Thursday, April 24, 2014

China’s Excess Capacity Weighing On Growth (excerpt)

China’s flash M-PMI edged up to 48.3 this month from 48.0 last month. It’s been below 50 for the past three months, suggesting that manufacturing is slowing. That’s not a surprise given recent weak exports data. In addition, the PPI inflation rate on a y/y basis has been negative for the past 26 months through March, indicating excess capacity is also weighing on manufacturing. The property construction market is also showing some signs of deflation recently.

So far, the government’s response hasn’t been sufficient to boost growth. That may be because the government is trying to reduce some of the excesses that led to the building of too many factories and too many ghost cities.

By the way, China’s crude oil demand has been flat at a record high over the past nine months through March. That doesn’t bode well for the country’s economic growth either. It actually suggests that growth may be slowing even faster than suggested by GDP and production indicators.

Today's Morning Briefing: Mixed Global Signals. (1) Top down and bottom up lead to same conclusion. (2) Industrial commodity prices firming. (3) Growth in global crude oil demand slowing, especially among EMs. (4) Europe’s soft data stronger than hard data. (5) Auto recovery just starting in Europe. (6) China paying the price for too much capacity. (7) Another setback for Abenomics in exports. (8) Housing and auto recoveries stalling, according to railcar loadings. (9) Focus on underweight-rated S&P 500 Energy. (More for subscribers.)

Wednesday, April 23, 2014

Is Slow Growth Bullish? (excerpt)

I’ve previously made the case for a secular bull market in stocks on the premise that subpar economic growth in the US and around the world reduces the likelihood of a recession. That’s because slow growth is bound to keep a lid on inflation, which means that the major central banks are more likely to maintain their easy monetary policies. In the past, maturing economic expansions often ended when inflationary booms caused monetary policy to tighten. The boom was then followed by a bust.

That’s not happening this time. The 4/20 WSJ included an interesting article titled, “Sluggish Economic Recovery Proves Resilient.” It reviews the various possible explanations for why the current recovery “is proving to be one of the most lackluster in modern times.” Nevertheless, “[i]t also is shaping up as one of the most enduring.”

The Business Cycle Dating Committee of the National Bureau of Economic Research determines the length of economic expansions and contractions (table). The current economic expansion just matched the 58.4 months average length of the previous 11 expansions since World War II. So far, real GDP is up 11.0% since Q2-2009, the trough of the last recession. That’s the weakest recovery of the previous six. That’s mostly attributable to the subpar recovery in real personal consumption expenditures.

So why is the recovery so slow? The article notes that Republicans blame Democrats for burdening the economy with taxes, debt, and regulations. Democrats blame Republicans for not agreeing to more fiscal spending and for playing a game of chicken with the debt ceiling. Economists are also a disagreeable lot, with some saying that the financial crisis of 2008 is still weighing on the economy. Others see “secular stagnation.” Not mentioned in the article was income inequality, which has recently become one of the main explanations of progressive economists.

I tend to side with the conservatives. I’ve frequently marveled at the resilience of the US economy notwithstanding the meddling of the federal government. I also believe that powerful deflationary forces have been unleashed by the proliferation of globalization and technological innovations. They are keeping a lid on inflation, which lowers the likelihood of a recession caused by tight money conditions.

Meanwhile, there’s certainly no hint of a recession in the Index of Leading Economic Indicators, which rose in March to a new cyclical high, and the highest reading since December 2007. The Index of Coincident Economic Indicators has been in record-high territory since last summer, and rose to yet another new high last month.

Our Fundamental Stock Market Indicator (FSMI), which tends to track the ECRI index, jumped 7.7% over the past eight weeks to a new cyclical high that nearly matches the previous peak during 2007. That’s a good omen for the stock market, since our FSMI is even more highly correlated with the S&P 500.

Today's Morning Briefing: Moving Forward, Slowly. (1) Q1 earnings growth turns slightly negative. (2) The upbeat Tale of Three Cities. (3) Forward earnings still moving forward. (4) Might slow growth be bullish for valuations? (5) No boom, no bust. (6) Dating Committee data show expansion set to exceed average length. (7) No recession in leading indicators, including ECRI weekly. (8) Our Fundamental Stock Market Indicator is bullish. (More for subscribers.)

Tuesday, April 22, 2014

LargeCaps Are Cheaper Than SMidCaps (excerpt)

So far this year, the SMidCaps have been trading around valuation multiples of 17-19, while the S&P 500 has been hovering around 15. That suggests that the bubble this time is in small stocks. Indeed, the forward P/E of the Russell 2000 universe of these stocks, at the end of March, was 24 for the composite, with the growth and value components at 30 and 20, respectively.

The Russell P/E is significantly higher than the S&P 600’s current reading of about 18 because it includes more stocks of companies that either have no earnings or are losing money. Yet investors are willing to pay high prices for them, expecting that they will eventually have great earnings. These great expectations more often than not end very badly once these companies actually start earning money. When they do so, it becomes obvious how dangerously overvalued these stocks are, especially if growth expectations turn more realistic and less fanciful.

By the way, while the forward P/E of the S&P 500 was 15.5 during March, the median forward P/E was 16.6. This indicates that the larger-cap stocks are more fairly valued in the S&P 500 than the smaller-cap ones in this universe of LargeCaps. Back during 1999, the reverse was true.

Today's Morning Briefing: Bubbles & Clouds. (1) Bubbles now and then. (2) Small stocks are more inflated than large ones. (3) Russell 2000 forward P/E at 24 thanks to lots of small companies with no earnings. (4) S&P 500 also has some high-priced industries. (5) Is the Cloud a bubble? (6) Defensive sectors are no bargains. (7) No national real estate bubble yet, but competition to make risky home loans is heating up. (8) European peripheral bonds rally like the worst is over. (9) Are ETFs the next weapon of mass financial destruction? (10) “Captain America” (-). (More for subscribers.)

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.)