Buffett’s Ratio Is Bearish (excerpt)

Warren Buffett’s favorite valuation model is screaming that stocks are overvalued. It was discussed in a 7/20 Business Insider article titled “Warren Buffett’s ‘single best measure’ of stock market value falls short in 3 big ways.” The article was based on a note to clients on Monday from Bank of America Merrill Lynch’s Savita Subramanian. She wrote that Warren Buffett’s favorite metric of long-term value “may have limited utility.” The market-cap-to-GDP ratio, which he once characterized as the “single best measure” of value, is used to determine whether the stock market is overvalued or undervalued. Here are the three shortcomings of the Buffett ratio according to BAML and my thoughts:

(1) Like price-to-sales ratios, the Buffett ratio doesn’t adjust for structural changes in profit margins due to lower taxes, lower interest expense, and higher operating margins attributable to technological innovation.

Maybe so, but that assumes that these changes are indeed permanent. They may be, but that is quite debatable. The implication that the profit margin may remain structurally high is a radical idea given that it has been a highly cyclical variable since the beginning of recorded time, i.e., since 1947. There are lots of reversion-to-the-mean believers who would vociferously dissent from the view that margins may remain higher than in the past.

(2) On average, more than half of S&P 500 revenues come from overseas. So comparing the index’s market cap to domestic GDP is flawed. It would be more accurate to measure it relative to a global measure of GDP.

I calculate the Buffett ratio dividing total US equity market capitalization excluding foreign issues by nominal GDP. Interestingly, it is almost identical to the market cap of the S&P 500 divided by the index’s revenues, which includes both domestic and overseas revenues. Both are near their peaks during 2000, suggesting that stocks are indeed extremely overvalued.

(3) The market cap of the S&P 500 has a much different industry mix than GDP. So the ratio is comparing apples and oranges.

I don’t disagree. However, I long ago concluded that every valuation model has flaws. That’s why I try to track them all. I see are lots of valuation measures that look quite stretched to me. But then again, valuation, like beauty, is in the eye of the beholder.

Today's Morning Briefing: Challenges for Earnings. (1) The dollar and oil price could weigh on earnings again. (2) Industrial commodity prices may also be signaling trouble for earnings. (3) The Boom-Bust Barometer may be running out of boom. (4) Will rebound in forward earnings move forward? (5) Are Gordon-type models really bullish for valuation? (6) The Buffett ratio is bearish, and it is flawed according to top Wall Street strategist. (7) Most valuation models are flawed for one reason or another. (8) Valuation is subjective. (More for subscribers.)

Will the “Silk Road” Boost Commodity Prices? (excerpt)

The crowd has been fleeing commodities since last year and continues to do so. My contrarian instincts are on full alert. However, I’m hard pressed to make the case for a sufficient pickup in global economic growth to advise going against the crowd.

China’s “Silk Road” project is a possible global growth booster. Yale Professor Valerie Hansen, who wrote a 2012 book titled The Silk Road: A New History, discusses the implications of this project in a 7/17 The Indian Express article titled “What the Silk Road means today.” She wrote: “The Silk Road initiative announced by Chinese President Xi Jinping in 2013 and implemented, beginning this year, contemplates so vast an investment in highways, ports and railways that it will transform the ancient Silk Road into a ribbon of gold for the surrounding countries. Officially called ‘The Silk Road Economic Belt and the 21st Century Maritime Silk Road’, the project also has the shorter title, ‘One Belt, One Road.’”

The professor concludes with a warning: “When the Chinese proclaim the One Belt, One Road as a win-win policy, more careful analysts will see this as yet another attempt to increase Chinese influence around the world. The Silk Road initiative is aptly named. Just as China used the Silk Road to expand its sphere of influence in the past, it is doing exactly the same thing now.”

The question is: How will this ambitious project get financed? The recent stock market rout must be a setback since the Chinese government was certainly counting on the equity capital markets for funding. That helps to explain why Chinese authorities have been scrambling to end the rout and restore the bull market.

Chinese officials are obviously counting on kicking their can down the Silk Road. They desperately need a new source of growth to replace their export-led model. They hope that by building more infrastructure along the road, they’ll reduce the excess capacity of all the infrastructure they built at home. While we are waiting to see how it all plays out, commodity prices continue to signal that there remain lots of gluts.

The ratio of the S&P 500 Materials sector to the S&P 500 is down to the lowest reading since November 9, 2005. It is highly correlated with the CRB raw industrials spot price index, which is also falling and is now down to its lowest level since November 12, 2009. The CRB index is inversely correlated with the trade-weighted dollar, which is up 16% since July 1, 2014.

Today's Morning Briefing: Reaching for Growth (RFG). (1) Reaching for yield vs. growth. (2) The most hated asset class is due for a bounce at least. (3) Investment strategist Yellen was right about RFY, wrong about RFG. (4) Reversal of fortune for Utilities, and bonds. (5) The growth-is-scarce scare. (6) No shortage of commodity gluts. (7) China aiming to kick some big cans down Silk Road. (8) Strengthening dollar once again depressing commodity prices. (9) Is gold just another commodity, or a pet rock? (10) Did Opie ever really kick the can down the road? (11) Focus on market-weight-rated S&P 500 Energy industries. (More for subscribers.)

Another Weak Revenues Season (excerpt)

According to Standard & Poor's, S&P 500 revenues fell 2.3% y/y during Q1 mostly as a result of the plunge in the revenues of the Energy Sector, and also the strength of the dollar. On a same company basis for both periods, we calculate that S&P 500 revenues fell 3.0% y/y during Q1, but rose 2.4% excluding the Energy sector.  A similar pattern is likely for Q2. Industry analysts currently estimate a 4.0% decline in revenues during the quarter, but a small gain of 1.5% excluding Energy.

The y/y growth rate in S&P 500 revenues tends to be highly correlated with the comparable growth rate in manufacturing and trade sales. The latter was down 2.2% in May, but up 1.9% excluding petroleum.

Industry analysts are currently estimating the following revenues growth rates for Q2 on a y/y basis, from high to low: Health Care (6.1%), Telecommunication Services (2.8), Information Technology (2.6), Financials (2.5), Consumer Staples (2.4), Consumer Discretionary (2.0), Utilities (0.0), Industrials (-3.9), S&P 500 (-4.0), Materials (-8.8), and Energy (-34.8).

Today's Morning Briefing: United Shoppers of America (USA!) (1) USA women rule soccer! (2) A patriotic happening. (3) Crowd chants “USA! USA! USA!” (4) Soccer unites, politics divides. (5) The standard of living and income inequality debate. (6) Flawed income measures used to gauge inequality and poverty. (7) Key items missing. (8) What about the Earned Income Tax Credit? (9) What about government support programs? (10) Real consumer spending per household at record high. (11) Consumer stocks confirm strength of consumer. (12) Another weak earnings season for revenues, led by plunge in Energy. (13) The Greek deal is to make a deal. (14) Tsipras as Sisyphus. (15) Focus on market-weight-rated S&P 500 Retail industries. (More for subscribers.)

China’s Bubble Pops (excerpt)

The Chinese may have set a record for inflating a huge stock market bubble in the shortest period of time. It started last year on November 21, when the PBOC cut interest rates for the first time in two years. It did so to revive economic growth. Instead, investors and speculators piled into the stock market. At the beginning of February, the PBOC lowered bank reserve requirements. Effective March 2, the PBOC cut interest rates for the second time in three months. On March 5, the PBOC lowered the rates it charges commercial lenders on a special short-term lending tool.

The Shanghai-Shenzhen 300 stock price index soared 107% from November 21 through this year’s peak on June 8. It has plunged 32% since then. Even the less volatile China MSCI stock price index (in yuan) jumped 35% from November 21 through April 27. It has plunged 21% since then, retracing most of the rally. In the past, this index was highly correlated with the price of copper, which failed to confirm the recent ascent in Chinese stock prices. Instead, the nearby futures price of copper remained near its lowest reading since July 2009.

The latest moves by Chinese officials to prop up stock prices certainly won’t revive confidence in China’s stock market. Why would anyone want to invest in a market where the government can ban selling?

Yesterday, Bloomberg reported: “China’s securities regulator banned major shareholders, corporate executives and directors from selling stakes in listed companies for six months, its latest effort to stop the nation’s $3.5 trillion stock-market rout. Investors with stakes exceeding 5 percent must maintain their positions, the China Securities Regulatory Commission said in a statement. The rule is intended to guard capital-market stability amid an ‘unreasonable plunge’ in share prices, the CSRC said.”

Regulators have introduced market-boosting measures almost every night over the past several days, as the following selected timeline shows:

6/25: PBOC injects cash into the financial markets.
6/27: PBOC cuts interest rates and lets banks lend more money.
7/1: Investors allowed to put up real assets as collateral to buy stocks.
7/2: Stock manipulation will be investigated.
7/4: IPOs suspended.
7/4: People’s Daily urged investors to stay calm.
7/4: Twenty-one brokerage firms will invest $19 billion in a stock market fund.
7/7: Trading suspended in more than 1,300 companies.
7/8: State-run companies ordered to maintain holdings in listed units.

The stock market meltdown and the inept official attempts to stop the rout could weaken confidence in the government’s ability to manage the economy, which has been slowing significantly. A slew of June data will be released in the next few days. May’s indicators were uniformly weak. For example, electricity output over the past 12 months through May was up just 3.5% y/y, the slowest pace since October 2009.

Today's Morning Briefing: The Confidence Game. (1) The first and second mandates. (2) The third mandate. (3) The credibility challenge. (4) Chinese set a record in the history of bubbles. (5) Roundtrip. (6) Banning selling is a dumb desperate measure. (7) Market-boosting measures failing to boost market. (8) Draghi running out of W-I-T. (9) Japanese exports are weak. (10) Fed needs to reload its gun. (11) “Stay Home” outperforming “Go Global.” (More for subscribers.)

Global Oil Supply Rising Faster Than Demand (excerpt)

Global oil demand rose to a new record high of 93.8 mbd based on the 12-month average through May. It’s been doing so since it recovered from the Great Recession ever since June 2010. It has been rising at a faster pace in recent months. It rose 1.2% y/y in May, up from a recent low of 0.6% during November 2014.

Does this suggest that global economic growth is picking up? I doubt it. More likely is that the drop in oil prices is boosting demand. That’s the way the price mechanism is supposed to work. While the upturn in demand has helped oil prices to rebound from their lows at the start of the year, there’s plenty of supply keeping a lid on them despite the fall in prices. Indeed, the ratio of demand-to-supply continued to fall in May as it has virtually every month since August 2013. I expect that the price of a barrel of crude will remain range bound between $46 and $68 (the year’s low and high in the nearby futures price) through the end of this year.

This suggests that the S&P 500 Energy sector isn’t likely to outperform the S&P 500. It might be a market performer at best. The sector isn’t cheap with a forward P/E of 24.7, although its forward earnings has stopped falling in recent weeks.

Today's Morning Briefing: Leading Sectors. (1) Three outperforming sectors: Health Care, Consumer Discretionary, and IT. (2) They aren’t cheap, but they can grow earnings. (3) Overall outlook for revenues and earnings growth is lackluster. (4) Industry analysts tend to be overly bullish about prospects for long-term growth. (5) Is the trend growth rate 10%, 7%, or 5%? (6) Investors are also optimistic given record-high PEG. (7) More upside for profit margins of some sectors. (8) Financial engineering can also boost earnings per share. (9) Why Goldman hates buybacks. (10) Lower prices boosting oil demand, but supply increasing faster. (11) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Here Comes Another Earnings Season (excerpt)

S&P 500 earnings rose 1.4% y/y during Q1. That’s not much, but industry analysts expected a drop of 4.0% at the start of that quarter’s earnings season. Among the sectors, the big loser was Energy. Excluding it, earnings rose impressively by 11.2% y/y. Here is the rundown of Q1’s earnings performance derby from best to worst: Financials (19.6%), Health Care (19.4), Information Technology (10.3), Consumer Discretionary (8.1), Industrials (5.5), Consumer Staples (4.0), Utilities (2.4), Materials (2.0), Telecommunication Services (1.8), and Energy (-59.7).

Q2 might also show underlying strength. Industry analysts are currently estimating that S&P 500 earnings will be down 4.5% y/y during the quarter. The latest analysts’ earnings consensus performance derby for the sectors is as follows: Financials (14.7%), Consumer Discretionary (7.1), Telecom (5.6), Health Care (4.1), Tech (3.0), Materials (1.2), Utilities (0.9), Industrials (-0.3), Consumer Staples (-2.9), and Energy (-63.8). Excluding Energy, the consensus currently anticipates a 4.8% gain in Q2 results.

Given that the price of oil crashed during the second half of last year, Energy earnings may continue to weigh on aggregate earnings during Q3, but have a diminishing impact from Q4 into next year. That’s assuming the price of oil won’t be dropping again anytime soon, as I do. That might be a bad assumption if the sanctions on Iran’s oil exports are lifted. I am also assuming that the trade-weighted dollar isn’t going much higher. That might be a bad assumption if Greece exits the Eurozone, which I am not expecting.

Today's Morning Briefing: Zigzag. (1) Another earnings season is around the corner. (2) Why do industry analysts cut their estimates? (3) We count 58 “earnings hooks” over the past 85 quarters. (4) The longest streak is the current one. (5) Will Q2 be as surprisingly strong as Q1, excluding Energy? (6) Joe slices and dices earnings. (7) With P/Es stretched, earnings matter more. (8) Health Care leads the pack. (9) US consumer indicators are mostly upbeat, while business indicators are mixed. (10) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

Eurozone Stocks Hit Air Pocket (excerpt)

This may very well be the week for a deal, or for no deal. The question is who will blink first in this dangerous game of chicken between Greece and its creditors. Global stock investors started to blink on April 13, when the EMU MSCI (in euros) hit the year’s high with a gain of 22.9% ytd. On Monday, it was down 9.4% from that peak and still up 11.3% ytd. So it continues to outperform the US, UK, and EM MSCIs. Interestingly, the latest selloff in the EMU MSCI has been remarkably widespread among the 10 sectors comprising the index.

The good news is that the forward earnings of the EMU MSCI has been recovering nicely over the 14 weeks through June 4. In addition, the region’s Net Earnings Revisions Index jumped to 4.0% during May, the highest since September 2010. Obviously, industry analysts either aren’t counting on a Grexit, or don’t expect it will matter much to their companies. The index remains relatively cheap, with the forward P/E at 15.1.

While numerous economic indicators show that the Eurozone’s economy is on an upswing, it’s a very anemic one based on the region’s measures of industrial production. Here is the y/y performance derby for the region and its four biggest economies: Spain (2.2%), Germany (1.3), Italy (0.1), and France (-0.1). That’s not much to get excited about. It’s not much better in some of the other European economies: Sweden (1.5), UK (1.2), and the Netherlands (-4.2).

Yesterday, one of our accounts asked me if Europe’s economy is strong enough to absorb the shock of a Grexit. I think so, but I wouldn’t bet the ranch on it. Keep in mind that the Eurozone’s recovery is weak despite the fact that the following six cylinders have all been firing: near-zero interest rates, QE, a weak euro, rising bank lending, soaring stock prices, and lower oil prices.

Today's Morning Briefing: Dead Reckoning.(1) Deduced reckoning. (2) Are investors in the same boat with Nicole Kidman? (3) Is the Greek play a tragedy or comedy? (4) In praise of kicking the can down the road. (5) Angela vs. Wolfgang. (6) Earnings finally recovering in Eurozone. (7) No wind in the sails of commodity, currency, and S&P 500 traders. (8) Eurozone’s economic recovery remains uninspiring. (9) China’s economy continues to struggle with excess capacity and PPI deflation. (10) Focus on market-weight-rated S&P 500 IT industries. (More for subscribers.)

Varieties of Valuation (excerpt)

In my ongoing research on valuation, I constructed a quarterly P/E series for the S&P 500 based on reported earnings from Q4-1935 through Q3-1988, and operating earnings since then. Its average is exactly 15.0. It was 18.5 during Q1-2015. It has been this high before and sometimes gone higher. A reversion-to-the-mean valuation model is bearish based on this measure of the P/E since it is currently higher than its mean.

Over 30 years ago, Jim Moltz, my mentor at CJ Lawrence during the 1990s, devised the Rule of 20. It states that for equities to be fairly valued, the P/E ratio plus the inflation rate has to be around 20. In April, the CPI inflation rate was minus 0.2% y/y, implying that the fair-value P/E should be 20.2, well above the trailing P/E. On the other hand, the core CPI was up 1.8% y/y, suggesting that 18.2 is the right valuation number.

Greg Donaldson, the chief investment officer of Donaldson Capital Management and a subscriber and friend of Yardeni Research, offers an interesting inflation-based analysis of the P/E in a 5/16 Seeking Alpha article titled “The Great P/E Debate: Are Stocks Overvalued?” Greg writes: “We do not find strong relationships between any of the widely followed indicators such as interest rates, GDP growth or earnings growth. We have found that inflation is the best predictor of P/E ratios at any given point in time.” He ran a regression of inflation (using the core PCED) on the earnings yield (E/P). He used it to calculate that the current P/E should be about 21 based on his model.

In addition to tracking the trailing P/E, I also monitor market-capitalization-to-sales and price-to-sales ratios. During Q1, the Fed’s Financial Accounts showed that the ratio of the market capitalization of all equities traded in the US (excluding foreign issues) to nominal GDP rose to 1.69, the highest since Q3-2000. The comparable ratio for the S&P 500 rose to 1.87 during Q1, also the highest since Q3-2000. The ratio of the S&P 500 to its forward revenues per share rose to a cyclical high of 1.82 in early June. Stocks are seriously overvalued according to these measures.

Today's Morning Briefing: Slice & Dice. (1) The valuation question again. (2) Waiting for the answer while stocks meander. (3) Earnings-led target of 2300 for the S&P 500 next year. (4) Reversion-to-the-mean model is bearish. (5) A 20 P/E isn’t irrational according to inflation models. (6) Fed model says either stocks are too cheap or bonds are too expensive. (7) Does revenues growth matter to valuation? (8) Price-to-sales models are bearish. (9) Retail sales data suggest soft patch is over. (10) Our in-house Gen Xer slices and dices generational demographics from A to Z. (11) “Love & Mercy” (+ + +). (More for subscribers.)

The Trend in Profits (excerpt)

The growth trend of corporate profits is determined by the growth trend of nominal GDP. My analysis shows that the trend of these variables has been 7% since 1960. Profits growth is much weaker during recessions and much faster during recoveries, but 7% has been the magic number for the trend. That seems to be the best we can expect in the coming years until the next recession. Given that valuation multiples are at their historical highs, 7% may also be the best we can expect in terms of annual capital gains in the stock market for the duration of the current bull market. That’s quite good compared to the bond yield and the inflation rate, which are both historically low.

On a cyclical basis, there is a strong correlation between the y/y growth rates of nominal GDP and S&P 500 revenues in aggregate. The correlation is even better with nominal GDP for goods. The two series do diverge often on a short-term basis, but have the same cyclical pattern. During Q1, revenues fell 2.5% y/y, while nominal GDP with and without services rose 3.6%. The recent plunge in oil prices had a bigger impact on S&P 500 revenues than on nominal GDP.

Over the past four and a half years, nominal GDP has been growing just under 5%, so it’s possible that this may be the new magic number for the trend growth in GDP, and therefore in profits. While there has been some recent chatter about the depressing impact of seasonal adjustment factors on Q1 real GDP, that distortion is eliminated simply by tracking the y/y growth rate, which has been relatively stable around 2.5% since mid-2010. In fact, while real GDP fell 0.7% (saar) during Q1, it was up 2.7% y/y! Meanwhile, inflation continues to decelerate in the GDP accounts. The GDP price deflator was up just 0.9% y/y during Q1, with the core rate also low at 1.1%. Again, put these trends together, and nominal GDP is growing below 5% rather than close to 7%.

Today's Morning Briefing: Probing Profits. (1) Profits measures: Take your pick. (2) We pick forward earnings. (3) Is the 7% trend still our friend for profits growth, or might it be 5%? (4) How much longer can profit margins break records? (5) Cash flow stalled at record high. (6) The government should fill potholes. (7) Assessing the soft patch in the oil patch. (8) Regional surveys add up to weak May. (9) Frightful freight index. (10) Signs of life in Eurozone’s corporate earnings. (More for subscribers.)

Central Banks Restore Wealth, Working on Growth (excerpt)

The major central banks of the world have been easing their monetary policies significantly since the financial crisis of 2008. They’ve succeeded in averting another financial crisis so far. They’ve also succeeded in recovering most of the fortunes that were lost during the crisis. For example, the total market value of all stocks traded in the US rose $22.7 trillion since Q1-2009 through the end of last year to $36.5 trillion. The S&P 500’s capitalization has increased $12.9 trillion during the bull market so far through last week. Both are at record highs, with the S&P 500 exceeding its 2007 peak by $5.0 trillion. All equity investors have benefited from the stock market rally.

Bond investors also enjoyed big gains as yields fell and prices rose. For example, US bond mutual funds had capital gains totaling $522 billion since the start of 2009. As we noted yesterday, the 12-month average of the median existing home price is up 29% since February 2012, while real estate held by households has increased by $4.2 trillion since then through the end of last year. Gold has also been golden, with a 118% rise in the price since the start of 2009 to its record high on September 6, 2011. It’s down 36% since then, but that’s hardly a sunken treasure for anyone who bought gold a few years ago.

Nevertheless, the central banks have been frustrated by the slow pace of the recoveries in their economies since the crisis of 2008. Reviving self-sustaining economic growth hasn’t been as easy as easing has been. Previously, I’ve argued that the ultra-easy monetary policies of the central banks might perversely have contributed to the slow pace of economic growth.

Today's Morning Briefing: Easy Come, Easy Go. (1) Elvis Presley and Janet Yellen. (2) Sunken treasures recovered. (3) Why easing hasn’t worked as expected. (4) Stock gains aren’t trickling down. (5) Savers earning less so saving more. (6) Fed has enabled fiscal excesses at cut-rate rates. (7) Near-zero interest rates contributing to income inequality. (8) Fed policies causing capital misallocation. (9) Enabling financial engineering. (10) The blame game. (11) Demography is also a downer. (12) Focus on market-weight-rated S&P 500 Industrials. (More for subscribers.)

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.)

Reenergized Earnings? (excerpt)

If oil prices have bottomed and the dollar has peaked, then forward earnings should be moving forward again. Until recently, the S&P 500 forward earnings was tracking 7% annualized growth, the historical trend for this series.

If so, then forward earnings is currently predicting that the four-quarter trailing average of S&P 500 earnings, which was $119.20 per share during Q1, will rise to around $125 early next year. I am forecasting $130 for all of 2016, up from $120 this year.

Of course, this optimistic outlook requires that the economy finds some traction to get out of its current soft patch with both business sales and industrial production rebounding from their recent dips and moving to new highs again.

Today's Morning Briefing: Reenergized Earnings? (1) From “peak oil” to “cheap oil” to bad oil data. (2) Will the real Phil please stand up? (3) What are oil inventories doing? (4) EIA gets authority to require oil drillers to fill out a monthly supply survey. (5) Fewer railcar loadings of oil. (6) Lots in storage still. (7) World oil demand/supply ratio remains bearish. (8) Oil earnings may have stopped weighing on S&P 500. (9) Profit margins rebounding from recent dip. (10) Brighter outlook for earnings depends on soft patch as well as oil patch. (11) Focus on market-weight-rated S&P 500 Energy industries. (More for subscribers.)

US Housing: Breaking Ground? (excerpt)

Many years ago, before China emerged, the price of copper was driven mostly by demand from the US housing industry. Could it be that US housing starts are taking off, which is why copper is firming? Let’s review some of the related indicators:

(1) Employment. Residential construction payrolls rose 23,600 during April. That was the best monthly increase since the start of the current housing expansion. However, that followed a decline of 1,800 during March, the first decrease since May 2012. Then again, total residential construction employment rose to 2.45 million, the highest since January 2009.

(2) Railcar loadings. On the other hand, railcar loadings of lumber and wood products are consistent with the current subdued pace of housing starts.

(3) Lumber prices. While both are volatile, there is a decent correlation between the nearby futures price of lumber and the S&P 500 Homebuilding stock price index. I have found that an average of the two is highly correlated with housing starts. The average is down 14.4% ytd.

Today's Morning Briefing: Breaking Bad? (1) China’s stock market turns volatile as P/Es surge. (2) The “insanity” trade in China. (3) PBOC warns about too much debt as it cuts interest rates. (4) China suffering from too much capacity, too much debt, too much deflation, too much pollution, and too many seniors. (5) Professor Copper is bullish on China and bearish on bonds. (6) Is housing turning up or down? (7) Payrolls say “up,” while lumber futures say “down.” (8) Brexit and Grexit? (More for subscribers.)

Analysts Continue to Lower S&P 500 Earnings (excerpt)

Although the dollar might have peaked on March 13 for a while, and the price of crude oil might have bottomed on January 13 for a while, industry analysts who cover the S&P 500 are still lowering their earnings estimates for both 2015 and 2016. They now expect $119.02 and $134.18 per share for this year and next year, down 5.9% and 5.2% from their estimates at the end of last year. For this year, they’ve been lowering their Q2-Q4 estimates as earnings have beaten expectations during Q1 with a 4.7% “hook-up” move so far over the past two weeks, which is typical during earnings seasons.

It’s getting harder to find much if any GAARP (growth at a reasonable price) in the US given the latest lofty valuation ranking for the S&P 500 sectors: Energy (28.8 vs. 14.2 year ago), Consumer Staples (19.7, 17.4), Consumer Discretionary (19.0, 17.4), Health Care (17.8, 16.2), Materials (17.2, 16.7), S&P 500 (17.2, 15.3), Utilities (16.4, 16.1), IT (16.2, 14.4), Industrials (16.2, 16.3), Financials (13.9, 13.5), and Telecom Services (13.4, 13.1).

Today's Morning Briefing: The World According to GAARP. (1) John Irving’s terminal cases. (2) Desperately seeking growth at a reasonable price. (3) Is looking for GAARP like waiting for Godot? (4) Global synchronized secular stagnation. (5) Industry analysts aren’t exuberant about outlook for revenues and earnings. (6) Secular stagnation rather than boom or bust. (7) Valuations aren’t cheap, but could go higher in a liquidity-driven melt-up. (8) Hard to find much GAARP in US. (9) Global M-PMIs uninspiring. (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.)

S&P 500 Forward Earnings Driving Economic Slowdown (excerpt)

There are lots of correlations between S&P 500 forward earnings and several key economic indicators. The former dropped sharply late last year and early this year as Energy industry analysts slashed their earnings estimates for this year and next year.

While the plunge in oil prices accounts for much of the weakness in forward earnings since last fall, the soaring dollar has also weighed on earnings. Corporate profits tend to be the key driver of employment and capital spending. Profitable companies tend to expand their payrolls and capacity. Unprofitable companies don’t do so.

This explains why there is such a good correlation between the y/y growth rates of forward earnings and aggregate weekly hours. Forward earnings is also highly correlated with total factory orders as well as nondefense capital goods orders excluding aircraft. The weakness in forward earnings confirms that the slowdown in US economic growth so far this year wasn’t attributable just to the icy winter. Spring’s economic indicators remain disappointing so far.

The profits picture should brighten a bit if the dollar has peaked and oil prices have bottomed. The US economic outlook should also brighten in this scenario. However, don’t expect a boom.

Today's Morning Briefing: Forward Thinking. (1) Six degrees of separation. (2) LinkedIn and the kindness of strangers. (3) Correlations and divergences. (4) Industrial commodity prices aren’t confirming oil rally. (5) The oil price might have bottomed and peaked. (6) The dollar might have peaked. (7) Don’t buy into A$, C$, and gold rallies. (8) Expected inflation rebounding. (9) Forward earnings flagging, and so is economy. (10) Profitable companies expand. Unprofitable ones don’t. (11) Neither boom nor bust. (12) Focus on now underweight-rated S&P 500 housing-related industries. (More for subscribers.)

From Ice Patch to Soft Patch (excerpt)

The performance of the US stock market is quite impressive considering that there isn’t much of a spring in the latest batch of economic indicators. The winter’s ice patch is looking more and more like the spring’s soft patch--all the more reason to expect either one-and-done or none-and-done from the Fed. Consider the following:

(1) Business surveys. Three of the six regional business surveys that I track are available through April. The averages of their composite indexes tend to be highly correlated with the national M-PMI. The average for the FRB districts of Kansas City, New York, and Philadelphia fell to -0.2 this month from 2.6 last month and a recent peak of 18.8 during November of last year. It’s the lowest since May 2013.

The average of the three new orders indexes was -5.8 this month, about the same as last month’s -6.2, which was the lowest since October 2012. The employment index fell to 1.0, the lowest since November 2013.

(2) Flash M-PMI. The national flash M-PMI compiled by Markit fell from 55.7 in March to 54.2 this month. The ISM’s M-PMI was much weaker than Markit’s reading in March. The same is likely this month given the weakness of the available regional surveys so far.

(3) Durable goods orders. The weakness in the regional orders indexes was confirmed by Friday’s release of March durable goods orders. While the overall number rose 4.0% m/m, boosted by a surge in aircraft orders, nondefense capital goods orders excluding aircraft fell for the seventh consecutive month through March, by a total of 6.7%. Orders have been especially weak for primary metals, fabricated metal products, machinery, and electrical equipment, appliances, and components. That probably reflects the combined depressing impact of lower oil prices on the energy industry and the higher dollar on exports.

(4) Lumber prices. In recent days, I’ve noted the plunge in lumber prices since the beginning of the year through Wednesday. That’s not a good omen for housing starts or the S&P 500 Homebuilding Index. Neither is the flat trend in railcar loadings of lumber and wood products over the past year. New home sales fell 11.4% m/m during March.

Today's Morning Briefing: Conspiracy Theories. (1) Compelling narratives without any proof. (2) The central bankers are doing it in broad daylight. (3) Bonds and stocks achieve “escape velocity,” while economies don’t. (4) Connecting the dots in Chicago. (5) Fed’s bunker in Chicago. (6) Bernanke’s new job in Chicago. (7) Spoofing the CME in Chicago. (8) Crash Boys: Michael Lewis has some questions for CME & CFTC. (9) Meet Sarao and Aleyniko. (10) Goldman’s sinister algorithm. (11) The stock market is high on life. (12) More soft-patch indicators in the US. (13) Flash-fried PMIs. (14) “House of Clinton” (+ + +). (More for subscribers.)

Industrial Commodities Still Sinking (excerpt)

There’s no party in the commodity pits. While the price of a barrel of crude oil has rebounded smartly from a low of $46.59 on January 13 to $62.84 yesterday, the CRB raw industrials spot price index continues to slip and slide. In the past, the weakness in the CRB index would have been a bearish omen for stock prices. It still might be, but the monetary liquidity that isn’t boosting global economic growth and commodity prices is fueling bull markets in stocks and bonds. Consider the following:

(1) From 2005 through mid-2011, there was a reasonably good correlation between the S&P 500 and the CRB index. The two have diverged since then, with the S&P 500 heading higher to new record highs, while the commodity index has been trending lower and is now at the lowest since February 8, 2010.

(2) Since late 2001, there has been a very good correlation between the Emerging Markets MSCI stock price index (in local currencies) and the CRB index. The two have diverged significantly over the past year, with the former only 2.6% below its 2007 record high. Leading the way since early 2014 has been India in anticipation of a new reform-minded government headed by Prime Minister Narendra Modi, whose party won election last May.

Since mid-November of last year, when the PBOC started to ease monetary policy, the China MSCI stock price index has also joined the global melt-up parade. It had been very highly correlated with the price of copper since 2009. They too have diverged over the past year. This is yet another sign that ultra-easy monetary policy is boosting asset inflation rather than real growth and price inflation.

Today's Morning Briefing: Go Away or Go Global? (1) Nice melt-up overseas. (2) Days of Infamy: May Day to Halloween. (3) Two wicked corrections. (4) Three choices: Stay Home, Go Global, or Go Away. (5) Sunrise in Japan? (6) Can central banks overcome secular stagnation? (7) Not much fun in the commodity pits. (8) Unusual divergence between stock prices and commodity prices. (9) Lumber trading like lead. (10) China’s international reserves depressed by depreciations of euro and yen. (11) China’s capital outflows story still rings true. (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.)