at Lumen Capital, we in general take a six to eighteen month view of markets.   If your time period is short, say if you need cash for a certain event like college tuition  before the fall, you probably shouldn't have that part of your investment money invested in stocks right now.  The risk of a volatility event in that period is too great.  Here I'm not talking about market seasonality.  This applies to anytime you see a need in the short term.  There's in general usually not enough time to recover.  

Longer term investors, especially those with an inordinate amount of money stashed in cash or bonds need to rethink their asset allocation.  Come talk to us and let us show you how we do it!

*Long ETFs related to the S&P 500 and the Nasdaq 100 QQQ's in client and personal accounts.  Long Apple individually in certain client accounts and in certain ETFs.

Link:  Blackrock.com: Digging into Dividends.

Next Monday is Memorial Day.  There will be no posts either then or Tuesday as I will be traveling that day.  As usual, we'll break in if events warrant.

Goldman Raises The Bar

Goldman Sachs is out this morning raising its S&P 500 estimates.  Year end 2013 goes to 1750.  They see 1900 next year and 2100 by 2015.  A rapid rise in dividends will keep the S&P yield at around 2%.  You can read the report as well as the executive summary here over at Value Walk.com.

*Long ETFs related to the S&P 500 in client and personal accounts.

an tSionna {Gold}

Gold!!!  {Via the ETF GLD}  Is this a double bottom forming?  Hard to tell but gold did experience a reversal yesterday.  I'm no gold bug.  I have small positions in this in a few of our strategies as a play on commodities.   It's over sold in all of our money flow measures we follow as well.  This merits watching.  A pick up here might signal an improvement in some overseas economies which would be good.  It could also signal a foreign crisis or perhaps other issues in the EU which would be bad.

*Long GLD in certain client accounts and strategies.

As a side note I will be out tomorrow.  Next post here will be Thursday.

How to Create a Diversified Investment Portfolio

Vanguard paper on how to create a diversified investment portfolio.  {Executive Summary}

1. Define your investment goals and constraints.

2. Have a broad strategic allocation among the primary asset classes such as equities, fixed income, and cash.

3. Choose your sub-asset allocation within such classes, such as U.S. or non-U.S. equities or large-, mid-, or small-capitalization equities, and so on.

4. Decide if you will use a passive, {indexed} and/or an actively managed approach to your assets.

5. For taxable investors, allocation of investments in taxable and/or tax-advantaged accounts.

6. Decide on the selection of individual managers, funds, or securities to fill allocations. 

Link:  Vanguard Investments: Vanguard's Framework For Constructing Diversified Portfolios.

Summer Hours

During the period between Memorial Day and Labor Day we traditionally don't publish on Fridays at this blog.  We're going to begin that schedule next starting next Friday.  In the meantime read this excellent article linked below by Joshua Brown over at the Reformed Broker.com where he does a much better job of making many of the same points  regarding the economy that we've argued over the past few months.  

In regards to the summer Friday schedule, rest assured we'll break in if events warrant.  I also want to let you know I'm working on a new series that's going to take a longer term view of the markets and investing over the next several years.  I'm in the process of writing it now so I hope you like it.

Link:  The Reformed Broker.com:  Remember this Moment.

An Interesting View Of The World's Population

Link:  The Reformed Broker.com:  Population Map.

This is why you have to have some exposure to overseas emerging markets.  For the most part these have underperformed in 2013 but longer term it is hard to see how population growth in these countries and their emerging middle classes won't be bullish for their equity markets.

*Long ETFs related to most overseas indices in client and personal accounts.

an tSionna: {05.15.13}

From Bespoke Investment Group:  {Highlights mine.}

"The chart {above} shows the average yield to maturity on the Merrill Lynch High Yield (Junk) Master Index.  At a current level of 5.24%, investors have never been paid less to own high yield debt.  Yields are so low, in fact, that five years ago the yield on the 10-Year US Treasury was higher than the current yield on junk bonds.  In the chart below, the red dots on the blue line represent periods going back to 2000 where the yield on the 10-year US Treasury was higher than the current yield on the High Yield Master Index.  With yields this low, high yield bonds are anything but high yielding."

My comment:  High yield also at some point has to likely equate to much higher risk at these levels.  I still own some of these in ETFs {and have purchased small amounts for some new money} but I am realistic as to their prospects down the road.  These are one of the first things I will likely sell for clients when interest rates start to rise.  The reason to own them right now is the yield is superior to most everything else and because there is no indication that interest rates will rise substantially in the near future.  However, this is an investment nobody should want to overstay their welcome at some point.

*Long certain junk bond ETFs in certain client accounts and risk strategies as well as in certain personal accounts.

Link:  Bespokeinvest.com: High Yield Yields Less Than Treasuries Five Years Ago

Tepper's Chart

Hedge fund manager David Tepper was on CNBC this morning.  He gave a very bullish longer term presentation on equities.  Part of his argument was the chart I'm showing above which purports to show that the Equity Risk Premium {EQP}, the gap between expected return on stocks vs. bonds is as cheap as it has been at other crisis points such as the 1972-74 bear market and in 2009 when everybody thought the world was going to come to an end.   There is no direct way to measure market expectations going forward so the folks over at Liberty Street Economics analyzed twenty-nine of the most popular and widely used models to compute EQP over the last 50 years.  Using a wide variety of tools permitted them to only look at data that would have been available at comparable times in the past.  For example to compute the equity risk premium for January 1970, they only used data available to them in December, 1969.

Of course one of the reasons EQP is so high right now is that interest rates are still at historic lows.  EQP could change dramatically if interest rates were to rise suddenly.  Another thing that could throw this analysis under the bus would be if we were to experience a sudden decline in profits in corporations.  Neither of these events looks to be in the offing over the next 6-12 months.  Corporate profits are at record highs and the Federal Reserve is unlikely to end their stimulus this year.  

Does this mean that stocks are going to rip higher in the months ahead.  Nobody knows.  What this does tell you though is that EQP probably provides some floor for stocks when the next correction hits Probability would therefore suggest that corrections for the foreseeable future are better to buy events.

Source Libertystreeteconomics.newyorkfed.org: Are Stocks Cheap? via Businessinsider.com  

Road to 15,000

The Dow Jones Industrial Average last week traded above 15,000.  Here is the Wall Street Journal's retrospective chart view on the past 30 years from the first time the Dow cracked 1000.

*Long ETFs related to the Dow in certain client accounts.

Source:  Wall Street Journal:   via The Reformed Broker

No Shortage of Cheap Stocks-Leon Cooperman

Omega Advisor's Leon Cooperman, a legendary Wall Street investor, discussed the stock market over on CNBC last week.

"What is the S&P?  If you bought the S&P what would you get?  An index of companies growing 5% a year that yields about 2% sells over two times book value, has 35% debt in their capital structure and for those statistics, you're paying about 15 times earnings.  We're looking for companies who are growing in line or more than the market or yield more than the market or sell at a much lower asset value.  You can find plenty of attractive ideas."

CNBC video of Leon Cooperman {Omega Advisors} Discussing the Market.

an tSionna {05.10.13}

From Chart of the Day:   "For some perspective on the trend of the overall stock market, today's chart illustrates the trend of the stock market (as measured by the S&P 500) since 2000. As today's chart illustrates, the post-financial crisis rally (which began in early 2009) has been significant enough to move the S&P 500 to all-time record highs. In addition, the latest leg of the post-financial crisis rally has the S&P 500 breaking above resistance created by the last two all-time record highs (see thick red line)."

The thing to note is how the PE has compressed over the years.  We've shown a chart similar to this before and we've discussed this compression at this post.  PE's have compressed from 25 in 2000 to 15 in 2007 to about 14.7 today based on forward four quarters earnings of $109.40,  numbers which by the way I am beginning to think are too low.    The earnings yield is now at 6.7% in a less than 2% interest rate environment.

Markets may be due for a bit of a rest as stocks have moved a lot in a very short period of time but based on what we know today, probability suggests the overall trajectory of prices ought to trend higher.  The major reasons for this in my mind are simple.  First the economy, particularly here in the US, is getting better. Secondly global stimulus in the form of monetary easing has reduced the attractiveness of all other forms of investment with the possible exception of real estate.  

Link:  Chart of the Day.com: S&P 500

What If Things Are Getting Better

Bloomberg.com: Jobless Claims in U.S. Unexpectedly Fall to Five-Year Low

Four Basic Traits of Successful Investors

From Pragmatic Capitalist.com via The Big Picture blog.

1. They look at objective indicators. Removing the emotions from the investing process, they focus on data instead of reacting to events;
2. They are Disciplined:  The data drives decision making with pre-established rules. External factors do not influence them;
3. They have Flexibility:  The best investors are open-minded to new ideas, or revisiting previous thoughts;
4. They are Risk adverse: Not always obvious to investors, it is a crucial part of successful investing.

Link:  Pragmatic Capitalist.com: Ned Davis Four Basic Traits of Successful Investors.

Managers Don't Beat Their Benchmarks.

It is stating the obvious {because you can see dozens of articles on the subject}, but investment managers generally don't do well versus their target indices.  This is why we use ETFs.  Here's some more insight on the subject via the blog Zero Hedge.  Some Highlights.

In regards to mutual funds:

"It may seem uncharitable to note that only .4%--that's 4/10th of 1%--of mutual fund managers outperform a plain-vanilla S&P 500 index fund over 10 years, but that is being generous: by other measures, it's an infinitesimal 1/10th of 1%.

Frequent contributor B.C. recently screened 24,711 funds on Yahoo Finance's fund screener and 17,785 funds on the Wall Street Journal's online screening tool. The results were sobering, to say the least: using a basic set of criteria, the first screen turned up a mere 5 managers who beat the S&P 500 index over five years. Using a slightly different set of criteria, the second screen found 71 funds out of 17,785 outperformed the index over ten years.  That's .4% of managed funds, i.e. an index fund beat 99.6% of all fund managers."

Hedge funds fair no better in longer term performance:

By definition "hedge" funds are no better, i.e., they hedge investors' returns to no better than cash:

Hedge Funds: Going nowhere fast (The Economist)

"The past year has been another mediocre one for hedge funds. The HFRX, a widely used measure of industry returns, is up by just 3%, compared with an 18% rise in the S&P 500 share index. Although it might be possible to shrug off one year’s underperformance, the hedgies’ problems run much deeper.

The S&P 500 has now outperformed its hedge-fund rival for ten straight years, with the exception of 2008 when both fell sharply. A simple-minded investment portfolio—60% of it in shares and the rest in sovereign bonds—has delivered returns of more than 90% over the past decade, compared with a meagre 17% after fees for hedge funds (see chart). As a group, the supposed sorcerers of the financial world have returned less than inflation."

Link:  Zerohedge.com: Poor Investment Management Performance

*Long ETFs related to the S&P 500 in client and personal accounts.

Sell In May: Real Money

Via Business Insider.com.  What $10,000 would be worth if the money was out of the market between May 1 and October 31 of each year using the Dow Jones Industrial Average going back to the 1950's.

That being said, there are some years where this strategy does not work.  1995-1997, during the glory years of the last Bull, this strategy did not pay off.  It didn't pay off as recently as 2009 either.  So many people are talking about how this is a sure fire way to avoid a decline this year that I think there's a much higher probability than normal that we could see this not pan out in 2013.  Time will tell.

Link:  Businessinsider.com: How Rich Would You Be if You Sold in May.

One thing I might add in here.  It is possible these old statistical patterns won't work this year.  However, stocks are up something like 4% in this last month and we're not extremely over bought short term.   That's a pretty impressive move by anybody's standards.  Anything is possible in this crazy market but it wouldn't surprise me to see us give some of this back at some point soon.  Not saying that's going to happen so I wouldn't sell based on what you read here.  {I don't give blanket advice anyway.}  Strong actions though often bring equally strong reactions.  Just file that little tidbit away.

Cyclicals vs. Staples

Cyclicals and growth industries such as tech have been shunned in favor of lower growth, defensive and consumer oriented names with yield.  Looking at the chart above gives you an idea why I'm beginning to warm up to tech, energy and more cyclical oriented names.  Have also been doing some selective buying in certain ETFs related to these areas.

*Long ETFs that hold all of the holdings you see in the charts above.  Long ETFs related to the S&P 500 in client and personal accounts.

Link:  Abnormalreturns.com: Chart of the Day.

Why Do Stocks Keep Going Higher?

Recent US economic date has been mediocre as has been the earnings season so far.  So why haven't stocks reacted more negatively?  More important why so far have the seasonal patterns not kicked in?Here's a pretty good summation of why these events don't seem to matter right now from Business Insider.com:

Analysts have advanced at least two interesting theories{On what's holding up stock prices}.

1) Cash Return: "[D]uring the current earnings season, US corporations continue to announce dividend increases and more share buybacks," said stock market guru Ed Yardeni as he rationalized the rally. "Previously, I’ve shown that this corporate cash flow into the stock market--which totaled $2.1 trillion for the S&P 500 since stock prices bottomed during Q1-2009 through Q4-2012--has been driving the bull market since it began."

2) The End Of Austeriy: "Some traders ... think that the new rally really kicked in when news that a graduate student had found flaws in the Reinhart/Rogoff paper on the limiting power of public debt on the economy – thus casting doubt on that thesis," said UBS's Art Cashin. Cashin is talking about UMass grad student Thomas Herndon, who has basically turned the global austerity movement into a joke. Austerity has been a major drag for economic growth, especially in many of the developed European countries.

Look, I think it's probable that stock prices will experience at least a 10% pullback between now and Labor Day.  But I also have to say that there is an underlying strength to stocks right now that we haven't seen this time of year at least since the mid-2000's.   

*Long ETFs related to the S&P 500 in client and personal accounts.

Link:  Businessinsider.com: Why Stocks Will Rally Without the Economy.

What If Things Are Getting Better?

Bloomberg.com: American Auto Industry Has Best Performance in 20 Years.

Bloomberg.com: Payrolls in US Rise 165K, Unemployment Drops to 7.5%-Big Positive Revisions in Previous 2 Months Data

Businessinsider.com: Citi Report on 10 Disruptive Technologies Changing the World

Juancole.com: Incredible Shrinking Cost of Solar Power

ABC news.com: Deficit Surprise US Pays Down National Debt  {First time since 2007}

Bill Gross on Bondholders, "There Will Be Haircuts"

Latest investment letter from Pimco's  Bill Gross.  In it he details four ways bondholders are screwed with interest rates at today's levels and the massive amount of debt governments have issued.  {Excerpt with my highlights in green.  Gross's highlights are in italicized green} Numbers 1 and 2 on Gross' list are probably the ones that US bondholders need to worry about the most.  However, the default rate on municipal bonds has edged up over the past few years and there are some cities, counties etc {i.e. Detroit} that investors should be concerned about.  Default is number 4.

1) Negative Real Interest Rates – “Trimming the Bangs”

During and after World War II most countries with high debt overloads resorted to artificially capping interest rates below the rate of inflation. They forced savers to accept negative real interest rates which lowered the cost of government debt but prevented savers from keeping up with the cost of living. Long Treasuries, for instance, were capped at 2½% while inflation was soaring towards double-digits. The resulting negative real rates together with an accelerating economy allowed the U.S. economy to lower its Depression-era debt/GDP from 250% to a number almost half as much years later, but at a cost of capital market distortions.

Today, central banks are doing the same thing with near zero-bound yields and effective caps on higher rates via quantitative easing. The Treasury’s average cost of money is steadily grinding lower than 2%. If current policies continue to be enforced in future years it will eventually be less than 1% because of the inclusion of T-bill and short maturity financing. The government’s gain, however, is the saver’s loss. Investors are being haircutted by at least 200 basis points judged by historical standards, which in the past offered no QE and priced Fed Funds close to the level of inflation. Large holders of U.S. government bonds, including China and Japan, will be repaid, but in the interim they will be implicitly defaulted on or haircutted via negative real interest rates.

Are Treasuries money good? Yes. But are they good money? Most assuredly not, when current and future haircuts are considered. These rather innocuous seeming (-1%) and

(-2%) real rate haircuts are not a bob or a mullet in hairstyle parlance. More like a “trimming of the bangs.” But at the cut’s conclusion, there’s a lot of hair left on the floor.

(2) Inflation / Currency Devaluation – “the “Don Draper”

Inflation’s sort of like your everyday “Mad Men – Don Draper” type of haircut. It’s been around for a long time and we don’t really give it a second thought except when it’s on top of a handsome head like Jon Hamm’s. 2% ± a year – some say more – but what the heck, inflation’s just like breathing air … you just gotta have it for a modern-day levered economy to survive. Sometimes, though, it gets out of control, and when it is unexpected, a decent size hit to your bond and stock portfolio is a possibility. If our TV idol Don Draper lives another decade or so on the airwaves, he’ll find out in the inflationary 70s. Such was the example as well in the Weimar Republic in the 1920s and in modern day Zimbabwe with its One Hundred Trillion Dollar bill shown below. As central banks surreptitiously inflate, they also devalue their currency and purchasing power relative to other “hard money” countries. Either way – historical bouts of inflation or currency devaluation suggest that your investment portfolio may not be “good as the money” you might be banking on.

(3) Capital Controls – the “Uncle Sam Cut”

Uncle Sam with his rather dapper white hair and trimmed beard serves as a good example for this type of haircut, if only to show that even the U.S. can latch on to your money or capital. Back in the 1930s, FDR instituted a rather blatant form of expropriation shown above. All private ownership of gold was forbidden (and subject to a $10,000 fine and 10 years in prison!) if it wasn’t turned into the government. Today we have less obvious but similar forms of capital controls – currency pegging(China and many others), taxes on incoming capital (Brazil) and outright taxation/embargos of bank deposits (Cyprus). Governments use these methods to keep money out or to keep money in, the net result of which is a haircut on your capital or your potential return on capital. Future haircuts might even include a wealth tax. Are gold and/or AA+ sovereign bonds good as money? Usually, but capital controls can clip you if you’re not careful.

(4) Outright Default – the “Dobbins”

Ah, here’s my favorite haircut, and I’ve named it the “Dobbins” in honor of this 5-year bond issued in the 1920s with a beautiful gold seal and payable, in dollars or machine guns! Bond holders got neither and so it represents the historical example of the ultimate haircut – the buzz, the shaved head, the “Dobbins.” As suggested earlier, the objective of central banks is to prevent your portfolio from resembling a “Dobbins.” I have tweeted in the past that the Fed is where all bad bonds go to die. That is half figurative and half literal, because central banks are typically limited from purchasing bonds payable in machine guns or subprime mortgages (there have been exceptions and Bloomberg reported that nearly 25% of global central banks are now buying stocks believe it or not)! But by purchasing Treasuries and Agency mortgages they have rather successfully incented the private sector to do their bidding. This behavior reflects the admission that modern-day developed economies are asset-priced supported. Unless prices can continuously be floated upward, defaults and debt deflation may emerge. Don’t buy a Dobbins bond or a Dobbins-like asset or a bond from a country whose central bank is buying stocks. They probably aren’t “good as money!”

Link:  Pimco.com: There Will Be Haircuts

Pisani On Earnings

Bob Pisani just on CNBC with an earnings season update. {Because this is breaking on the tube I can't source it right now.  I will try to do so later.}

-2/3s of companies have now reported 1st quarter earnings.

-Quarter earnings estimate is now $26.44 on the S&P 500.  

-70% of these companies have beaten their bottom line estimates.

-Only 43% are beating on the bottom line. This translates to a 4.1% increase on bottom line increases and only a 1.8% increase on the top line.

-175 companies have raised dividends so far in 2013.

*Long ETFs related to the S&P 500 in client and personal accounts.

Update from earlier:  

Here's that link: CNBC.com-Bob Pisani-Trader Talk: Record Quarterly Earnings

Also there's one other little factoid in Pisani's subsequent post:

"About 70 percent of companies are beating estimates. Especially strong have been health care (72 percent beat), financials (75 percent beat), and even technology, where 70 percent have beat. Those are the three largest sectors in the S&P 500.  Companies are not just beating, they are beating on average by 5.7 percent—that is about the historical norm.  By the way, projections are for earnings growth of 7 percent this year. The market seems to be happy with anything around 5 percent earnings growth."

Technology's underperformance is largely attributed to Apple' Computer's 2013 decline.  If Apple is stabilizing, tech could prove interesting in the 2nd half of the year.  Also earnings growth of 7% this year implies S&P 500 earnings closer to $109-110.  The midpoint of that range currently gives the index a 14.5 forward PE and a 6.8% earnings yield.

*Certain clients hold legacy positions in Apple or have we have purchased it for them at their direction.

Housing Climbs Back

Chart, article and links from Business Insider.com.  Yesterday's Case-Shiller housing report was much stronger than the Street was looking for {estimates were for a 9% increase}.  Average home prices were up 9.3% in the 20 metropolitan areas the index tracks.  Hosing prices according to this chart are back to Autumn 2003 levels.

Put this in the "What If Things Are Getting Better?" department.  Housing was expected to be in a 10-20 year depression back in the dark days of 2008-2010.  Almost nobody expected to see this kind of rebound this soon.    This kind of rebound adds to the net worth of homeowners and puts a floor under the housing industry.  Remember we went through about a five year period where new housing starts and household formation didn't match up as nobody was building anything.  New housing and new demand are potentially huge catalysts for future economic growth.

Link:  Businessinsider.com: Rise in Housing Prices.

*Long certain ETFs related to housing in client and personal accounts.