Thursday, April 17, 2014

Eurozone’s Recovery Is Lackluster (excerpt)

There aren’t too many upside economic surprises in the Eurozone. In fact, one needs a magnifying glass to see the economic recovery since last summer over there. The region’s industrial production edged up only 0.2% during February. It’s up just 1.8% y/y, and remains 3.1% below the most recent cyclical peak during August 2011. The recoveries in Germany and Spain are a bit easier to see, but they have been weighed down by ongoing weakness in France and Italy.

So why is the European Monetary Union MSCI stock price index up 53% from 2012’s low? It’s not because of the EMU MSCI forward earnings, which shows no recovery at all. Indeed, it remains on a slight downtrend, which started in mid-2011. So far, the EMU MSCI rally has been all about valuation.

The lesson is that we should never underestimate the ability of central banks to drive up stock prices by promising to do whatever it takes to avoid financial meltdowns, recessions, deflations, and plagues. That’s what ECB President Mario Draghi pledged in his July 26, 2012 speech. He seems to be reiterating that theme recently, as I noted yesterday. So are some of his colleagues. That might be enough to drive valuations still higher for the EMU MSCI, as long as the Ukraine crisis doesn’t trip up the Eurozone’s feeble recovery.

Today's Morning Briefing: The Big Thaw. (1) From the Big Chill to the Big Thaw. (2) Spring forward. (3) February's batch of upward revisions is a big surprise. (4) Retail sales and production at record highs. (5) Housing has some headwinds. (6) Magnifying glass needed to see Eurozone recovery. (7) No recovery in forward revenues and earnings of EMU MSCI. (8) Will Draghi continue to levitate valuations? (9) Production growth slowing in emerging economies. (10) Focus on overweight-rated S&P 500 IT. (More for subscribers.)

Wednesday, April 16, 2014

The Fed’s Questionable Inflation Mandate (excerpt)

March data released yesterday showed an increase in the CPI inflation rate to 1.5% y/y from 1.1% the month before. It was led by food prices and rents. The former rose 0.4% m/m, and 1.7% y/y. The CPI rent of shelter component rose 0.3% m/m, and 2.7% y/y, the highest reading since March 2008. This is a very odd measure indeed. It accounts for 32% of the total CPI. It has two major subcomponents, namely tenant rent and owners’ equivalent rent (OER). The former, which reflects actual rent paid by actual renters and accounts for 7% of the CPI, rose 2.9%, and has been hovering around this rate for the past 10 months. The latter, accounting for 24% of the CPI, has increased from 2.2% six months ago to 2.6% during March.

OER is an imputed measure of the rent homeowners would have to be charged to rent the homes they own. I kid you not, though I’m sure you knew that already. Presumably, it is based on actual tenant rent. Nevertheless, the recent leap in the OER inflation rate obviously can’t be explained by a similar jump in tenant rent inflation.

This oddity is one reason why the Fed prefers to use the personal consumption expenditures deflator (PCED) as a better measure of consumer price inflation. Both rent components are in the PCED too. However, the overall weight of rent of shelter is only 15% of the PCED, with tenant rent at 4% and OER at 11%.

It’s not obvious to me why the Fed’s commitment to boost inflation is a good thing, especially if inflation is led by higher food prices and rents. I doubt that will stimulate economic activity by causing consumers to buy food and rent apartments before their prices go higher. On the contrary, the rising costs of these essentials reduce the purchasing power of consumers.

Today's Morning Briefing: The Inflation Mandate. (1) Choppy market. (2) Yellen is remarkable. (3) Beware of what you wish for. (4) Food and rent lead inflation higher. (5) The oddity of paying rent on your owned home. (6) Fed’s inflation mandate is questionable. (7) Microeconomic models explain low inflation better than macro ones. (8) Easy money can be deflationary. (9) Mario Draghi is still talking about doing whatever it takes. (10) Focus on market-weight-rated S&P 500 Consumer Staples. (More for subscribers.)

Tuesday, April 15, 2014

Are Low Yields Bullish for P/Es? (excerpt)

Of course, there are still investors who believe that higher valuation multiples are justified by historically low interest rates. However, I’m not in that camp. Multiples should be driven by expectations for earnings growth. Currently, historically low interest rates reflect subpar economic growth with rising risks of deflation.

That’s not a wonderful scenario for revenues growth, nor for earnings growth given that profit margins are at record highs. Yet S&P 500 industry analysts are expecting earnings growth over the short term (STEG over the next 12 months) and long term (LTEG over the next five years) of around 10%. That seems a bit high to us, especially for LTEG.

The ratio of the forward P/E of the S&P 500 to LTEG (a.k.a. the PEG ratio) was at 1.4 during the week of April 3. That’s not far below previous cyclical peaks, which have all been around 1.5 since 1995. Those peaks haven’t always been associated with the start of bear markets. However, the PEG ratio confirms that stocks aren’t cheap. They are pricing in relatively optimistic earnings growth.

Meanwhile, the bond market seems to be discounting much slower nominal economic growth than the earnings growth rate in the stock market. I view the 10-year Treasury bond yield as the fixed-income market’s assessment of current nominal GDP growth on a y/y basis. The latter rose 4.1% during Q4-2013. Yet the yield is currently around 2.65%. Again, it seems as though historically low yields should justify higher P/Es, but the message from the bond market isn’t upbeat about the prospects for higher nominal growth.

Today's Morning Briefing: Curbing Enthusiasm. (1) Sentiment turns slightly less bullish. (2) Everyone is a value buyer for now. (3) A choppy year so far. (4) Are low bond yields bullish or bearish? (5) Long-term expected earnings growth is high. (6) So is PEG. (7) The bond market has a more subdued outlook for growth. (8) SMidCaps rerating? (9) Revenues and earnings growth rates likely to rebound from winter chill. (10) Focus on market-weight-rated S&P 500 Consumer Discretionary Retailers. (More for subscribers.)

Monday, April 14, 2014

China Is Deflating (excerpt)

The news out of China was mostly bad last week. On Wednesday, we learned that the country’s exports, on a seasonally adjusted basis, rose 11.0% m/m during March, recovering less than half of February's 24.2% plunge. Imports dropped for the second consecutive month by a total of 18.7% to the lowest reading since April 2012.

While the CPI edged up to 2.4% y/y during March, the PPI continued to deflate with a drop of 2.3% y/y, the 25th month of such negative readings. Our new publication China Inflation & Deflation shows that PPI deflation is widespread, confirming that there is relatively weak demand and plenty of excess industrial capacity in China.

On Friday, the Chinese government failed to sell about a quarter of a one-year bond offering. This “bond failure” was attributed to the unwillingness of the finance ministry to offer a higher yield to attract buyers.

On Thursday, following the release of the disappointing trade figures, Premier Li Keqiang said, “We will not resort to short-term stimulus policies just because of temporary economic fluctuations and we will pay more attention to sound development in the medium to long run.” He also said that the government’s target of "about" 7.5% GDP growth this year was flexible, and Beijing would not act to pump up growth as long as “there is fairly sufficient employment and no major fluctuations.”

Today's Morning Briefing: Valuation Correction. (1) Good news isn’t helping stocks. (2) Bullish FOMC minutes didn’t work last week. (3) Momentum meltdown reduces risk of broader melt-up/meltdown. (4) Reiterating 2014 by the end of 2014. (5) FSMI at cyclical high. (6) Latest Chinese data show slower growth with industrial deflation. (7) Ukraine turning deadly. (8) Earthquake for fracking? (9) What’s behind the valuation correction? (10) High P/Es not just in Biotech and Internet stocks. (11) Global MSCI volatility. (12) “The Lunchbox” (+ +). (More for subscribers.)

Thursday, April 10, 2014

Declining Misery Index Boosting P/E (excerpt)

Is “lowflation” good or bad for stocks? In her speech last week, IMF Managing Director Christine Lagarde warned that inflation might be too low: “There is the emerging risk of what I call ‘lowflation,’ particularly in the Euro Area. A potentially prolonged period of low inflation can suppress demand and output--and suppress growth and jobs.” That sounds like a bearish environment for stocks. However, she then said that the solution is “[m]ore monetary easing, including unconventional measures…” Her advice was directed particularly at the ECB.

More ultra-easy monetary policies from the world’s major central banks in response to lowflation is bullish for assets in general and stocks in particular. In the past, there has been an inverse correlation between inflation, as measured by the core personal consumption expenditures deflator (PCED), and the forward P/E of the S&P 500. Most recently, the P/E rose from a low of 10.4 during August 2011 to 15.5 last month. Over that same period, the PCED inflation rate, on a y/y basis, fell from 1.6% to 1.1%.

An even better fit is between the P/E and the Misery Index, which is the sum of the inflation rate and the unemployment rate. Since the 2011 low in the P/E, the Misery Index has declined from 10.6% to 7.8%.

Lowflation is bullish because the Fed is much less likely to tighten as long as it persists. While Fed Chair Janet Yellen caused a stir recently by suggesting that the FOMC might start raising interest rates six months after QE is terminated at the end of this year, she also said it depends on whether inflation rebounds back to 2%.

Today's Morning Briefing: Lowflation. (1) IMF chief warns about “lowflation.” (2) P/E inversely correlated with inflation and Misery Index. (3) Central bankers are macroeconomists blindly following the “slack” model. (4) What if globalization, technology, cheap money, and competition are driving lowflation towards deflation? (5) Any signs of deflation in revenues, margins, and earnings? (6) A whole bunch of global forward earnings comparisons. (7) Focus on underweight-rated S&P 500 Materials. (More forr subscribers.)