S&P 500 Sectors Relative P/Es

Today’s charts show the forward P/Es of the 10 S&P 500 sectors relative to the overall market’s valuation multiple on a daily basis, though based on weekly forward earnings data for the sectors. Stable sectors are all trading at or near recent cyclical high P/Es. Since the market bottomed during March 2009, there has been a rally in the valuations of the Stable sectors. Among the Stable sectors, Telecom Services is the most expensive, selling at more than a 30% premium to the market. The cheapest of the Stable sectors is still Health Care. It is selling at a small discount after selling at very large discounts during 2009 and 2010. In the past it sold at a premium. However, yesterday’s court ruling in favor of ObamaCare may put a lid on the sector for a while.

Among the Cyclical sectors, Energy is the cheapest with a discount of 14%. However, it tends to trade at a discount to the market. Financials is also selling at a discount, which is also par for the course. Given the big hit to Bank of America and the ongoing mess in the mortgage market, this sector may remain earnings challenged for a while. The most expensive Cyclicals are Consumer Discretionary and Industrials, selling at 16% and 11% premiums. However, their earnings continue to rebound at solid paces, and they are probably best positioned to benefit from the resumption of faster economic growth following the recent soft patch.



Fundamental Stock Market Indicator & Third Year of Presidential Cycle

Our Fundamental Stock Market Indicator continues to meander around the recent cyclical high. It’s been doing so since initial unemployment claims rose back above 400,000 during the week of April 9 and the CRB raw industrials spot price index peaked on April 12. Jobless claims should drop back below 400,000 during July or August as the auto industry ramps up production. In addition, the pace of payroll cuts among state and local governments should slow now that they’ve cut their costs to balance their budgets for the new fiscal year that starts July 1.

 

We have been monitoring the performance of the S&P 500 this year, which is the third year of the Presidential Cycle, relative to the previous 15 comparable years of this political cycle. So far, it is most closely tracking the Harry Truman market of 1951. If it continues to do so, then the S&P 500 should be up to 1410 by the end of August and to 1465 by the end of the year. That would make it a gain of 16.5% for the year, slightly underperforming the average third-year gain of 18.3% since 1951.

 



Personal Consumption Expenditures



Personal consumption expenditures fell 0.1% in May following the same decline during April. On a three-month change basis, the three-month average of real consumer spending rose only 1.5% (saar) in May, down from a cyclical peak of 4.0% during December, and the slowest pace since January 2010.

 

The good news is that the recent weakness in consumer spending was mostly in durable goods consumption, especially in auto sales, and probably temporary. Over the past three months, outlays on durable goods rose just 0.8% (saar), the weakest since the start of 2010. The spike in gasoline prices during the spring certainly depressed such sales. The shortage of autos attributable to Japan’s earthquake also dampened sales. The outlook for auto sales in coming months is improving as gasoline prices fall and auto production rebounds.



Let’s not get too excited. There are a number of chronic problems that will continue to weigh on consumers for a while. The labor market remains challenging. There is plenty of deleveraging ahead. Home prices are still falling. Income inequality is widening. So while durable goods spending should rebound during the second half of the year, the pace of overall spending may remain subdued as evidenced by the lackluster growth rates over the past three months of 1.3% (saar) in real nondurable goods and 1.6% in real services, based on three-month averages.

US Durable Goods Orders & Shipments

There was lots of good news in May’s durable goods orders release. Especially important is that orders for nondefense capital goods excluding civilian aircraft orders (which tend to be volatile) rose to a new cyclical high. So did shipments of this stuff. The former jumped 14.4%, and the latter rose 9.1% based on the three-month change in the three-month average at an annual rate.

These numbers suggest that capital spending could boost real GDP growth this year. That shouldn’t be a surprise given record corporate profits and cash flow, as well as record cash on corporate balance sheets, plus record low borrowing rates and the 100% depreciation allowance for 2011.

Crude Oil Supply & Demand

On Friday, June 10, a Saudi newspaper reported that Saudi Arabia will unilaterally raise output to 10mbd in July, from 8.8mbd in May. The report suggests that Riyadh, led by King Abdullah, is asserting its authority over fellow members of OPEC, particularly Iran, after it failed to convince the 12-member cartel to lift output. We have production data starting during 1973 for Saudi Arabia. The Kingdom’s output hasn’t exceeded 9.5mbd since February 1982. So if the Saudis actually do pump 10mbd, that will prove that they actually do have excess capacity and that they are willing to use it to keep a lid on oil prices.

 

World oil demand rose to a record 88.9mbd over the past 12 months through May. Pacing the advance was demand in the “New World” countries, which rose to a record 50.8mbd. China’s demand for crude oil rose to a new record high of 9.6mbd over the past 12 months through May. Lagging behind was the demand of the “Old World” countries, i.e., the US, Western Europe, and Japan. Their usage was 38.1mbd, still well below their record peak of 41.9mbd during August 2005.

 



Japan’s crude oil demand was especially weak following the recent earthquake and tsunami. The latest data also show some “demand destruction” in the US and in Europe.






S&P 500 Index & Crude Oil Price

At one account I visited in London yesterday, a PM observed: “It’s just crazy that the outlook for the global financial system depends on the whims of 11 million Greeks.” The Greek drama clearly has investors on the edge of their seats. The S&P 500 is also on the edge of its 200-day moving average, which was 1265.39 at yesterday’s close. The actual index is down 6.3% to 1278.36 since peaking this year at 1363.61 on April 29. Last year, it peaked on April 23 and bottomed on July 2 after dropping by 16.0%. Back then it fell below its 200-dma during the summer.

 

The price of a barrel of WTI crude oil is also on the edge of its 200-dma, which was $92.91 yesterday. This morning, the actual price is $94.03. During the financial crisis of 2008, this price fell below its 200-dma on September 2. It continued to plunge in a free-fall until it bottomed on December 19 at $33.87.



US Economic Indicators & the Soft Patch



Soft patches are common during business cycle expansions. The chart above shows the three-month percentage change in the Index of Coincident Economic Indicators from 1960 to now. There were eight business cycle expansions since then, and all of them had soft patches. Especially encouraging is that the Index of Leading Economic Indicators (LEI) rebounded by a larger than expected 0.8% in May. That followed a 0.4% drop in April, which was the first decline in 10 months. Eight of the 10 components contributed positively to the LEI last month, compared with four in April.



May’s data for US industrial production strongly support our view that the current economic soft patch is mostly attributable to a shortage of Japanese parts, especially ones required to assemble a car. Let’s review:

(1) Auto production remained depressed in May. It rose 0.3% during the month to 7.9 million units after plunging 10.8% during April. It should jump to a new cyclical high exceeding 9.0 million units during August and September.

(2) Overall industrial production, which includes the output of manufacturers and utilities, rose 0.1% during May following no change in April. Excluding production of motor vehicles & parts, it rose 0.1% in May following a 0.3% gain in April.

(3) Manufacturing output rose 0.4% during May following a 0.5% drop in April. Excluding production of motor vehicles & parts, it rose by a solid 0.6% in May following a 0.1% decline in April.

US Economic Indicators

The latest grab bag of US economic indicators suggests that the US economy continues to muddle along in its soft patch. The most upbeat data are personal income tax receipts, which totaled $1,054.0 billion over the past 12 months through May. That’s the best reading since March 2009, and up 24.5% from the most recent cyclical low of $846.8 billion. Less encouraging is that despite the cut in payroll taxes on individual paychecks at the beginning of the year, inflation-adjusted retail sales have stalled recently. Over the past 12 months through May, total payroll taxes paid by employees and employers fell to $834.2 billion from $860.0 billion at the end of last year.

Yet, inflation-adjusted retail sales flattened out during April and May. The three-month average of these sales through May fell 2.1% over the past three months, on a seasonally adjusted annual rate basis. That suggests that real consumer spending on goods could be a big drag on real GDP growth during the second quarter. Part of the problem is the shortage of Japanese cars and car parts, which should be resolved later this summer, setting the stage for a rebound in consumer spending on cars.

China’s M2, Bank Loans, and Electricity Usage

 The soft patch may not be so soft after all, at least not in China. When the country’s May manufacturing purchasing managers index (M-PMI) was released on May 31, investors fretted when it fell to a nine-month low of 52.0. When China’s May trade data came out last week, investors were disappointed by the weakness in exports, and unimpressed by the strength of imports. On June 13, China released data on M2 and commercial bank loans during May. The former was up $145.6 billion m/m and the latter rose $85.1 billion m/m. Those are both solid increases. The average monthly increase in China’s M2 from January through April was $172.1 billion. Over the same period, bank loans rose $87.5 billion, on average.
 


There is a strong correlation between China’s real GDP growth rate on a y/y basis versus the yearly percent change in the three-month average of electricity usage in China. During April, electricity usage was up by 13.4% on this basis from a recent low of 6.2% during December 2010. (We update these charts regularly for subscribers to our service in our China Briefing Book.)



Japan’s Exports & the Global Soft Patch

There is mounting evidence that Japan’s devastating earthquake and tsunami on March 11 caused the global soft patch. Japanese exports plunged 14.0%, or $119.6 billion, during March and April to $735.3 billion (saar). That’s the lowest pace since February 2010. During February of this year, Japan’s exports total was at a cyclical high that nearly matched the previous record high during March 2008.

US imports fell in April, as US imports from Japan dropped 25.5% (on a not seasonally adjusted basis) led by a 69.4% plunge in autos. Also dropping, by 21.2% m/m, were parts imported from Japan needed to assemble motor vehicles in the US. Some of the recent weakness in Chinese imports was probably caused by the Japanese parts shortage too. China’s imports from Japan dropped 14.6% during April to $178.3 billion (saar), the lowest reading since September 2010. This total recovered some of the loss during May with a gain of 6.1%, but was still 18.2% below January’s record high.

S&P 500 Sectors Relative P/Es

The recent outperformance of the Defensive sectors has been attributable to sharp increases in their relative P/Es. During the week of June 2, they rose to new highs for the year: Telecom Services (1.32, up from a low of 1.16 earlier this year), Consumer Staples (1.18 from 1.04), Utilities (1.08 from 0.94), and Health Care (0.96 from 0.84).

Meanwhile, among the Cyclical sectors, Energy edged up to 0.86. That’s still the lowest of the 10 sectors, and down from a high of 1.01 during the week of February 24. The second lowest sector is Financials at 0.87, which is the lowest this year, and down from 0.94 during the week of February 17. The highest among the Cyclicals in Consumer Discretionary at 1.16. It has been holding up remarkably well all year. The second highest among the Cyclicals is the Industrials sector, but it is down to 1.10, which is the lowest since November 18, 2010. Information Technology (0.98) is the cheapest since 1995.

Expected Inflation and the P/E

The Fed implemented QE-2.0 to bring down the unemployment rate and to avert deflation by stimulating faster economic growth. As Fed Chairman Ben Bernanke acknowledged yesterday, the recovery is slow and “uneven.” Unemployment remains high. It’s not obvious that deflation was a clear and present danger late last year when QE-2.0 was implemented. Nevertheless, expected inflation in the 10-year TIPS yield rose from last year’s low of 1.49% on August 24 to a recent high of 2.64% on April 8. Since then, it dropped to 2.25% yesterday. The core CPI is up from 0.6% during October to 1.3% during April.

There’s good correlation between the S&P 500’s forward P/E and expected inflation in the 10-year TIPS yield. As noted above, expected inflation has dropped 39bps to 2.25% since April 8 through yesterday. The forward P/E dropped from 13.1 to 12.4 over this same period.

Super PMIs

Today we show the averages of the M-PMIs and NM-PMIs for all the major economies we follow. Of the eight Super-PMIs, the only one below 50 during May was Japan’s at 47.5, but that was up sharply from 40.4 during April. The only other one that rose during the month was China’s to 53.2 from 52.3 in April.

The other S-PMIs all declined during May, but remained in expansion mode with readings above 50: France (58.7), Germany (56.9), Eurozone (55.3), US (54.1), UK (52.9), and Italy (51.5).

US Auto Sales

Auto sales dropped sharply in May to 11.8 million units (saar) from 13.1 million units during April. Much of this weakness reflects the shortage in Japanese car parts rather than the depressing effect of the spike in gasoline prices earlier this year.

 

Fuel-efficient domestic and imported vehicle sales dropped by more than the less efficient domestic light truck sales. The former declined 1.0 million units to 5.8 million, while the later declined 0.3 million units to 6.0 million. Sales of imported vehicles, including cars and light trucks, declined by 0.4 million units to 2.5 million. Thousands of Japanese new autos never made it to the US when they were swept away by the tsunami or couldn’t be manufactured because of the parts supply disruptions in Japan. Auto inventories were already relatively low during April when the days’ supply fell to 40. So sales could have been depressed in May if dealers didn’t have the models that would-be buyers wanted. The buyers might also have been put off from showing up at the showrooms by stories that there was a shortage of certain models and that price discounts were cut back.

Purchasing Managers Surveys

A shortage of parts made in Japan is temporarily disrupting global manufacturing, in general, and the auto industry, in particular. In the US, the purchasing managers index (PMI) for manufacturing declined from 60.4 during April to 53.5 in May. It was led by sharp drops in the New Orders Index (from 61.7 to 51.0) and in the Production Index (from 63.8 to 54.0). Interestingly, the Employment Index dropped by less (from 62.7 to 58.2), and it remained above 50. The Inventory Index dropped below 50 (from 53.6 to 48.7). That’s consistent with the view that manufacturers are drawing down their parts inventories while they wait for more supplies from Japan.

 

Not surprisingly given that Japan produces lots of key parts for auto companies around the world, the soft patch has gone global. The UK’s PMI fell from 54.4 in April to 52.1 last month, the lowest in 20 months. The PMI for the EU declined from 58.0 in April to a seven-month low of 54.7 in May. Germany’s PMI dropped below 60.0 for the first time in six months to 57.7. Please notice that there is no great tragedy in any of these PMI indicators. They all remain solidly above 50. Keep in mind that they are diffusion indexes. That means that at some point in an economic expansion business might be great, but no greater than the month before. When that happens, the index will tend to cycle back down towards 50.



The Bond Yield




The corporate bond calendar has been huge recently, yet yields have been falling. We should know by now that the supply of bonds rarely affects the bond yield. More specifically, the supply of corporate bonds tends to swell when there are lots of willing buyers. The motto of the issuers is “Issue when they will come.” Demand creates its own supply in the corporate bond market. Demand is driven by the perception of the growth in nominal GDP, which tends to be in the same ballpark as the bond yield.

 



Even the Fed’s rounds of quantitative easing haven’t always had the anticipated impact on yields. Last year during March, QE-1.0 terminated after the Fed purchased $1.25 trillion in mortgage securities. Nevertheless, the yield fell during the spring and summer months from 4.01% on April 5 to the year’s low of 2.41% in early October because economic growth seemed to be weakening. When the Fed implemented QE-2.0 on November 3, 2010, the 10-year yield had already risen to 2.67% from the year’s low of 2.41%. It continued to move higher, rising to the most recent peak of 3.75% on February 8 this year. That happened because the economy looked to be growing faster late last year. Now, the yield is back down to almost 3% in response to the economy’s soft patch.