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.)