Wednesday, August 27, 2014

Upbeat Consumer Optimism Is Bullish for Economy & Stocks (excerpt)


Rising consumer confidence in the US is confirming my bullish outlook for the economy and stocks. Yesterday’s release of the August Consumer Confidence Index (CCI) was especially upbeat. It is based on a survey conducted monthly by the Conference Board. I think it is more sensitive to labor market conditions than the survey conducted by the University of Michigan to derive their Consumer Sentiment Index (CSI). Here are some of the key highlights that impressed me the most:

(1) The CCI jumped 2.1 points to 92.4 in August. That’s the highest reading since October 2007. The gain was led by the CCI’s present situation component. Also leading the way higher was the CCI for consumers who are 55 years old or older. They tend to have more income and wealth, and to spend more when they are optimistic.

(2) The Conference Board reported that the “jobs plentiful” response rate jumped from 15.6% during July to 18.2% during August, the highest since March 2008. The CCI is highly correlated with the quits rate. The latter rose in June to the highest reading since July 2008. August’s CCI suggests that it continued to rise during July and August. As Fed Chair Janet Yellen has noted, when workers perceive that jobs are plentiful, they are more likely to seek another job and quit their current one.

(3) I average the CCI and CSI to derive our Consumer Optimism Index (COI). It was little changed at 85.8 in August from July’s 86.1, which was the best level since October 2007. The present situation index jumped to 97.1, the highest since January 2008. The expectations component remains in its flattish and choppy range of the past couple of years.

Today's Morning Briefing: 2015 By 2015? (1) Bullseye! (2) Bull running ahead of schedule. (3) 2015 math: E = $140, P/E = 16.5, P = 2310. (4) No recession in 2015, so no bear market. (5) Positive thoughts on revenues, margins, and buybacks. (6) The longer the expected economic expansion, the higher the P/E. (7) Won’t Fed tightening be frightening in 2015? (8) Monetary normalization coming in baby steps. (9) The fifth-longest bull market of the 44 since 1928. (10) Consumer confidence rising because jobs are more plentiful. (11) Focus on overweight-rated S&P 500 Industrials. (More for subscribers.)

Tuesday, August 26, 2014

US & Eurozone Continue to Decouple (excerpt)

Can the US continue to grow if the Eurozone’s recovery continues to stall? It is doing a good job of doing just that so far. I think it may continue to do so. The question is, why are the two economies decoupling? The short answer is that the social welfare state remains too big in the Eurozone. There are too many government regulations and regulators, and not enough startups and entrepreneurs. Labor markets remain too rigid. Too much credit is provided by bankers, who aren’t lending, while capital markets remain relatively limited sources of capital. The region depends too much on Russian gas, and isn’t doing enough to find domestic sources of energy. It may also be more exposed to terrorism perpetrated by homegrown Islamic jihadists.

The latest evidence of decoupling between the US and the Eurozone’s economies is Germany’s IFO business confidence index. It dropped to 106.3 during August, down from a recent cyclical peak of 111.2 during April, and the lowest since July 2013. The expectations component, which is highly correlated with Germany’s M-PMI, fell from 107.2 to a 15-month low of 101.7 over this period. Flash estimates show the German M-PMI fell to 52.0 this month, while the US M-PMI rose to 58.0.

Credit remains amply available in the US capital markets and from US banks. The same cannot be said of the Eurozone’s capital markets and banks. Over the past 12 months through May, nonfinancial bond issuance totaled $750.5 billion. Short-term business credit rose to a record-high $2.0 trillion in mid-August. In the Eurozone, bank credit is down 2.2% over the past 12 months through June.

Today's Morning Briefing: Recoupling & Decoupling. (1) The bears keep seeing market tops as the bull charges ahead. (2) Market leaders leading again. (3) SmallCaps still lagging. (4) Retailers recharging. (5) Financials keeping pace with bull run. (6) Dow Theory is bullish. (7) IT and Health Care are hot this year. (8) 2014 by 2014 is just around the corner. (9) Oil made in USA is very bullish for US stocks. (10) The bull is maturing, not aging. (11) Why is Eurozone decoupling from US? (12) Draghi ready to do more whatever-it-takes. (13) US and German yields falling toward Japanese yields. (14) Focus on now underweight-rated S&P 500 Energy. (More for subscribers.)

Monday, August 25, 2014

Are Biotech Stocks Stretched? (excerpt)


On July 15, Fed Chair Janet Yellen testified before the US Senate Committee on Banking, Housing, and Urban Affairs. She presented the Fed’s semiannual Monetary Policy Report (MPR) to the Congress. In her prepared remarks, she stated that while valuation seems “stretched” in some areas of the bond market, equities “remain generally in line with historical norms.” Yet in the MPR, which bears her signature, the following observation appeared: “Nevertheless, valuation metrics in some sectors do appear substantially stretched--particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”

In other words, in her opinion, the stock market is showing some signs of irrational exuberance. Of course, this term was popularized by Fed Chair Alan Greenspan in a speech on December 5, 1996 indicating his concern about a possible bubble in stock prices. About two years later, on January 28, 1999, in testimony before a Senate Committee, he defended the mania in Internet stocks by offering his Lottery Principle. The following is a reconstruction of various quotes picked up by the press from his response to a question about this issue:

“You wouldn't get hype working if there weren't something fundamentally, potentially sound under it. The issue really gets to the increasing evidence that a significant part of the distribution of goods and services in this country is going to move from conventional channels into some form of Internet system--whether it's retail goods or services or a variety of other things. The size of that potential market is so huge that you have these pie-in-the-sky type of potentials for a lot of different vehicles. And undoubtedly some of these small companies, which have stock prices going through the roof, will succeed and they very well may justify even higher prices will succeed [even if] the vast majority are almost sure to fail. There is something else going on here though, which is a fascinating thing to watch. It is, for want of a better term, a 'lottery' principle. What lottery managers have known for centuries is that you could get somebody to pay for a one-in-a-million shot, more than the value of that chance. In other words, people pay more for a claim on a very big payoff, and that's where the lotteries' profits have always come from. What that means is that when you are dealing with stocks--the possibilities of which are it's going to be valued at zero or some huge number--you get a premium in that stock price which is exactly the same sort of price-evaluation process that goes on in the lottery.”

So who is right, Yellen or Greenspan? With the benefit of hindsight, we now know that Greenspan was too much of a cheerleader during the second half of the 1990s. He certainly contributed to the stock market bubble that burst one year after he promoted his Lottery Principle. However, that principle actually makes more sense today. This is especially true for biotechnology stocks, as I wrote on July 31:

“In addition, one has to wonder whether it is even appropriate for the Fed to express opinions about specific stock groups. Lots of sophisticated investors purchase biotech companies that have no earnings and are regularly raising cash to stay in business. These investors do so knowing that the outcomes are binary: The companies they invest in will either find a cure for a disease or they won’t. Their new drugs will either be approved by the FDA or they won’t. They might be acquired for a huge premium or they might not, or might go out of business. Why should the Fed weigh in on the valuation of biotechs? After all, speculators are providing the funding that might actually cure diseases. Or they might get wiped out. Why should the Fed get in the middle?”

In any event, industry analysts have been scrambling to raise their earnings estimates for S&P 500 Biotechology industry. They now expect earnings to rise 38.7% this year and 13.6% next year compared to forecasts of 15.8% and 17.8% at the beginning of the year. Forward earnings has soared 64.3% y/y through mid-August. Consensus expected earnings growth over the next five years is around 19% per year, up from 11% in 2011. The stock index is at a record high, up 23.4% ytd and 56.5% y/y, after a brief swoon during March and April. Yet the forward P/E has actually declined from this year’s peak of 24.0 during the week of January 23 to 16.1 currently.

Within days of Yellen’s testimony, Facebook, Google, and Twitter all reported better-than-expected results for Q2 earnings. The S&P 500 Internet Software & Services stock price index is up 17.0% from this year’s low on May 8. Forward earnings rose to a new record high in mid-August. The stocks seem expensive with the forward P/E around 20. But that’s also the expected annual growth rate for earnings over the next five years.

Today's Morning Briefing: Taking Issue With Yellen. (1) Are social media and biotech stocks still “stretched?” (2) Greenspan’s clever contribution to investment strategy: irrational exuberance and the Lottery Principle. (3) The biotech lottery. (4) Binary outcomes with all or nothing payouts. (5) Is the Fed registered to give investment advice? (6) Biotech earnings expectations are soaring. (7) The Internet’s fundamentals are also hot. (8) Yellen is a two-handed economist on wages. (9) The wage stagnation myth again. (10) Are baby boomers dropping out of the labor market, or staying in too long? (More for subscribers.)

Thursday, August 21, 2014

Real Wage Stagnation Is a Bit of a Myth (excerpt)

Contrary to popular belief, wages have been rising a bit faster than prices. In other words, real wages haven’t stagnated as widely believed, but have been moving higher, albeit at a slow pace:

(1) Real hourly wage rate. Average hourly earnings for all workers divided by the core personal consumption expenditures deflator (PCED) rose to a record high during February of this year. It edged down in June, but was up 0.4% y/y. This measure of real hourly wages is up 6.7% since the start of the data during March 2006. Using the headline PCED, real hourly wages also rose to a record high during February of this year and are up 5.2% since the start of the data. That’s not great, but it isn’t stagnation either.

(2) Real wages per worker. I calculate earned income per worker by dividing wages and salaries in personal income by payroll employment. It was at a record high of $49,500 during June. Dividing this series by the headline PCED shows that real wages and salaries per worker is up 1.4% y/y, and 6.0% since the start of 2006. Again, that’s not great, but it isn’t stagnation either.

Today's Morning Briefing: Jackson Hole. (1) Central bankers just wanna have fun. (2) Talking about the dynamics of the labor market. (3) Are investors jumping the gun ahead of Yellen? (4) She won’t let us down. (5) Pleasing the boss. (6) Less slack, yet wage and price inflation remain subdued. (7) Wage stagnation is a bit of a myth. (8) Drilling down to forward earnings by industries finds some gushers. (9) Standouts include Internet Retail, Oil & Gas Exploration, Consumer Finance, Biotech, Semiconductors, Specialty Chemicals, and Gas Utilities. (More for subscribers.)

Wednesday, August 20, 2014

A Good Year for Emerging Markets So Far (excerpt)

There was a 6.1% drop in the Emerging Markets MSCI stock price index (in dollars) at the beginning of this year, from January 22 to February 5, on fears of another emerging markets crisis. I didn’t buy this latest “endgame” scenario. On the other hand, I didn’t expect that the index would rebound by 17.5% through yesterday’s close. It has been highly correlated with the CRB raw industrials spot price index, which I use as a sensitive indicator of global economic growth. I don’t see enough of it to drive EM stock prices higher on a sustainable basis. The CRB index is back down to its lowest reading since February 13 after a brief and small rally.

There have been impressive rebounds in lots of EM stock price indexes since February 5. Among the so-called “Fragile Five,” there are ytd gains in the MSCI indexes (in dollars) for Indonesia (29.8%), India (24.2), Turkey (14.2), Brazil (13.1), and South Africa (11.0). The China MSCI (in dollars) has also rallied sharply by 20.0% since March 20, with a ytd gain of 6.4%. However, this rally hasn’t been confirmed by the price of copper, which has become a sensitive indicator of China’s economy in recent years.

By the way, there has also been a high inverse correlation between the EM MSCI and the trade-weighted dollar. Maybe that’s because the dollar tends to be strong when the global economy is relatively weak compared to the US. A strong dollar tends to depress commodity prices, confirming the relative weakness in the global economy. Weak commodity prices aren’t good for EMs that produce them. The trade-weighted dollar has been strong recently, and relatively flat since the start of the year. It hasn’t confirmed the rally in EM stocks.

The attraction of EM stocks has been their relatively low valuation. They are currently trading at a forward P/E of 11.0, which is up from the year’s low of 9.7 during the week of February 6. That’s still below the forward P/E of the MSCIs for the US (15.6), Japan (13.5), UK (13.3), and EMU (13.0).

Today's Morning Briefing: Staying Close To Home. (1) All the comforts of home are at home. (2) Eurozone may still have some upside. (3) Missing out on Abenomics, which may be striking out. (4) Emerging markets rally not confirmed by weak industrial commodity prices and strong dollar. (5) Nevertheless, EMs are still relatively cheap. (6) US MSCI still leading the pack this year, and since March 9, 2009. (7) Might easy money be deflationary? (8) Low inflation allows central banks to delay normalizing their ultra-easy policies. (9) US CPI gives Yellen more time to create more jobs. (More for subscribers.)