Reversion to the Mean (excerpt)

"The end is near" has been the bears' dire prediction since the start of the bull market on March 9, 2009. This year's rally to new record highs suggests that the bears have lost their credibility and that investors are becoming increasingly convinced that the end is actually still far off.

For the past three years, the market's valuation multiple has been held down by fears that a financial meltdown in Europe, a double-dip recession in the US, and a hard landing in China will cause a recession. Yesterday, the forward P/E of the S&P 500 rose to 14.4. That's the highest since April 23, 2010, just before Greece hit the fan and just before the bears became obsessed with their Endgame scenario triggered by growth-crushing woes in Europe, the US, and China.

If the end of the Endgame is far off or if there is no end to the Endgame, then valuation multiples have been too low for the past three years and have room to move higher, which is what they are doing now. From this perspective, the recent valuation-led rally in stocks isn't irrational exuberance. Rather, it is a bullish rejection of the bearish and dreaded prediction of the Endgame prognosticators pontificating that the end is near or even imminent.

The mean of the monthly forward P/E of the S&P 500 since September 1978, when the data start, is 13.7. The recent valuation-led rally may simply be a reversion to the mean, as the P/E has rebounded from 12.1 at the end of last year on November 14 to 14.4 yesterday. The bull market’s trough P/E was actually 10.2 on October 3, 2011. The bull market’s peak P/E was 15.1 on October 14, 2009 before the bears distracted us with their Endgame scenario, which depressed P/Es. Reverting above the mean to 2009’s peak would put the S&P 500 at 1744, up 5.2% from yesterday’s close.

Today's Morning Briefing: MAMU? (1) If it looks like a melt-up, is it? (2) Sit back and relax? (3) It probably isn’t different this time. (4) Valuation multiple could revert back above its mean. (5) Rule of 20 puts P/E at 18. (6) The fundamentals are mixed. (7) But bad news is good news. (8) Going vertical. (9) Fasten your seat belt. (10) The Mother of All Melt-Ups? (11) Greenspan's melt-up. (More for subscribers.)

China (excerpt)

China may be slowing, but it’s still growing. I’m hard-pressed to see any signs of a hard landing in China anytime soon. Real GDP rose 7.7% y/y during Q1-2013, only a bit below the previous quarter’s 7.9% pace. Is that alarming? Not to me. I’m not alarmed by similar marginal declines in the growth rates of other recent economic indicators.

In the first four months of this year, China’s fixed-asset investment rose 20.6% y/y, marginally lower than the 20.9% gain in the first quarter. Still, investment in the property sector jumped 21.1% during the four months, up 0.9 percentage point from that in the first quarter. China’s industrial production rose 9.3% y/y in April, up from March’s 8.9%. Retail sales continue to post double-digit gains, rising 12.8% in April. Chinese oil demand rose to another record high in April.

Today's Morning Briefing: The End Is Far Off. (1) From near to far. (2) Nothing to fear but fear. (3) At 14.3, P/E is back to spring 2010 high. (4) If the end isn’t near, then P/Es have been too low. (5) Irrational exuberance or rational rejection of the Endgame? (6) The last correction was insignificant. (7) Averting the fiscal cliff was bullish. (8) Income shifting last year boosting federal revenues this year. (9) GDP passing the stall speed test. (10) Draghi passed a couple of tests earlier this year. (11) Hard-pressed to see hard landing in China’s numbers. (12) Focus on underweight-rated Energy sector. (More for subscribers.)

S&P 500 Earnings Expectations (excerpt)

Let’s assess the impact of the latest company results on expectations for revenues and earnings for the remaining quarters of the year, as well as annual expectations for this year and next year:

On a weekly basis, I monitor the consensus expectations of industry analysts for quarterly and annual S&P 500 operating earnings. The consensus for Q1 at the start of the earnings season was $25.73 per share. The latest number as of the week of May 9, reflecting all the reported results, is exactly one dollar higher at $26.73. Over this same period, the estimates for Q2, Q3, and Q4 were knocked down $0.79, $0.55, $0.29, respectively, and $1.63 in total.

The 2013 and 2014 estimates fell to new lows of $110.98 and $123.39, with the former up 6.9% y/y and the latter up 11.2% y/y. While these y/y growth rates would be fine, I am troubled to see that forward earnings has been stuck around its record high of $115 for the past nine weeks. This is the measure of earnings that I believe drives the market.

Today's Morning Briefing: Yearning for Earnings. (1) Singing the blues about earnings. (2) Some are reaching for yield, while others are yearning for earnings. (3) Putting a high price on dividend growers. (4) Q1 results depressing estimates for the rest of the year. (5) Stay Home vs. Go Global. (6) Forward earnings stuck at record high in recent weeks. (7) Revenues growth estimates in the low single digits. (8) Analysts still expecting higher margins. (9) Focus on overweight-rated Retailers. (More for subscribers.)

Central Banks Gone Wild (excerpt)

Central bankers claim that they aren’t starting a currency war. They deny that their policies are aimed at the competitive devaluation of their currencies. Let’s call it competitive ultra-easing. Consider the following:

(1) BOJ is going wild. On April 4, Japan’s central bank announced a plan to double the monetary base over two years from 138 trillion yen at the end of 2012 to 270 trillion yen at the end of 2014. (That would be $2.7 trillion at an exchange rate of 100 yen per dollar.) Reserve balances jumped 13.3 trillion yen during April. The yen has plunged from 79.39 on November 13, 2012 to 101.6 on Friday. The Nikkei is up 68.7% over this same period.

(2) China loans are still going strong. On Saturday, Bloomberg reported: “China’s new local-currency loans exceeded estimates last month while money supply expanded at a faster pace, a sign policy makers are maintaining credit support for the economy after first-quarter growth unexpectedly slowed.” Lending was 792.9 billion yuan ($129 billion), and M2 rose 16.1% y/y in April.

Last Thursday’s WSJ included an interesting article about China’s slowing economy, noting: “A sharp fall in factory prices--the 14th straight monthly decline--signals further trouble for a Chinese economy already facing mounting debt and slowing growth, as old-line industries struggle with growing overcapacity. Producer prices…dropped 2.4% in April, the sharpest decline since October, paced by particularly steep falls in the metals and chemicals sectors. That could add to concerns about China's slowdown in growth…because falling producer prices make it tougher for makers of industrial goods and commodities to make profits, pay off their debts and pay their suppliers on time.”

Last week, the People's Bank of China (PBOC) said that it will use various tools to guide “stable and reasonable” growth in money supply and credit. “The negative spillover effects from loose monetary policy in major economies are growing, which has helped pro-cyclical credit expansion at home,” the PBOC said.

Today's Morning Briefing: Managing Exuberance. (1) A leak at the Fed’s favorite leak outlet. (2) The Fed’s exit strategy. (3) How will they know the difference between rational and irrational exuberance? (4) What is prudent risk-taking? (5) The Fed’s Financial Stability Monitoring Program. (6) Big Ben is watching. (7) Competitive devaluation leads to competitive ultra-easing. (8) BOJ starts going wild in April. (9) China’s loans and M2 growing fast as PPI drops fast. (10) Reaching for yield in Rwanda. (11) Another test for the bull. (12) Soaring industries. (13) “The Great Gatsby” (+). (More for subscribers.)

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