FaceBook: The Complete Forensic Post-Mortem

Saturday, May 19th, 2012

While much has already been writ­ten on the topic of peak val­u­a­tion, social bub­bles pop­ping, and the eth­i­cal social util­ity of yesterday's his­tor­i­cally over­hyped IPO, nobody has done an analy­sis of the actual stock trad­ing dynam­ics as in-depth as the fol­low­ing com­plete foren­sic post-mortem by Nanex. Because more than any­thing, those tense 30 min­utes between the sched­uled open and the actual one (which just hap­pened to coin­cide with the Euro­pean close), showed just how reliant any form of pub­lic cap­i­tal rais­ing is on tech­nol­ogy and elec­tronic trad­ing. And to think there was a time when an IPO sim­ply allowed a com­pany to raise cash: sadly it has devolved to the point where a pub­lic offer­ing is a pol­icy state­ment in sup­port of a bro­ken cap­i­tal mar­ket, which how­ever is fully in the hands of SkyNet, as yesterday's chain of events, so very humil­i­at­ing for the Nas­daq, showed.

From a delayed open­ing, to 2 hour trade con­fir­ma­tion delays, vir­tu­ally every­one was in the dark about what was really hap­pen­ing behind the scenes! As the analy­sis below shows, what hap­pened was at times sheer chaos, where every­thing was hang­ing by a thread, because if FB had got­ten the BATS treat­ment, it was lights out for the stock mar­ket. Well, the D-Day was avoided for now, but at what cost? And how much over the green­shoe Face­Book stock over­al­lot­ment did MS have to buy to pre­vent it from tum­bling below $30 because as Reuters reminds us, "had Mor­gan Stan­ley bought all of the shares traded around $38 in the final 20 min­utes of the day, it would have spent nearly $2 bil­lion." What about the first defense of $38?  In other words: in order to make some $67 mil­lion for its Invest­ment Bank­ing unit, was MS forced to eat a sev­eral hun­dred mil­lion loss in its sales and trad­ing divi­sion just to avoid look­ing like the world's worst under­writer ever? We won't know for a while, but in the mean­time, here is a visual sum­mary of the key events dur­ing yesterday's far less than his­toric IPO.

May 18 — The Face­book IPO

The first warn­ing sign, was the delay in trad­ing. Here's the sta­tus mes­sages from Nas­daq for that day.

The first 4 charts are 5 sec­ond inter­val charts of Face­book show­ing the first hour and 15 min­utes of quotes and trades.

Chart 1. NBBO (National Best Bid or Offer) Spread. Black: bid < ask (nor­mal), Yel­low: bid = ask (locked), Red: bid > ask (crossed)all bids and offers color coded by exchange.

Chart 2. Best bids and offers (NBBO) color coded by exchange.

Chart 3. All bids and offers color coded by exchange.

Chart 4. All trades color coded by exchange.

The next 4 images are tick charts show­ing quotes and trades. How to read these charts

Chart 5. The first sec­onds of trading.

Chart 6. The first sec­onds of trad­ing, continued.

Chart 7. Sud­denly, a vac­uum appears and pro­duces a record 12,285 trades in 1 second.

Chart 8. Same as above, show­ing just Nasdaq.

The next 2 charts (10 sec­ond inter­val) show how Nasdaq's quote stopped, but trades from Nas­daq did not (direct feeds must have been fine, but not the consolidated).

Chart 9. Nas­daq Bids and Offers along with NBBO.

Chart 10. Nas­daq Trades

The next 2 charts (20 mil­lisec­ond inter­val) show the effect when Nasdaq's quote returned. There were two sig­nif­i­cant gaps in quotes (for all exchanges) and 1 sig­nif­i­cant gap in trades.
Note how the gap in trades is not at the same time as the gaps in quotes.

Chart 11. All bids and offers color coded by exchange.

Chart 12. All trades color coded by exchange.

The next chart (5 mil­lisec­ond inter­val) shows the result of the blast in trades and quotes when Nasdaq's quote returned. Trades printed at least 900 mil­lisec­onds before quotes, an impos­si­bil­ity if orders are being routed accord­ing to reg­u­la­tions. We have jok­ingly referred to this anom­aly as fan­tasec­onds.

Chart 13. Nas­daq bids and offers (tri­an­gles), Nas­daq trades (cir­cles) and NBBO (gray/yellow/red shading).

The next 2 charts (500 mil­lisec­ond inter­val) detail the HFT Trac­tor Beam area where coin­ci­den­tally or not, Nas­daq quotes began "sput­ter­ing" right before stop­ping for about 2 hours.

Chart 14. NBBO Spread and quote rate from all exchanges.
Note the flat lines at the bot­tom. Also note how the quote rate (lower panel) surges when prices rise above the flat line, which is what we would expect. How­ever, on Nas­daq (next chart)..

Chart 15. NBBO Spread and quote rate from just Nas­daq.
When prices rise above the flat line, quotes from Nas­daq stop, exactly oppo­site of expected behav­ior and what we see from other exchanges at that time (see chart above).

And finally, Nanex on the fall­out:

Dur­ing the FaceBook's failed IPO open­ing period (11 — 11:30)  and shortly after the trad­ing began, bad prices (spikes) began appear­ing in other stocks, includ­ing sym­bols APPL, INTU, NFLX, PDCO, QCOM, QLD, UST and ZNGA. They also occurred in Face­book dur­ing the first 15 min­utes of trad­ing (see Chart 4 on this page). There are likely other stocks that were affected. In nearly all of these cases the price spikes were exe­cut­ing against quotes that were far out­side the NBBO. Most of these exe­cu­tions occurred on the CBOE, and a few on Chicago and AMEX. For­tu­nately, by chance, the prices were not wide enough to trig­ger cir­cuit break­ers in these stocks.

We think these bad price exe­cu­tions are related to what­ever issues Nas­daq was hav­ing in face­book and prob­a­bly are from errors in rout­ing soft­ware. A sim­i­lar thing hap­pened dur­ing BATS failed IPO in AAPL and other stocks.

Chart 1. AAPL

Chart 2. NFLX

Chart 3. QCOM

Chart 4. QLD

Chart 5. UST

Tags: Bats, Bubbles, D Day, Electronic Trading, Greenshoe, Hanging By A Thread, Hundred Million, Investment Banking, Ipo, Morgan Stanley, Nasdaq, Post Mortem, Public Offering, Reuters, S Chain, Skynet, Stock Market, Stock Trading, Trade Confirmation, Underwriter
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Month of May: Sell and Go Away, or Hang in There? (Sonders)

Tuesday, May 15th, 2012

May 14, 2012

by Liz Ann Son­ders, Senior Vice Pres­i­dent, Chief Invest­ment Strate­gist, Charles Schwab & Co., Inc.

Key Points

• We believe the stock market's cor­rec­tion is likely to be less severe this year rel­a­tive to 2010 or 2011.
• Be aware of the pos­si­ble per­ils of fol­low­ing a "sell in May" trad­ing strategy.
• For now, macro concerns—including Europe and the loom­ing "fis­cal cliff"—are trump­ing bet­ter micro news.

The stock mar­ket is in cor­rec­tion mode and investors are on edge. There are likely sev­eral rea­sons for the weak­ness, includ­ing what we pointed out in our early-April report on ele­vated opti­mistic sen­ti­ment. Since sen­ti­ment tends to work a con­trar­ian magic on the mar­ket, we were antic­i­pat­ing a period of con­sol­i­da­tion after the stel­lar six-month, 30% run off the early Octo­ber 2011 low—and we're get­ting it.

Of course, we're also yet again deal­ing with the euro­zone debt cri­sis, but also chop­pier eco­nomic indi­ca­tors in the United States recently, a volatile elec­tion sea­son and con­cerns about the so-called "fis­cal cliff" head­ing into the end of this year. But one of the ques­tions I've got­ten most often recently has been about the sea­sonal phe­nom­e­non called "sell in May and go away," and whether the market's in store for another sum­mer swoon like we've had the past two years.

Macro trump­ing micro

I'll start with "sell in May," but before I do, I want to address an impor­tant gen­eral obser­va­tion. As we've noted many times recently in reports and media appear­ances; and as detailed in a ter­rific recent report by Wall Street research firm Wolfe Tra­han, macro is trump­ing micro. One of the rea­sons for this is the decline in guid­ance investors are receiv­ing from com­pany managements.

In the past, guid­ance was often an anchor of rea­son in volatile times. Events like Euro­pean elec­tions or spik­ing euro­zone sov­er­eign bond yields might not have been such big market-moving events when we could rest on US com­pa­nies' guid­ance as to the future. Add to that rapid-fire trad­ing, short­ened time hori­zons, greatly increased access to infor­ma­tion, greatly increased speed of news' dis­sem­i­na­tion, and much more glob­al­ized eco­nomic and finan­cial sys­tems, and you have a recipe for increased volatil­ity around macro events.

Sell in May?

Much is made every year of the "sell in May" phe­nom­e­non. Its basis is rooted in the fact that the best per­for­mance for the mar­ket has gen­er­ally come in the Novem­ber through April period, while the worst has come between May and October.

There is some truth to the adage. Accord­ing to data com­piled by Ned Davis Research (NDR), through the begin­ning of May this year the aver­age per­for­mance for the period from May 1 through Octo­ber 31 each year since 1950 was 1.2%. The aver­age per­for­mance for the period from Novem­ber 1 through April 30 each year since 1950 was 7.0%.

As com­pelling as those num­bers may seem, there are many things to con­sider, espe­cially if it's your incli­na­tion to develop a trad­ing strat­egy around those sea­sonal pat­terns. First, the cal­en­dar months indi­vid­u­ally tend to fall into either the "hot" or "cold" columns for per­for­mance, as you can see in the table below. Three of the six months that fall into the "all out" period span­ning from May through Octo­ber are actu­ally his­tor­i­cally strong months, while three of the six months that fall into the "all in" period span­ning from Novem­ber through April are actu­ally his­tor­i­cally weak months.

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of 1928-April 30, 2012.

As you can see, all of the sea­sons seem to be ade­quately rep­re­sented in both columns. And what we know for a fact is that time hori­zons have become much shorter over the recent years, and the reac­tion func­tion gets trig­gered more often. It's likely that many investors may find their patience tested when expe­ri­enc­ing either a great month (or two) dur­ing the May-October "all out" period and/or a poor month (or two) dur­ing the November-April "all in" period. Of course, the sea­sonal trad­ing strat­egy must con­sider trans­ac­tion costs and tax impli­ca­tions.

Sec­tor per­for­mance May-October

For investors who like to take a tac­ti­cal approach to the sea­sonal ten­den­cies, a sec­tor bias strat­egy may be worth con­sid­er­ing. Before I get to the details, let me remind our clients that we moved toward a more sector-neutral strat­egy back in early April when we became more cau­tious about the mar­ket in the short term. Presently the only out­per­form rat­ing we have is on the infor­ma­tion tech­nol­ogy sec­tor, while the only under­per­form rat­ing we have is on the util­i­ties sector.

As you can see in the table below, cour­tesy of The Leuthold Group, cycli­cal groups have tended to out­per­form dur­ing the market's tra­di­tion­ally strong November-April period, while defen­sive sec­tors have been the rel­a­tive win­ners dur­ing the cus­tom­ar­ily weaker May-October period. In fact, the size and per­sis­tence of these effects have been impres­sive (at least since 1989, the span of the analy­sis).

S&P 500 Sec­tor Seasonality

Source: The Leuthold Group, Octo­ber, 1989-April, 2012. Defen­sive sec­tors: con­sumer sta­ples, health care and util­i­ties. Cycli­cal sec­tors: con­sumer dis­cre­tionary, indus­tri­als and mate­ri­als.

Buy in May in elec­tion years?

There's also the rub of this being an elec­tion year, dur­ing which sit­ting out the May through Octo­ber period has his­tor­i­cally not worked well. Using the Dow Jones Indus­trial Aver­age because of its longer his­tory, the mar­ket has been up 4.5% dur­ing elec­tion years in the May-October span ver­sus 2.6% for all years (includ­ing elec­tion years). And for what it's worth, accord­ing to NDR, the mar­ket has bucked sea­sonal weak­ness even more when the incum­bent pres­i­dent has won, with a median gain of 7.6% ver­sus 0.5% when the incum­bent pres­i­dent has lost.

NDR pro­vides a clue as to why this is the case: A cor­rec­tion has occurred dur­ing the sec­ond quar­ter of elec­tion years, on aver­age (sound famil­iar?). But the cor­rec­tion has tended to be con­cen­trated in the sec­ond quar­ter, set­ting the stage for a sum­mer rally.

2012's pos­i­tive off­sets to present weakness

I actu­ally think the sce­nario noted above is more likely than not this year. Mus­cle mem­ory has many investors fret­ting a repeat of 2011 and 2010, when eco­nomic weak­ness in the spring led to bru­tal cor­rec­tions each year, to the tune of –19% and –16%, respec­tively. But there's a long list of pos­i­tive off­sets this year rel­a­tive to the past two years:

• Infla­tion is com­ing down, espe­cially among com­mod­ity prices.
• Credit growth is quite strong, espe­cially for consumers.
• Hous­ing has improved markedly.
• The US man­u­fac­tur­ing sec­tor is humming.
• NFIB's small busi­ness sur­vey made recent upside breakout.
• Job growth is much better.
• Con­sumer con­fi­dence is improving.
• Private-sector lever­age ratios are much improved (debt ser­vic­ing costs are extremely low).
• Recov­ery in state/local gov­ern­ment spending.
• The US econ­omy some­what decou­pling from rest of world; at least Europe.
• US bank capital/health is much bet­ter than Europe's.
• The Euro­pean Cen­tral Bank's Long-Term Refi­nanc­ing Oper­a­tions have reduced like­li­hood of global finan­cial contagion.
• Ger­many appears more will­ing to accept higher infla­tion, open­ing the door to eas­ier mon­e­tary pol­icy for the eurozone.
• Val­u­a­tions are quite cheap, espe­cially on for­ward earnings.
• Investor sen­ti­ment has improved sharply with the cor­rec­tion to-date (mean­ing pes­simism has kicked back in).

I don't think the present cor­rec­tion is over, but do believe it could be kept to within the nor­mal 5–10% range. Since the cur­rent bull mar­ket began in March 2009, the S&P 500 has had 15 cor­rec­tions of more than 5% that were pre­ceded by at least a 5% rally (con­sis­tent with this year's pat­tern). The table below high­lights their dura­tion and ulti­mate per­cent­age drop.

S&P 500 5% Cor­rec­tions

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of May 11, 2012.

Wall of worry being rebuilt

Tem­per­ing my short-term con­cern has been the afore­men­tioned improve­ment in sen­ti­ment con­di­tions. That said, I think there's likely a bit more pes­simism needed to estab­lish a short-term bot­tom for the mar­ket. As you can see, the well-watched NDR Crowd Sen­ti­ment Poll (CSP) has moved deci­sively lower, but not yet to the extreme pes­simism zone:

Bye-Bye Opti­mism

Source: NDR, Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as May 8, 2012.

NDR noted in a recent report sev­eral key rea­sons to expect the cor­rec­tion to be within the nor­mal 5–10% range:

• Ini­tial rever­sals in CSP extremes are con­sis­tent with median declines of about 8% within six months.
• The first half of elec­tion years have shown median declines of just less than 10%.
• Once "pre-waterfall" highs have been exceeded, as occurred in Feb­ru­ary of this year, median mar­ket declines have ranged between –3% and –7% within six months.

Sav­ing the worst for last

I think investors and the media may be under­es­ti­mat­ing the impact the com­ing "fis­cal cliff" is hav­ing on mar­ket and busi­ness psy­chol­ogy. The fis­cal cliff refers to the near-simultaneous Jan­u­ary 2013 expi­ra­tion of the Bush tax cuts, the pay­roll tax cuts, emer­gency unem­ploy­ment ben­e­fits and the sequester (auto­matic spend­ing cuts) estab­lished in last summer's debt-limit agreement.

The range of esti­mates for its ulti­mate impact are, unfor­tu­nately, quite wide. The low­est esti­mate I've seen comes from NDR, using Con­gres­sional Bud­get Office assump­tions, with the impact at a rel­a­tively "low" 2.4% of US gross domes­tic prod­uct (GDP). Most esti­mates tend to clus­ter around 3.5% of GDP.

It's impos­si­ble to know what's right because dif­fer­ent assump­tions are being used. But the con­sen­sus is clos­ing in on a worst-case sce­nario of about 4% of GDP. ISI recently put the num­bers into three dis­tinct buck­ets, each with about $200 bil­lion of impact:

1. Pro­vi­sions likely to cre­ate a fis­cal drag (approx­i­mately (≈) $221 bil­lion or 1.4% of GDP):
   • Cuts to dis­cre­tionary spend­ing (≈$84 billion)
   • Tax increases on upper-income Amer­i­cans included in the Afford­able Care Act (≈$21 billion)
   • Pay­roll tax cut (≈$116 billion)
2. Bush tax cuts (≈$200 bil­lion or 1.3% of GDP, although likely impact would be spread over sev­eral years)
3. Items unlikely to be allowed to take affect and thus aren't likely to cre­ate a fis­cal drag (≈$179 bil­lion or 1.1% of GDP):
   • Huge increase in num­ber of Amer­i­cans pay­ing the alter­na­tive min­i­mum tax (≈$94 billion)
   • Sequester cuts (~$85 billion)

There are three addi­tional items that don't fall neatly into ISI's three buck­ets, includ­ing tax exten­ders, extended unem­ploy­ment insur­ance ben­e­fits and the "doc fix," which would together total about $75 bil­lion. These items are not expected to cre­ate a sig­nif­i­cant fis­cal drag.

I actu­ally think this is hav­ing a larger impact on psy­chol­ogy than many believe, espe­cially on the con­fi­dence of cor­po­rate lead­ers and their abil­ity to plan (and guide Wall Street's ana­lysts) for the future.

Mus­cle mem­ory may fail us this year

In sum, there's much to fret about, and volatil­ity is likely to remain ele­vated until this cor­rec­tion has run its course. But a lot has changed in the past two years—much for the better—particularly for domes­ti­cally ori­ented US com­pa­nies. There's at least a lit­tle bit of decou­pling under­way, cer­tainly between the United States and Europe, and that's likely to assist in keep­ing the cor­rec­tion from mir­ror­ing the ones in 2010 and 2011.

Impor­tant Disclosures

The infor­ma­tion pro­vided here is for gen­eral infor­ma­tional pur­poses only and should not be con­sid­ered an indi­vid­u­al­ized rec­om­men­da­tion or per­son­al­ized invest­ment advice. The invest­ment strate­gies men­tioned here may not be suit­able for every­one. Each investor needs to review an invest­ment strat­egy for his or her own par­tic­u­lar sit­u­a­tion before mak­ing any invest­ment decision.All expres­sions of opin­ion are sub­ject to change with­out notice in reac­tion to shift­ing mar­ket con­di­tions. Data con­tained herein from third party providers is obtained from what are con­sid­ered reli­able sources. How­ever, its accu­racy, com­plete­ness or reli­a­bil­ity can­not be guaranteed.Examples pro­vided are for illus­tra­tive pur­poses only and not intended to be reflec­tive of results you can expect to achieve.

Tags: Anchor, Bond Yields, Charles Schwab, Chief Investment Strategist, Debt Crisis, Economic Indicators, Election Season, European Elections, Liz Ann, Media Appearances, Micro News, Perils, Seasonal Phenomenon, Senior Vice President, Sentiment, Stock Market, Swoon, Trading Strategy, Trahan, Volatile Times
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Earnings Growth—Is It Enough? (Ezrati)

Monday, May 7th, 2012

by Mil­ton Ezrati, Lord Abbett

After two-plus years of exceed­ing expec­ta­tions, earn­ings this year seem poised, at last, to reflect the plod­ding nature of this eco­nomic recov­ery. In 2010 and 2011, even as the real econ­omy man­aged only a pal­try 2.4% aver­age annual rate of expan­sion, the earn­ings of S&P 500^® Index¹com­pa­nies soared, ris­ing more than 47% in 2010 and almost 20% in 2011. Such a pat­tern could not per­sist. And this year, the slow fun­da­men­tals will almost surely assert them­selves. Even so, it would be a mis­take to read mat­ters too pes­simisti­cally. There cer­tainly is noth­ing omi­nous in the pat­tern. It is, after all, well-established his­tor­i­cally that earn­ings should come into line with slower-growing rev­enues in this, the third year of eco­nomic recov­ery. Besides, this year’s prob­a­ble 10% earn­ings growth, though only about half 2011’s pace, is suf­fi­cient to sus­tain the stock mar­ket rally.

This unfold­ing pat­tern of surge and mod­er­a­tion is hardly sur­pris­ing or new. It has, in fact, become a cycli­cal com­mon­place, a reflec­tion of the increas­ingly huge oper­at­ing lever­age of Amer­i­can busi­ness. Every year, busi­ness relies more and more on machin­ery, facil­i­ties, sys­tems, and other forms of tech­nol­ogy, often in place of labor. Because the trend builds a larger pro­por­tion of fixed costs into the pro­duc­tion model, even slight vari­a­tions in rev­enues have an exag­ger­ated impact on the bot­tom line. In the more dis­tant past, when vari­able labor costs were a big­ger part of the over­all pro­duc­tion equa­tion, lay­offs could reduce a sig­nif­i­cant part of over­all costs and so relieve some of the strain on the bot­tom line in reces­sions, and then, when rehir­ing raised labor costs in recov­ery, the prof­its recov­ery was more muted. But oper­at­ing lever­age has intro­duced a more volatile pattern.

The dra­matic effect was clear dur­ing the last reces­sion and in this recov­ery so far. In 2008-09, when the real econ­omy dropped 5.1% peak to trough over 18 months, rev­enues fol­lowed, but because busi­nesses had lit­tle abil­ity to cut costs, the full brunt of the down­turn fell on earn­ings, which, for the S&P 500, plunged from almost $22 a share in the sec­ond quar­ter of 2007 to a loss of more than $25 at the end of 2008. But how­ever much strain the oper­at­ing lever­age imposed in the reces­sion, it has worked in business’s favor in this recov­ery. As this huge array of pro­duc­tive cap­i­tal has come back on line, the fixed costs allowed vir­tu­ally all the addi­tional rev­enue to fall to the bot­tom line. And because prof­its are a small dif­fer­ence between rev­enues and costs, the small per­cent­age rev­enues gain have cre­ated huge per­cent­age changes in prof­its. But now, in this third year of expan­sion, when most of this pro­duc­tive cap­i­tal has at last become more fully uti­lized, the effect of oper­at­ing lever­age should dis­si­pate, forc­ing earn­ings to fol­low slower rev­enues growth more faithfully.

Still, even as 2012 fails to enjoy the remark­able earn­ings surges of 2010 and 2011, the out­look for this year is not entirely as depress­ing as some media reports imply. Earn­ings can still out­pace the 5–6% expected advance in domes­tic rev­enues because there is still some oper­at­ing lever­age left in the sys­tem and because S&P com­pa­nies gather more than half their rev­enues abroad. Europe’s reces­sion, of course, will weigh against for­eign rev­enue growth, but the emerg­ing economies should more than off­set Europe’s depress­ing influ­ence. Though these economies, too, have slowed, and that fact has attracted a lot of atten­tion, they still out­pace the United States and other devel­oped economies by far. China, after slow­ing, still reg­is­ters real growth of more than 8% and India more than 6%. In nom­i­nal terms (which, of course, is the way rev­enues are mea­sured), those economies should still con­tribute double-digit growth of their part of the 2012 S&P rev­enues equa­tion. Adding to likely 7–8% over­all rev­enues gains, the remains of oper­at­ing lever­age should bring S&P earn­ings up to about 10% in 2012.

That growth, though half last year’s pace, should nonethe­less allow equity mar­kets to hold the gains they have already made and likely rise fur­ther. Even after mar­ket gains of the last six months, val­u­a­tion mea­sures are far from stretched. Price-to-earnings mul­ti­ples, after all, depend­ing on which of the seem­ingly end­less cal­cu­la­tions one chooses, show a mar­ket that at worst is near its his­tor­i­cal val­u­a­tion bench­mark, allow­ing it room to keep up with earn­ings at least. Since, in most other respects, val­u­a­tions are still more attrac­tive, equity price advances should exceed the earn­ings growth. Stocks, rel­a­tive to Trea­sury bonds, offer val­u­a­tions not seen since the early 1950s or even the Great Depres­sion. Next to cor­po­rate bond yields, equity val­u­a­tions look less dra­matic, but still sug­gest con­sid­er­able upside poten­tial. It is note­wor­thy that, even today, div­i­dend yields on many stocks atyp­i­cally exceed the yields on the firm’s own bonds.

Since earn­ings, though slow­ing, are still show­ing sub­stan­tive growth, the most con­ser­v­a­tive inter­pre­ta­tion of val­u­a­tions would sug­gest that equi­ties should hold this year’s gains so far. Any­thing other than the most con­ser­v­a­tive inter­pre­ta­tion sug­gests greater gains.

¹The S&P 500^® Index is widely regarded as the stan­dard for mea­sur­ing large cap U.S. stock mar­ket per­for­mance and includes a rep­re­sen­ta­tive sam­ple of lead­ing com­pa­nies in lead­ing industries.

The opin­ions in the pre­ced­ing com­men­tary are as of the date of pub­li­ca­tion and sub­ject to change based on sub­se­quent devel­op­ments and may not reflect the views of the firm as a whole. This mate­r­ial is not intended to be legal or tax advice and is not to be relied upon as a fore­cast, or research or invest­ment advice regard­ing a par­tic­u­lar invest­ment or the mar­kets in gen­eral, nor is it intended to pre­dict or depict per­for­mance of any invest­ment. Investors should not assume that invest­ments in the secu­ri­ties and/or sec­tors described were or will be prof­itable. This doc­u­ment is pre­pared based on infor­ma­tion Lord Abbett deems reli­able; how­ever, Lord Abbett does not war­rant the accu­racy or com­plete­ness of the infor­ma­tion. Investors should con­sult with a finan­cial advi­sor prior to mak­ing an invest­ment decision.

Investors should care­fully con­sider the invest­ment objec­tives, risks, charges, and expenses of the Lord Abbett funds. This and other impor­tant infor­ma­tion is con­tained in each fund’s sum­mary prospec­tus and/or prospec­tus. To obtain a prospec­tus or sum­mary prospec­tus on any Lord Abbett mutual fund, con­tact your invest­ment pro­fes­sional or Lord Abbett Dis­trib­u­tor LLC at 888–522-2388 or visit us at www.lordabbett.com. Read the prospec­tus care­fully before you invest.

Tags: American Business, Bottom Line, Commonplace, Dramatic Effect, Earnings Growth, Economic Recovery, Forms Of Technology, Layoffs, Lord Abbett, Market Rally, Milton Ezrati, Moderation, Operating Leverage, Production Model, Proportion, Recession, Recessions, Reflection, Stock Market, Trough
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Where's the Collateral? (Smith)

Tuesday, May 1st, 2012

Sub­mit­ted by Charles Hugh Smith from Of Two Minds

Where's the Collateral?

A sound sys­tem of credit is built on col­lat­eral. A doomed sys­tem of debt sits pre­car­i­ously on phan­tom collateral.

The global "recov­ery" is based not on reduc­ing debt but on increas­ing it. Nice, but where's the col­lat­eral? The basic idea of debt is that credit is extended based on col­lat­eral, i.e. some­thing of endur­ing, trad­able value, or an income stream that isn't reduced to zero by non-discretionary spend­ing and taxes.

A funny thing hap­pened to col­lat­eral like hous­ing equity and finan­cial assets in the past four years–it shrank by tril­lions of dol­lars. Accord­ing to the lat­est Z1 "Bal­ance Sheet of House­holds and Non-Profits" from the Fed­eral Reserve, real estate fell by $4.9 tril­lion since the bub­ble top in 2007 and own­ers' equity lost $4.2 trillion.

Despite the stock mar­ket dou­bling since 2009 and a healthy run-up in the value of bonds, finan­cial assets shrank by $2 tril­lion as well.

These are non-trivial sums when we con­sider that col­lat­eral is gen­er­ally lever­aged. If a home buyer puts down 20% cash, then that cash col­lat­eral is lever­aged 4-to-1 in an 80% mort­gage. If the buyer puts down 3% (as in an FHA loan), then the lever­age is over 30-to-1.

Col­lat­eral mat­ters when it comes to assess­ing the value of the debt. If a bank lists the mort­gages in its "assets" col­umn at full value even though the under­ly­ing col­lat­eral (the houses) has lost much of their value, then the bank is grossly over-estimating the value and secu­rity of the mort­gage. The bank's "assets" are based on phan­tom collateral.

Take away $1 in col­lat­eral and you impair $4, $10, $20 or even $30 of debt.

Recall that the vast major­ity of real estate equity and finan­cial wealth is owned by the top 20%, with the major­ity of that con­cen­trated in the top 5%. That means the bot­tom 80% own lit­tle col­lat­eral to lever­age into debt.

How about lever­ag­ing income into more debt? Since the top 10% receive almost 50% of the income, and most of the bot­tom 90%'s income goes to non-discretionary spend­ing and taxes, then only the top 10% have dis­cre­tionary income that can be lever­aged into more debt.

Inter­est­ingly, The Wedge between Pro­duc­tiv­ity and Wages by econ­o­mist Mark Thoma reports that the enor­mous advances in pro­duc­tiv­ity over the past few decades did not trans­late into higher wages for the bot­tom 90%.

I have often addressed income dis­par­ity and the evap­o­ra­tion of col­lat­eral, for exam­ple, Two Amer­i­cas: The Gap Between the Top 5% and the Bot­tom 95% Widens (August 18, 2010) and The Hous­ing Bub­ble Broke the Mid­dle Class (April 27, 2011).

Regard­less of the var­i­ous causal fac­tors, the fact remains that 90% of Amer­i­can house­holds have lim­ited col­lat­eral or dis­cre­tionary income to lever­age into more debt. That leaves around 10 mil­lion house­holds (the top 10%) with the means to take on more debt–if they want to. Can 10% of the house­holds prop up the entire econ­omy with more debt and con­sump­tion? What if the wealthy decline the oppor­tu­nity to lever­age more debt?

We can also ask "where's the col­lat­eral?" of the bank­ing sec­tor. As fre­quent con­trib­u­tor Harun I. observed about the Euro­pean bank­ing sector's phan­tom collateral:

Euro­pean banks do not have enough money for deposit redemp­tions (peo­ple with­draw­ing their cash from the banks) and the only way to get it is to have the Euro­pean Cen­tral Bank (ECB) print money out of thin air thereby devalu­ing every euro, thereby destroy­ing pur­chas­ing power (you get your money but it buys less).

 

And what col­lat­eral are the banks pro­vid­ing for these loans? The sov­er­eign debt of coun­tries that are insol­vent. Why not sell the bonds to raise the cap­i­tal that is right­fully owed to depos­i­tors so that they could receive their money at par? Why then bond prices would tum­ble and gov­ern­ments would be forced to bor­row at much higher inter­est rates. But bor­row from whom? Insol­vent banks that must have money printed to give depos­i­tors their money back at a frac­tion of its worth from when they deposited it. Not due to mar­ket forces which indi­cate their labor is worth less but because every­body just wants what's right­fully theirs.

 

So to sum­ma­rize this, the ECB prints money to buy the bonds of insol­vent banks which are backed by the bonds of insol­vent nations. The result of which is insol­vent nations or in real­ity the peo­ple thereof are not only poorer, they are now respon­si­ble for pay­ing back money that was their prop­erty to begin with... at interest.

Put these two fac­tors together and you get a global econ­omy depen­dent on debt bor­rowed against phan­tom col­lat­eral and an Amer­i­can econ­omy in which only the top 10% have cred­i­ble col­lat­eral and income to lever­age into more debt. In a sane sys­tem, when the col­lat­eral van­ishes, so too does the debt (write­downs, write-offs, bank­ruptcy, take your pick). In an insane sys­tem, then phan­tom col­lat­eral sup­ports ever greater moun­tains of debt.

How long do you reckon the insane sys­tem we have now will last? The col­lat­eral is phan­tom, but the inter­est pay­ments are very, very real.

Tags: Balance Sheet, Bubble Top, Cash Collateral, Collateral Recovery, Discretionary Spending, Estate Equity, Federal Reserve, Fha Loan, Financial Assets, Funny Thing, Global Recovery, Home Buyer, Hugh Smith, Income Stream, Leverage, Reducing Debt, Stock Market, Trillion, Trillions, Z1
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The Fed Clarifies and the Market Yawns

Thursday, April 26th, 2012

by Peter Tchir, TF Mar­ket Advisors

I think we all know now what the Fed is think­ing. Ben is happy to add more liq­uid­ity to the sys­tem but is con­strained by a group that needs to see bad data before they can sup­port him. I think it is pretty straight­for­ward on the eco­nomic data front. Bad data, par­tic­u­larly in jobs and hous­ing will make the Fed react, but it will take some actual bad data, not just “blah” data like we have had the past few weeks.

The big­ger ques­tion is how quickly would Ben respond to a decline in the stock mar­ket? Although the Fed made it clear they focus on the econ­omy, there is strong evi­dence that they would react to a down­turn in the mar­ket, but I think they would be reluc­tant to move unless we saw a sig­nif­i­cant move. With­out weak data, I don’t think the Fed is in posi­tion to do any­thing until the S&P 500 broke 1,300 and bank stocks were under pres­sure. So there is a Bernanke put, but I think that put is much far­ther from “spot” than many investors believe.

Now that the Fed is out of the way, what else is there? Pretty much just the ECB is left with any near term abil­ity to “fix” the mar­kets. The IMF has raised its “fire­wall”. What the fire­wall accom­plishes is beyond me, but in any case, rumors of a big fire­wall can­not help the mar­kets any­more, so it really is going to take the ECB to pro­vide any form of gov­ern­ment or cen­tral bank stim­u­lus. Oth­er­wise we are left with earn­ings, which as I said on Bloomberg TV last night, are okay, but not great. There have been some big “beats”, with AAPL being the most obvi­ous, but there has been some weak guid­ance, and pre­tend­ing that ana­lysts don’t set “beat­able” num­bers is a bit silly. The game is clearly to set esti­mates that com­pa­nies can “beat” them, so unless it is an extremely big beat, don’t get too excited, and we do also seem back to a stage where some of the biggest earn­ings beats have been from com­pa­nies that took great pains in what they cat­e­go­rized as recur­ring or one-time charges.

Yesterday’s short cov­er­ing rally in Europe seems over. Today in CDS, Spain is 10 wider, at 475, while Italy is only 3 wider, help­ing con­firm that most of yesterday’s price action was short cov­er­ing as the most illiq­uid and most “beat up” names out­per­formed. Span­ish 10 year bonds are back out to 5.85% and briefly get­ting below 5.7% yes­ter­day. Remem­ber when 15 bps was a week’s worth of trad­ing, and not 24 hours? That con­tin­ued lack of liq­uid­ity remains a concern.

The eco­nomic data this morn­ing should move the mar­kets, and for once, I think bad news will be bad, and good news will be good, as the Fed’s posi­tion is pretty clear.

Then we will likely spend the entire after­noon track­ing moves in AAPL, since if not yet at the stage of “national pas­time” is cer­tainly the main thing for traders to focus on in the absence of any other news.

Fixed income ETF’s per­formed extremely well again yes­ter­day, with both HY ETF’s doing extremely well. I can­not find much to like about HYG and JNK at these prices. The under­ly­ing bonds that drive the yield are get­ting sketchy at these prices. While high yield still offers value, I think it is key to find some alpha as most of the beta has been squeezed out. Look­ing for spe­cific cred­its and spe­cific bonds for those cred­its is the most impor­tant it has been in at least a year (from the long risk standpoint).

Copy­right © TF Mar­ket Advisors

Tags: Aapl, Amp, Bank stocks, Beats, Bernanke, Decline, Downturn, Earnings, ECB, Economic Data, Estimates, Firewall, Form Of Government, Guidance, Imf, liquidity, Nbsp, Stimulus, Stock Market, Tf
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Dean Tenerelli: Why European Stocks Make Sense Now

Wednesday, April 25th, 2012

Why the world’s most reviled stock mar­ket could be poised for a sus­tain­able turn­around. T Rowe Price’s Euro­pean Stock Fund man­ager, Dean Tenerelli explains why Euro­pean stocks make sense now.

Tags: Dean, European Stock, European Stocks, Stock Fund, Stock Manager, Stock Market, T Rowe Price, Turnaround
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WSJ's Hilsenrath: Fed Will Stay Pat

Tuesday, April 24th, 2012

Before we get to Fed talk in the early action we've obvi­ously seen the S&P 500 break through 1370 (with vigor), and last week's lows of 1365s. The pre­vi­ous week's surge down to 1357 is the next key level. Now of course with sharp sell­offs there can be large reflex­ive bounces along the way – we saw that last Tues­day when the mar­ket sky­rock­eted on the back of Apple, but all that led to was more choppy action the rest of the week and then today's smack to the face. So unless one's timetable is mea­sured in hours it's a mar­ket com­plex­ion one does not want to be deal­ing with much.

Off to Fed speak… as long time read­ers know the Fed has its spe­cial lit­tle birdies in the media that it likes to speak to us through, and Jon Hilsen­rath is among the most promi­nent. Not sur­pris­ingly Jon says the Fed will stay pat at this meet­ing – I believe the key one shall be mid June as Oper­a­tion Twist fin­ishes up, and they need a replace­ment pro­gram. Any good cor­rec­tion in the mar­ket will also help as the Fed now believes their trans­mis­sion pol­icy for Fed can largely come through the tran­si­tory "wealth effect" of the stock mar­ket – even if that ben­e­fit accrues to a rel­a­tively small por­tion of soci­ety. [Nov 10, 2010: Who Will Any Form of Inter­me­di­ate Term Wealth Effect Really Help? Not the Masses] On that end, we're prob­a­bly half way to the point Ben will feel he must step in to make sure the "free" mar­ket goes up.

• If the Fed expects eco­nomic growth to slow, infla­tion to fall, or unem­ploy­ment to stall at high lev­els or rise, it will be inclined to do more to sup­port growth with new pro­grams to reduce inter­est rates. If it sees the oppo­site, the con­ver­sa­tion turns toward rein­ing in credit. The chang­ing fore­cast will be one of the most impor­tant top­ics of dis­cus­sion at the cen­tral bank's pol­icy meet­ing Tues­day and Wednes­day, when offi­cials will update their quar­terly eco­nomic projections.
• It's pos­si­ble to hand­i­cap the Fed's chang­ing fore­cast in part because offi­cials are becom­ing open about it. And the out­look doesn't look like it's shift­ing in a way that would sup­port new ini­tia­tives to boost eco­nomic growth. The new fore­casts could project a lit­tle more infla­tion in 2012 than the Fed fore­cast in Jan­u­ary, thanks in part to a recent rise in gaso­line prices. It could also project a lit­tle less unem­ploy­ment for 2012, thanks to recent declines in the job­less rate.
• But with many offi­cials still doubt­ful about the dura­bil­ity of the recov­ery and expect­ing infla­tion to recede, the broader view at the Fed seems likely to favor stick­ing to their plan to keep rates low until late 2014.
• Taken alto­gether, the econ­omy doesn't seem to be break­ing in a way right now that would cause the Fed to shift the stance it laid out in Jan­u­ary. Investors expect­ing a sig­nal of an early rise in rates are likely to be dis­ap­pointed. And those expect­ing a new bond buy­ing pro­gram are likely to be dis­ap­pointed too. The Fed is on hold until its fore­cast shifts more clearly.

Tags: Amp, Bounces, Complexion, Economic Growth, Economic Projections, inflation, interest rates, Last Tuesday, Little Birdies, Lows, Rest Of The Week, Selloffs, Small Portion, Stock Market, Time Readers, Timetable, Unemployment, Vigor, Wealth Effect, Wsj
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Technical Take: Bulls Lose Enthusiasm

Sunday, April 22nd, 2012

by Guy Lerner, The Tech­ni­cal Take

The “dumb money” indi­ca­tor has become more neu­tral sug­gest­ing that the bulls have lost enthu­si­asm for this bull mar­ket.  As can be seen in fig­ure 1 (below), the indi­ca­tor has dropped below the upper trad­ing band (green arrow).  From this per­spec­tive, the play­book becomes real sim­ple.  If the indi­ca­tor moves back above the upper trad­ing band, then investors are putting risk back on, and all in like­li­hood, this would rep­re­sent the last gasp of spec­u­la­tion in an aging bull mar­ket.  This would be worth play­ing for.  The other option and the next best time to buy equi­ties would be when there are too many bears (i.e., bull sig­nal), and this occurs when the indi­ca­tor drops below the lower trad­ing band (red arrow).  The best and most effi­cient way for this sce­nario to develop is by hav­ing lower prices.  Period.  With the indi­ca­tor neu­tral, the bulls have lost their mojo and there is lit­tle edge.

As a reminder, the 2011 mar­ket top took over 6 months to develop.  The S&P 500 trav­eled in a nar­row 75 point range before drop­ping 20% over a 4 week perid.  The top can best be described as a period of dis­cus­sion.  Is the econ­omy sput­ter­ing?  Will the Euro­pean con­ta­gion effect the US econ­omy?  Will the fis­cal cliff be real­ized?  And of course, the #1 topic of dis­cus­sion and the only one that mat­ters: will there be QE3?  This all sounds familiar.

The “Dumb Money” indi­ca­tor (see fig­ure 1) looks for extremes in the data from 4 dif­fer­ent groups of investors who his­tor­i­cally have been wrong on the mar­ket: 1) Investors Intel­li­gence; 2) Mar­ket­Vane; 3) Amer­i­can Asso­ci­a­tion of Indi­vid­ual Investors; and 4) the put call ratio. This indi­ca­tor is now neu­tral. The data shows that the opti­mal sign to sell is 1 week after the indi­ca­tor crosses below the upper trad­ing band. But these are opti­mal sce­nar­ios, and I should cau­tion that opti­mal and stock mar­ket are rarely spo­ken of in the same sen­tence. The mar­ket is just too unpre­dictable. Who saw the May, 2010 “flash crash” or the 20% drop over 3 weeks in 2011 com­ing? If you hang around too long, you could be one of those casu­al­ties. Alas, there are no right answers or guar­an­tees. These are just sign­posts that help us bet­ter under­stand the price action.

Fig­ure 1. “Dumb Money”/ weekly

Fig­ure 2 is a weekly chart of the S&P 500 with the Insid­er­Score “entire mar­ket” value in the lower panel. From the Insid­er­Score weekly report: “An Indus­try Buy Inflec­tion, our strongest quan­ti­ta­tive sig­nal of pos­i­tive sen­ti­ment, was trig­gered in the Rus­sell 2000 last week as buy­ers out­num­bered sell­ers for the first time since the final week of Novem­ber 2011. It was the first time an Indus­try Buy Inflec­tion was trig­gered since August 2011, when insid­ers bought at their most aggres­sive pace since the multi-year mar­ket bot­tom of March 2009. Qual­i­ta­tively the activ­ity within the Rus­sell 2000 is sim­i­lar to what we wit­nessed in June 2011 when an Indus­try Buy Inflec­tion was also triggered.”

Fig­ure 2. Insid­er­Score “Entire Mar­ket” value/ weekly

Fig­ure 3 is a weekly chart of the SP500. The indi­ca­tor in the lower panel mea­sures all the assets in the Rydex bull­ish ori­ented equity funds divided by the sum of assets in the bull­ish ori­ented equity funds plus the assets in the bear­ish ori­ented equity funds. When the indi­ca­tor is green, the value is low and there is fear in the mar­ket; this is where mar­ket bot­toms are forged. When the indi­ca­tor is red, there is com­pla­cency in the mar­ket. There are too many bulls and this is when mar­ket advances stall. Cur­rently, the value of the indi­ca­tor is 65.34%. This is the sec­ond week in a row that the indi­ca­tor has turned down week over week. Val­ues less than 50% are asso­ci­ated with mar­ket bot­toms. Val­ues greater than 58% are asso­ci­ated with mar­ket tops. It should be noted that the mar­ket topped out in 2011 with this indi­ca­tor between 70% and 71%.

Fig­ure 3. Rydex Total Bull v. Total Bear/ weekly

Copy­right © The Tech­ni­cal Take

Tags: American Association Of Individual Investors, Best Time, Bulls, Contagion Effect, Dumb Money, Extremes, Figure 1, Green Arrow, Guy Lerner, Last Gasp, Likelihood, Market 1, Marketvane, Mojo, Playbook, Put Call Ratio, Red Arrow, Reminder, S&P500, Scenarios, Speculation, Stock Market
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Man Vs Machine: How Each Sees The Stock Market Part 2

Saturday, April 14th, 2012

Two weeks ago we shared a post on the topic of vari­ant per­cep­tion, specif­i­cally how the two dis­tinct classes of mar­ket par­tic­i­pants, humans and machines, view their nat­ural habi­tat. Judg­ing by the inter­est in the arti­cle, this approach to break­ing cog­ni­tive dis­so­nance was quite wel­come, which is why cour­tesy of Nanex, we bring you part two.

This is what you see:

This is what HFT-bot (which accord­ing to the SEC pro­vides liq­uid­ity by lift­ing limit offers) sees:

The actual move up took just 275 milliseconds:

Tags: Cognitive Dissonance, Distinct Classes, liquidity, Market Participants, Milliseconds, Natural Habitat, Perception, Sec, Stock Market
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The Outlook for Earnings (Brown)

Tuesday, April 10th, 2012

by Dr. Scott Brown, Ph. D, Chief Econ­o­mist, Ray­mond James

April 9 – April 13, 2012

The stock mar­ket has risen nicely this year, partly on improv­ing eco­nomic data, but are such gains jus­ti­fied by the earn­ings out­look? The level of the S&P 500 Index does not appear to be out of line with earn­ings expec­ta­tions, but there may be some pres­sure on prof­its over the longer term. As the elec­tion approaches, we may hear more about class warfare.

In the late 1990s, share prices rose more than was jus­ti­fied by the earn­ings out­look. In hind­sight, the mar­ket was clearly in a bub­ble. In the last decade, the mar­ket rose roughly in line with earn­ings. How­ever, the Great Reces­sion sent earn­ings sharply lower, and the stock mar­ket fol­lowed. Since the reces­sion has ended, earn­ings have more than recov­ered. Bottom-up earn­ings esti­mates for more than a year out, com­piled from ana­lysts’ fore­casts of indi­vid­ual com­pa­nies, still look a bit giddy, but that’s typ­i­cal. Top-down esti­mates, pro­vided by econ­o­mists and strate­gists, are more mod­er­ate – and con­sis­tent with some slow­ing in cor­po­rate earn­ings rel­a­tive to the last few years. That’s to be expected. Much of the rebound in earn­ings has reflected the bounce-back from the reces­sion. Firms have a ten­dency to cut too many jobs and overly cur­tail cap­i­tal expen­di­tures near the end of the down­turn and there’s some catch-up as con­di­tions begin to improve.

Click here to enlarge

Part of the strength in cor­po­rate prof­its in the recov­ery has been due to the restraint in labor costs. Given the large amount of slack in the labor mar­ket, wage pres­sures are rel­a­tively sub­dued. More­over, since the labor mar­ket slack is expected to remain ele­vated for some time, cor­po­rate prof­its are likely to stay rel­a­tively strong. As a per­cent­age of national income, cor­po­rate prof­its are very high and labor com­pen­sa­tion is rel­a­tively low. The share of national income going to prof­its and the share going to labor cycles back and forth over time and at some point the pen­du­lum seems likely to swing back in the other direc­tion, but prob­a­bly not any­time soon.

Click here to enlarge

It’s hard to have an intel­li­gent dis­cus­sion about the dis­tri­b­u­tion of income. One side sites “cor­po­rate greed,” the other sites “class envy.” For the most part, econ­o­mists have gen­er­ally shied away from income dis­tri­b­u­tion issues. This is mostly a ques­tion of pol­i­tics. It’s dif­fi­cult to say what an “appro­pri­ate” dis­tri­b­u­tion of income should be and what steps should be taken to achieve it.

How­ever, there’s no doubt­ing that the dis­tri­b­u­tion of income has widened sig­nif­i­cantly over the last thirty years. Real wages have stag­nated. A lot of that is due to the decline of union mem­ber­ship. In the early 1970s, 25% of private-sector jobs were union jobs. Now unions account for less than less than 7% (note that 37% of public-sector jobs are union, but many of these are teach­ers and the dynam­ics are a lot dif­fer­ent). In the late 1960s and early 1970s, we typ­i­cally had more than 300 work stop­pages per year, involv­ing mil­lions of work­ers. We had 19 last year, involv­ing 113,000 workers.

It’s unclear what role the dis­tri­b­u­tion of income will take in this year’s elec­tion, but investors should pay attention.

Tags: Capital Expenditures, Chief Economist, Class Warfare, Corporate Earnings, Corporate Profits, Downturn, Dr Scott, Earnings Estimates, Economic Data, Hindsight, Individual Companies, Labor Compensation, Last Decade, Raymond James, Recession, Share Prices, Slack, Stock Market, Strategists, Wage Pressures
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Has the Bear Market for Bonds Begun? (Schwab)

Monday, April 9th, 2012

April 5, 2012

by Rob Williams, Direc­tor of Income Plan­ning, Schwab Cen­ter for Finan­cial Research, and

Has the Bear Mar­ket for Bonds Begun?

Why are inter­est rates still so low? The econ­omy is recov­er­ing, unem­ploy­ment is falling, gaso­line prices are ris­ing and the stock mar­ket has dou­bled in value in the last three years. We’ve noted the com­men­tary lately about an end to a 30-year bull mar­ket in bonds, and whether investors are at sig­nif­i­cant risk for losses if rates rise. The ten­dency, as we’ve seen it, is to worry about these broad con­cerns with a mix of skep­ti­cism and fear. While we think that inter­est rates will con­tinue a mod­est increase over the rest of this year, we’re less con­vinced that we’ll see a sharp, uncon­trolled spike in rates or decline in investor demand. We see other long-term struc­tural sup­ports, with a few of the larger ones high­lighted here.

• De-risking sup­ports demand for bonds. The sim­plest expla­na­tion for why rates are so low is that investors—individual and institutions—are still ‘de-risking.' For indi­vid­ual investors, the expla­na­tion for the propen­sity to favor bonds over stocks is pretty straight­for­ward. Since 2000, indi­vid­ual investors, in aggre­gate, have gone from prince to pau­per one too many times. After a period of low volatil­ity dur­ing the 1990s, we’ve moved to a period of excep­tion­ally high volatil­ity. Not only have returns from the stock mar­ket been volatile, but net worth has been volatile as well thanks to the drop in home prices. Aging investors may sim­ply want to hold on to more of what they have, sup­port­ing demand for bonds.
• More impor­tantly, insti­tu­tional investors are de-risking as well. We focus on indi­vid­ual investors, of course, but the U.S. bond mar­ket has been dri­ven, by-and-large, by large insti­tu­tions such as pen­sion funds, insur­ance com­pa­nies, global banks and inter­na­tional sov­er­eigns. This is an enor­mous mar­ket, and they are de-risking as well. In our view, pen­sion funds, insur­ance com­pa­nies and oth­ers with lia­bil­i­ties to fund have been, and will likely con­tinue, to reduce expo­sure to riskier assets in favor of bonds. Here are a few statistics:

1. Accord­ing to Ned Davis and the Fed­eral Reserve, in 1953 bonds accounted for 84% of assets invested in U.S. insur­ance and pen­sion funds. The per­cent­age has fallen steadily since then, to 40% of $15.7 tril­lion in global assets as of the end of 2011. (Yes, tril­lion.) Over the same period, the allo­ca­tion to stocks rose from under 8% in 1953 to peaks of over 42% in the late 1990s and mid-2000s before falling back to under 34% today with the rest allo­cated to bonds and other investments.
2. Accord­ing to Mil­li­man, a pen­sion fund con­sult­ing com­pany, cor­po­rate pen­sion funds are under-funded by $372 bil­lion. Munic­i­pal pen­sions are under-funded by tril­lions more. After dis­ap­point­ing returns from equi­ties, many are shift­ing slowly back to a more tra­di­tional method of match­ing fixed assets with future lia­bil­i­ties. On the mar­gins of this multi-trillion dol­lar mar­ket, a one-percentage point move is a big deal.
3. Insur­ance com­pa­nies face sim­i­lar met­rics. Many will need to add more fixed income to match future lia­bil­i­ties. Accord­ing to Mer­cer, an insur­ance con­sul­tant, demand for fixed income secu­ri­ties from insur­ance com­pa­nies could run in the range for $500 to $600 bil­lion annually.

• Demo­graph­ics are also chang­ing. It's no secret that the U.S. pop­u­la­tion is aging and that the first wave of "baby boomers" is retir­ing. Some have been pushed into early retire­ment while oth­ers have cho­sen to stop work­ing. It’s our sense that many investors may remain less inclined toward extra risk with the money they have to live on for the next few decades, for a grow­ing por­tion of their port­fo­lios. Return of cap­i­tal, in nom­i­nal terms, may be as impor­tant as return on it, at least for money that doesn't have as much time to recover from volatil­ity in other markets.
• And then there's the Fed. The other big fac­tor hold­ing down yields, of course, is the Fed. Over the past year, the Fed has pur­chased 61% of new Trea­sury issuance, keep­ing a cap on rates. With the fed funds rate at zero and the Fed buy­ing long-term bonds, yields are likely to remain low as long as those poli­cies are in place. Right now, the Fed is indi­cat­ing that the pol­icy is expected to last another year or more. We’ll know more when they meet next in late April to see if they com­mu­ni­cate any change in tone. But for now, state­ments from Fed Chair­man Bernanke and oth­ers show that the Fed remains cau­tious about the strength of recent eco­nomic num­bers, still wor­ried about slow­ing growth in Europe and China, and believes that unem­ploy­ment needs to be lower before they are close to ful­fill­ing their mandate.
• This analy­sis is not meant to say that inter­est rates will stay low for­ever or that long-term Trea­sury bonds are attrac­tively val­ued. At some point, when the econ­omy appears to be on firmer foot­ing and/or infla­tion expec­ta­tions rise sub­stan­tially, the Fed is expected to begin to unwind its pro­grams and inter­est rates are likely to move higher. We've already seen a mod­est rise in rates off lows in late March, and we'd expect to see a slowly ris­ing trend through the rest of the year. We look for­ward to the time when rates begin to move up a bit, actu­ally, because it’ll mean that the econ­omy is health­ier and investors face addi­tional options for return on their sav­ings. How­ever, we don't know when that time will arrive, and we're not in the camp that sees rates ris­ing dra­mat­i­cally any­time soon for many of the rea­sons we've cited above. Still, we think it’s a good time to look at your allo­ca­tion to dif­fer­ent types of bonds, by credit risk and matu­rity. It's dif­fi­cult to pre­dict inter­est rates, and you can’t con­trol them. But you can con­trol what you hold in your portfolio.

Q1 2012 Sec­tor Performance

The wide range of per­for­mance between dif­fer­ent sec­tors of the global bond mar­ket, by matu­rity and level of credit risk, reminds us that the bond mar­ket defies easy gen­er­al­iza­tion. Not all bonds are cre­ated equal. Dur­ing the quar­ter, there was a sharp price-driven appre­ci­a­tion in ‘riskier' assets, such as cor­po­rate, high yield and emerg­ing mar­ket bonds, while long-term Trea­sury bonds fell as yields rose. Over­all, we expect we'll see sim­i­lar per­for­mance by sec­tors through much of the rest of 2012, with yields ris­ing mod­estly for Trea­suries on improved eco­nomic data, with peri­ods of volatil­ity and re-trenching if we see weaker data or con­cerns about global growth.

• Flat line on returns for the tax­able bond index. The Bar­clays US Aggre­gate Bond Index turned in a mea­ger per­for­mance over the first quar­ter, deliv­er­ing 0.3% in total return on the com­bi­na­tion of coupons and a mod­est drop the price of the index as yields for gov­ern­ment bonds rose sharply in March. For those focused on income, the index is now yield­ing north of 2.2% with an aver­age dura­tion (i.e. the weighted aver­age tim­ing of inter­est and prin­ci­pal pay­ments, and a mea­sure of inter­est rate risk) of just under 5 years. We expect that income will drive returns for much of the rest of this year, with a range on inter­est rate risk most likely through year-end.
• Invest­ment grade cor­po­rate bonds, includ­ing finan­cials, out­per­formed. High-grade cor­po­rate bonds were the pri­mary ben­e­fi­ciary of increased risk-appetites and yield-chasing, a theme that's con­tin­ued from late 2011 into 2012. But per­for­mance was not spread out evenly across asset classes. The finan­cial and bank­ing sec­tor, a lag­gard as recently as Q3 2011, beat util­i­ties and indus­tri­als over the last three months. This is thanks in part to improv­ing mar­ket con­di­tions and no real neg­a­tive sur­prises in the Fed's recent bank stress tests. Few investment-grade sec­tors look cheap now, a con­cern for investors who have been look­ing for yield and pour­ing money into cor­po­rate bonds. We're more cau­tious at the moment, given the strong recent run. It may make sense to look for oppor­tu­ni­ties when they present them­selves at more attrac­tive lev­els. The cycle, to us, still favors credit.

Q1 2012 Sec­tor Performance

Source: Bar­clays, as of March 30, 2012. Shown above are total returns for cor­re­spond­ing Bar­clays indices. Past per­for­mance is not indica­tive of future results.

• High-yield returns show the shift in sen­ti­ment toward yield and risk. More return poten­tial means more risk, of course. We think the cycle still favors credit, as we've said, with high yield beat­ing the pack with a 5.3% return for the quar­ter plus a 5+% yield pre­mium over Trea­suries. With cor­po­rate bal­ance sheets gen­er­ally appear­ing strong, it looks like investors are being ade­quately com­pen­sated for risk, rel­a­tive to the alter­na­tives. An impor­tant con­sid­er­a­tion, as always, is not to push the invest­ment the­sis too far, tilt­ing too far away from the more con­ser­v­a­tively invested core bond port­fo­lio in the search for yield.
• Euro-zone risk eases, boost­ing inter­na­tional per­for­mance. Euro­zone trou­bles are far from over, but two rounds of liq­uid­ity injec­tions and orderly Greek ‘restruc­tur­ing' did help to tem­per uncer­tainty so far in Q1. For­eign bonds ben­e­fited, while emerg­ing mar­kets ben­e­fited more, due pri­mar­ily to the improved appetite for risk assets. Emerg­ing mar­ket debt mir­rored U.S. high yield for a 5.9% total return. In the cur­rent low-rate cli­mate, a com­bi­na­tion of emerg­ing mar­ket and U.S. high yield bonds may still make sense for the more ‘aggres­sive' sleeve of a more risk-seeking portfolio.

Mea­sur­ing Inter­est Rate Risk

We started the con­ver­sa­tion in this newslet­ter with thoughts on the bull mar­ket for bonds. Is it over? More impor­tantly, is the bear mar­ket for bonds under­way? If rates rise, what risks do you face? Mea­sur­ing risk is bet­ter than guess­ing, in our view. Duration—the weighted aver­age time until pay­ment of inter­est and prin­ci­pal on bonds—is one measure.

• The U.S. tax­able bond mar­ket has a dura­tion today of 5 years. The aver­age matu­rity is around 7 years. The ten­dency is to look at and refer to the 10-year or 30-year Trea­sury as a bench­mark or bell-weather for the larger mar­ket for bonds. But it's worth remem­ber­ing that the mar­ket as a whole has shorter matu­ri­ties on aver­age. Longer-term bonds are riskier, if rates rise. But long-term bonds are part, not all, of the entire mar­ket. If you hold a port­fo­lio with a mix of short– to intermediate-term bonds, you may not have much expo­sure to long-term bonds. A port­fo­lio focused on short– to intermediate-term bonds, with matu­ri­ties between 1 and ten years, is good place to start, in our view, for most investors.
• A tax­able bond mar­ket with dura­tion of 5 would be expected to fall roughly 5% in value if rates rise 1%. This esti­mate is a rule of thumb, using dura­tion as a mea­sure of risk. It assumes a 1% increase in rates across the yield ‘curve'—meaning at every matu­rity, and for every bond. If rates across the curve rise 2%, from 2.2% to 4.2% on the 10-year Trea­sury, for exam­ple, and at every other matu­rity from one out to 30 years or more, the value should fall 10%. This is rough, but gives a sense of how much dam­age an investor might feel if invested in a broadly diver­si­fied port­fo­lio of short– and intermediate-term bonds or funds. Shorter-maturities are less sen­si­tive, gen­er­ally, if rates rise, than longer-maturity bonds. Bonds with higher coupons are gen­er­ally less sen­si­tive also, com­pared to bonds (Trea­suries, for exam­ple) where coupons tend to be lower. The income paid by bonds in the form of coupons off­set a por­tion of these price changes, espe­cially if inter­est is rein­vested at higher yields and com­pounded over time.
• The cur­rent bench­mark dura­tion of 5 is also around the aver­age dura­tion for the aver­age intermediate-term bond fund. Intermediate-term bond funds have dura­tions of 3.5 to 6 years (or, if dura­tion is unavail­able, aver­age effec­tive matu­ri­ties of four to ten years), using the def­i­n­i­tion that Morn­ingstar uses to define mutual fund cat­e­gories. “These port­fo­lios are less sen­si­tive to inter­est rates, and there­fore less volatile, than port­fo­lios with longer dura­tions,” says Morningstar.
• Short-term bond funds have a dura­tion of one to 3.5 years, on aver­age, accord­ing to Morn­ingstar. So if short-term rates rose 1%, short-term funds would be expected to fall in value by 1% to 3.5%. We gen­er­ally sug­gest short-term bonds or funds for money needed within 1 to 3 years, with cash invest­ments or bonds that are near­ing matu­rity for money needed sooner. Short-term rates will rise, ulti­mately. But it seems less likely that they will until the Fed changes poli­cies and says that they will, to us. The Fed can gen­er­ally drive short-term rates more directly than they can long-term rates using tra­di­tional mon­e­tary pol­icy includ­ing the Fed funds rate.
• In con­trast, long-term bond funds, espe­cially those with heavy Trea­sury expo­sure, involve the high­est risk if rates rise. Dura­tions for long-term funds are gen­er­ally 6 years or longer, often con­sid­er­ably longer. This is where investors who have ben­e­fited from strong cap­i­tal appre­ci­a­tion in long-term bonds or funds can look to take some ‘dura­tion' off the table, re-positioning a por­tion of strong gains by short­en­ing dura­tion back to bench­mark. It may not be the most attrac­tive place, in our view, for most investors to think about adding money now.
• You can tar­get dura­tion, using lad­ders or funds. As a place to start, we think investors should con­sider a mix of short– and intermediate-term bond funds, for a mix of lower inter­est rate sen­si­tiv­ity (in short-term funds) and income poten­tial with mod­er­ate risk (intermediate-term funds). It may sound like a bro­ken record, we know, but we still like bond lad­ders with a mix of matu­ri­ties from ready-to-mature out to around 10 years. When inter­est rates rise, there will be short-term bonds matur­ing to rein­vest for higher yields. And lad­ders can help reduce the over­all volatil­ity in the bond port­fo­lio. This kind of port­fo­lio helps with a plan to man­age inter­est rate risk proactively.

Please visit www.schwab.com/onbonds for more fixed income per­spec­tive from the Schwab Cen­ter for Finan­cial Research. If you have ques­tions or con­cerns about the issues raised in this pub­li­ca­tion, please speak to your Schwab representative.

Impor­tant Disclosures

Tags: Bear Market, Bond Market, Bond Markets, Bonds, Fixed Income, Gasoline Prices, Global Bond, Individual Investors, Interest Rate Risk, Investor Demand, Net Worth, Pauper, Propensity, Schwab, Skepticism, Stock Market, Strategist, Structural Supports, Volatility, Well Thanks
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Man Vs Machine: How Each Sees The Stock Market

Wednesday, April 4th, 2012

What you see with one min bars:

What the algos see in 9.5 sec­onds:

Cour­tesy of Nanex

Tags: Man Machine, Stock Market
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Comfortably Numb: Have Investors Become Too Complacent?

Wednesday, April 4th, 2012

Com­fort­ably Numb: Have Investors Become Too Complacent?

April 2, 2012

Let's get right to the point: It was the best first quar­ter for the stock mar­ket since 1998. The total return of the S&P 500 index® was 12.6% for the quar­ter; up nearly 30% from the Octo­ber 3, 2011 low. What was par­tic­u­larly notable about the surge since then has been the atten­dant plunge in volatility.

Com­pla­cency?

As you can see in the chart below, the CBOE Volatil­ity Index (VIX) has dropped dra­mat­i­cally from its high of 48 last August (when Washington's fear­less lead­ers failed to con­struct a debt deal, lead­ing to Stan­dard & Poor's down­grade of US debt) to 15 recently.

Plung­ing Volatility

Source: Fact­Set, as of March 30, 2012.

Many investors—notably those painfully on the sidelines—have sug­gested this shows a high level of com­pla­cency. And the fact that trad­ing vol­ume has been weak has been another pil­lar in the bears' case for why the "rally isn't for real." (See more on trad­ing vol­ume later in this report.)

Most read­ers know I have been opti­mistic, and remain so. But, the con­trar­ian in me does have some sym­pa­thy for the case that opti­mism has become ele­vated enough to offer a head­wind for the mar­ket in the near term.

I am a big fan of the sen­ti­ment work done by Ned Davis Research (NDR) and SentimenTrader.com. NDR noted recently in a report that the recent backup in Trea­sury yields has accom­pa­nied a rise in opti­mism by investors, and this com­bined indi­ca­tor did flash a short-term sell sig­nal for the mar­ket. That said, NDR argues, and I con­cur, that yields remain extremely low and as such, are not "bit­ing" stocks yet.

Ele­vated opti­mism = near-term headwind

Below is NDR's most widely-followed sen­ti­ment mea­sure, its Crowd Sen­ti­ment Poll, and as you can see, accom­pa­ny­ing the market's rally has been a surge in opti­mism into the "uncom­fort­able" zone. Given a bit chop­pier action lately by stocks, I am hope­ful we will see a wan­ing of this opti­mism, at least back into the neu­tral zone.

Ele­vated Optimism

Source: Fact­Set, Ned Davis Research (NDR), Inc. (Fur­ther dis­tri­b­u­tion pro­hib­ited with­out prior per­mis­sion. Copy­right 2012 © Ned Davis Research, Inc. All rights reserved.), as of March 27, 2012.

Another sen­ti­ment met­ric show­ing ele­vated opti­mism is SentimenTrader's Smart Money/Dumb Money Con­fi­dence index, shown below.

Smart Money Warm­ing Up to Market

Source: Fact­Set, SentimenTrader.com, as of March 30, 2012.

Although no where near the recent extremes of smart money pes­simism and dumb money opti­mism, it bears watch­ing. The good news is that the gap has begun to nar­row in a favor­able way. Remem­ber, as the labels sug­gest, the smart money tends to be right at extremes of sen­ti­ment, while the dumb money tends to be wrong.

Crash wor­ries still abound

But not all sen­ti­ment met­rics are cre­ated equal. One I dis­cov­ered recently is put together by the folks at Yale and it mea­sures the per­cep­tions about the like­li­hood of a stock mar­ket crash among indi­vid­ual and insti­tu­tional investors. I quib­ble with the way they pose the ques­tion, mak­ing the chart a lit­tle dif­fi­cult to deci­pher, but let me explain. First, see the chart below:

Crash Like­li­hood Still Seen as High

Source: Fact­Set, Yale School of Management/International Cen­ter for Finance, as of Feb­ru­ary 28, 2012.

The ques­tion is asked in a way that the read­ing expresses the per­cent­age of sur­vey respon­dents that believe a crash will not occur. In other words, as per the lat­est read­ings, less than 25% of the survey's respon­dents, either indi­vid­ual or insti­tu­tional, believe the mar­ket won't suf­fer a crash. Put another way, more than 75% believe there's a high like­li­hood of a crash. This is a clear sign that the "wall of worry" the stock mar­ket likes to climb is still very much intact.

Investors lov­ing bonds

Much of what I've high­lighted above are sen­ti­ment mea­sures of atti­tudes, not actions. One clear way to judge the lat­ter is to look at mutual fund flows. Given that the past five years have seen a record $1.3 tril­lion spread in favor of bonds over stocks, I agree with the notion that investors have yet to become overly enthused by stocks.

All About Bonds

Source: Fact­Set, Invest­ment Com­pany Insti­tute, as of Feb­ru­ary 28, 2012.

I also think fund flows help explain why trad­ing vol­ume has been so low. Sim­ply, the retail investor has not been engaged with this mar­ket rally and much money has remained on the side­lines. Add to that the fact that high-frequency traders (HFT), which accounted for over 70% of last year's trad­ing vol­ume at times, are under a mag­ni­fy­ing glass held by the Secu­ri­ties and Exchange Com­mis­sion (SEC) for ques­tion­able trad­ing prac­tices. This has likely kept many of the HFTs in hibernation.

Busi­nesses happy; con­sumers less so

Let me step off the mar­ket path for a moment and share another inter­est­ing sen­ti­ment analy­sis. Last Wednes­day, the Busi­ness Round­table recently released its first quar­ter CEO Eco­nomic Out­look Sur­vey, pre­ceded the day before by the release of the Con­fer­ence Board's mea­sure of con­sumer con­fi­dence. CEOs are now as opti­mistic as they were dur­ing much of the pre-recession period. Although they cite head­winds includ­ing Europe, China, oil prices and US polit­i­cal uncer­tainty, they do not believe they will mate­ri­ally impact their business.

On the other hand, con­sumer con­fi­dence pulled back from a still-weak read­ing in the lat­est report. It had risen sharply in Feb­ru­ary. The level of con­fi­dence, with a head­line of 70, is well below where the index stood dur­ing prior eco­nomic expansions.

For what it's worth, CEO con­fi­dence has his­tor­i­cally acted in a sim­i­lar man­ner as the afore­men­tioned "smart money" and its high level of con­fi­dence is com­fort­ing. On the other hand, very weak peri­ods of con­sumer con­fi­dence have typ­i­cally been accom­pa­nied by higher stock mar­ket gains, as the con­sumer has his­tor­i­cally acted in a sim­i­lar man­ner as the afore­men­tioned "dumb money."

Schwab's sur­vey says

Finally, we have a new sur­vey from Schwab of its active traders. The lat­est Charles Schwab Active Trader Sen­ti­ment Sur­vey polled 421 indi­vid­ual investors who trade fre­quently and found 51% now con­sider them­selves bullish—the high­est level since we began track­ing active trader sen­ti­ment in April 2008. This is up from only 25% in Octo­ber 2011. Only 14% say they are cur­rently bearish.

In sum, my opti­mism in the medium-to-long-term has not been dented by the lat­est sen­ti­ment read­ings. Last week was the 26th con­sec­u­tive week of better-than-expected eco­nomic news. Of the 17 indi­ca­tors that ISI tracks that did a good job track­ing 2010 and 2011 double-dip reces­sion con­cerns, only two are presently weak­en­ing, with First Call's earn­ings revi­sion index notably strong. How­ever, I do think the mar­ket has become more vul­ner­a­ble to neg­a­tive news in the short term.

Impor­tant Disclosures

Tags: Cboe Volatility Index, Charles Schwab, Chief Investment Strategist, China, Complacency, Contrarian Indicator, Debt Deal, Factset, Fearless Leaders, Headwind, Liz Ann, Ndr, Ned Davis Research, Optimism, Plunge, Senior Vice President, Sentimentrader, Sidelines, Stock Market, Treasury Yields, Volatility Index Vix
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Chuck Royce: Why the Rally Can Last

Tuesday, April 3rd, 2012

by Chuck Royce, Royce Funds

Can the cur­rent rally last through the end of the year?

I think it can. What's inter­est­ing to me is that we're see­ing one of those rare occa­sions when one of our pre­dic­tions for the mar­ket as a whole worked out almost exactly the way we thought it would. For a while now, we have been not­ing the dis­junct between the very neg­a­tive and alarmist head­lines and the more opti­mistic view our own analy­ses and con­tacts with man­age­ments were reveal­ing. It seemed to us as early as last Sep­tem­ber that the econ­omy was in bet­ter shape than the con­ven­tional wis­dom was suggesting.

"I think we're on our way to a pos­i­tive and sat­is­fac­tory year.
I also believe that we're on our way to see­ing three– and five-year
aver­age annual total returns that will look bet­ter than what
most investors have seen recently."

There were—and are—problems that need to be worked out, but we were hope­ful that even­tu­ally the world's bankers and politi­cians would for­mu­late solu­tions, at least for the most imme­di­ately press­ing issues, such as Greek default. The announce­ment of a bailout plan for Greece cre­ated a great sense of relief through­out the cap­i­tal mar­kets. Once it became clear that Europe would not go bust, investors felt bet­ter about the grow­ing sta­bil­ity in the world econ­omy. This pos­i­tive devel­op­ment, along with the improv­ing econ­omy and the under­per­for­mance of the stock mar­ket over the last five years, leads me to think that the rally can last. The year's remain­ing quar­ters may not be as robust as 2012's first three months, but I remain cau­tiously opti­mistic and still think that this decade will be bet­ter for stocks than the pre­vi­ous one.

So you're still a strong believer in equities?

Absolutely. I think we're on our way to a pos­i­tive and sat­is­fac­tory year. I also believe that we're on our way to see­ing three– and five-year aver­age annual total returns that will look bet­ter than what most investors have seen recently. To me, it all comes down to equi­ties remain­ing the most effec­tive choice for assets that carry risk. I agree strongly with the notion that a care­fully con­structed stock port­fo­lio is the best way to build long-term returns that can out­pace infla­tion and pre­serve pur­chas­ing power.

Returns for the major U.S. indexes—and many around the globe—were closely cor­re­lated in the first quar­ter. When do you expect this to change?

It's cer­tainly more pleas­ant to par­tic­i­pate in a cor­re­lated rally than it was last year to be part of a wide­spread bear mar­ket. I expect cor­re­la­tion to remain fairly high through the inter­me­di­ate term, though I don't see that refut­ing the argu­ment that we still need to shop the mar­ket for what we think are the high­est qual­ity small-cap com­pa­nies trad­ing at attrac­tive val­u­a­tions. So as much as cor­re­la­tion has been a fact of life for most of the cur­rent mar­ket cycle, we con­tinue to invest with an eye toward non-correlated equity results, par­tic­u­larly when look­ing at com­pa­nies out­side the U.S. We build our port­fo­lios antic­i­pat­ing that they will out­per­form and, more impor­tantly, pro­vide strong absolute returns over the long term. At some point, we expect cor­re­la­tion to abate and more dif­fer­en­ti­ated returns to materialize.

Do you still see qual­ity stocks, regard­less of mar­ket cap, as poten­tial mar­ket cycle leaders?

We do. Qual­ity as we define it—companies with strong bal­ance sheets, pos­i­tive cash flow, and high returns on invested capital—has done well on an absolute basis both in the cur­rent rally and since the small-cap high in July 2007. How­ever, dur­ing the rally off the Octo­ber 3, 2011 small-cap low, qual­ity small-cap stocks have lagged. This hasn't been alto­gether sur­pris­ing since most ral­lies, espe­cially those in the after­math of the finan­cial cri­sis, have not favored qual­ity. How­ever, our thought is that qual­ity will likely begin to lead when we start to see more dif­fer­en­ti­ated returns. When those investors who have been avoid­ing stocks return to the mar­ket, we sus­pect that many will be look­ing for those attrib­utes that we typ­i­cally seek.

Should there be room in asset allo­ca­tion plans for global or inter­na­tional small-caps?

We think that any diver­si­fied asset allo­ca­tion plan should include some global or inter­na­tional stocks. The real­ity is that we are in an increas­ingly global econ­omy. Equity port­fo­lios that hold mostly or exclu­sively domes­tic com­pa­nies are invested in stocks that derive a sub­stan­tial amount of rev­enue from out­side the U.S. More impor­tant from our per­spec­tive is the vast size and return poten­tial of the uni­verse. We see it as too impor­tant an area to ignore.

What do you see as Royce's strengths culturally?

We also believe strongly in eat­ing our own cook­ing. Each of our port­fo­lio man­agers is a large share­holder in the funds that he or she man­ages, which is an absolute neces­sity. I don't think you can man­age effec­tively with­out some skin in the game.

First, com­pany cul­ture is an impor­tant and nec­es­sary topic. It's espe­cially impor­tant for finan­cial ser­vices firms in light of the op-ed piece that Greg Smith wrote recently in The New York Times. We have always cher­ished cer­tain val­ues here at Royce, and those val­ues inform every­thing that we do. For exam­ple, our long-term ori­en­ta­tion doesn't sim­ply apply to our port­fo­lios, it also applies to the hold­ing peri­ods we have for stocks, the tenure of port­fo­lio man­agers on our funds, the length of time we want all of our employ­ees to be with the com­pany, and even the objec­tives and tenures of the man­age­ment teams that we meet with. We look for com­pa­nies capa­ble of estab­lish­ing long-term goals for their busi­nesses because we typ­i­cally plan on hold­ing com­pa­nies for at least a few years. There are sev­eral that we have owned for more than a decade.

We also believe strongly in eat­ing our own cook­ing. Each of our port­fo­lio man­agers is a large share­holder in the funds that he or she man­ages, which is an absolute neces­sity. I don't think you can man­age effec­tively with­out some skin in the game. Our employ­ees who are not part of the invest­ment staff are also share­hold­ers, so it's a company-wide prac­tice that we encour­age. Some­what related to this is the fact that many man­agers serve on mul­ti­ple port­fo­lios, which had fos­tered a highly col­lab­o­ra­tive cul­ture. There are no rewards for hav­ing the best idea and no penal­ties for com­ing up with ones that don't work. We eval­u­ate our peo­ple with the same long-term stan­dard that we use for port­fo­lios, so each man­ager will have his or her share of hits and misses. Mak­ing mis­takes is part of learn­ing how to be suc­cess­ful, so we allow for that and are never shy about admit­ting when we've screwed up. We can't expect share­hold­ers to make a long-term com­mit­ment to us with­out being trans­par­ent about our process and practices.

Finally, I think that dis­ci­pline and con­sis­tency are vital parts of our cul­ture. Main­tain­ing our dis­ci­pline has been cru­cial to build­ing long-term returns, whether we're talk­ing about the '87 crash, the early ‘90s reces­sion, the Inter­net Bub­ble or the 2008 cri­sis. Through all of those points and more, we stuck to what we think we do best. It wasn't always easy, but our sense through each try­ing time was that even­tu­ally we and our share­hold­ers would be rewarded for our patience.

Impor­tant Dis­clo­sure Information

The thoughts expressed in this piece are solely those of the per­son speak­ing and may dif­fer from those of other Royce invest­ment pro­fes­sion­als, or the firm as a whole. There can be no assur­ance with regard to future mar­ket movements.

This mate­r­ial is not autho­rized for dis­tri­b­u­tion unless pre­ceded or accom­pa­nied by a cur­rent prospec­tus. Please read the prospec­tus care­fully before invest­ing or send­ing money. Invest­ments in secu­ri­ties of micro-cap, small-cap and/or mid-cap com­pa­nies may involve con­sid­er­ably more risk than invest­ments in secu­ri­ties of larger-cap com­pa­nies. (Please see "Pri­mary Risks for Fund Investors" in the prospec­tus.) Secu­ri­ties of non-U.S. com­pa­nies may be sub­ject to dif­fer­ent risks than invest­ments in secu­ri­ties of U.S. com­pa­nies, includ­ing adverse polit­i­cal, social, eco­nomic or other devel­op­ments that are unique to a par­tic­u­lar coun­try or region. (Please see "Invest­ing in For­eign Secu­ri­ties" in the prospec­tus.) There­fore, the prices of secu­ri­ties of for­eign com­pa­nies, in par­tic­u­lar coun­tries or regions may, at times, move in a dif­fer­ent direc­tion than those of secu­ri­ties of U.S. com­pa­nies. (Please see "Pri­mary Risk of Fund Investors" in the prospec­tus.)

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Tags: Bailout Plan, Believer, Bust, Capital Markets, Conventional Wisdom, Decade, Disjunct, First Three Months, Gold, Greece, Last September, Optimistic View, Politicians, Quarters, Rally, Royce Funds, Shape, Stock Market, Stocks, Those Rare Occasions, World Economy
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Are Stocks Giffen Goods? (Tchir)

Tuesday, April 3rd, 2012

by Peter Tchir, TF Mar­ket Advisors

So when will retail investors start buy­ing stocks? One of the final legs prop­ping up this rally is the belief that retail investors will finally pile into stocks. There is hope that all this “money on the side­lines” will find its way into the stock mar­ket. The S&P at 1,350 was sup­posed to do the trick. Cer­tainly 1,400 on the S&P was going to be enough to chase retail investors into stocks. Basi­cally the argu­ment that retail will capit­u­late and finally invest in stocks is based on the assump­tion that higher prices increase demand – aka, a Gif­fen Good.

Is it real­is­tic to assume that investors will decide to pur­chase more of some­thing just because the price has gone up? They did it in 2000 with inter­net stocks, that infat­u­a­tion ended badly. They did it with hous­ing in the mid 2000′s, which ended even worse. If any­thing, Amer­i­cans have become more focused on buy­ing things on sale and get­ting things at a bar­gain. Why shouldn’t that apply to stocks as much as it applies to any­thing else?

We have hit multi year highs, yet most peo­ple seem to shrug it off. If the retail investor was about to increase their allo­ca­tion to stocks, do you not think there would be more hype in the media about how well stocks have done? Expect­ing “the masses” to buy just because some­thing is already up 20% seems a lit­tle silly, if not down­right arro­gant. The retail investors are not stu­pid. They can also see that the stock mar­ket has decou­pled from the econ­omy. While pro­fes­sional investors can eas­ily accept that, retail investors still have some level of con­vic­tion that the stock mar­ket should reflect eco­nomic activ­ity and not just cen­tral bank print­ing and gov­ern­ment spend­ing. Retail investors can see that the U.S. debt has con­tin­ued to grow and that in spite of lip ser­vice to deficit reduc­tion, we are cre­at­ing a big­ger deficit. They are ner­vous about what will hap­pen when finally the spend­ing gets pulled in. They are also very ner­vous (as are many pro­fes­sional investors) that they will be the last pur­chase of stocks before the cen­tral banks stop pump­ing fresh money into the sys­tem in their never end­ing attempt to inflate asset prices.

If there is one sec­tor where the upward price move­ment is suck­ing in more money it is amongst cor­po­ra­tions them­selves. The num­ber and size of buy­back announce­ments seems to be increas­ing. That makes sense, since if any group has shown an abil­ity to buy high and sell low, it is cor­po­ra­tions them­selves. In 2007 and the first half of 2008, com­pa­nies, includ­ing AIG, were buy­ing back their own stock aggres­sively. From the sec­ond half of 2008 and all of 2009, most com­pa­nies couldn’t afford to buy back shares and many had to issue. It is just wrong to expect indi­vid­u­als to be as friv­o­lous with their money as cor­po­ra­tions are.

I con­tinue to believe that retail is rea­son­ably allo­cated to equi­ties, under the new allo­ca­tion model. The new allo­ca­tion model takes into account debt before deter­min­ing what is investible. Then there is an actual allo­ca­tion to ultra-safe “rainy day” money. That “investible” money is then allo­cated at a much more real­is­tic per­cent­age to equi­ties and fixed income and “other invest­ments”. A myr­iad of new invest­ment vehi­cles have helped make it eas­ier for investors to par­tic­i­pate in the fixed income mar­ket and other asset classes, help­ing to ensure that the allo­ca­tion to those remains higher than it was through the 90′s and the first part of this century.

I do not believe stocks are a Gif­fen good, at least when it comes to retail, so expect­ing “dumb” money to come in and take out the “smart” money may be just as para­dox­i­cal as a Gif­fen good.

The mar­ket is a lit­tle weaker again this morn­ing, so I bet­ter type quickly, since the “Europe went home” rally now starts before Europe goes home.

Chi­nese ser­vice PMI came in strong, but no one really cares about China as a ser­vice econ­omy, so that news was largely shrugged off.

Euro­zone PPI came in slightly higher than expected and last month was revised slightly higher as well. Noth­ing too earth shat­ter­ing, but ris­ing infla­tion with falling employ­ment makes for a very bad combination.

Span­ish bond yields are once again under pres­sure – as they should be. Italy is also feel­ing weaker again. In 10 years Spain is back to 5.40% and Italy is at 5.15%, out by 5 and 7 bps respec­tively. We have seen sup­port, whether nor­mal mar­ket sup­port, or cen­tral bank pur­chase sup­port around the 5.20% and 5.45% lev­els in the past few days, so need to keep a close eye on these lev­els. Spain is under­per­form­ing more notice­ably in the 5 year sec­tor, but still trades at 4.19% com­pared to Italy at 4.32%. Yes, Spain yields more in 10 years than Italy, but less in 5 years. Span­ish 5 year CDS is at 436, but Ital­ian 5 year CDS is at 388. So the 5 year bond inver­sion is clearly an anom­aly and a func­tion of sup­ply and demand and an obvi­ous sign of how inef­fi­cient bond prices are. There are so many “tech­ni­cals” at work in the bond mar­ket that it is extremely hard to sep­a­rate what part of price is reflect­ing risk as per­ceived by the mar­ket and what part is influ­enced by other non mar­ket fac­tors. That is one rea­son CDS is so pop­u­lar – it is fun­gi­ble and not con­strained by who holds what issue.

CDS indices are all a lit­tle bit bet­ter today. Euro­pean ones were largely catch­ing up to the after­noon move tighter here. IG18 is trad­ing even richer to fair value. This shows a lack of con­vic­tion in the rally by the mar­ket as a whole since it looks like investors want to set their longs in the most liq­uid prod­uct giv­ing them the great­est abil­ity to exit if nec­es­sary. At 7 bps rich with a spread of 90, investors are over­pay­ing for that liq­uid­ity. Look for IG18 to con­tinue to lag.

Other anec­do­tal evi­dence of this ten­ta­tive con­vic­tion can be seen in the bond mar­kets, where once again, new issue trad­ing is dom­i­nat­ing daily flows. Investors have their core longs in bonds, add beta via the index, and look for alpha on new issue allo­ca­tions and flip­ping. While not bad in of itself, it is not a sign of a truly healthy mar­ket. The ETF’s con­tinue to get some inflows, but the pace has slowed dra­mat­i­cally and much of it can be accounted for by div­i­dend re-investment and “arb” activ­ity. While the ETF’s remain at a pre­mium, “arbs” are buy­ing the bonds that the ETF is will­ing to accept and exchang­ing them for new shares, which they then sell into the mar­ket. That form of share cre­ation is far less indica­tive of strength in the mar­ket, than when peo­ple are truly just buy­ing shares and leav­ing deal­ers and ETF man­agers scram­bling to find bonds. That is a sub­tle, but impor­tant difference.

Sources: Bloomberg, TFMA

 

Copy­right © TF Mar­ket Advisors

Tags: Amp, Assumption, Buying Stocks, China, Conviction, Deficit Reduction, Economic Activity, ETF, ETFs, Giffen Good, Giffen Goods, Hype, Infatuation, Internet Stocks, Invest Stocks, Lip Service, Mining, Professional Investors, Retail Investor, Retail Investors, Sidelines, Spite, Stock Market, Tf
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“Shrugging Off Bad News!” (Saut)

Tuesday, April 3rd, 2012

“Shrug­ging Off Bad News!”

by Jef­frey Saut, Chief Invest­ment Strate­gist, Ray­mond James

April 2, 2012

Most traders, and investors, seem to become con­vinced of the gen­uine­ness of a move­ment in either direc­tion only when it approaches a cul­mi­na­tion. . . . One reli­able indi­ca­tion of the start of an upward swing is afforded when, after a period of declin­ing prices or, less fre­quently, dull­ness, the mar­ket advances or refuses to go down fol­low­ing the receipt of bad news. News can sel­dom be uti­lized by the pub­lic for mar­ket pur­poses, even when its authen­tic­ity is beyond ques­tion. For instance, if tomor­row morning’s news­pa­pers should announce the death of the Pres­i­dent or the fail­ure of a great ‘cor­ner house,’ or the com­plete destruc­tion of Gary, Indi­ana, it is more likely that stocks sold on the news would bring the low­est prices of the day, for the very good rea­son that each seller would be com­pet­ing with thou­sands of other sell­ers who would have learned the news at the same time.

... One-Way Pock­ets, by Don Guyon; 1917

One of my early men­tors in this busi­ness was Lucien Hooper; strate­gist, ana­lyst, econ­o­mist, stock mar­ket his­to­rian, the longest con­tribut­ing colum­nist to Forbes, and my friend. I can hear his sage words like it was yes­ter­day. The year was 1971, and we had just walked across the floor of the Amer­i­can Stock Exchange. As we headed down the atten­dant stair­case for lunch at “Harry at the Amex” Lucien said, “Jef­frey, when mar­kets ignore bad news, that’s good news!” Said state­ment has stuck with me ever since; and, it is just as true today as it was 41 years ago. Fast for­ward, over the past few weeks the equity mar­kets have had to endure a plethora of bad news – China’s slow­ing econ­omy, ris­ing inter­est rates, $4.00 per gal­lon gaso­line, a dys­func­tional gov­ern­ment, Iran, etc., yet the equity mar­kets have refused to sur­ren­der much ground. Last week was no excep­tion, for despite the neg­a­tive news back­drop the senior index (INDU/13212.04) gained 1%. Such action remains con­sis­tent with my mantra for this year, “You can get cau­tious, but DO NOT get bear­ish.” How­ever, many investors are either bear­ish, or frozen like a deer in the head­lights of a car, hav­ing been stung in last year’s June – August angst because they didn’t man­age the risk when they should have.

Recall, it was in March/April of last year that I rec­om­mended rais­ing cash. At the time the major “push back” from accounts was, “The stock mar­ket is going up, why should I raise cash?” And that was the exact rea­son you should have been rais­ing cash and rebal­anc­ing port­fo­lios. Most did not heed that strat­egy and sub­se­quently suf­fered through a ~20% decline only to liq­ui­date their port­fo­lios around August 8th when the equity mar­kets were in the process of bot­tom­ing. At the time I was actu­ally rec­om­mend­ing putting cash back to work based on the fact that we were expe­ri­enc­ing a cli­mac­tic capit­u­la­tion of his­toric pro­por­tions. Indeed, at the August 8th “low” less than 2% of all stocks traded were “up” on the day. As writ­ten, “You have to go back to May 13, 1940 to find another ses­sion whereby less than 2% of all stocks traded were ‘green’ on the day. Inter­est­ingly, on 5/13/40 the Ger­man army punched a 60-mile wide hole in the Mag­inot Line and invaded France, leav­ing every­one think­ing, “It’s the end of the world as we know it!”

Luck­ily, at those August lows, I began using the anal­ogy of the declines that occurred in Octo­ber 1978 and Octo­ber 1979 (see the charts on page 3). Those late-1970s Octo­ber declines came out of the blue, and were equally as debil­i­tat­ing as the June – August 2011 affair. They also ended with a sell­ing cli­max like that seen on August 8, 2011. As writ­ten at the time, post the selling-climax the sub­se­quent trad­ing pat­terns of Octo­ber 1978 and 1979 saw a bot­tom­ing sequence that left the senior index bob­bing and weav­ing for seven to eight weeks fol­lowed by an “under­cut low” (a low below the selling-climax low) that was for buy­ing. Study­ing the atten­dant charts shows the cor­re­la­tion between the Octo­ber 1978 and 1979 bot­tom­ing sequences and last year’s bot­tom­ing sequence, which is what gave me the con­vic­tion to rec­om­mend buy­ing the Octo­ber 4, 2011 “under­cut low.” Since then, I have been pretty bull­ish, save my cau­tion of the past num­ber of weeks. Indeed, for the past month I have averred that the over­bought con­di­tion of the indices could be cor­rected in one of two ways. They could either cor­rect with the per­func­tory 5–8% pull­back, or they could trade side­ways while the stock market’s over­bought con­di­tion was cor­rected, and the market’s inter­nal energy was rebuilt. Obvi­ously, at least so far, it has been a side­ways affair, which brings us to the start of the new quarter.

So, what’s in store going for­ward? I believe the Fed­eral Reserve wants Wall Street to inflate; and, with the Pres­i­den­tial elec­tions loom­ing, Pres­i­dent Obama will likely do every­thing in his power to keep the stock mar­ket ebul­lient. Thus, investors should be pre­pared for fur­ther poli­cies designed to stim­u­late the econ­omy, which should allow stocks to travel higher even if they do pause, or stum­ble, in the near-term on con­cerns the fun­da­men­tals are turn­ing squir­relly. Nev­er­the­less, what many investors don’t under­stand is that in the short/intermediate-term there is not a lin­ear rela­tion­ship between the fun­da­men­tals and the stock market’s direc­tion­al­ity. Man­i­festly, it is the dilu­tion of our cur­rency, with a con­cur­rent decline in its value due to a mas­sive increase in the money sup­ply, which is caus­ing money to flow into assets of all kinds, includ­ing stocks. And that, ladies and gen­tle­men, is the nat­ural reac­tion to the flood of liq­uid­ity injected into the sys­tem by the world’s cen­tral banks. I don’t think it will end any­time soon.

Mean­while, the over­bought con­di­tion, as reflected by the NYSE McClel­lan Oscil­la­tor, that got us wor­ried fol­low­ing the end of the “buy­ing stam­pede” at the end of Jan­u­ary, has been cor­rected; and the stock market’s inter­nal energy is being rebuilt. Ver­ily, our daily inter­nal energy indi­ca­tor has lifted from a “totally used up” 30 read­ing on March 19th to 50 as of last Fri­day. For a full charge of energy that indi­ca­tor needs to be above 55. The weekly energy indi­ca­tor, how­ever, is still around the 30 level. Hereto, for a full charge of energy the weekly needs to be above 55. Accord­ingly, my sense is that the equity mar­kets need another few weeks of con­va­lesc­ing, prob­a­bly in a range between 1385 and 1420 basis the S&P 500 (SPX/1408.47), before they are ready to re-rally. The big test for this week should be Friday’s employ­ment report, which is antic­i­pated to be bad. Still, as long as the SPX resides above 1385 the bull­ish case remains intact.

Speak­ing to the econ­omy, while last week’s +3% GDP report was in the fore­front, less noticed was the GDI report. Sur­pris­ingly, the Gross Domes­tic Income report rose a larger than expected 4.4%. This is not an unim­por­tant obser­va­tion because the GDI mea­sures all the wages and prof­its in the econ­omy while the GDP mea­sures only spend­ing. The­o­ret­i­cally, the GDP and GDI reports should be the same. To me, this is just fur­ther evi­dence that the econ­omy is not sink­ing back into reces­sion. Another boost for the equity mar­kets last week seemed to be the tone of the ques­tion­ing by the Supremes sug­gest­ing Oba­macare may be in more trou­ble than expected. Such news con­tin­ues to be a night­mare for the under­in­vested crowd; and the world remains pro­foundly under­in­vested in U.S. equities.

The call for this week: March came in like a bear, but went out like a bull, cap­ping the best first quar­ter since 1998. For the quar­ter the SPX gained 11.99% for its 10th best start of the year ever. For me it was almost like déjà vu as I recalled the best first quar­ter of my life­time, which was 1975’s surge of 21.59%. Why déjà vu? Well, it is because I began writ­ing strat­egy In Novem­ber of 1974 with the line, “I believe now is the time to accu­mu­late stocks.” At the time the Dow was trad­ing below 600, hav­ing fallen from its March high of 891 for a 34% decline. Sim­i­larly, on Octo­ber 3, 2011, in a report titled ”Under­cut Low” I rec­om­mended buy­ing stocks fol­low­ing the Dow’s decline of ~20%. As stated at the time, “I have been adamant since March 2009 that like the ‘nom­i­nal’ price low of Decem­ber 1974 this wide-swinging trad­ing range mar­ket saw its nom­i­nal price in March 2009. Last Octo­ber I sug­gested what we could cur­rently be expe­ri­enc­ing is sim­i­lar to the “val­u­a­tion” low of August 1982 because the SPX was trad­ing below 10x for­ward earn­ings esti­mates with an earn­ings yield of over 10%, ren­der­ing an equity risk pre­mium of more than 8% for val­u­a­tion met­rics not seen in decades. I still believe that is the case.

Click here to enlarge

Copy­right © Ray­mond James

Tags: American Stock Exchange, Amex, Bad News, Chief Investment Strategist, China, Culmination, Don Guyon, Gary Indiana, Genuineness, Hooper, India, jeffrey saut, Lucien, Negative News, One Way Pockets, Plethora, Raymond James, Rising Interest Rates, Sage Words, Stock Market, Time One, Upward Swing
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Too Little to "Lock In" (Hussman)

Monday, April 2nd, 2012

Too Lit­tle to "Lock In"

by John P. Huss­man, Ph.D., Huss­man Funds

We've reg­u­larly observed that cor­po­rate profit mar­gins (and economy-wide, prof­its as a share of GDP) have a strong ten­dency to "mean revert" over time — specif­i­cally, ele­vated profit mar­gins are asso­ci­ated with unusu­ally weak earn­ings growth over the fol­low­ing 5-year period, and depressed profit mar­gins are asso­ci­ated with unusu­ally strong earn­ings growth over that hori­zon (see last week's com­ment, A False Sense of Secu­rity ). Notably, the ratio of cor­po­rate prof­its to GDP is presently nearly 70% above its his­tor­i­cal norm. Of course, the most com­mon val­u­a­tion meth­ods used by Wall Street ana­lysts (whether they use the "Fed model" or "for­ward oper­at­ing earn­ings times arbi­trary P/E mul­ti­ple") rely almost exclu­sively on esti­mates of year ahead earn­ings. Embed­ded in these toy mod­els is the quiet assump­tion that cur­rent profit mar­gins will be sus­tained indefinitely.

By con­trast, a wide range of mea­sures that use "nor­mal­ized" fun­da­men­tals of one form or another are extra­or­di­nar­ily stretched. Andrew Smithers recently took note of the ele­vated lev­els of cycli­cally adjusted P/E ratios and price to replace­ment cost ("q") and observed "As of 8th March, 2012, with the S&P 500 at 1365.9 , the over­val­u­a­tion by the rel­e­vant mea­sures was 48% for non-financials and 66% for quoted shares. Although the over­val­u­a­tion of the stock mar­ket is well short of the extremes reached at the year ends of 1929 and 1999, it has reached the other pre­vi­ous peaks of 1906, 1936 and 1968."

At 1400 on the S&P 500, the market's over­val­u­a­tion has now reached 70% on these mea­sures, which have a far stronger cor­re­la­tion with sub­se­quent mar­ket returns than the Fed Model or other unad­justed meth­ods using for­ward oper­at­ing earn­ings. This is par­tic­u­larly true over hori­zons of 4 years or longer. As a side note, since the reliance on for­ward oper­at­ing earn­ings is now an estab­lished Wall Street prac­tice, Valu­ing the S&P 500 Using For­ward Oper­at­ing Earn­ings details how to improve the reli­a­bil­ity of mar­ket val­u­a­tions based on these figures.

We presently esti­mate a nom­i­nal total return on the S&P 500 aver­ag­ing 4.1% annu­ally over the com­ing decade. This mod­estly exceeds the yield avail­able on a 10-year Trea­sury, but by a small mar­gin that — out­side the late 1990's bub­ble period — has pre­vi­ously been seen only dur­ing the two-year period approach­ing the 1929 peak, between 1968–1972 (which was finally cleared by the 73–74 mar­ket plunge), and briefly in 1987, before the crash of that year.

While it's true that inter­est rates are depressed, appar­ently set­ting a low "bar" for equi­ties, an addi­tional ques­tion one should ask is whether inter­est rates them­selves are "fair" in the sense of being ade­quate com­pen­sa­tion for long-horizon risks. For exam­ple, back in 1982, stocks had a rea­son­able 10-year prospec­tive risk-premium ver­sus bonds, but both were priced to achieve extra­or­di­nar­ily strong returns. Presently, stocks have a weak 10-year prospec­tive risk-premium ver­sus bonds, but both are priced to achieve unsat­is­fac­tory returns. In 1982, investors had an incen­tive to lock in either, and were served well regard­less of their choice. At present, investors have no rea­son­able incen­tive at all to "lock in" the prospec­tive returns implied by cur­rent prices of stocks or long-term bonds (though we sus­pect that 10-year Trea­suries may ben­e­fit over a short hori­zon due to con­tin­ued eco­nomic risks and still-unresolved debt con­cerns in Europe, which has already entered an eco­nomic downturn).

It's also inad­vis­able to view the present 4.1% pro­jected (nom­i­nal) 10-year return on the S&P 500 as if it is some sort of "yield," because even that expected return involves the risk of sig­nif­i­cant volatil­ity and severe short-horizon loss.

But don't low inter­est rates at least limit the poten­tial down­side in stocks, allow­ing stocks to remain at ele­vated val­u­a­tions that are con­sis­tent with sim­i­larly low prospec­tive returns? On that ques­tion, the his­tor­i­cal record is instruc­tive. Since 1930, the 10-year Trea­sury yield has been below 3% nearly 30% of the time. In 78% of those peri­ods, the prospec­tive 10-year total return on the S&P 500 exceeded 10% (based on our stan­dard esti­ma­tion method). In fact, the 10-year Trea­sury yield has his­tor­i­cally been below 2.5% about 15% of the time (pri­mar­ily in the period prior to 1952) and in fully 94% of those peri­ods, the prospec­tive 10-year total return on the S&P 500 exceeded 10%. The belief that prospec­tive equity returns are tightly linked to bond yields is largely an arti­fact of the 1980–1998 period (when both enjoyed a per­sis­tent decline dur­ing a long period of dis­in­fla­tion), and is far less evi­dent in broad mar­ket history.

Ignore the fact that long-term "sec­u­lar" bull mar­ket advances have invari­ably started from val­u­a­tions imply­ing prospec­tive 10-year total returns of nearly 20% annu­ally (which is pre­cisely why the sec­u­lar advances that fol­low are so durable). The mar­ket decline required to build in prospec­tive returns of that mag­ni­tude seems too extreme to even con­tem­plate. Indeed, we esti­mate that the S&P 500 would presently have to decline by nearly 40% sim­ply to reach val­u­a­tions con­sis­tent with prospec­tive 10-year total returns of 10% annu­ally. It's an open ques­tion whether we'll see that level of prospec­tive return in the next mar­ket cycle, but even if we touch that level of prospec­tive returns 5 or 6 years from now, stocks will have gone nowhere in the interim (includ­ing div­i­dends). Investors would need to have a ter­ri­bly short mem­ory in order to rule out that sort of risk. Last week's val­u­a­tion chart may be a use­ful reminder of where we stand rel­a­tive to history.

On the sub­ject of profit mar­gins, James Mon­tier at GMO pub­lished a nice piece last week, using a little-known national income iden­tity (the Kalecki prof­its equa­tion) to demon­strate that:

Prof­its = Invest­ment — House­hold Sav­ing — Gov­ern­ment Sav­ings — For­eign Sav­ings + Dividends

Some might object that this is sim­ply an iden­tity (true by def­i­n­i­tion) and doesn't imply causal­ity. That's a rea­son­able point, but as with all analy­sis, it's not enough just to toss out an objec­tion and walk away — you've got to go to the data and find out the truth. So let's do that.

We can actu­ally sim­plify things a bit to make the point more intu­itive. As we've shown before, gross pri­vate invest­ment has a very strong rela­tion­ship with the cur­rent account deficit ("for­eign sav­ings"). Specif­i­cally, large increases in gross pri­vate invest­ment are almost invari­ably financed by run­ning a trade deficit in goods and ser­vices, and import­ing for­eign sav­ings to make up the dif­fer­ence. Mean­while, div­i­dends tend to be very smooth, so they don't intro­duce a lot of vari­abil­ity to the equation.

What remains then is a fairly sim­ple asser­tion: the pri­mary way to boost cor­po­rate prof­its to abnor­mally high — but unsus­tain­able — lev­els is for the gov­ern­ment and the house­hold sec­tor to both spend beyond their means at the same time.

If we go to the data, we see the link between profit mar­gins and deficits in the quar­terly fig­ures, but the tight­est rela­tion­ship is actu­ally a causal one — large gov­ern­ment deficits (as a per­cent­age of GDP) cou­pled with weak house­hold sav­ings rates result in tem­porar­ily high cor­po­rate profit mar­gins, with a lead of about 4–6 quarters.

The con­clu­sion is straight­for­ward. The hope for con­tin­ued high profit mar­gins really comes down to the hope that gov­ern­ment and the house­hold sec­tor will both con­tinue along unsus­tain­able spend­ing tra­jec­to­ries indef­i­nitely. Con­versely, any delever­ag­ing of presently debt-heavy gov­ern­ment and house­hold bal­ance sheets will pre­dictably cre­ate a sus­tained retreat in cor­po­rate profit mar­gins. With the ratio of cor­po­rate prof­its to GDP now about 70% above the his­tor­i­cal norm, dri­ven by a fed­eral deficit in excess of 8% of GDP and a deeply depressed house­hold sav­ing rate, we view Wall Street's embed­ded assump­tion of a per­ma­nently high plateau in profit mar­gins as myopic.

[Geek's Note: If you think in terms of equi­lib­rium in the asso­ci­ated real out­put (actual goods and ser­vices of one sort or another), the Kalecki equa­tion also means that the deficit-financed goods and ser­vices are essen­tially already spo­ken for, so the result­ing cor­po­rate prof­its are not matched by sim­i­lar increases in real invest­ment. Instead, cor­po­ra­tions accu­mu­late claims on the gov­ern­ment and house­holds (i.e. they acquire a pile of gov­ern­ment and con­sumer debt oblig­a­tions). These oblig­a­tions can only be "spent" in aggre­gate by the cor­po­rate sec­tor on invest­ment goods once house­holds and the gov­ern­ment begin to release a "sur­plus" of out­put by sav­ing instead of spend­ing beyond their means. Either that, or the trade deficit would explode as cor­po­ra­tions accu­mu­lated invest­ment goods by trans­fer­ring their claims on the U.S. gov­ern­ment and house­holds to foreigners.]

A few quick eco­nomic notes. Real income declined month-over-month in the lat­est report, which is very much at odds with the job cre­ation fig­ures unless that job cre­ation reflects extra­or­di­nar­ily low-paying jobs. Real dis­pos­able income growth has now dropped to just 0.3% year-over-year, which is lower than the rate that is typ­i­cally observed even in reces­sions. Real per­sonal con­sump­tion growth ticked up slightly from 1.6% to 1.8% year-over-year, remain­ing in a range that is rarely observed except in asso­ci­a­tion with reces­sion. Given the con­trac­tion in real income, we also saw a sharp down­turn in the sav­ings rate in the lat­est report, to the low­est level since just before the last reces­sion. While the slight bump in con­sump­tion could help near-term cor­po­rate prof­its, the income dynam­ics aren't sup­port­ive of a con­tin­u­a­tion at all.

Finally, we've been watch­ing the new unem­ploy­ment claims data for some time. Almost with­out fail, when a new num­ber is released, the new claims fig­ure for the pre­vi­ous week is revised upward by about 3000 or so. Last week, we saw an unusual revi­sion in new claims data, not just for the pre­vi­ous week, but in months of prior releases, with upward revi­sions aver­ag­ing about 10,000 in the most recent reports (e.g. the Feb 25 fig­ure was revised from 354,000 to 373,000). This reflects an annual update in the sea­sonal fac­tors used by the Labor Depart­ment (which is why the revi­sions weren't matched by sim­i­lar changes in the non-seasonally adjusted data). It's not clear what this implies for revi­sions in the monthly employ­ment fig­ures, if any­thing, but our "unob­served com­po­nents" mod­els con­tinue to sug­gest a gen­eral trend toward dis­ap­point­ments in eco­nomic data, par­tic­u­larly over the next 6–8 weeks. Given that so much investor enthu­si­asm has focused on the new claims fig­ures, it's inter­est­ing that the large and gen­er­ally upward revi­sions in months of prior data seemed to go vir­tu­ally unnoticed.

Mar­ket Climate

As of last week, the Mar­ket Cli­mate remained char­ac­ter­ized by a hos­tile syn­drome of over­val­ued, over­bought, over­bull­ish, rising-yield con­di­tions. We've reviewed a vari­ety of oper­a­tional def­i­n­i­tions of this syn­drome in numer­ous prior weekly com­ments. For­get about the major declines that typ­i­cally fol­lowed the hand­ful of other instances we've observed this syn­drome in the past, includ­ing the major peaks in 1972, 1987, 2000, and 2007. Even if we look over the past two years — and despite some early sig­nals where mar­ket weak­ness was post­poned by extra­or­di­nary mon­e­tary inter­ven­tions — we still have not observed these con­di­tions with­out result­ing mar­ket declines of more than 15% (one in 2010 and another in 2011) that wiped out all of the gains since the ear­li­est sig­nal occurred, and then some.

Mon­e­tary inter­ven­tions can peri­od­i­cally fuel spec­u­la­tive runs, which defer and spread out the adjust­ments that result from per­sis­tent over­val­u­a­tion and mis­al­lo­ca­tion of cap­i­tal. But they can't get around the inevitabil­ity of those adjust­ments. The only real choice pol­icy mak­ers have is how large a bub­ble they choose to see col­lapse. On that front, we're clearly in bet­ter shape than we were at the peaks of 2007, 2000 and 1929, but con­di­tions are gen­er­ally more hos­tile than they have been in the vast remain­der of mar­ket his­tory. This will change. By our analy­sis, now remains one of the worst times on record to assume that mar­ket risk is acceptable.

Strate­gic Growth and Strate­gic Inter­na­tional remain fully hedged. Strate­gic Div­i­dend Value remains 50% hedged, its most defen­sive posi­tion, and Strate­gic Total Return con­tin­ues to carry a dura­tion of just under 3 years in Trea­suries, with about 5% of assets allo­cated across pre­cious met­als shares, util­i­ties, and for­eign cur­ren­cies. We don't view the prospec­tive returns in any asset class as being desir­able enough to "lock in" on an invest­ment basis, which means that most finan­cial risks here are essen­tially spec­u­la­tive, and rely on the emer­gence of investors will­ing to accept even lower prospec­tive returns. Again, the one con­stant in the finan­cial mar­kets is that these con­di­tions will change. Patient oppor­tunism remains essen­tial here.

—

Tags: 8th March, Andrew Smithers, Assumption, Corporate Profit, Corporate Profits, Correlation, Earnings Growth, Extremes, False Sense Of Security, Fed Model, GDP, Horizons, Hussman Funds, Profit Margins, Ratios, Sense Of Security, Stock Market, Toy Models, Valuation Methods, Wall Street Analysts
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James Paulsen: Does Gold Still Glitter?

Friday, March 30th, 2012

Does GOLD Still Glitter?

by James Paulsen, Chief Invest­ment Strate­gist, Wells Cap­i­tal Man­age­ment (Wells Fargo)

Gold has been an invest­ment dar­ling in recent years. Indeed, it is often per­ceived as the cure for any invest­ment worry. Whether you are con­cerned about infla­tion, defla­tion, gov­ern­ment deficits, war, a U.S. dol­lar col­lapse, reces­sion, or depression—GOLD is the answer!

The extra­or­di­nary pop­u­lar­ity of gold today is easy to understand—it has done so well for so long! Since the end of the 1990s, the price of gold has risen almost six-fold from less than $300 to its cur­rent price of almost $1,700. Many expect the price of gold to rise con­sid­er­ably higher in the next sev­eral years and per­ceive the mod­est decline in the gold price since its all-time peak last Sep­tem­ber as a buy­ing oppor­tu­nity. While own­ing some gold is fine for all investors (diver­si­fi­ca­tion is para­mount), we think gold weight­ings should be scaled back in most port­fo­lios. The yel­low metal may soon lose some of its lus­ter as its strug­gles with its newly ele­vated val­u­a­tion and with the like­li­hood that con­fi­dence through­out the econ­omy is begin­ning to improve.

Gold is OVERVALUED!

Unlike stocks or bonds, gold has always been more dif­fi­cult to value since it pro­duces no cash flow (i.e., earn­ings or coupons) that can be dis­counted to arrive at a present (fair) value. How­ever, Exhibit 1 illus­trates a sim­ple “rel­a­tive val­u­a­tion” method­ol­ogy pro­vid­ing an his­tor­i­cal per­spec­tive against most other invest­ment classes (e.g., stocks, bonds, com­modi­ties, and real estate) and rel­a­tive to the value of labor and a bas­ket of con­sumer goods and ser­vices. In each of the six charts shown, the price of gold on a rel­a­tive basis is either near­ing or is at one of its high­est val­u­a­tions of the last 50 years. At the end of the 1990s, it took almost 5.5 ounces of gold to buy the S&P 500 Stock Price Index. Today, it only takes 0.8 of a sin­gle ounce to buy the stock mar­ket. Rel­a­tive to stocks, gold is almost as expen­sive today as it was in the late 1970s when the price of gold had surged after its peg was elim­i­nated and after the stock mar­ket was rav­ished by a decade of run­away inflation.

Rel­a­tive to Trea­sury bonds, the price of gold cur­rently trades near an all-time, post-war record high sur­pass­ing its old rel­a­tive val­u­a­tion record estab­lished in the late 1980s when bonds were incred­i­bly cheap. It is indeed remark­able that gold today is this expen­sive rel­a­tive to an asset class (bonds) which most agree is prob­a­bly itself extremely overvalued.

In recent years, while gold prices have soared, U.S. home prices have col­lapsed. Although the price of gold rel­a­tive to U.S. homes is not yet as high as it reached in the late 1970s, its cur­rent rel­a­tive val­u­a­tion com­pared to house prices leaves lit­tle opti­mism about the future poten­tial for gold prices. Gold is also expen­sive rel­a­tive to worker pay. In 2000, it took less than 20 hours of work (at the aver­age hourly wage rate) to pur­chase a sin­gle ounce of gold. Today, by con­trast, it takes almost 90 hours of labor to buy an ounce of gold! In a sim­i­lar fash­ion, the price of gold rel­a­tive to the bas­ket of con­sumer goods and ser­vices com­pris­ing the Con­sumer Price Index is near its all-time record high reached in the early 1980s.

Finally, even com­pared to other com­mod­ity prices, the price of gold is near­ing its all-time record rel­a­tive price reached in the late 1980s. Even though com­mod­ity prices in gen­eral have increased sig­nif­i­cantly in the last decade, the price of gold has risen even more dramatically.

While val­u­a­tion met­rics have not tra­di­tion­ally been a good invest­ment tim­ing tool, they have pro­vided a use­ful indi­ca­tion of the future upside/downside price poten­tial of an invest­ment. Rel­a­tive to other invest­ments, the charts in Exhibit 1 not only sug­gest upside is prob­a­bly lim­ited for gold but also cau­tions that down­side price risk could be sig­nif­i­cant. At a min­i­mum, these charts do not seem to sup­port the wide­spread pop­u­lar­ity and opti­mism con­cern­ing gold investing.

Gold and the “Fear Premium”?

Exhibit 2 shows the price of gold rel­a­tive to other com­mod­ity prices. Although gold has been a spec­tac­u­lar invest­ment since 2000, so have other com­modi­ties. Sur­pris­ingly, since 2000, the price of gold has only sig­nif­i­cantly out­paced other com­mod­ity prices dur­ing a few months in late 2008 when the “Great Finan­cial Cri­sis” erupted. Between 2000 and late 2008, the rel­a­tive price of gold to other com­modi­ties remained flat at about 1.5 imply­ing both gold prices and other com­mod­ity prices rose by equal amounts dur­ing the period. Sim­i­larly, the rel­a­tive price of gold was also unchanged between early 2009 and today. That is, “all” com­mod­ity prices rose just as much as gold prices between 2000 and late 2008 and again between early 2009 until today (despite this, how­ever, gen­eral com­modi­ties remain a much less pop­u­lar invest­ment than gold).

The only time gold sig­nif­i­cantly out­paced other com­mod­ity invest­ments was when investor “fear” surged. Exhibit 2 illus­trates the “fear pre­mium” the price of gold received rel­a­tive to other com­mod­ity prices dur­ing the 2008 cri­sis and how much of this pre­mium is still embed­ded in its price today. Between 2000 and late 2008, the price of gold oscil­lated in broad range about 1.4 times the value of the S&P GSCI Com­mod­ity Price Index. Today, gold trades at about 2.4 times the value of this com­mod­ity index. The risk or fear pre­mium embed­ded in the price of gold (i.e., about 1.0, the dif­fer­ence between the rel­a­tive price of gold today at 2.4 and where it used to trade prior to the 2008 cri­sis at about 1.4) is quite large and needs to be assessed when con­sid­er­ing an invest­ment in gold. A pri­mary risk for gold investors is the poten­tial for decay in this fear premium.

Gold’s Best Friend (Fear) May be Fading?!?

Exhibit 3 illus­trates the chal­lenge gold investors may face in the next few years should con­fi­dence slowly improve and “cri­sis fears” fade. This exhibit com­pares the rel­a­tive price of gold to the Con­sumer Con­fi­dence Index. The con­fi­dence index (dot­ted line) is shown on an inverted scale so a rise (fall) in the dot­ted line illus­trates peri­ods when con­fi­dence is declin­ing (increasing).

While not a per­fect rela­tion­ship, the rel­a­tive price of gold rel­a­tive to other com­mod­ity prices seems impor­tantly dri­ven by con­fi­dence. Gold’s best friend in recent years has been fear! As con­fi­dence col­lapsed in 2008, the rel­a­tive price of gold far out­paced other com­mod­ity invest­ments. Like­wise, the decline in con­fi­dence after the tech wreck and after 9/11 in the early 2000s pro­duced a sim­i­lar “fear pre­mium” in the rel­a­tive per­for­mance of gold prices. How­ever, between 2003 and 2007, the “fear pre­mium” embed­ded in gold even­tu­ally evap­o­rated once con­fi­dence again revived as the eco­nomic recov­ery matured. A sim­i­lar revival in eco­nomic con­fi­dence may be emerg­ing today. If the Consumer

Con­fi­dence Index does recover to at least 100 in this recov­ery, a good por­tion of the “fear pre­mium” embed­ded in the price of gold may evap­o­rate pro­duc­ing dis­ap­point­ing results for gold bugs.

Sum­mary

Main­tain­ing some gold expo­sure within port­fo­lios makes sense. Should cri­sis fears con­tinue to peri­od­i­cally flare in the next sev­eral years, gold should pro­vide the port­fo­lio with some defen­sive prop­er­ties. How­ever, we believe investors should con­sider reduc­ing gold expo­sure. This is an invest­ment which today seems far too pop­u­lar among the masses, appears extremely over­val­ued rel­a­tive to most other asset classes and faces a chal­leng­ing envi­ron­ment should eco­nomic con­fi­dence slowly improve in the next sev­eral years. The val­u­a­tion of gold rel­a­tive to vir­tu­ally any other asset class (stocks, bonds, real estate or com­modi­ties) seems to sug­gest the price of gold is either extremely rich today and at risk of sig­nif­i­cant decline or sug­gests most other asset classes are very cheap. Either way, it is prob­a­bly time to posi­tion port­fo­lios to ben­e­fit from a slow but steady revival in con­fi­dence rather than in an asset which only “glit­ters” when fear predominates.

Copy­right © Wells Cap­i­tal Management

Tags: Chief Investment Strategist, Commodities, Commodity, Consumer Goods, Diversification, E G Stocks, Glitter, Gold, Gold Price, Government Deficits, Historical Perspective, Last September, Luster, Price Of Gold, Relative Basis, Relative Valuation, Stock Market, Stock Price Index, Stocks Bonds, Time Peak, Valuations, Wells Capital Management, Wells Fargo
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The Second Differential of the ECRI

Monday, March 19th, 2012

Last week the Eco­nomic Cycle Research Insti­tute (ECRI) affirmed their call made last fall that the U.S. econ­omy would soon be in reces­sion.   The ECRI’s main busi­ness focus is to try and pre­dict the ups and downs of the busi­ness cycle, and they have had an out­stand­ing record over the years.  Right now the absolute level of the index may sug­gest eco­nomic weak­ness, but the sec­ond dif­fer­en­tial has sug­gested an improv­ing stock mar­ket is also in the cards.

The ECRI has devel­oped a weekly indi­ca­tor where they have com­bined var­i­ous eco­nomic sta­tis­tics into a series that they pub­lish.  Details are not pro­vided on the spe­cific of the com­po­si­tion of this index, but they include broad mea­sures of out­put, employ­ment, income and sales.  When describ­ing the weekly ECRI index, they always empha­size that these met­rics are based on lead­ing indi­ca­tors rather than coin­ci­dent indi­ca­tors, so their data should carry more weight. No argu­ment here, as we’d agree with this assessment.

In an arti­cle writ­ten last week, they reit­er­ated their call that a U.S. reces­sion is forth­com­ing.  Con­fi­dence in this call was based on the year over year analy­sis of the weekly ECRI index, as it was again sig­nal­ing weak­ness.  Year over year sta­tis­tics help alle­vi­ate sea­son­al­ity in the num­bers, which has been a com­mon com­plaint over recent months.  Again, we are not debat­ing the merit of this argu­ment, as this seems like solid rea­son­ing.   But what we would say, is that investors may be bet­ter served to remem­ber that the ECRI is pre­dict­ing the econ­omy, and not the stock mar­ket. These two are highly cor­re­lated, but cer­tainly do not always move in the same direc­tion together, except per­haps when you take the 2nd dif­fer­en­tial into con­sid­er­a­tion.  The 2nd dif­fer­en­tial is another way of say­ing, “less bad” data.  Less bad data (aka Green Shoots) is arguably what started the rally off the bot­tom in March 2009.

If you look at the chart above, the trends are fairly clear.   It’s not the absolute level of the data being pos­i­tive or neg­a­tive, it’s the trend of the num­bers.   The mar­ket is not as for­ward think­ing as most investors believe.   It moves up on data that is ‘less bad’ or bet­ter than it was pre­vi­ously, and moves down on ‘more bad’ or worse than the prior data before.

So it seems to us that the weekly  ECRI data series should be viewed dif­fer­ently when think­ing about the econ­omy ver­sus the stock mar­ket.  The absolute num­bers accu­rately reflect the over­all econ­omy, and the 2nd dif­fer­en­tial is a bet­ter reflec­tion of the direc­tion of the stock market.

Tags: Absolute Level, Business Cycle, Business Focus, Coincident Indicators, Composition, Confidence, Differential, Economic Cycle Research Institute, Economic Statistics, Economic Weakness, Ecri, Employment Income, Leading Indicators, Metrics, Rally, Recession, Seasonality, Stock Market, Ups, Ups And Downs
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12-Mo. Target “Street” Consensus: S&P 500 Up 7.41% to 1509

Monday, March 19th, 2012

Based on apply­ing Street Con­sen­sus for each indi­vid­ual S&P 500 stock to the market-cap weight of the stock in the index, to arrive at the over­all consensus.

Tags: Amp, Consensus, Market Cap, Stock Market, Target
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