Tag Archives: economy

Jim Paulsen’s latest on US stocks in 2015

January 16, 2015 By in Shaping a portfolio for 2015, Strategy Tags: , , , , , , , Leave a comment

Although I don’t think I’ve ever met Jim Paulsen, I like his work.  He’s fundamentally sound, with an optimistic bias–kind of the way I’d hope others would describe me.

As I read his most recent Economic and Market Perspective release, he’s trying awfully hard to be bullish   …but can’t find enough facts that will support a bullish position.

The basic issue he’s dealing with is that, as he puts it, the S&P 500 entered 2015 trading at 18x trailing earnings, a high rating the index has achieved only about a quarter of the time in the past.  On the surface, that’s not overly worrying.  If we look at the wider universe of all US stocks, including smaller-cap issues, the NYSE Composite and Nasdaq, however, the US market is trading at record-high levels based on PE, price/cash flow and price/book.

Not only that, but the high valuations aren’t concentrated in a few market sectors, as was the case during the Internet Bubble of the late 1990s.  The median stock has all the characteristics of the averages.

Paulsen’s thinks the best that we can hope for is that stocks will move sideways until value is restored through higher corporate earnings–a process that will probably take all of 2015.  As I read him, he believes it’s highly unlikely that stocks can go up during this period.  There’s a good chance of one or more declines of 10% during the year.  Declines could be deeper.  The only safe haven he can see is in stocks outside the US.

my take

The one factor Paulsen may not be giving enough weight to is the price of alternative investments–here I mean bonds, not hedge funds.

Generally speaking, stocks and bonds are in equilibrium when the interest yield on bonds  =  the earnings yield on stocks, i.e. 1/PE.

In 1973, just before the onset of a major bear market, the 10-year treasury rate was 6.5%.  This would imply a stock market multiple of 15.  The actual multiple on the S&P was 19.

In 1987, just before another major market downturn, the 10-year yield was 7%, implying a stock market multiple of 14.  The actual multiple was about 20.

In 1999, just before the Internet Bubble popped, the 10-year was yielding 6.7%, implying a stock market multiple of 15.  The actual multiple was 30!

Right now, the 10-year Treasury is yielding 1.82%, implying a stock market multiple of 55!  The actual multiple is 18.

My conclusion is that today we’re in a weird situation where there’s little relevant historical precedent.

working backwards

If we work the bonds-stocks equivalence equation the other way and ask what 10-year Treasury yield an 18 multiple on the market implies, the answer is 5.5%.  Even if we take Paulsen’s median multiple for all US stocks of 20, the 10-year Treasury yield should be 5.0%.  This suggests the hard-to-fathom result that current stock prices already factor in all the tightening the Fed is likely to do over the next two or three years.

Looked at a little differently, significant stock market downturns come either when PEs are out of whack with bond yields or when earnings are about to evaporate because of recession, or both.  Neither appears to be the case today.  The closest I can come is the idea that the sharp depreciation of the euro will undermine the 2015 results of US companies with significant euro-based earnings or assets.  But that exposure isn’t big enough to offset even tepid US domestic earnings growth.  And I think the US will be much better than “tepid.”

the bottom line

The fact that an experienced dyed-in-the-wool bull has turned bearish is a cause for worry.  It is also true that PEs are high.  The key difference between Paulsen and myself is how we regard bonds as influencing stock pricing.

 

 

 

 

the December 2014 Employment Situation

January 9, 2015 By in Current Market Thoughts, economics, employment, Employment Situation report, wage gains Tags: , , , , , , , Leave a comment

The Bureau of Labor Statistics, part of the Labor Department, published its monthly Employment Situation for December at 8:30am est.

The report continued the recent string of exceptionally strong results.  The economy added 252,000 new positions (240,000 in the private sector) during December, or +12,000 better than consensus estimates of a 240,000 jobs gain.

Revisions to the two prior months’ data were unusually good, as well.  In its initial update to November data, the BLS now says the US gained 353,000 new jobs that month, +32,000 more than initially thought–even though the initial November figures were a huge positive surprise.  The agency now puts October job gains at +261,000–a boost of another +18,000 positions over its November estimate.

The unemployment rate fell from 5.8% to 5.6%; the number of unemployed fell by 383,000.

 

No sign of wage increases yet.  Average hourly earnings (now $24.57 for private non-farm workers) are up by 1.7% year-on-year.  Hourly wages fell by a nickel in December, after rising by 6¢ in November.

No sign of net layoffs in energy-related industries, although it may be too soon for this to be happening.  Still, there are no signs that validate the (odd, to my mind) conclusions of statistically-driven economic researcher that a declining oil price is a harbinger of recession.

 

 

 

crude oil (ii): what’s happening now

January 8, 2015 By in Energy, Mining, shale oil, shale oil and gas Tags: , , , , , , , 1 Comment

lower oil price+=less new drilling

Sharply lower oil prices have two main effects on the planning of new drilling by oil exploration companies:

–the more obvious is that they are only getting about half as much for the oil they are selling today than from output they sold half a year ago.  If production is constant, their cash flow has been cut in half

–the second is that projects on the drawing board and highly profitable at $100 a barrel may not be moneymakers at $50.

For both these reasons, less cash flow and fewer winning projects, exploration firms are cutting their capital spending budgets for 2015.

also…

–when prices are rising, oil explorer/developers tend to build up large inventories of supplies for “just in case.”  Instead of having, say, a three-month supply of the steel drill pipe that lines the walls of the wells, companies may want six months’ worth.  Now that drilling may only be half the level originally anticipated, a wildcatter could be saddled with what is now a year’s worth of pipe, or 4x what he could carry in normal times.  And he’s looking to save cash.

One of the company’s first calls is to suppliers.  It will want to cancel any outstanding orders–and to see if the supplier will take back some of what the firm already has in inventory.

It’s no surprise, then, that US Steel just announced layoffs at a big steel pipe-making plant.

–In good times, banks are happy to lend.  Wildcatters–natural optimists and not very risk averse–are eager to borrow.

I remember talking in early 1982 with the CFO of a mid-sized oil explorer that a short time later went bankrupt.  He said that over the preceding few years he routinely went to the local bank for drilling loans, which were always promptly approved.  He assumed the bank had done all the analysis needed to determine that the project was sound;  the chief loan officer assumed that because the CFO had an MBA he had done the work.  In reality, no one had.  Whoops.

During the same period, a small Oklahoma bank called Penn Square (located in one tiny office in a strip mall) originated tons of drilling loans, supposedly vetted by expert loan officers and collateralized by oil and gas assets, and sold them on to other Midwestern banks eager to participate in the late-1970s drilling boom.  Turns out no screening was done   …and documents securing the collateral were never signed.

In today’s world, a lot of drilling finance has come through junk bond issuance rather than bank loans.  That may be a plus for the exploration companies, if lenders have done their usual poor job of protecting their own interests through debt covenants.

At any rate, I think the bad debt story for drilling companies has just begun to unfold.

a price turnaround?

At some point–which I don’t think is anywhere close to today–at least a few savvy producers will begin to withhold production from the market.  This will come as/when they think oil is too cheap and likely to rebound in price within a relatively short period of time.

We’ve also already seen American car buyers adjust to lower gasoline prices by starting to favor gas guzzling cars and trucks again.

However, like any other commodity, the bottom for oil will come when the cash flow of the highest-cost firms turns negative and they cease production.   My not-very-well-informed guess is that this is between $40 and $50 a barrel.

 

 

the December 2014 FOMC

December 19, 2014 By in Federal Reserve, Portfolio management, Recent Market Action, Strategy Tags: , , , , , Leave a comment

The US stock market has rallied strongly since the Fed released a statement from its Federal Open Market Committee meeting on Tuesday-Wednesday and Chairperson Janet Yellen had her accompanying press conference.

The broad picture:

In October, the Fed ended a long period of continually upping the level of monetary stimulation of the US economy.  It is still in a period of applying extreme stimulation but is no longer increasing the amount.  And it is now starting to focus on the nuts and bolts of how to begin to wean the economy from excessive monetary stimulus, a process the Fed envisions will take several years.

Janet Yellen’s main points:

–there’s no set timetable for withdrawing excess stimulus.  The process consists in gradually raising the Fed Funds rate for overnight money from the current zero to a normal level of 3%+.  Most FOMC members think the first rate rise should come during 2015, but the Fed is prepared to slow down the process if the economy is weaker than expected, and vice versa.

Wall Street fears that the Fed will willy-nilly raise rates according to a predetermined formula and without regard to economic conditions is completely misplaced.  The Fed will be patient in this process (the Fed estimate of where Fed Funds will be at the end of 2015 continues to come down and is now at 1.15%; speculation is that the figure Ms. Yellen has in mind is lower).  The major goal is not to disrupt growth.

–inflation is not a current problem.  The Fed has been trying hard with every tool in its arsenal to create conditions where inflation is a possibility for six years without much success.  The Fed did say that it expects inflation will only gradually rise toward its 2% target.  Wall Street fears of runaway inflation are unrealistic.

–deflation isn’t a concern, either.   Investors worried about deflation are making the rookie mistake of confusing headline inflation figures, which contain lots of transitory elements, with core inflation–which is what really counts and which is steady at somewhat under 2%.

–lower oil prices are a net plus for the US, because the country is still a large oil importer.  A Russian recession is more a trouble for the EU than the US.  US trade with Russia is very small; US holdings of Russian portfolio and capital assets are tiny.

Other than its comments about oil, almost nothing the Fed said breaks new ground.  Given the tragic example of Japan’s mistaken attempts to remove economic stimulus too soon, it’s not surprising that the Fed said it will not repeat them here.  The main takeaway from the meeting statement/press conference is that the Fed said this explicitly and in detail, leaving little for the Wall Street rumor mill to worry about.

Shaping a portfolio for 2015 (vii): putting the pieces together

December 15, 2014 By in bond market, growth vs value, Portfolio management, securities markets, Shaping a portfolio for 2015, stock market, Strategy Tags: , , , , , , , 2 Comments

I expect 2015 to be a “normal” year, in contrast to the past six.  This is important.

Over the past six recovery-from-recession years, global stock markets have had a strong upward bias.  Yes, outperformance required the usual good sector and individual security selection.  But if “bad” meant up 12% instead of up 15%, most of us would be happy enough with the former.

This year, though, is more uncertain, I thin.  Whether the S&P 500 ends the year in the plus column or the minus depends on importantly on four factors:

–PE expansion.  Unlikely, in my view.  

–interest rates.   Arguably, rising rates may cause PE contraction, ash or bonds become more attractive investment alternatives to stocks

—currency changes.  A rising currency acts much like an increase in interest rates.

—profit growth.  In a normal year, earnings per share growth is the primary driver of index gains/losses.  It will be so for 2015, in my view.

Another point.  Four moving parts is an unusually large number.  There are other strong forces acting on sectors like Energy and Consumer discretionary, as well.  Because of this, unlike the past few years, where one could make a plan in January and take the rest of the year off, it will be important in 2015 to monitor plans frequently and be prepared to make mid-course corrections.

profit growth

Here’s my starting point (read:  the numbers I’ve made up):

US = 50% of S&P 500 profits.  Growth at +10% will mean a contribution of +5% to overall index growth

EU = 25% of S&P 500 profits.  Growth of 0 (due to euro weakness vs. the dollar) will mean no contribution to index profit growth

emerging markets = 25% of S&P 500 profits.  Growth of +10% (really, who knows what the number will be) will mean a contribution of +2.5% to             index growth.

Therefore, I expect S&P 500 profits for 2015 to be up by about 7% – 8%.

interest rates

The Fed says it will raise short-term rates, relatively aggressively, in my view, from 0 to +1.5% by yearend 2015, on the way to +3.5% by yearend 2017.  This plan has been public for a long time, so presumably at least part of the news has already been factored into today’s stock and bond prices.  What we don’t know now is:

–how much has already been discounted

–what the Fed will do if stocks and junk bonds begin to wobble, or emerging market securities fall through the floor, because rates are rising.  My belief:  the Fed slows down.

–is the final target too aggressive for a low-inflation world?  My take:  yes it is, meaning the Fed’s ultimate goal of removing the US from monetary intensive care may be achieved at a Fed Funds rate of, say, 2.75%.

My bottom line (remember, I’m an optimist):  while rising rates can’t be considered a good thing, they’ll have little PE contractionary effect.  Just as important, they won’t affect sector/stock selection.  The major way I can see that I might be wrong on this latter score would be that Financials–particularly regional banks–are better performers than I now anticipate.

If rising rates do have a contractionary effect on PEs, the loss of one PE point will offset the positive impact on the index of +6% -7% in earnings growth.  So the idea that the Fed will slow down if stocks begin to suffer is a crucial assumption.

 

currency effects

The dollar strength we’ve already seen in 2014 will make 2015 earnings comparisons for US companies with foreign currency asset/earnings exposure difficult.  Rising rates in the US may well cause further dollar appreciation next year.  Even if the dollar’s ascent is over, it’s hard for me to see the greenback giving back any of its gains.

Generally speaking, a rising currency acts like a hike in interest rates;  it slows economic activity.  It also redistributes growth away from exporters and import-competing firms toward importers and purely domestic companies (the latter indirectly).

The reverse is true for weak currency countries.  At some point, therefore, companies in weak currency countries begin to exhibit surprisingly strong earnings growth–something to watch for.

growth, not value

Typically, value stocks make their best showing as the business cycle turns from recession into recovery.  During more mature phases (read: now) growth stocks typically shine.

themes

–Millennials, not Baby Boomers

–disruptive effects of the internet on traditional businesses.  For example: Uber, malls, peer-to-peer lending.  Consider an ETF for this kind of exposure.

–implications of lower oil prices.  Consider direct and indirect effects.  A plus for users of oil, a minus for owners of oil.  Sounds stupidly simple, but investing isn’t rocket science.  Sometimes it’s more like getting out of the way of the oncoming bus.

At some point, it will be important to play the contrary position.  Not yet, though, in my view.

–rent vs. buy.  Examples:  MSFT and ADBE (I’ve just sold my ADBE, though, and am looking for lower prices to buy back).  Two weird aspects to this: (1) when a company shifts from buy to rent, customers are willing to pay a lot more for services (some of this has to do with eliminating counterfeiting/stealing); (2) although accounting for rental operations is straightforward, Wall Street seems to have no clue, so it’s constantly being positively surprised.