Time Off

The July 4th holiday is approaching and a combination of business, family and vacation beckons over the next week or so.  Normally when coming up to a week where I know that I'm going to be out and about, I schedule a few stories in advance.  These are usually posts that I hope clients and friends of the firm find interesting, but those stories are not necessarily timely regarding current event in the markets.  The demands of my business have made it impossible to put these out right now.  I'm going to now take the next week off and recharge the batteries.  I will of course break in if something major comes about.  I don't expect that given the nature of the holiday, but one never knows.  Look for something back here starting July 8th.  

Frankly I don't know that it matters right now if I put something out on a daily basis as markets have been on this slow motion melt up now since April.  Probability suggests that we'll hold markets together through the end of the quarter.  My crystal ball right now doesn't go out much beyond that.  At some point markets will sell off and we'll see something besides a few one day declines.  But 28 years of doing this tells me that right now all the external things that the market pundits worry about don't seem to matter much.  Stocks bleed higher and that seems to be the current path of least resistance.  

Still the surface of the lake may seem calm but underneath are currents that may dictate the course of the markets in the coming weeks.  I'll try to list a few of those that I see and may add to these next time I put something up here.

1.  The Economy:  Revised 1st quarter GDP numbers down 2.9% were dreck.  Markets right now seem to be willing to look beyond these, likely using the horrific winter as the excuse.  Besides that,  corporate earnings are holding up and these have so far proven to be a solid support for stocks.  All that  being said, economic numbers better have improved in the 2nd quarter or probability suggests stocks may be in a tougher spot.  That's particularly true given that valuations seem to be a bit elevated right now on historic comparisons.  {See post from yesterday below where we put out a review of current earnings estimates.}  We'll start seeing how these numbers stack up in early July along with earnings season.

2.  Iraq:  Iraq is FUBAR.  Old timers will understand that phrase.  Anyone under the age of 30 can look it up here.  At some point maybe I'll do a post on the concept of watching two trillion of our dollars go up in smoke in about a month's time, but now is not that time.  However, there are longer term geopolitical consequences of what's occurring there now and markets may be impacted.  This is especially so if the price of oil continues to go up as a response to this.  BTW there's a longer story here that links Russia/Ukraine, China and the South China Sea, Libya, other parts of Africa and a few other places in the world but that's also for another time.

3.  Immigration:  It seems that much of Central America is moving "en masse" towards our borders and we have no effective strategy for dealing with this crisis.  This will have legs into the election cycle in the fall.  As an aside, I was required to read a book in college with the title "The Camp of the Saints".  That story dealt with mass immigration from India to France and Europe.  I thought it was a horrible read.  However, there are scenes from that book that remind me of our southern border today. 

4.  Election Cycle:  Markets hate uncertainty and the off year election cycle will have that in spades.  Probability suggests that volatility will increase as we get closer to voting in November.

5.  Interest Rates:  Anything that even hints that rates are starting to move higher could roil not only the stock market but also bonds.  

These are the primary things that I'm watching.  Of course it's likely that the thing which will finally give markets a pause and even lead to some sort of a decline isn't even registering on any body's radar.  That's the way it is sometimes.  Nobody for example thought at the beginning of the summer in 1990 that Iraq would invade Kuwait.  Or it could be that stocks have already taken all this into account, discounted the outcomes and nothing will come of any of it.  We'll have to see.  That's why we have our indicators.  The indicators, just so you know, are indicating a slight potential of change in the coming weeks. We'll hold off on discussing this till we have a better look at the tea leaves.  

Happy 4th of July!

Valuation 06.25.2014

We are getting ready to end the second quarter of 2014 and are on the cusp of the 4th of July holiday.  Next week officially kicks off Wall Street's summer season.  For the rest of the US, July 4th is a sad reminder that summer {as measured by the kid's vacation season} is half over.  In fact in some places, its more than half over as school in many parts of the country now starts in mid-August.  

Time to take a look at valuations in the market.  As of this writing the S&P 500 is trading at 1,950.  The S&P 500 has tacked on about 3% since we last looked at valuations on May 21.2014.

Our Midpoint S&P 500 Earnings Estimate of $118.75 {Through 12.31.2014}

Current PE:                     16.42

Earnings Yield:               6.08%

Dividend Yield:               1.82%

Rolling Four Quarter Estimate  $123.04 {Through 07.21.2014 via Fundamentalis.com}

Current PE:                   15.84

Earnings Yield:               6.31%

Dividend Yield:              1.86%

Current Expected Price Cone of Probability,   06.25.2014:   1,700-2,100.

The current yield on the 10 year US Treasury is 2.58%.  

The Cone of Probability is our current assessment of the trading range within which we think stocks have the potential to trade during the described time period.  It is a probabilistic assessment based on a many factors.  Some of these inputs are: Earnings estimates, also are those estimates rising or falling, dividend yield, earnings yield and the current yield on the US 10 year treasury.  This is not an exhaustive list of all of the variables that are used in creating the cone.  The Cone of Probability is used solely for analytical purposes.  It will fluctuate with market conditions and changes to the data inputs.  Index prices can and have traded outside of the range of the cone.  The data supplied when we discuss the cone is for informational use only.  There should be no expectation that this price range will be accurate and there are no guarantees that this information is correct.

*Long ETFs related to the S&P 500 in client accounts, although positions can change at any time.  

Give With One Hand, Take With Another

Some thoughts on the family budget:

My mortgage reset lower at the beginning of May and the savings to me over the course of the next year will amount to around $1,100.00.  We changed our family telephone plan.  That's going to save me another $700-1,000.00.  Natural gas bill is lower on average, as is my consumption of electricity.  It's impossible for me in a short period of time to quantify that down to actual dollars due to variables like the winter, but I know on average we've been paying lower amounts for these things.  All of that's good right?  Now the other side of the ledger.  

My property taxes are likely to increase $400 to $1,000 this year as every governmental entity in Cook County, Illinois that can is trying to tack on an increase.   Our food budget today for two people is nearly identical to what we used to pay when we had five people living at home.  I know this is true because when cleaning out a drawer the other day I found an old grocery receipt from 2008.  That's the last year I permanently had three children living under my roof.  Now granted some of that  increase has to do with an upgrade in what we buy to eat.  Kids like mac n cheese.  We prefer fresh veggies and the like.  Still that is a huge increase in what we pay for food.  Everything seems to have a price increase now as well.  Whether it's the person who cuts my hair,  to the price of going to a movie or an evening at a restaurant, it all seems to have set prices higher to the tune I'm guessing of 5-10% in the last year.  I've been to one movie in the past six months.  My daughter and I went to see Godzilla when it was released.  In all fairness we went to an upgraded cinema and saw the movie in 3D.  Our tickets were $30.00.  I paid $5.00 to park and we shared a popcorn and two bottles of water.  The evening cost me $60.00.  That to me is not a casual evening out but rather more like a date night.  For a mindless summer movie no less!  Finally we've been informed to expect a pretty substantial increase in our health insurance this fall when we receive the new rates.  

I'm guessing that when you balance the debit and credit side of my personal ledger that every bit of savings we've seen in a few areas of our balance sheet have been offset on the expense side.  In fact I'm guessing that I'm actually negative when you sum both together.  I'm a believer that economically things are getting better, but I'll speculate that one of the reasons we see personal spending so slack is that many of us see the same kinds of increases every day in our personal expenses.  Figure out how to translate real savings into the family budget and maybe you'll see better economic growth.  Until then, don't expect as much help from the consumer.  For the most part he or she is still just treading water or worse.

Quick Musings

I unexpectedly have to be out today and maybe tomorrow on business so I don't have time right now to do anything more than offer a few quick thoughts.  I will try to put up something more substantive later in the week.  Here goes:

High yield bonds now for the most part offer yields under 5%.  That is too much risk for too little reward in my book.  I told you last week that these are marked for sale in my book and have in fact done some selling in this area.

Bullish sentiment amongst individual investors has been increasing now for the past month.  Expect to start seeing soon the inevitable articles about how the individual investor is always wrong as well as more articles either saying we are in an equity bubble or we are close to a market top.  The one thing that probability would suggest is that stocks have a reasonable likelihood of doing well between now and June 30th.  That's when the 2nd quarter ends.  The professional investing world has a strong incentive to keep markets looking well through that date.  Makes the quarterly performance numbers look better and helps all of us to get paid!

At some point there will be some political fallout here at home to the fact that Sunni militants have torched the trillion or so dollars we've invested in Iraq since 2003.  President Obama is likely to receive the lion's share of the blame but the GOP also doesn't come off looking so hot from this debacle.  

Ed Yardeni notes that the market seems to go up every time Janet Yellen speaks.  

Echo

I have three children they are all in their late teens and early 20s now.  {BTW that's hard for me to believe they are now adults and I'm that old!}  Business Insider quoted Deutsche Bank's Torsten Slok yesterday who noted that "there are more 23 year olds today than any other age group".  These children of the baby-boomers are called echo boomers.  I've never heard that before but I won't argue with the term. These kids have now heard for years how hard the job market is going to be for them.  That may be true right as they come out of school or are in the early years of their careers, but in the long run demographics are likely on their side.  The chart above shows that as the baby-boomers retire or move higher up the economic food chain, somebody's going to need to fill their shoes.  All these under employed younger folks are going to be in the prime spot to fill that void in the coming years. Besides the obvious demographic implications, here's the other investment angles from the article:

"The fact that the echo-boomers are coming has implications for household formations and housing demand in coming years, inflows into 401(k) accounts, demand for risky assets (younger cohorts tend to put their retirement savings in stocks rather than bonds), the amount of student debt outstanding (there are more young people and more young people get an education), and as the baby-boomers retire echo-boomers will come in and take the jobs of the baby-boomers but at a lower pay."

Link:  Here Come America's 23 year olds

*Long three young adults.  Happy with that trade!

Asset Returns

A snap shot of differing asset classes we track via their ETFs.  Performance charts come from Stockcharts.com.

Winners hands down have been REITS and T-Bonds.  Both make sense given the decline in interest rates this year.  That has also helped REITS but they also came into 2014 undervalued and were one of the worst performers last year.  Note that with the exception of the bonds we have exposure in one form or the other to most of what you see in these charts.  Note also that the distribution of these assets isn't uniform across all of our accounts due to different investment strategies and also note these positions can change at any time.

Exit Fees

Interest rates are now at multigenerational lows.  Amazingly, sovereign government bond rates in places like Spain and Italy actually carry lower ten year bond yields than US Treasuries.  Junk bond spreads to US Treasuries are at levels highly suggestive of being over valued.  Irrespective of these facts and irrespective now of a two year bullish phase in stocks that have seen global stock markets post for the most part nice double digit gains, money flows into bonds have been positive in 2014.  This bet has paid off this year as yields have declined.  Declining yields mean the price of bonds goes higher.  The reverse occurs when interest rates rise.

The question that must be asked is what's going to happen when rates reverse themselves for longer than a few weeks.  How much of that money currently parked in bond funds is going to stay put?Apparently some folks in Washington are wondering the same thing.  The Financial Times {FT} yesterday published an article where they noted that "Federal reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors."  The FT states that "US retail investors have pumped more than $1 trillion dollars into bund funds since early 2009.  This has created a boom environment for fixed income money managers, but raises the prospect of a massive disorganized flight of money out of the industry should interest rates rise sharply in the coming years."  

The article goes on to state that the chances of such a change currently occurring are remote as the SEC does not seem to be in favor of it.  But it does show what could happen and what is potentially on the drawing boards when the tide goes out in this neck of the investment waters.  "Sell when you can, not when you have to," is another of those old Wall Street maxims.  In the case of the bond markets, with rates at levels where it's virtually impossible for them to go much lower, the faint tinkle of the bells being brought out when it's time to sell may now start to be heard.  I do not offer investment advice regarding specific investments on this blog as that is not the intent of what I do here.  But in regards to the asset class of fixed income, particularly when it comes to bond funds {either mutual funds or ETFs} these are now marked for sale in many of my client accounts.  Marked for sale does not mean I will be a seller today or tomorrow.  It does mean that I have no problem in the coming months of selling off these assets when I feel the secular trends have turned against me.  That process I believe will accelerate if I become more concerned that the Government imposes an exit cost to my clients if they want to exit the trade.

*Long certain bond funds and other fixed assets in client accounts.

Financial Times:  Fed Looks at Exit Fees on Bond Funds.

Stocks Work Higher Even As Economic Expectations Decline

This chart from the website Zero Hedge shows how equity prices worldwide have moved higher since 2012 even as economic expectations via world GDP have declined.  The post from which this is taken quotes a Financial Times article that seems to pin at least some of this advance on the world's central banks investing in equities.  Here's the main point:

"The {Financial Times} reports "a cluster of central banking investors has become major players on world equity markets." The report, to be published this week by the Official Monetary and Financial Institutions Forum (OMFIF), confirms $29.1tn in market investments, held by 400 public sector institutions in 162 countries, which 'could potentially contribute to overheated asset prices." China’s State Administration of Foreign Exchange has become “the world’s largest public sector holder of equities”, according to officials, and we suspect the Fed is close behind (courtesy of more levered positions at Citadel), as the world's banks try to diversify themselves and "counters the monopoly power of the dollar." 

I think this perhaps explains some of the rise over the last two years in stocks.  I'm not sure it explains the entire picture as we don't know how accurate the article is, how much central banks have actually invested in equities or when they started doing so.  I do know that stocks a few years ago were cheap irrespective of what ultimately happened to world GDP expectations and perhaps somebody else saw this opportunity back then.

The bigger take-away that I see from this chart is that stocks have less room for error at current economic levels than they did a year or so ago.

Link:  Clusters of Central Banks Have Secretly Invested $29 Trillion in the Market.

an tSionna {06.12.14}

From Chart of the Day {Subscription Required to access their work product.  The chart above is available to the public}.  Their commentary below.

"For some perspective on the post-financial crisis rally, today's chart illustrates how much of the downturn that occurred as a result of the financial crisis has been retraced by several major international stock market indices. For example, the S&P 500 peaked at 1,565.15 back in October 9, 2007 and troughed at 676.53 back on March 9, 2009. The most recent close for the S&P 500 is 1,950.79 -- it has retraced 143.4% of its financial crisis bear market decline. As today's chart illustrates, China (Shanghai Composite), Japan (Nikkei 225), India (S&P BSE Sensex), Germany (DAX), France (CAC 40) and the UK (FTSE 100) are all above their financial crisis lows (i.e. above 0% on today's chart) and three of the aforementioned countries (Germany, India and the UK) are currently trading above their respective pre-financial crisis peak (i.e. are above 100% on today's chart). It is interesting to note that the US (epicenter of the financial crisis) has outperformed the other major stock market indices (* keep in mind that the German DAX is unique in that it includes for the reinvestment of dividends) while China has lagged to the point where it only trades 7.9% above its financial crisis lows -- not that impressive of a performance considering that the financial crisis occurred well over five years ago."

My comment.  Can't help but wonder if that discrepancy between Asia and the US is at some point going to either mean revert or even out.  See our post Tuesday on Valuation via the Telegraph.  

Link:  Chart of the Day:  Current Post-Financial Crisis Retracement Level.

**Long ETFs related to most of these countries either individually or regionally in both client and personal accounts.  Please note that our positions can change at any time without notice.

A Few Things I'm Thinking About

Does Eric Kantor's loss mean immigration reform is dead?  What does it say about the GOP?

What does the stunning rout of the Iraqi army in Mosul say about our strategy in Iraq for the past six years.  What does it say going forward.

When will markets and the chattering classes start paying attention to the immigration crisis that's currently occurring on our southern borders?  See LA Times here and here.

What do the problems currently plaguing the Veteran's Administration say about the Affordable Health Care Act?

Regarding the markets, I'm rethinking some of our indicators.  Here's some of the reasoning behind that with markets now up over 6% for the year {although I will point out that they are down about a half percent in the pre markets}.  Bullish sentiment is currently above 50% this has traditionally been seen as a contrary indicator.  The percentage of stocks trading above their 200 and 40 day moving averages are elevated.  Most stocks and indices are currently overbought by our work.  Are markets topping?  See Ritholtz on Why it's So Hard to Call a Market Top.  Also at 1,950 on the S&P 500 how concerned should we be that we are closing in on much of Wall Street's price target's for 2014?  See Bespoke here. 

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.

Foreign Markets

Story and graph in London's Telegraph that ran yesterday tailing about which world markets are cheap on a relative basis.  You can go read the article here but if you want a quick take away, you can just simply note that green is cheap and red is expensive in their eyes.  By that regard the US is expensive and Asia is cheap.   

Foreign markets have started to outperform their US counterparts this year but substantially lagged in 2013.  We've been talking about this for for over a year and you can read some of those thoughts  here, here, here, here and here.  I thought these markets were attractive over a year ago so you can see how long it can take for an idea to potentially pan out.  Only time will tell if this move into foreign markets has legs or if it simply represents a catch up phase.  It may take a correction to see if a move into markets overseas has legs.

*We are long certain ETFs related to foreign markets in client and personal accounts.  Please note that these positions can change at any time and we are under no obligation to inform you when such changes occur.

Things Are Getting Better

From Calculated Risk:  US finally regains all the jobs lost in the last recession.  Note however that we are still behind in job creation when population gains are taken into account.

Note the one headwind to job creation is employment in the public sector.  

That is according, again to Calculated Risk, overall employment at the local, state and Federal levels which has lagged in this recovery.  This is a headwind that could change for the better as governments at all levels start to see improvements in their own finances.  One thing I know from almost 30 years living in Chicago is that politicians love to hire folks.

Europe

Europe is in the news this morning as the European Central Bank cut interest rates, reduced its deposit rate to a NEGATIVE 0.10% and plans to announce other measures to counter slow growth and deflation in the worlds second-largest economy.  I've posted above a chart of the Vanguard MSCI Europe ETF.  Like a lot of major market indices, it's plodded higher this year.  Nothing spectacular, just a steady grind into the north-east quadrant of the chart.  There's support around 60 on the chart and like a lot of the ETFs we follow, its over bought in most of the timeframes we measure.  

*This is not a recommendation to buy, sell or hold this ETF, although we are long VGK in both client and personal accounts.  Just a look at a chart that's currently in the news.  Note that our positions in this name and any other security we ever mention are subject to change at any time without notice to readers of this blog.

an tSionna {PE Levels}

Above you see a chart of the S&P 500 ETF, SPY, devoid of any other indicator except certain Price to Earnings {PE} levels that I've penciled in on its chart.  Note that these are not drawn to scale at the top or bottom and should be used solely as reference points. These are PE's based on a current four quarter rolling estimates of $123.06.  Anything above the Blue line has a 15 PE and anything below it carries a 14.  Back in the day when I was just a whelp of a young broker the Consigliere took pity on me and taught me the basics of the business.  One of the things he always said "is that a market trading with a forward {PE} higher than 16 starts to get expensive and a PE under 14 starts to look cheap".  

That's been a pretty good rule to live by during my career.  Now of course with every rule with investing you have to look at the time and circumstances.  For example maybe right now stocks deserve to trade at a higher multiple given the low rates of return you can earn in other assets such as bonds. You also have to understand that stocks can trade above and below these perimeters for long periods of time.   The market basically traded under a 14 PE until last year from the 2007-2009 decline.  The market is also smarter than you or I so perhaps it's telling us that earnings will be better going forward than most expect right now.  But at any rate you can see where we are today.  Only time will tell what this means and I don't consider this by itself a reason to be nervous.  But you have to know where we are in relation to valuation and this at the very least is something to take note of as we go forward into the summer months.

*Long ETFs related to the S&P 500 in client and personal accounts although these positions can change at any time.

Charts come to us via stockcharts.com.  Earnings estimates come from the excellent blog Fundamentalis.com.

an tSionna {06.03.14}

Today's chart is of the Powershares Preferred Stock ETF {PGX}.  I'm showing this to illustrate the effect of interest rates on fixed income assets like ETFs.  {BTW I'm long this ETF in both client and personal accounts although those positions can change at any time.}  Fixed income assets like PGX were some of the worst performing groups last year as they were hit by both rising interest rates and the  market's preference in 2013 for growth.  

The tables have turned so far in this year.  As rates have declined ETFs and other fixed income assets such as this have been bid up.  PGX is up 9.55% in 2014 beating the market's roughly 4% return.  There are two things to take away from this.  First is that probability and past performance strongly suggest that these will underperform when rates start to rise at a sustained rate.  Also it shows the benefits of having a diversified portfolio.  ETFs like PGX would have been a drag on performance in 2013 but they are anchoring the portfolios so far this year.  

Chart from Finviz.com.

an tSionna {06.02.14}

I updated the chart of the S&P 500 this AM and realized that I annotated one that was a few days old.  That's staying up too late watching hockey and the Blackhawks go down to defeat!  Tough luck.  Anyway here's the annotated chart from the 29th with my notes and below that is the update through Friday last week.  Irrespective of the date, the market action is the same.

And here's the updated chart.  Both are from Finviz.com.

*Long ETFs related to the S&P 500 in client and personal accounts although positions can change at any time.