Interest rates are rising. That indisputable truth was brought home more drastically last week when mortgage (lending) rates hit their highest level in 12 months, further dampening the specter of the economy’s lone bright spot, namely the housing industry.
For the last five years, as the stock market dug out of its technology hole, investors have pointed to the explosion in home values, and other tangible assets, as the bulwark of support for speculating in stocks, real estate, and commodities, all the while decrying any data which supported the return of inflation concerns. How the two might not be linked is another story.
Nevertheless, as margin borrowing expense began to eat away at savings, the amount of leverage in the equities market became absurd, despite the fact that some claim the market’s surge was “liquidity-driven”.
But now, as the economy clearly slows in certain areas, employment, wages, borrowing, and production are all being affected. Most retailers, except for the high end, are seeing not just seasonally or weather-related slowdowns in purchasing, but a more persistent lethargy, as well.
Even the technology market has slowed to a crawl as innovation and sales demonstrate anemic growth.
Evidence of a slowdown have been gestating for months. The stock market, which marches to its own drummer, might have been going up, but it does so without full participation amongst its sectors. Financials, Cyclicals, and Tech stocks are languishing behind.
It is true that many companies have shown nominal profit/earnings growth. We all know that those gains have come from “enhancements” such as share buybacks, layoffs, and price increases. I consider this to be artificial manipulation. The classic earnings paradigm should show high demand and nominal production in order to keep pace with order flow. To the contrary, while manufacturing is nominal, demand is slowing in the consumer sectors. At some point, the ability to raise prices or to inflate margins at your expense will cease. The cost of oil, manufacturing, and production will ultimately fall back into the companies who have little wiggle room right now.
These cost pressures are what’s driving interest rates. The monetary models have gone from bullish to bearish. Before the Fed considers lowering interest rates to incentivize demand, they must deal with the spiraling cost pressure that permeates the economy.
Drugs, energy, utilities, transportation, education, agriculture and entertainment are examples of the burden price pressure puts upon the mainstream economy.
While the market has doubled in value since 2002 so too has the rate of inflation. Federal spending is out of control as are the spending habits of the wealthy. Savings in the United States are the lowest percentage of take home pay since statistics were developed on this subject.
Do not anticipate a reduction in punitive borrowing costs any time soon.
History has shown that the market loses relative value as absolute values skyrocket. Right now the excessive spike in equity prices is good for the monthly brokerage statement, but dangerous for a quantitative outlook. Arlington Econometrics shows the highest expanse of price-to-earnings ratios than anytime since 1999. Only this time it’s not Tech stock related.
Our favorite stocks are just too “pricey”. As the market has before, expect that a linear, not parabolic, uptrend will be matched by a capitulation of 10-30%, and nearly identical in linear shape.
Tuesday, May 29, 2007
Monday, May 21, 2007
Market Commentary for the week of May 21, 2007
The parallel disconnect between negative economic data and positive equity market performance is setting up an uncomfortable scenario in which one of those two has to reverse direction in order to achieve parity. Obviously, negative jobs growth, wage stagnation, low savings rates, tepid capital expenditures, etc., cannot turn on a dime since these data are trends not phenomena. So it seems likely that with short-term relative strength numbers at high value the equity markets have a higher probability of reversing course than do the economic numbers. But simply to ignore the disparity is the most foolish course of all. There’s simply too much cash in stocks quantitatively to support a high probability upleg.
By denying these valuation discrepancies investors might impose a self fulfilling death wish upon their portfolios. Using one’s emotions as justification for portfolio modeling is just plain foolish. However, that seems to be the only dynamic at work right now.
As an earnings driven investor, I count fewer and fewer stocks that qualify for recommendation if one considers three year accrual patterns. But if you look at the activity within the market, the tide is raising (nearly) all ships in the harbor. Over time, there is nothing wrong with valuation acceleration. But within short cyclic outbursts, these levels are excessive.
Good news, or high expectations, are not viable, methodological, justifications for moving markets to record highs, in the face of declining economic statistics and high inflation in commodities and core costs. In fact, expectations are irrelevant statistically to the relative strength (RSI) data which refute the current short term trend.
When the “consensus” is that markets cannot go down, there is usually an implicit threat to stock ownership.
The obvious herd mentality is negative for long term equity patterns because linear trends unwind too quickly and do too much damage psychologically and financially.
The last time the markets were confronted with the parallel disconnect was just prior to the “tech-wreck” in 2000. In that case companies without earnings were being accorded exorbitant valuations because the emotion and justification of the New Paradigm in technological development was being hailed as the changing of the guard, “new this time”.
But cycles are parabolic, not linear. The spike in prices might have been justified over time, as some of today’s winners were born of that era, but not immediately nor so quickly. Without suitable gestation, no new industry can sustain lofty expectations or high prices. Emotion took over from methodology and investors paid the price.
Not my investors. We held firm to our earnings driven selection criteria and chose to avoid the mess entirely.
Today, the fantasy of valuation explosion and record highs flies in the face of market fundamentals and quantitative statistics.
On a price-to-sales level most companies are way overpriced. Capacity is nowhere near full. Instead, the “productivity” catch phrase is lauded as proof that companies can do more with less. Margins are being pumped at the expense of workers who are, in fact, these company’s consumers. As costs for materials rise look for these inflated valuations to come back to Earth.
The data is incontrovertible. Too few consumers are in a mindset to spend money they don’t have, eroded by taxes, declining real estate values, high margin expenses, rising costs of energy, and nonexistent savings.
The subtlety of my discipline is that it cannot predict deadlines or barriers, only quantify them. Therefore I am not trying to be negative about stock ownership, only realistic. With imposed criteria (such as earnings patterns, sector allocation, and relative strength ratios) it is possible to observe the lunacy without succumbing to it.
By denying these valuation discrepancies investors might impose a self fulfilling death wish upon their portfolios. Using one’s emotions as justification for portfolio modeling is just plain foolish. However, that seems to be the only dynamic at work right now.
As an earnings driven investor, I count fewer and fewer stocks that qualify for recommendation if one considers three year accrual patterns. But if you look at the activity within the market, the tide is raising (nearly) all ships in the harbor. Over time, there is nothing wrong with valuation acceleration. But within short cyclic outbursts, these levels are excessive.
Good news, or high expectations, are not viable, methodological, justifications for moving markets to record highs, in the face of declining economic statistics and high inflation in commodities and core costs. In fact, expectations are irrelevant statistically to the relative strength (RSI) data which refute the current short term trend.
When the “consensus” is that markets cannot go down, there is usually an implicit threat to stock ownership.
The obvious herd mentality is negative for long term equity patterns because linear trends unwind too quickly and do too much damage psychologically and financially.
The last time the markets were confronted with the parallel disconnect was just prior to the “tech-wreck” in 2000. In that case companies without earnings were being accorded exorbitant valuations because the emotion and justification of the New Paradigm in technological development was being hailed as the changing of the guard, “new this time”.
But cycles are parabolic, not linear. The spike in prices might have been justified over time, as some of today’s winners were born of that era, but not immediately nor so quickly. Without suitable gestation, no new industry can sustain lofty expectations or high prices. Emotion took over from methodology and investors paid the price.
Not my investors. We held firm to our earnings driven selection criteria and chose to avoid the mess entirely.
Today, the fantasy of valuation explosion and record highs flies in the face of market fundamentals and quantitative statistics.
On a price-to-sales level most companies are way overpriced. Capacity is nowhere near full. Instead, the “productivity” catch phrase is lauded as proof that companies can do more with less. Margins are being pumped at the expense of workers who are, in fact, these company’s consumers. As costs for materials rise look for these inflated valuations to come back to Earth.
The data is incontrovertible. Too few consumers are in a mindset to spend money they don’t have, eroded by taxes, declining real estate values, high margin expenses, rising costs of energy, and nonexistent savings.
The subtlety of my discipline is that it cannot predict deadlines or barriers, only quantify them. Therefore I am not trying to be negative about stock ownership, only realistic. With imposed criteria (such as earnings patterns, sector allocation, and relative strength ratios) it is possible to observe the lunacy without succumbing to it.
Monday, May 14, 2007
Market Commentary for the week of May 14, 2007
Not only have we begun the identification of several data bits about economic statistics, but those “bits” have begun to take on the appearance of trends and measurable statistics. Previously, we had all heard anecdotal information about retail sales, gas prices, unemployment, etc. But now those anecdotal stories are piecing together to weave a fabric of the economic landscape. Unfortunately, that tapestry is largely a tale of negative influences.
What strikes me as terribly disingenuous is that the markets seem to ignore the underlying statistics to create a “fabric” of their own which looks nothing like the data that goes into it. One would think that the memory of how the dot.com fiasco got blown out of proportion would resonate with experienced investors. Unfortunately, the generational life-cycle of an investor is not 20 years, but more like 30 minutes.
Without applying science or methodology to one’s investing, you derive only a hodge-podge of mismatched bets and unbalanced portfolios. Based upon the tumultuous run-up of the markets recently, I would guess that most investors can’t recall the allocation weightings of their stocks, only the fact that they are “going-up in value”. Can the same be said about “down days” like last Thursday?
Indeed last week produced more of the same: poor earnings and jobs data with market net to the upside.
I think we need to pay heed to the quantitative statistics that Arlington is producing. My work shows consumer spending is slowing, capital expenditures are slowing, and valuation is expanding beyond traditional standard deviation.
The new theory for the market is to inflate prices and worry about substantiation later. This sounds eerily familiar to 2000.
One would expect the greed/fear factor to play a bigger role in leveling out the imbalances, particularly the magnitude of upside penetration. Not so coincidentally, the confidence and wage gap between the get-rich hedge fund managers and the typical investor on Main Street is widening. When we read about moderate inflation “ex agriculture and energy prices” we should be highly suspicious of the data, unless you don’t plan to eat or travel anywhere.
These conclusions are not meant to be punitive or negative. Rather, reality should be heeded rather than ignored. The impact of these parallel disconnects could become severe as savings and spending patterns recede.
The pressure upon corporate and personal balance sheets is objectively negative. As a last resort, borrowing has supplanted investing as the habit of choice. Pretty soon the spigot of cheap money will run dry.
Knowing about, and acknowledging, the data is only the first step. Prudent asset allocation should protect investors from whatever missteps might befall the markets, while positioning portfolios, at the same time, to benefit from the current surge.
Despite what might appear to be my negativism, I am long-term optimistic, but cautious nonetheless.
Global warming, fuel dependency, healthcare, technology are not only crises but long-term investment windfalls, as well. Bottom line expense ratios pale by comparison to the potential opportunity within the investment landscape. I hope that the current depletion of net capital does not dissipate the abundant potential for finding and investing in new ideas and new stocks for the next cycle of capital gains.
What strikes me as terribly disingenuous is that the markets seem to ignore the underlying statistics to create a “fabric” of their own which looks nothing like the data that goes into it. One would think that the memory of how the dot.com fiasco got blown out of proportion would resonate with experienced investors. Unfortunately, the generational life-cycle of an investor is not 20 years, but more like 30 minutes.
Without applying science or methodology to one’s investing, you derive only a hodge-podge of mismatched bets and unbalanced portfolios. Based upon the tumultuous run-up of the markets recently, I would guess that most investors can’t recall the allocation weightings of their stocks, only the fact that they are “going-up in value”. Can the same be said about “down days” like last Thursday?
Indeed last week produced more of the same: poor earnings and jobs data with market net to the upside.
I think we need to pay heed to the quantitative statistics that Arlington is producing. My work shows consumer spending is slowing, capital expenditures are slowing, and valuation is expanding beyond traditional standard deviation.
The new theory for the market is to inflate prices and worry about substantiation later. This sounds eerily familiar to 2000.
One would expect the greed/fear factor to play a bigger role in leveling out the imbalances, particularly the magnitude of upside penetration. Not so coincidentally, the confidence and wage gap between the get-rich hedge fund managers and the typical investor on Main Street is widening. When we read about moderate inflation “ex agriculture and energy prices” we should be highly suspicious of the data, unless you don’t plan to eat or travel anywhere.
These conclusions are not meant to be punitive or negative. Rather, reality should be heeded rather than ignored. The impact of these parallel disconnects could become severe as savings and spending patterns recede.
The pressure upon corporate and personal balance sheets is objectively negative. As a last resort, borrowing has supplanted investing as the habit of choice. Pretty soon the spigot of cheap money will run dry.
Knowing about, and acknowledging, the data is only the first step. Prudent asset allocation should protect investors from whatever missteps might befall the markets, while positioning portfolios, at the same time, to benefit from the current surge.
Despite what might appear to be my negativism, I am long-term optimistic, but cautious nonetheless.
Global warming, fuel dependency, healthcare, technology are not only crises but long-term investment windfalls, as well. Bottom line expense ratios pale by comparison to the potential opportunity within the investment landscape. I hope that the current depletion of net capital does not dissipate the abundant potential for finding and investing in new ideas and new stocks for the next cycle of capital gains.
Monday, May 7, 2007
Market Commentary for the week of May 7, 2007
The banana peel.
I don’t know what others are seeing, but it makes me quite skeptical when I see the market averages explode upward because data indicates, as it did last week, that “productivity gains rose slightly, and per-worker costs remained within target ranges”. To me, that’s code which means that output per worker is rising without commensurate pay raises. It’s no wonder more jobs are being exported, or that unemployment stubbornly refuses to go down.
A typical scenario has a company piling on the debt, trying to use money at low cost, then telling its workers that it must lay people off (“downsize”) or raise sales prices to meet margin (profit) expectations. However, the data fails to support that theory, showing in fact that overall output is declining, not rising. In what looks more like recession era economics, the gross domestic product (GDP) has actually declined for two quarters. Adjusted for rising inflation in energy, the numbers have actually underperformed, looking more like 2005 than 2007.
Simply, consumers are running out of cash and out of steam. Automobile sales, discretionary household purchases, new home sales, magazine advertising, and retail stores all showed red ink in the last quarter. These declines are more than bumps, they are systemic.
Taking the long view.
The only industries that approximate cyclic growth are those which have high demand, limited supply, or pricing power. Look at the economic and equity performance of Energy, Telecom, Electric Utilities, Pharmaceuticals, and Basic Materials to realize that the sea-change from consumer spending to tangible assets/pricing pressure is built-in to our economy, and most of the globe, as well.
While quantitative oscillators might indicate temporary negative or positive impulses, the longer range cycle measures indicate that the “price-trend” continuum is a part of the fabric of the market’s landscape, in a way in which it hasn’t previously exerted such influence.
For the first time since the mid 1990’s the trend models are leaning towards the “back-end” of sector rotation. This means that analysts no longer look first at consumer spending patterns to determine future economic cycle direction. Rather, we now look at corporate borrowing, capital expenditures, wage data, employment, and price patterns as predictors of first resort. If the consumer market place spends, fine. So be it. But most businesses now look first at their costs, not your spending or demand habits.
Market sleight-of-hand.
In previous writings I have referred to the “Parallel Disconnect”. I define this phenomenon as the appearance of the market and the economy moving in lock-step synchronicity, when, in reality, their parallel appearance only masks a declining rate of acceleration in one, with an increasing rate of mania for the other. It doesn’t matter which is manic and which is accelerating. The de-coupling of their vectors makes it look synchronized and connected, but it is not actually so.
The slowdown in earnings, the rate of inflation, the depletion of savings and the intense borrowing for future gains is in direct opposition to a psychological equity hysteria that loves record highs and expanding price/earnings valuations. Somehow, leverage and debt keep finding their way into the economic psyche.
Couple that with the activity in mergers and acquisitions, and share buybacks, and you have more players for fewer equities….another recipe for price acceleration fervor.
I’m not mocking the market’s gains. I, and my clients, like gains. I want them to notice, however, that we’re making money with limited exposure to the hysteria. Current equity asset allocations are averaging less that 40%. I expect to remain prudently optimistic, but always cautious.
Subscribe to:
Posts (Atom)