QE & ZIRP

Fed Chairman Ben Bernanke yesterday confirmed that QE-2.0 will be followed by QE-2.5. The Fed will purchase Treasuries with the proceeds from maturing securities in its portfolio. Here is a brief history of QE:

(1) QE-1.0 started during the week of November 25, 2008, when the Fed began buying mortgage-backed securities (MBS) and agency debt for the first time. The program terminated in March 2010, when this portfolio peaked at $1.24 trillion and the Fed’s balance sheet had risen to $2.31 trillion.

(2) QE-1.5 was announced on August 10, 2010, when the Fed started purchasing Treasury securities to offset maturing MBS and agency debt. (During QE-1.0, the Fed added $300.3 billion in Treasuries to its existing portfolio of these securities.)

(3) QE-2.0 was first vetted by the Fed Chairman in his August 27, 2010 speech at the Fed’s Jackson Hole meeting. It was officially implemented on November 3 with the announcement that the Fed would purchase $600 billion in Treasuries by the middle of 2011, and offset maturing securities with additional purchases of such securities. At the time, the Fed’s holdings of Treasuries was $839.9 billion. The latest figure shows that it was up to $1.39 trillion during the week of April 20.

During all the rounds of quantitative easing, the federal funds rate has remained near zero. In my opinion, the main impact of them was to reinforce the Fed’s zero interest rate policy (ZIRP). There was no chance that the Fed would raise interest rates while it was engaged in QE. ZIRP is the policy that is boosting stock prices and commodity prices and depressing the dollar. And, just as a reminder, ZIRP will continue for “an extended period.” Fed Chairman Ben Bernanke explained yesterday that means no rate hike for at least the next two FOMC meetings.

Consumer Confidence

It was a bit surprising to see the overall Consumer Confidence Index (CCI) rise from 63.8 in March to 65.4 in April given the recent surge in gasoline prices. The Conference Board’s survey tends to put more weight on the employment situation, which is improving, than on other factors that influence consumer confidence. The present situation component of the CCI has been up for the past seven months. However, it remains relatively depressed at 39.6, which is still below the previous cyclical trough of 59.7 during September 2003.

The weakness in the present situation component this far into an economic recovery is unusual, but not surprising given that 4 out of 10 respondents agree that it is hard to get a job. The percentage of respondents saying that “jobs are hard to get” fell to 41.8% during April. That is the lowest reading since January 2009. The most recent cyclical peak in this series was 48.8% during November. The labor market is improving, but it is still hard to get a job.

US Earnings, Global Exports, & US Manufacturing

In our Forward Earnings & The Economy chart book (available to subscribers), we track the relationship between S&P 500 forward earnings on a monthly basis and numerous key global and US economic indicators. We are particularly impressed with the relationship between forward earnings and the IMF’s measure of the value of global exports, as well as the measure of the volume of global exports compiled by the Netherlands Bureau for Economic Policy (CPB). The V-shaped recovery in profits has been driven by the V-shaped recovery in global exports measured either way. The volume index rose to another record high during February, exceeding its previous high during April 2008 by 5.1%. It is up a whopping 66.5% since 2000.

The growth rate of forward earnings is also highly correlated with the manufacturing purchasing managers index (PMI) based on the monthly survey conducted by the Institute for Supply Management. The M-PMI was 61.2 during March, matching previous cyclical highs. That probably means that the growth rate in earnings may be peaking. However, that doesn’t mean that it won’t continue to grow along with world exports.

CNBC Appearance

Global Oil Demand Growth

While there might be plenty of oil around, there are also plenty of risks that its supply will be disrupted. Meanwhile, global demand for crude continues to rise to new record highs, hitting 88.5mbd on average over the 12 months through March. On this basis, it is up 3.6% y/y, the same as in February. This growth rate may be peaking because high oil prices may be slowing it down.



Interestingly, the growth rate in crude oil demand among the 30 OECD economies rose to a new cyclical high of 2.2% in March, while it dropped to 5.2% for non-OECD countries from the most recent cyclical peak of 5.7% during August 2010. This may be an early warning that slower growth may be ahead as high oil prices are pushing up inflation rates in emerging economies, forcing their central bankers to tighten and to slow economic growth. (We update these charts for subscribers to our service in our Global Oil Demand & Supply.)

Equity Holdings

During February, equity mutual funds accounted for 69.3% of the share of all such funds that invest in stocks and bonds. This percentage has ranged between 65% and 85% since the mid-1990s. So it is currently near the bottom of this range.

At the end of last year, equities directly held by households accounted for 17.9% of their financial assets and 12.0% of their financial and tangible assets. Both are up from two years ago, as stock prices have doubled. However, they are closer to the bottoms than the tops of their respective ranges since the early 1950s.

CPI Inflation in the US

Fed Chairman Ben Bernanke and Vice Chair Janet Yellen blame the Emerging Market Economies (EMEs) for their inflation problem. In their opinion, commodity prices are soaring because of surging demand from EMEs. The refusal by Bernanke and Yellen to acknowledge that the Fed’s ZIRP and QE-2.0 might be contributing to global inflationary pressures is bizarre. The Fed remains very US centric and focused on the core CPI, which was up just 1.2% y/y during March. That’s still below the Fed’s “comfort” target of 2%. The headline rate was 2.7% last month, led by a 15.5% increase in energy prices, which have boosted airfare prices by 13.7%.

Food prices are up 2.9% y/y and 5.1% over the past three months at an annualized rate, using the three-month moving average. Tenant rent inflation may also be getting hotter too. It is up 1.2% y/y, and 2.5% (seasonally adjusted annual rate) over the same three-month period.

China's M2 & Bank Loans




Central banks have been providing lots of intoxicating liquidity to keep the party going. Leading the merry band of bankers has been the People’s Bank of China (PBoC). It is still doing so. China’s M2 increased $363.8 billion during March, the biggest monthly increase on record.

 


China’s M2 is up 21.3% y/y and 48.7% over the past two years. It now exceeds America’s M2 by 29.5%. Ten years ago, America’s M2 exceeded China's M2 by 202%. Over the past two years, the PBoC has been raising the amount of reserves that banks are required to hold. It did so again on Saturday by raising the reserve ratio for large banks by 50bps to a record 20.5%, less than two weeks after hiking interest rates. However, the PBoC has simultaneously injected more reserves into the banking system by accumulating foreign exchange reserves totaling a record $3.0 trillion during February, up $565.9 billion over the past year. As a result, commercial bank loans continue to rise rapidly. During March, they rose $108.5 billion m/m and $1,297 billion y/y.



Bloomberg Interview

US Federal Budget Deficit

The more they talk in Washington about reducing the federal budget deficit, the larger it gets. In the past, during the third year of economic expansions, the deficit has always narrowed as the growth of tax receipts outpaced the growth of outlays. This year may be the first ever when the federal deficit widened to a record high this far into an economic upturn. During the first six months of fiscal 2011, which started on October 1 of last year, the federal deficit totaled $829.4 billion, up 15.7% and 6.1% from the same periods during 2010 and 2009. It is the biggest deficit for this period in history.

In the past, political gridlock was bullish because warring factions and special interest groups checked and balanced one another’s fiscal ambitions and excessive demands. In recent years, they’ve learned that they can all get what they want by issuing more and more government debt. Today’s gridlock is all about nobody being willing to compromise by giving up any of the deficit-financed perks they managed to get from the government. But wait a minute: Won’t the need to raise the debt limit before the end of May force the Democrats and the Republicans to agree on a deficit reduction plan? They will. They’ll agree that the deficit needs to be cut by $4 trillion over the next 10-12 years. That may be as much progress as they are likely to make for a long time. (We update these charts regularly for subscribers in our Government Finance briefing book.)

Crude Oil

The price of a barrel of Brent crude oil was 39.1% above its 200-day moving average at the end of last week, when it peaked at $126.47 on Friday. After yesterday’s selloff, it was still 32.4% above its 200-dma, which was $91.43.

According to the CFTC’s Commitments of Traders data, large speculators held futures contracts on WTI light sweet crude totaling 252 million barrels on April 5. That’s equivalent to a whopping 71% of US crude oil inventories during the week of April 1.

German Production, Orders & Stock Market

Germany has certainly been at the epicenter of the global boom, much more so than most other industrial countries. The latest German factory data suggest that the global economy continues to expand rapidly. During February, German factory orders increased for the fourth time in five months, soaring 2.4% m/m, and 9.2% over the five-month period. Orders are up 48.7% from the February 2009 bottom. Manufacturing output rose 1.4% m/m, and 15.2% y/y during February.

Germany’s stock market is up 96.5% since it bottomed during March 2009. A few days ago, it successfully retested its 200-day moving average. It now seems set to rise to a new cyclical high.

 





Bull/Bear Ratio



What about last week’s eye-popping pop in the Bull/Bear Ratio to 3.65, the highest reading since June 17, 2003? The bull market is more than two years old, and now the ratio is the highest it has been over the entire period. That is a bit worrisome.



However, there have been times in the past since 1987 when a ratio of 3.0 or more was followed by higher stock prices sometimes, following a brief correction. Then again, such elevated ratios have also marked a few significant tops. Beware.



Gold

Yesterday, the price of gold rose to a record for a second day. Gold is widely perceived to be a hedge against inflation. Actually, it is a hedge against reckless monetary and fiscal policies. One of the best measures of global monetary policy is non-gold international reserves held by central banks. The monthly data are compiled by the IMF. The price of gold seems to track the parabolic trajectory of the reserves data relatively well. Over the past decade, the price of gold has soared 470% from a low of $255.95 an ounce on April 2, 2001 to $1,459.10 this morning. Over this period through January, reserves held by central banks soared 376%, much faster than the 121% increase during the previous 10-year period, when the price of gold fell 28.4%.



The correlation between the price of gold and the US federal debt to nominal GDP ratio isn’t quite as close as the relationship shown above, but it is close enough to suggest that reckless fiscal policy in America is contributing to the run-up in the price of gold.

Earnings & Valuation

It has been a “Lost Decade” for the S&P 500 LargeCaps with a loss of 12.8% since the S&P 500 peaked at 1527.46 on March 24, 2000 through yesterday’s close. Over the same period, there was no lost decade for the SMidCaps, with the S&P 400 and S&P 600 up 100.1% and 105.3%. The short-term and long-term outperformances of these two indexes is attributable to their outperforming earnings and valuations. The forward earnings of the S&P 400 and 600 are up 153.8% and 126.3% since the start of 2000, while it is up 75.4% for the S&P 500. The former two now exceed their 2007 record highs, while the forward earnings of the S&P 500 now matches its previous record high during 2007. All three have traced out remarkably strong V-shaped recoveries over the past two years.

Valuation has also contributed to the divergence of the LargeCaps from the SMidCaps. During the late 1990s and early 2000, the forward P/E of the S&P 500 exceeded those of the SMidCaps by as much as 600bps. LargeCap IT stocks had lofty multiples that came crashing down over the past 10 years. The S&P 500 IT sector’s forward P/E peaked at a record 48.3 (hard to believe, but true) during March 2000 and fell to a low of 10.4 during November 2008. It is currently at 12.5.

S&P 500 Earnings Squiggles



Industry analysts are most likely underestimating the contribution of global business to the bottom lines of the companies they follow. You can’t blame them because even company managements can’t provide them with much guidance on this source of earnings strength. That’s because more and more companies are targeting several fast-growing emerging economies as the ones most likely to boost their revenues and earnings. It’s hard to predict which ones will fire up a company’s performance during any particular quarter.



Historically, based on data starting in 1979, industry analysts tended to be too optimistic about the outlook for annual earnings and usually had to lower their numbers as companies reported their quarterly results. That changed during 2003-2006, when their weekly consensus earnings forecasts rose for each of those four years. That coincided with the global boom at the time. Estimates were then crushed during 2007-2009 by the global recession. But subsequently, the estimates for 2010-2012 have been rising since early 2009. Again, this coincides with the surprisingly strong and V-shaped recovery in the global economy.

The Profit & Employment Cycles

The New Normal crowd has been touting the notion that employment would remain depressed and that unemployment would remain chronically high for a long time. We have been arguing that there is a very powerful relationship between the profits cycle and the employment cycle. We’ve been predicting and tracking the surprisingly strong growth in profits over the past two years. We argued that the subpar recovery in employment was caused by all the regulatory meddling by Congress during 2008 and 2009.





Last year, we predicted a regime change in Congress on November 2. When that happened, we concluded that employment should expand at a faster pace because there was likely to be much less of an anti-business attitude in Congress. Payroll employment in private industry rose 182,750 per month, on average, from December through March. During the previous 11 months, it rose 91,450 per month.