Another Soft Patch Ahead? (excerpt)

Businesses are building their inventories of merchandise and new homes. That activity boosted real GDP during Q3, and may be doing it again during the current quarter. The question is whether some of this restocking is voluntary or involuntary.

The recent weakness in producer and consumer prices suggests that some of it is attributable to slower-than-expected sales. To move the merchandise, producers and distributors are offering discounts. November’s surge in housing starts may also be outpacing demand, as evidenced by weak mortgage applications.

In other words, the rebound in the Citigroup Economic Surprise Index over the past 10 days might not be sustainable into the start of next year. I’m not turning pessimistic about the outlook for 2014. I am just raising a warning flag given the remarkable increase in inventories recently and weakness in pricing.

We will be closely monitoring Bloomberg’s weekly Consumer Comfort Index in coming weeks. It dropped from late September through early November, but seems to be on the rise again. I’m thinking that Obamacare could weigh on consumer confidence and spending at the start of the new year as more Americans realize that their out-of-pocket expenses for health care are likely to be higher in 2014.

Today's Morning Briefing: Build and They Will Come? (1) Restocking for the holidays. (2) Voluntary or involuntary? (3) Another soft patch ahead early next year? (4) Watching consumer confidence. (5) Auto dealers using incentives to reduce inventories. (6) Housing starts strong, but lack confirmation in permits and mortgage applications. (7) Pricing is weak, reflecting discounts and cheap imports. (8) Can the Fed boost inflation? (More for subscribers.)

Singles & Income Inequality (excerpt)

By most measures, income inequality has worsened in recent years. The problem with these measures is that they mask lots of structural changes. They can also exaggerate the nature of the problem. Even if they are accurately depicting a deteriorating situation, it’s not at all obvious that government policies can make things better.

In the US, demographic changes are having a significant impact on income distribution. Most significantly, in my opinion, is that for the first time ever, the number of single people in America is almost equal to the number of married ones. Let’s review the stats, which are released monthly by the Bureau of Labor Statistics in the employment report:

(1) During November, there were 124.1 million married persons and 122.5 million singles who were 16 years old or older. The percentage of singles in the total adult population (16+ years old) rose from 37.7% at the start of 1977 to 49.7% now.

(2) The adult population that has never been married rose to a record high of 74.5 million during November, accounting for 30.2% of the adult population, up from 22.4% at the start of 1977.

(3) The adult population that is divorced, separated, and widowed was 48.0 million during November, accounting for 19.5% of the adult population, up from 15.4% at the start of 1977.

It stands to reason that these demographic trends might be having a significant impact on income distribution and exaggerating the extent of inequality. On average, a young or senior single is likely to earn less than the combined income of a married couple.

Today's Morning Briefing: Singles & Income Inequality. (1) Obama set to fight inequality. (2) It’s here to stay. (3) Governments can impose equality by spreading poverty. (4) Populist ruling classes and their capitalist cronies. (5) Demography is driving income distribution in US. (6) Single persons could soon outnumber married ones. (7) Two earners make more than one. (8) The Fed is struggling to communicate. (9) Low inflation provides great opportunity to taper. (10) Technology finds more commodities. (11) Mexico deregulates crude and should produce more of it. (12) Focus on underweight-rated S&P 500 Materials. (More for subscribers.)

Europe’s Weak Money & Credit (excerpt)

I’ve recently noted that the rebound in the Eurozone’s PMIs in recent months isn’t showing up in the hard economic data for the region. Yesterday, Markit reported that the Eurozone’s flash Composite Output PMI rose from 51.7 in November to 52.1 in December. That’s a three-month high. Germany's reading ticked down from 55.4 to 55.2, while France's fell from 48.0 to 47.0. The Eurozone's M-PMI rose to a 31-month high of 52.7, with Germany's rising to 54.2, while France's fell to 47.1. The NM-PMI for the Eurozone was little changed at 51.0.

The big problem in the Eurozone is that banks account for much of the credit available in the region, and their loan portfolios continue to decline. Lending has been in negative territory every month but two since October 2011. The growth rates of the monetary aggregates have been decelerating all year, with October’s M3 up just 1.4% y/y, the lowest since October 2011.

Today's Morning Briefing: Happy Homeland. (1) Bittersweet ending. (2) Tiny taper ahead? (3) Low inflation won’t be a taper-killer if it helps keep yields down. (4) Productivity driving inflation lower and profit margins higher. (5) Hot coincident indicators. (6) Whatever is the matter with Washington may matter less. (7) Happy Eurozone PMIs again, but banks aren’t lending. (8) Abe should be thankful for latest Tankan survey. (9) A warning about profit warnings. (10) Forward earnings at another record high. (11) Focus on overweight-rated S&P 500 Information Technology. (More for subscribers.)

The US Dollar (excerpt)

“What about the dollar?” I heard that question more often in London last week than I usually do in the US. Odds are it will remain strong relative to the yen. Once the Fed starts tapering, the currencies of EMs, especially the ones with current account deficits, could come under renewed downward pressure, as we saw this summer when Fed officials started talking about curtailing bond purchases.

The strength of the euro has been surprising given the weakness of the Eurozone economy. It certainly doesn’t help their feeble recovery since it is likely to weigh on exports. There are two obvious explanations for the strength of the euro: The Eurozone is running a trade surplus (thanks to Germany and Italy), while the US has a trade deficit. In addition, the Fed’s balance sheet is growing, and will continue to do so even when tapering begins, while the ECB's balance sheet has been shrinking since the end of June 2012.

Today's Morning Briefing: Back Home. (1) “Stay Home” or “Go Global”? (2) "World-wind" tour in London. (3) Upbeat on US, with a few concerns. (4) Obamacare is equivalent to fiscal drag. (5) Housing facing some headwinds. (6) Retail sales rising along with solid earned income gains. (7) Eurozone stock rally yet to be confirmed by fundamentals. (8) Eurozone’s hard data remains soft. (9) More downside for yen and more upside for Nikkei, but Japan’s economic prospects remain challenging. (10) China is looking better than other EMs. (11) Why is the euro so strong? (12) Focus on market-weight-rated S&P 500 Retailers. (More for subscribers.)

Valuation Multiples (excerpt)

There are plenty of other P/Es that have more historical data, though they tend to be quarterly rather than daily/weekly/monthly as is the forward P/E of the S&P 500, which is our preferred measure of valuation. As of Q3, the market capitalization of equities was 14.7 times corporate profits, not much higher than the average since 1960. Tobin’s “q” measures the market value of nonfinancial corporations relative to their replacement cost. During Q3, it was equal to 1.0, which is in fair-value territory.

Today's Morning Briefing: The Great Moderation II. (1) Two alternative scenarios. (2) Is New Normal the return of the “Great Moderation?” (3) Bernanke’s remarkable speech. (4) Higher P/E for New Normal or Old Normal? (5) Forward P/E slightly exceeds historical average. (6) Other P/Es are in fairly-valued territory too. (7) Tobin’s q ratio is 1.0. (8) Great Recession II? (9) A list of excesses. (More for subscribers.)

Tapering & the Stock Market (excerpt)

Yesterday, the Fed released its latest Flow of Funds report updated through Q3. It’s loaded with an overwhelming amount of interesting data series about the economy's financial flows and consolidated balance sheets. We track lots of them in our US Flow of Funds chart book and related publications on our website.

For now, let’s focus on the ones in our US Flow of Funds: Equities. They mostly show that despite record cash flow and cash holdings by corporations, they have been borrowing at a record pace in the bond market. They’ve been using lots of the cash they’ve earned and borrowed to buy back their shares. Domestic individual investors and foreign investors are also buying more shares through mutual funds and ETFs. Let’s review the data:

(1) Asset values. The total market value of all equities rose to a record $31.2 trillion at the end of Q3, up $17.5 trillion or 127% from the low during Q1-2009. Over the same period, the Wilshire 5000 Index rose 180% to $19.2 trillion. The grand total exceeds the previous cyclical high during Q3-2007 by 22%.

(2) Valuation. The market value of all equities divided by nominal GDP rose to 1.14, the highest since Q4-2000, and well above the historical average of 0.68. That’s still well below the record high of 1.53 during Q1-2000.

(3) Corporate Finance. Corporate cash flow rose to a record $2.3 trillion (saar) during Q3. Liquid assets held by all nonfinancial corporations (NFCs) rose to a record $1.9 trillion at the end of Q3. Yet, the NFCs raised a record $665 billion in net new bond issues over the past four quarters. Apparently, some of those funds must have been used to buy back shares, as net equity issuance was minus $364 billion over the same period.

(4) Buyers. During Q3, equity mutual funds and ETFs purchased $411 billion (saar) in equities. Foreigners purchased $47 billion. Institutional investors had net sales of $93 billion. The household sector is a residual in the Fed’s FOF accounts, so the buy backs of shares tend to show up as selling by households, which was $400 billion during Q3.

So there you have it. The Fed’s ultra-easy monetary policy has encouraged corporations to issue bonds at record low interest rates and use some of the proceeds to buy back their shares. That’s boosted earnings per share and stock prices. Tapering isn’t likely to stop all this if bond yields remain low assuming that the Fed’s forward guidance convinces investors that the federal funds rate will remain near zero for a very long time. That policy would be even more credible if inflation remains near zero as well.

Today's Morning Briefing: Go With the Flow. (1) What’s next after tapering? (2) How about deflation? (3) Bullard wonders why inflation is so low when the Fed has been so easy. (4) Friedman’s theory isn’t passing the latest test. (5) Or is it doing so in Japan? (6) Abenomics boosting profits, but will it trickle down to workers? (7) Fed’s latest Flow of Funds report shows record net issuance of corporate bonds. (8) So easy Fed is also driving share buybacks, boosting earnings per share and stock prices. (More for subscribers.)

Europe’s Anemic Recovery (excerpt)

European stock markets rallied smartly during the summer and fall, but have started to flag recently. The region’s leading indicators, which are compiled by the OECD, continued to rebound impressively during October. The region’s purchasing managers have also been upbeat in recent months. However, the hard data on orders and production remain surprisingly comatose. For example, German orders fell 2.2% during October and German output dropped 1.2% during the month. There’s been an uptrend in both in recent months, but they are barely back to where they were in 2010.

Today's Morning Briefing: A Short Worry List. (1) The other side of the pond. (2) Thinking about the downside in London. (3) Seven trouble spots. (4) Tapering could be troublesome for housing and EMEs. (5) Central bankers fighting deflation, which isn’t all bad. (6) More mischief from Washington? (7) If Obamacare is so depressing, why is confidence rising? (8) Europe’s hard data still looks soft. (9) Is Abenomics losing its mojo? (10) Geopolitical risk is always out there somewhere. (11) Too many underinvested bulls? (More for subscribers.)

Record Corporate Profits (excerpt)

Over the same period that the P/E has increased 44% from 2011's low, forward earnings rose 12% to a new record high of $120.74 per share. Also at new record highs were after-tax profits during Q3, as reported in the National Income and Product Accounts (NIPA), along with GDP on Thursday.

Last week, I noted that the S&P 500’s profit margin rose to a record high of 9.7% during Q3. The NIPA data show that after-tax reported profits as a percentage of nominal GDP rose to 11.1% during Q3, also a new record high. The S&P and NIPA profit margins are highly correlated. The former is only available since Q4-1993. The latter starts in 1947, and is currently well above all previous cyclical peaks.

On a pre-tax basis, profits of nonfinancial industries rose 8.1% y/y to a record high of $1.24 trillion (saar) during Q3. Financial industry profits rose to a record high as well, but were up only 3.0% y/y. The FDIC’s latest Quarterly Banking Profile showed that banks continued to lower their provisions for loan losses and net charge-offs to the lowest readings since before the Great Recession. There may not be much more room for banks to boost their earnings in this manner.

Today's Morning Briefing: Taper-Ready. (1) A good trade. (2) Jobless rate falls to 7% ahead of Fed’s schedule. (3) Whistling a different tune at the Fed. (4) From “shovel-ready” to “taper-ready.” (5) From “Good Rotation” to “Great Rotation.” (6) Record inflows into equity funds. (7) Nothing to fear but nothing to fear. (8) Lots of measures of profits and margins at record highs. (9) YRI Earned Income Proxy at record high. (10) Encouraging developments in the labor market. (More for subscribers.)

More Good News (excerpt)

The US economy has performed surprisingly well despite the backup in yields and Washington’s latest fiscal fiasco. Let's review:

(1) Purchasing managers. The average of the M-PMI and NM-PMI was 55.6 during November, a solid reading indeed. The average of their orders indexes was 60.0, also well above 50.

(2) Employment indicators. ADP private payrolls rose 215,000 during November, the best reading this year. As Debbie reports below, October was revised up by 54,000 to 184,000.

(3) Exports and petroleum. Inflation-adjusted US exports rose 3.2% during October to a record high. Contributing to its strength in recent weeks has been a surge in US exports of petroleum products.

Today's Morning Briefing: Too Many Bulls? (1) Santa came early this year for stock investors. (2) Can December match October and November? (3) Nothing to fear but tapering because economy is strong? (4) Is yearend rally running into a crowd of too many bulls? (5) Bond market has already discounted tapering. (6) Solid indicators. (7) How do you say $20 oil in Farsi? (8) S&P vs. Thomson Reuters on earnings. (9) Focus on overweight-rated S&P 500 Transportation. (More for subscribers.)

US Economy Back in the Fast Lane? (excerpt)

Better-than-expected economic indicators on Monday (November’s M-PMI) and on Tuesday (October’s car sales) depressed the S&P 500, which fell 0.6% over the past two days. Investors may be taking some profits on expectations that the Fed might start tapering QE sooner rather than later.

Is this the beginning of a significant correction? I doubt it since corrections and bear markets are triggered by mounting concerns about a recession. The latest data are pointing more to a boom than a bust.

I’m not sure if the folks at the Economic Cycle Research Institute (ECRI) have changed their mind yet about the economy being in a recession. Their Weekly Leading Indicator sure doesn’t show it. Neither does the Conference Board’s Leading Economic Indicator, which rose to a cyclical high during October.

The Citigroup Economic Surprise Index remains subdued with a reading of 5.1 yesterday. However, November’s M-PMI was surprisingly strong, causing some economic truthers to question its accuracy. I expressed some of my doubts yesterday as well.

But then auto sales came out for November, showing that they spiked up to a new cyclical high of 16.4 million units. However, this may be partly a rebound from October’s sales, which were depressed by the partial shutdown of the federal government. The two-month average was 15.8 million units, a slight uptick from the third quarter’s 15.7 million units.

Another upbeat indicator was yesterday’s construction report showing that total construction put in place also rose to a new cyclical high, though it remains 25% below the record high during March 2006.

Today's Morning Briefing: A Tablet on Every Table. (1) Something is different this time. (2) Dow Chemical shedding low-margin businesses. (3) Trauma of 2008 remains traumatic. (4) Improving on the margin. (5) IT leading the margin parade. (6) There’s an app for that, even when dining out. (7) Industries with rising and falling margins. (8) Corrections usually caused by recession fears. (9) No correction if QE tapered due to strong economy. (10) Car sales and construction spending at cyclical highs. (11) Focus on overweight-rated auto-related S&P 500 industries. (More for subscribers.)

Manufacturing Boom? (excerpt)

Why do US stock investors pay such close attention to the M-PMI? At the beginning of each month, it provides one of the early reads on economic activity during the previous month. It also tends to be a good leading indicator of the y/y growth rate of S&P 500 revenue. The nonmanufacturing PMI tends to be a more coincident indicator of revenue growth. November’s M-PMI jumped to 57.3, the best reading since April 2011. It is up from the year’s low of 49 during May 2013. It suggests that revenue could be growing around 10% within the next 3-6 months, up from under 5% currently.

Before we get too excited, let’s check whether the Fed’s regional business surveys confirm the national M-PMI. The average of the regional composite manufacturing indexes (for New York, Philadelphia, Richmond, Kansas City, and Dallas) is highly correlated with the M-PMI. They rebounded together earlier this year, but the regional average has been relatively flat for the past three months, though at a solidly expansionary level. The same can be said for the average of the regional orders indexes and the M-PMI’s new orders component, which rose to 63.6 last month. The regional employment index actually edged down, while the national index edged up during November.

Today's Morning Briefing: Manufacturing Boom? (1) Amazon vs UPS. (2) Drone delivery. (3) The New Industrial Revolution. (4) GE fixes an engine problem by changing software code. (5) Global boom in M-PMIs. (6) PMI diffusion indexes showing more strength than actual manufacturing data. (7) Three possible explanations. (8) Regional business surveys also strong on balance. (9) UK, US, and Japan leading the pack with Eurozone and EMs trailing. (10) Focus on overweight-rated S&P 500 Industrials. (More for subscribers.)

Perma-Bears (excerpt)

A few investment strategists have recently started to argue that stocks are significantly overvalued relative to “normalized” earnings. Their self-evident truth is that normalized earnings are lower than actual earnings so stocks are especially overpriced and vulnerable to a big fall from their current prices. These strategists have been the bull market’s perma-bears, who consistently underestimated the rebound in earnings since 2009.

Now these bears are saying that since the S&P 500’s operating profit margin is at a record high of 9.7% (based on the trailing four-quarter average), it must inevitably revert to its mean, which is 7.6% using data available since 1994. Normalizing S&P 500 forward earnings to this mean would reduce earnings by 22% and boost the normalized forward P/E to a bubbly 19.2, well above the conventionally measured current reading of 15.0. I think that’s their contention.

Since a cyclically high profit margin will always revert to its mean and fall below it during a recession, this normalization approach to valuation simply implies that stocks are overvalued relative to earnings if a recession is coming soon. Of course, since the perma-bears have been predicting an imminent “endgame” scenario since the start of the bull market, their latest spin is clearly just a variation on their bearish theme. What has changed is that they aren’t as strident about impending doom, so they’ve tactically switched to the notion that stocks are too expensive given that doom is inevitable, even if it isn’t imminent.

Today's Morning Briefing: Bully! (1) Are we all wild and crazy bulls now? (2) The bears have left the building. (3) A sell signal for contrarians? (4) P/E-led rally since summer 2011. (5) From depressed to normal valuation. (6) Bubble in angst. (7) More stocks are getting pricey. (8) Does it make sense to compare stock prices to “normalized” earnings? (9) Record high profit margin in Q3. (10) Approaching bubble territory. (11) Fundamentals remain mostly upbeat. (12) “The Hunger Games: Catching Fire” (-). (More for subscribers.)

Earnings & the Bull Market (excerpt)

My bullishness since March 2009 has been driven by rising earnings. The rebound in S&P 500 forward earnings was V-shaped from 2009 through mid-2011, breaking out to new highs during May 2011. It’s been making new highs ever since then. In November, it was at $120.55 per share, up 92% from the cyclical low of $62.92 during May 2009.

Forward earnings, which is the time-weighted average of consensus operating earnings for the current year and next year, is a very good year-ahead leading indicator of actual earnings over the next four quarters So there's a good chance that the S&P 500 will earn about $120 per share in 2014, which coincides with my forecast.

That forward earnings number is currently in the market with the forward P/E at 15, up from about 10 during the summer of 2011. That was a retest of the P/E low in March 2009. Forward earnings are also at record highs for the S&P 400 MidCaps and S&P 600 SmallCaps with their respective forward P/Es at 16.9 and 18.5.

Today's Morning Briefing: Thanksgiving. (1) Counting our blessings. (2) Thanks to Tom Hanks. (3) Symbology and strategy. (4) From 666 to 1802. (5) Is there any meaning in 777? (6) Since March 2009, forward earnings up 83%, P/E up 45%. (7) Net Earnings Revisions Indexes are mostly negative around the world. (8) NERI dives in France and runs out of mojo in Tokyo. (9) NERI upticks in China and India. (10) Focus on market-weight-rated housing-related stocks. (More for subscribers.)

Oil Prices & the Iran Nuke Deal (excerpt)

The nuclear deal signed on Sunday with Iran will not allow any more Iranian oil into the market, nor let western energy investors into the country. However, it does freeze US plans for deeper cuts to Iranian crude exports. "In the next six months, Iran's crude oil sales cannot increase," according to a fact sheet posted by the White House on the US State Department's website on Sunday.

US sanctions effectively bar Iran from repatriating earnings from oil exports, forcing customers to pay into a bank in their country. Washington estimates that Iran has around $100 billion in foreign exchange earnings trapped in such accounts. Under the terms of the deal, Iran will be allowed access to $4.2 billion of oil export revenues. But nearly $15 billion still will flow into accounts overseas over the next six months, according to the US government.

Nevertheless, if the interim agreement is setting the stage for a diplomatic resolution of the Iran nuke issue, then the price of oil could drop even before sanctions are completely removed. The price of a barrel of Brent crude oil jumped $3.36 to $111.95 last week on pessimism about a deal getting done. It could tumble on expectations of a rebound in Iran’s crude oil exports, which plunged by more than one million barrels per day since sanctions were imposed in early 2012.

Of course, Libya’s oil output has also dropped over the past few months as a result of the anarchy caused by numerous rival militia groups. Nevertheless, world crude oil supplies rose to a new record high of 90.9mbd during October, led by a sharp increase in non-OPEC production in recent months. The combined output of the US and Canada rose to a record 11.5mbd during October, exceeding Saudi Arabia’s output of 9.5mbd.

These developments should put a lid on energy inflation. In the US and Europe, CPI energy inflation rates, on a year-over-year basis, were -4.8% and -1.7%, respectively, during October. The price of gold continued to slide last week, suggesting that other commodity prices may also remain weak.

Today's Morning Briefing: The Nuclear Option. (1) Nuclear reactions. (2) Reid lobs the bomb. (3) Yellen is in like Flynn. (4) Flying with the doves. (5) The Supreme Leader got a good deal. (6) A second Nobel Peace Prize. (7) Badly wanting a bad deal. (8) “Historic mistake.” (9) Obamacare as “vaporcare.” (10) Oil prices could tumble. (11) Stage set for stock market melt-up. (12) US economy muddling along. (13) Germany looking up, while France looking down. (More for subscribers.)

QE & the Deficit (excerpt)

To taper QE, or not to taper QE? That is the question. Another question is why haven’t the members of the FOMC considered tying QE tapering to the tapering of the federal deficit? Over the past 12 months through October, the federal deficit has totaled $652 billion, or $54 billion per month on average. That’s down from the $88 billion per month average during December 2012, when the FOMC decided to purchase $45 billion per month in US Treasuries.

Given that the federal deficit has narrowed by about 40% since last December, why not taper Treasury purchases by the same amount to $27 billion per month? That would be a credible, obvious, and easy way to sell tapering. Instead, Fed officials are subjecting us to their tiresome dramatics over an initial tapering that probably won’t be any bigger than $10 billion to $15 billion per month.

It would make sense for the FOMC to taper QE purchases of Treasuries as the federal deficit narrows. However, Fed officials don’t want to admit that QE amounts to monetizing the federal debt. They prefer to say that they are striving to achieve the mandate of full employment and low inflation set for them by Congress.

Today's Morning Briefing: Hamlets. (1) The show must go on and on. (2) Bullard’s performance. (3) QE is a “booster rocket.” (4) No “obvious” bubbles. (5) Negative interest rates might be in fashion this winter. (6) Fathoming the unfathomable QE exit mess. (7) Lots of QE-or-not-QE questions. (8) Why not tie QE tapering to tapering of the federal deficit? (9) Hamlet on earnings and revenues. (More for subscribers.)

Global Oil Demand (excerpt)

The Oil Market Intelligence (OMI) group tracks monthly global oil demand. I track the 12-month moving averages of their data to smooth out the monthly volatility. Total world demand rose to a record 91.1mbd during October. However, that’s up at a rather anemic pace of 1.3% y/y. The OMI data show that demand in the 34 advanced economies of the OECD fell 0.3% y/y last month. The growth rate among non-OECD countries has been slowing since January, from 3.8% to 3.0% during October.

By the way, so far, it’s hard to see any positive impact of Abenomics on Japan’s oil demand, which has been falling for the past nine consecutive months through October. Electric power consumed by large producers rebounded earlier this year, but fell sharply during August and September.

Today's Morning Briefing: Super-Cycle. (1) Super, but short. (2) Gold’s message. (3) Industrial commodity prices not so super since 2011. (4) When emerging economies emerged. (5) The best cure for high commodity prices. (6) Margin squeeze. (7) Glencore vs. Caterpillar. (8) Slow global growth is bullish for stocks. (9) OECD’s downbeat outlook. (10) Europe’s malaise. (11) Not much heat in global oil demand. (12) Focus on underweight-rated S&P 500 Energy. (More for subscribers.)

US Transportation Stocks (excerpt)

It’s good to see that the US economy continues to be an important source of strength for the global economy. Over the past few years, there has been a close correlation between the CRB raw industrials spot price index and the S&P 500 Transportation Index. Since the summer of 2012, the former has been relatively flat, while the latter has gone on to make numerous new record highs during 2013.

I view the commodity index as a sensitive indicator of global economic growth that has been especially sensitive to the pace of growth in China. The Transportation Index tends to be a more US-centric economic indicator. Its bullishness is confirmed by railcar loadings. Total loadings rose to a cyclical high in early November. Intermodal loadings rose to a record high. The ATA Trucking Index also rose to a new record high in September.

Not surprisingly, the forward earnings of the S&P 500 Transportation Index rose to a new record high in mid-November. The same can be said for the forward earnings of the S&P 500 Railroads industry, which accounts for 45% of the market cap of the Transportation Index. The fact that forward earnings is also at a record high for S&P 500 Air Freight & Logistics suggests that the global economy is not as weak as suggested by the flat trend in global exports. Of course, the recent weakness in oil prices is also a bullish development for transportation stocks.

Today's Morning Briefing: Bubble Balderdash. (1) Financial press is bubbling about bubbles. (2) Yellen doesn’t see any. (3) Summers says we need them. (4) Krugman agrees and wants negative deposit rates. (5) A bubble in Keynesians and their flawed models. (6) Summers says beware of Asiaphoria because slowdowns happen. (7) Another big bang in China? (8) Five-step reform program. (9) China MSCI is cheap. (10) Focus on overweight-rated S&P 500 Transportation stocks. (More for subscribers.)

The Bond Bubble (excerpt)

Presumably, among the risks of QE are speculative debt-financed asset bubbles. However, last week, Janet Yellen said, “At this point, I don't see a risk to financial stability, although there are limited signs of a reach for yield.” She said that based on current valuations, stocks aren’t “in territory that suggest bubble-like conditions.”

I see more bubble-like conditions than Janet Yellen does. Her lack of concern may be justified currently, but by expressing it she increases the odds of triggering melt-ups in asset markets, especially if she turns out to be even more dovish than Bernanke, as I expect. Consider the following:

(1) Emerging market debt. The result of the widespread “reach for yield” is that debt sales by emerging markets rose to $439 billion this year through October, within reach of last year’s record of $488 billion. According to the 11/6 FT article on this subject, “record debt sales from the developing world have rebounded after a summer of turmoil and the US budget crisis stunted demand, leading analysts and bankers to predict the second record year of bond issuance in a row.” Tapering chatter during the summer nearly burst the bubble in emerging market debt. Since the 9/18 decision not to taper, more air has been pumped into it.

(2) Corporate bonds. The Fed’s Flow of Funds data show that the outstanding amount of corporate bonds issued by nonfinancial corporations rose to a record $6.1 trillion at the end of Q2-2013. That’s up by a record $625 billion y/y. That may not seem like a bubble since corporations may be using some of the proceeds to reduce their short-term debts, and have lots of liquid assets. However, corporations also are likely to be using some of their bond proceeds to buy back shares, which artificially inflates earnings per share. That’s a bubble-like development if stock prices are getting a significant lift from debt-financed share buybacks rather than actual earnings growth.

Today's Morning Briefing: Party On, Dudes! (1) Yellen and Gatsby. (2) Yellen is in no rush to taper. (3) Benefits outweigh the costs of QE for now, she said. (4) No bubble in stocks, she said. (5) Bull following lead of FOMC’s doves. (6) Record bond issuance as investors reach for yield. (7) Yellen’s first press conference on March 19 should be bullish. (8) Yellen may have to nurse economy from Obamacare disaster. (9) Yellen stocks. (10) “Dallas Buyers Club” (+ +). (More for subscribers.)

A Quick Tour of Global IT (excerpt)

The information technology industry is one of the most competitive in the world. Creative destruction is its modus operandi. Given my interest in the knowledge economy, I am closely tracking the key metrics of the World Information Technology Sector MSCI. The bad news is that forward revenues actually peaked during 2012 and have been gradually declining since then. The cannibalization of PCs by smartphones and Cloud computing can explain the recent weakness in revenues.

The good news is that while sales and margins have been dropping in the PC industry, IT companies with higher margins are doing well, as evidenced by the forward profit margin of the global IT sector. It has actually been rising to new record highs since 2012.

As a result, forward earnings of the global IT sector edged up to a new record high during the first week of November. The forward P/E of the sector is 13.9, matching the valuation multiple of the World MSCI. That’s the cheapest relative valuation of the sector since 1995!

Today's Morning Briefing: Structural Problems. (1) Cyclical or structural? (2) Unconventional is turning conventional. (3) Great for asset holders, not so for job seekers. (4) Drowning in liquidity. (5) Lots of reasons for subpar growth. (6) The downside of the knowledge economy. (7) Brains putting brawn out of work. (8) Record-high spending on knowledge capital. (9) Margins rising for World IT MSCI, and the index is cheap. (10) Euro zone stocks discounting a recovery that may be weaker than expected. (More for subscribers.)

The Return of the Bond Zombies (excerpt)

I think that the 10-year Treasury yield could be in a trading range between 2.5%-3.5% through 2014 and maybe beyond. That’s mostly because I think that inflation is dead, and likely to flat-line around 1% for the foreseeable future. My “Bond Vigilantes” model for the bond yield simply compares it to the y/y growth rate in nominal GDP.

This model shows that since 1953, the yield has fluctuated around the growth of GDP. They both tend to be volatile. As a result, they rarely coincide. When they diverge, the model forces us to explain why this is happening and can reveal important inflection points in the relationship. Here’s a brief history of this relationship:

(1) During the 1950s-1970s, investors consistently underestimated inflation. Bond yields rose during this period, but remained consistently below nominal GDP growth.

(2) That changed during the 1980s when investors belatedly turned much more wary of inflation, just as it was heading downwards. Nevertheless, the yield tended to trade above the growth in nominal GDP. The July 27, 1983 issue of my commentary was titled, “Bond Investors Are The Economy’s Bond Vigilantes.” I concluded: “So if the fiscal and monetary authorities won’t regulate the economy, the bond investors will. The economy will be run by vigilantes in the credit markets.”

(3) During the 1980s and 1990s, there were several episodes where rising bond yields slowed the economy. The heydays of the Bond Vigilantes were during the first term of the Clinton administration, which adopted policies aimed at placating them. Indeed, Clinton political adviser James Carville said at the time that “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

(4) During the previous decade, the Fed kept the federal funds rate too low for too long mostly on fears of deflation. As a result, bond yields remained mostly below nominal GDP growth. Mortgage rates and mortgage lending standards were too low. The result was a huge bubble in housing, which led to the Great Recession.

(5) Over the past five years, the Fed’s response to the anemic recovery following the Great Recession has been to peg the federal funds rate near zero and to purchase bonds. The Bond Vigilantes were buried by the Fed’s ultra-easy policies. However, the Bond Zombies rose from the dead during the spring and summer! The yield rebounded back close to the growth rate of nominal GDP, which was 3.1% during Q3.

Today's Morning Briefing: New Normal Is Bullish. (1) Hit-and-miss ultra-easy monetary policy. (2) Getting back to business. (3) PIMCO’s spin on the new “new normal.” (4) Ambiguous advice. (5) A brief history of the “Bond Vigilantes” model of the bond yield. (6) Bond Zombies. (7) The Fed was horrified. (8) Where is the exit door? (9) Before and after 2008. (10) Signs of life in World-ex US revenues. (11) OECD leading indicators looking good for advanced economies, and not so good for BRICs. (More for subscribers.)

The Fed & Inflation (excerpt)

Fed officials have said that their ultra-easy monetary policy is justified not only by weakness in the labor markets but also by declining consumer price inflation, especially if it gets too close to deflation. They’ve indicated that even if the unemployment rate falls down to 6.5%, they might be in no rush to tighten policy if inflation remains too low.

While Friday’s employment report received lots of attention, the inflation data in the personal income report were mostly overlooked. The personal consumption expenditures deflator excluding food and energy (a.k.a. the “core” PCED) was up only 1.2% y/y during September, which was also well below the core CPI inflation rate of 1.7%. The core PCED inflation rate has been below the Fed’s 2% target since October 2008 for all but four months in early 2012 (when it was around 2%).

While rent inflation has been trending higher since 2010, the inflation rates for hospital fees and physician services have declined significantly. The former is down to 1.5%, the lowest since December 1998, while the latter is down to zero, the lowest since February 2003. Why would the Fed possibly want to see these inflation rates move higher?

Today's Morning Briefing: Inflating Inflation. (1) Taper chatter is back. (2) There are two goals in the dual mandate. (3) Inflation remains below target. (4) Consumer durable goods prices on long decline. (5) Drug prices weighing on nondurable goods inflation rate. (6) Rent inflation is boosting services, while hospitals and doctors are not. (7) Why do central bankers want higher inflation? (8) Friedman’s truism not so true recently. (9) Liquidity is boosting asset inflation, not price inflation. (10) Central banks don’t control real incomes. (11) CPI inflation squeezing wages in Japan. (More for subscribers.)

GDP Continues to Muddle Along (excerpt)

For now, the data show that real GDP on a y/y basis rose only 1.6%, continuing to grow just below the dreaded “stall speed” of 2%, as it has been since the start of the year. However, excluding government spending, it is up to 2.7% from Q1’s 2.1%, suggesting that the private sector may be resuming its relatively steady growth since mid-2010 around 3%.

There was some other encouraging news in the GDP report. While total real capital equipment spending edged down during Q3, industrial equipment spending jumped to a new cyclical high ($195bn saar), R&D spending rose to a new record high ($250bn), and software outlays remained around a record high ($297bn). One more cheery item: Exports rose to a new high, suggesting that the global economy continues to grow and to offer sales opportunities to US companies.

Today's Morning Briefing: Four Shades of Grey. (1) Talking Ed. (2) Three shades of grey scenarios. (3) Latest GDP and employment reports aren’t black and white. (4) Final sales growing slowly. (5) Is Obamacare draining confidence? (6) New highs for R&D and software spending, and exports too. (7) Preliminary payroll data unreliable. (8) YRI Earned Income Proxy at record high. (9) Europe’s recovery is still a slow-go. (10) ECB spooked by deflation. (11) Obamacare is sickening so far, but could be bullish for stocks. (More for subscribers.)

More Upside for Euro Zone’s P/Es? (excerpt)

What’s up in Europe? Forward P/Es are up a lot since the summer of 2011, when there were still widespread fears that the euro zone might disintegrate. Those fears evaporated one year later when ECB President Mario Draghi pledged to do whatever it takes to keep the euro zone intact. The forward P/E for the Europe ex-UK MSCI bottomed at 8.3 during the summer of 2011. It is now up to 13.6, matching the 2009 high.

The rebound in forward P/Es has been widespread among the major stock markets of the euro zone. They are mostly back to 2009 levels prior to when Greece hit late that year and early in 2010. In other words, investors no longer seem to be worrying about a “Grexit” or any other threat to the integrity of Europe’s monetary union. The question is whether there is more upside for the region’s valuation multiples.

I think there might be, but forward earnings, which has been flat-lining since 2011, as I noted yesterday, needs to show some signs of life. That, in turn, requires that European economic indicators show that the region’s economy hasn’t just bottomed, but is actually recovering. The latest batch of these indicators does show a recovery, but a slow-paced one that may already have been discounted by the rebound in valuation multiples.

Today's Morning Briefing: Sentimental Journey. (1) Stampeding bulls. (2) The Bull/Bear Ratio jumps to 3.54. (3) A melt-up signal: Rising BBR and rising stock prices. (4) Q3 earnings season didn’t lower bullish 2014/15 earnings estimates. (5) Next big deal from the Fed: Less QE-Forever, More NZIRP-Forever. (6) Rosengren sees full employment at 5.25% unemployment rate. (7) A Fed model recommends lowering jobless threshold from 6.5% to 5.5%. (8) An idea whose time is coming. (9) Investors no longer worrying about euro disintegration. (10) Is there more upside for euro zone valuations? (More for subscribers.)

China’s Profit Margin May Be Bottoming (excerpt)

Emerging markets, which account for 20% of the World ex US MSCI, have lost their earnings groove. The forward earnings for the EM MSCI rose to a new record high during 2009 through mid-2011. However, it stalled since then and continues to flat-line. As I’ve noted before, the forward earnings of EM MSCI has been highly correlated with the CRB raw industrials spot price index since the mid-1990s. The commodity index has been slowly losing altitude since the start of the year.

China accounts for 4% of the World ex-US MSCI, and 19% of the EM MSCI. The forward earnings of the China MSCI also flattened out around mid-2011, but it’s been edging up into record-high territory this year. Yesterday’s FT included a story titled, “Chinese manufacturers feel squeeze of stronger renminbi.” While that may be so anecdotally, the forward profit margin of the China MSCI actually might have started to bottom late last year.

Today's Morning Briefing: Global Earnings Tour. (1) The earnings “hook.” (2) A recurring pattern. (3) Does 2013 matter anymore? (4) Forward earnings climbing to new record highs almost weekly. (5) US ahead of the pack in world forward earnings derby. (6) Europe’s forward earnings still flat-lining. (7) UK’s is surprisingly weak given strong economic indicators. (8) Japan’s was boosted by Abenomics. (9) Emerging markets' forward earnings aren’t emerging. (10) Industrial commodity prices aren’t helping EMs. (11) China’s forward earnings at record high as profit margin seems to be turning up. (More for subscribers.)

Autos Driving Capital Spending (excerpt)

As I noted yesterday, the US auto industry is leading a global rebound in manufacturing this year. However, sales remain below the previous cycle’s high pace. Yet both new orders and industrial production of motor vehicles and parts were in record-high territory during September.

Undoubtedly, the strength of the auto industry is contributing to the strength in new orders for both industrial machinery and metalworking machinery. The former is near previous cyclical highs, while the latter is in record-high territory.

On the other hand, machinery demand for construction and farming has been relatively weak recently. The same can be said of new orders for mining, oil field, and gas field machinery. All three tend to be very volatile on a monthly basis.

Today's Morning Briefing: Industrious Industrials. (1) Are companies short-sighted? (2) From “TMT” to “MEI” to “CFI.” (3) Capital goods orders stalled at cyclical high, but orders for factory machinery at record highs. (4) New tech revolution led by Cloud, Big Data, and GPS technologies rather than computer hardware. (5) Backlog of orders for civilian aircraft at record high. (6) Industrials are less volatile way to play global growth than Materials & Energy. (7) Yellen and Yale. (More for subscribers.)