How the Fed Depressed the Recovery (excerpt)

In my opinion, the Fed has significantly contributed to the weakness of the current economic expansion as follows:

(1) By keeping interest rates near zero for so long, risk-averse savers have had to accept bupkis for returns on their liquid assets, which rose to a record $10.7 trillion during the week of May 11. Many of them have been saving more, thus spending less. The 12-month sum of personal saving has been running around $700 billion since the end of the financial crisis in 2008, double the pace during the 1990s and the first half of the previous decade.

(2) Ultra-easy money attracted investors rather than nesters into the housing market following the 2008 crisis. They bought up all the cheap homes and drove home prices back up to levels that may be unaffordable for many first-time homebuyers.

(3) As I’ve discussed many times over the past year, thanks to the Fed, corporate bond yields have been trading below the S&P 500’s forward earnings yield since 2004, providing companies with an incentive to buy back their shares and engage in M&A rather than invest in plant and equipment.

Cheap money did stimulate some business investment, but the increased capacity wasn’t matched by more demand, resulting in some deflationary pressures. Stock prices have soared, but this has exacerbated the perception of widespread income and wealth inequality.

Today's Morning Briefing: Tiptoe Through the Soft Patch. (1) Tiny Tim and Janet Yellen. (2) Is the Great Recession over yet? (3) ECI wages get a footnote. (4) Yellen still worrying about underwater homes. (5) Three abating headwinds. (6) Fed sees 2.5% real GDP growth ahead. (7) Yellen is in one-and-done camp. (8) What’s the matter with Kansas? (9) Are the headwinds abating? (10) Here is how the Fed’s policies have depressed consumer and business spending, and housing activity. (11) What’s the matter with the dollar, bonds, and stocks? (More for subscribers.)

Valuation & the Fed Model (excerpt)

Valuation like beauty is in the eye of the beholder. With bond yields at historical lows, why shouldn’t valuation multiples be at historical highs? At 2%, the 10-year Treasury bond yield has an effective forward P/E of 50, implying that stocks trading at a forward earnings yield of 5.9% and a multiple of 17 are grossly undervalued by as much as 62%. Of course, this “Fed Model,” as I first named it back in July 1997, has been showing that stocks are undervalued since the Tech bubble burst. Furthermore, historically low interest rates may be a sign of secular stagnation, which isn’t particularly bullish.

Previously I’ve argued that valuations are being driven by equity purchasers who don’t pay much attention to valuations. They are corporate managers buying back their shares because the forward earnings yields on their shares exceed their borrowing cost of capital in the bond market. As far as they are concerned, beauty is measured by the appreciation of their stock price as they buy back their shares. In this scenario, the source of irrational exuberance is the ultra-cheap money available in the bond market for share buy backs and M&A thanks to the ultra-easy monetary policies of the Fed.

Today's Morning Briefing: Beauty Contest. (1) Episode 42 in The Twilight Zone. (2) Different strokes: Dear Leader vs. King Kong. (3) Some pushback on valuation. (4) Irrational Exuberance Zone. (5) The 3 scenarios again. (6) Channeling the Tech bubble. (7) Record PEG for S&P 500. (8) Smithers & Co. on Tobin’s Q. (9) Does valuation matter? (10) Do interest rates matter? (11) Draghi renews his vows. (12) Front-end loaded QE. (13) Lackluster recovery in Eurozone. (More for subscribers.)

We Are All Bulls Now (excerpt)

Everyone is bullish. Contrarians know that must be bearish. However, everyone has been bullish for a while, yet the S&P 500 rose to a record high of 2117 on April 24. That’s because everyone has finally figured out that fighting the Fed in particular and central banks in general is dumb. So we are all smart now. As a result, bullish sentiment is at a record high, though the bull market, which is more than six years old, is no spring chicken.

I calculated the 52-week moving average of the Investor Intelligence Bull/Bear Ratio. At 3.46 this week, it is the highest in the history of this series, which starts in 1987. The 52-week average of the sum of those who are bullish or expect a correction rose to 84.4%, also a record high. The percentage of bears fell to only 13.9% this week, with the 52-week average down to a record low 15.5%.

If we are all bullish, who is left to buy stocks? A 4/12 FT article reported: “Shareholders in the biggest US companies stand to receive a record $1tn in cash this year, as blue chips’ concerns over the global economic outlook have diverted cash away from investment and is driving a boom in buybacks and dividends.”

Today's Morning Briefing: Cold Cash. (1) Everyone is bullish, but that’s not bearish. (2) We are all smart bulls now. (3) No spring chicken. (4) Has-been Fed Model has been working since 2010. (5) Companies set to return $1tn to investors this year. (6) Fed’s easy money enables buybacks, spinoffs, and M&A. (7) Buybacks = Corporate QE. (8) Fed depending on undependable data. (9) Dollar looking peakish. (10) Money is exiting Greece in fear of Grexit. (11) More upbeat indicators out of Eurozone. (More for subscribers.)

Churning (excerpt)

So far so good. In the 2/2 Morning Briefing, I wrote: “[T]he stock market may continue to trade in a volatile range during the first half of this year. The main negative for stocks is that valuation multiples are historically high, while earnings growth estimates are declining in the face of a strong dollar, weakening commodity prices, a flattening yield curve, and slowing global economic growth. The big positives are that bond yields are at historical lows and the plunge in oil prices is boosting consumer confidence and spending. Joe and I are still targeting 2150 for the S&P 500 by the end of this year and 2300 by the middle of next year.”

Yesterday, Kristen Scholer posted a story on the WSJ website titled “Why Record Highs May be Harder to Come By This Year.” She observed: “The Dow Jones Industrial Average and S&P 500 set 188 fresh all-time highs, or the equivalent of roughly one every five trading sessions, during 2013 and 2014. This year, though, the major indexes have booked only nine historic highs as stocks have moved sideways for much of 2015. … It has been 34 sessions since the S&P 500 last finished at a historic high. That’s the index’s longest streak without an all-time high since the first record of the current bull market in 2013, according to Bespoke Investment Group.”

Why has this been happening? According to the article: “Corporate buybacks, deals and low interest rates have kept equities afloat, while stalled earnings growth, high valuations and slowing economic activity have put a lid on gains.” If that sounds like the same story I’ve been telling, then I should disclose that I was interviewed for the WSJ story and mentioned as follows: “He thinks the tug of war between the bulls and the bears will continue through the summer and into the fall. ‘While some institutional investors might be inclined to sell due to overvaluation, the most significant buyers continue to be corporate managers buying back their shares, and they aren’t nearly as sensitive to valuations,’ he said.”

At the beginning of 2013, in the 1/29 Morning Briefing, which was titled “Nothing to Fear but Nothing to Fear.” I noted: “In recent discussions, some of my professional friends told me they are now worrying that there is nothing to worry about. They note that there may be too many bulls for the good of the bull market.” I also noticed that many of them had “anxiety fatigue.” After the widely feared Fiscal Cliff was averted, investors seemed to be less prone to anxiety attacks. In other words, they were less prone to sell on bearish news, and more likely to hold their stocks and add to their positions on any weakness.

Now they seem to have “bull market fatigue” because valuations are stretched. Nevertheless, they are mostly staying fully invested. Consider the following:

(1) Anxiety fatigue. Since the start of the year, the S&P 500 has been trading between a record high of 2117 on March 2 and a low of 1992 on January 15. There have been lots of panic attacks since 2013, but none that turned into significant corrections. Recent worries that the plunge in the oil price might trigger a rout in the junk bond market haven’t panned out. China’s latest batch of weak economic indicators has been mitigated by the PBOC’s easier monetary policy. The winter/spring economic slowdown in the US increases the odds of a “one-and-done” or “none-and-done” rate hike by the Fed this year.

(2) Moving averages. The S&P 500 has remained above its still-rising 200-day moving average after briefly retesting it in early October last year. The S&P 500 Transportation index is currently back to its 200-dma. That’s a bit of a concern from a Dow Theory perspective, especially since the index’s 50-day moving average has turned down since it peaked on January 22.

(3) Melt-up worries. Interestingly, in recent conversations with our accounts, I am finding that more of them are worrying about missing a melt-up in stock prices than about dodging a correction or a meltdown. What might trigger a melt-up? The obvious answer is a significant postponement of monetary normalization by the Fed. A more likely scenario is that the initial lift-off in interest rates might cause corporations to stampede into the bond market to raise funds for more buy backs and M&A.

Today's Morning Briefing: Paths of Least Resistance. (1) Going nowhere fast. (2) Tug of war. (3) From “anxiety fatigue” to “bull market fatigue.” (4) Still too many bulls. (5) Home on the range. (6) Sector-neutral strategy beating many active managers. (7) Melt-up anxiety. (8) Hard to find anything bullish in crude oil’s demand/supply balance. (9) Maybe it’s geopolitical. (10) Saudis playing for keeps. (11) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Inflation Warning (excerpt)

Last week, the 4/16 WSJ reported: “U.S. wages may be starting to pick up, a development that could help policy makers at the Federal Reserve feel more confident that sluggish U.S. inflation also will gain traction, Fed Vice Chairman Stanley Fischer said Thursday.” He said so on a panel discussion in Washington. That same morning, in a CNBC interview, he said the Fed knows the markets “look ahead somewhat, so I think--I hope--that they are taking into account that the Fed, at some point, is likely to raise the interest rate.” On timing, he said markets “can’t depend on the current situation continuing forever--or even probably--beyond the end of this year.”

He reiterated that “there are more signs every day” of mild wage increases. What is he looking at? Let’s have a look:

(1) Minimum wage. Anecdotally, the minimum wage was raised in 21 states at the start of the year. However, during March, average hourly earnings rose only 2.1% and 1.8% for all workers and for production and nonsupervisory workers.

(2) McDonald’s. On 4/15, fast-food cooks and cashiers demanding a $15 minimum wage walked off the job in 236 cities in what organizers called the largest mobilization of low-wage workers ever. On April 1, McDonald’s announced plans to give employees a 10% pay bump and some extra benefits. The raise will affect about 90,000 workers at a small fraction of McDonald’s stores. Employees at franchises, which make up the majority of the burger chain's locations, won't be affected.

(3) Walmart. At the start of April, Walmart raised its minimum starting wage to $9 an hour, 24% higher than the federal minimum. A 4/10 story on PBS NewsHour noted, “The company says that its wage increases will impact 500,000 workers, but the number who will see their wages rise from the federal minimum of $7.25 to $9 is much smaller. Only 5,000 of its 1.4 million workers actually make the minimum wage. And the minimum in most of the country, 29 states, is already considerably higher than the federal minimum. Seven states and the District of Columbia have minimums of $9 or higher. So the average pay raise for the affected Walmart workers will be far less than the 24% raise for the very small number currently earning the federal minimum.”

(4) Quit rate. The quit rate in retailing tends to be relatively high, especially among low-paid workers. Retailers are raising their wages to reduce their labor turnover costs.

(5) Q1 wages and prices. Average hourly earnings for all workers rose 3.9% (saar) during the first three months of the year, the highest since December 2008. That’s the kind of y/y increase that Fed officials have said would allow them to normalize monetary policy sooner and at a faster clip.

In addition, the core CPI inflation rate edged back up to 1.8% during March, closer to the Fed’s 2% target--which is really for the core PCED, which was 1.4% during February. The three-month annualized change in the core CPI through March was 2.3%, suggesting that the core PCED, which was 0.9% through February, might show a higher increase when March data are released on Thursday, April 30.

Today's Morning Briefing: The Twilight Zone. (1) Valuations on the border of the Irrational Zone. (2) Three fears hit market: Greek exit, China bubble, and inflation uptick. (3) Recapping stretched valuations. (4) Institutional investors remain skeptical. (5) Outperforming SMidCaps less exposed to dollar. (6) Shortage of bargains. (7) Buybacks = Corporate QE. (8) Corporate execs comparing earnings yield to borrowing rate when buying back shares. (9) Warning: Inflation may be warming. (More for subscribers.)