(Important) Housekeeping comments:
1. We’re approaching the date when we will combine 2 weekly email letters into 1. The new letter will contain a very brief summary and website link to facilitate login and access to the entire letter (economic news and data, analysis, the greedometers, and details on the specific investments we plan to buy / sell.)
2. An interactive greedometer gauge will be added to the website. For example, raising the profit margin on the S&P500 will show a rise to the greedometer reading, and raising the VIX will lower the greedometer reading. (pretty cool)
3. A new section of the website will be added to support an up-coming service: an annual subscription to a weekly newsletter. The service will be intended for investors that want to manage their own portfolios or perhaps cannot afford asset management service (or both). This subscription newsletter service will include information contained in the newsletter, but not information regarding what and when we’re buying or selling.
4. New web pages will be added next week regarding the book. I’m very pleased that some industry titans have agreed to provide feedback on portions of the book before I hit the send button to the publisher: Dr Lacy Hunt, Dr. Marc Faber, David Rosenberg, and John Mauldin.
Two weeks ago I wrote - ’We now resume our regularly scheduled crash — this is what secular tops looks like.’ I reiterate that point.
As the data slowly but surely arrive in early 2012, the greedometers are continuing to paint a picture consistent with the largest US stock market collapse since 1929 — slightly larger than the 57% drop in the S&P500 in 2007 – 2009. The greedometers have accurately anticipated and identified a secular (multi-year) top in US risk assets (common stock, REITS, high yield bonds, commodities). From here, more cracks will emerge in the foundation of the latest central banker induced bear market rally.
It was not surprising to see the S&P500 run out of steam and begin to fall back to earth :
- once it rose to the 23 level on the adjusted PE (2 weeks ago). As you know, this is one of the 8 parameters in the greedometer.
- since the gap between the 200-day exponential moving average and the daily price grew monumentally wide a month ago (and I commented on this in the March 21 Private Client letter).
- since the rats were jumping off the ship in the first 3 months of the year (corporate execs were selling shares in a quiet near-panic as they frequently do several months before a secular stock market peak).
- and of course, the greedometers……..
The greedometers are suggesting :
- the US economic growth rate peaked late last year
- early 2012 economic growth will be anemic
- the economy will enter recession in Q2 — probably in late May or early June. (We may get confirmation of this from the BEA at some point next year.)
- there will be a bounce back in risk assets between now & early July. But whether risk assets dip lower along the way is a tough call. Regardless, it won’t matter because the pre-Q2 earnings season faith-based rally is going to be obliterated in July and August as the S&P500 bounces off the 1140 range (a 20% drop from the April peaks, and the official entry point to a bear market for the S&P500). Queue Ben…
Will Ben Bernanke see his shadow when he emerges from his Jackson Hole meeting in August? Will we get 6 more months of Operation Twist? Or will he bite the bullet, resume his Vegas Fed ways, and announce efforts for a coordinated $6 – 10T round of new QE across the US, Europe, Japan, Britain, Canada, Australia, and others? When the S&P500 officially enters bear market territory in August, the pressure to print will be immense. Too tempting for a Keynesian.
Here in the US:
- A facebook IPO is coming! I can think of few things more worthy of shorting. In another sign the US stock market is peaked-out, we can add up the IPOs over the past year and find some real dogs. And speaking of technology companies that act as sirens for the broad economy, did you catch Cisco Systems CEO John Chambers last week? A nearly 14% drop in the stock price in 1 week. Over 21% since early April.
- 1Q 2012 earnings season is wrapping up. As of Thursday morning,
- 458 S&P500 companies had reported so far.
- 66% of companies are beating consensus earnings estimates. This has dropped a great deal from the initial 83% beat figure 4 weeks ago. 2 weeks ago I wrote that we’d likely end this earnings season in the 60 – 65% beat rate. I see no reason to change that. This is likely to be the lowest beat rate since the recovery in 2009. The long term average earnings ‘beat rate’ is roughly 67%.
- Profit margin is 9.3% — very similar to last quarter’s near record profit margin. So, margins are holding up remarkably well. But! Recall the sudden collapse in April retail sales in Europe. This is going to dent profit margins and work its way back into the rest of the economic machine. Look for US retail sales to slow down this summer and for that to have follow-on effects elsewhere in the economy.
- My latest view of where S&P500 profit margins are going. Note the use of a 3-month rolling average for the profit margin, and 1-month average for stock market prices.
- What about next quarter’s pivotal earnings season forecast? More of the same sandbagging is being demonstrated by Wall St as depicted by the familiar slide in earnings estimates shortly before reality ‘makes fools of us all’…. This graph comes courtesy of Howard Silverblatt at S&P.
- This is old news, but since there was no economic comment last weekend, we’ll provide one on the jobs front.
- Right on schedule, the April jobs report from the BLS disappointed. As weak as the headlines were, without hundreds of thousands of people continuing to fall out of the back end of the UI benefits system, the headline (U3) rate would have risen to 8.4%, not dropped to 8.1%.
- The labor participation rate continued to drop — to the lowest level in decades.
- The quality of jobs is dropping. Many that previously had high paying careers have had to settle for new careers / jobs with far lower salaries and benefits.
- The yield on the US 10-yr Tnote continued lower this week – for the 8th week in a row. It closed the week at 1.84%. And the 30-yr Tbond yield fell to 3.01% to close out the week. How many Wall St prognosticators foresaw that in January? Since bond prices are inversely correlated with yields, prices marched higher. I’m still looking for the 10yr T-note yield to drop to the 1.5% range this summer, and for 15-yr mortgage rates to drop to the 2.2% range.
- JP Morgan had a tough week. Shares fell over 11% — over 9% yesterday alone. Late thursday saw an announcement that the bank (the largest in the US) incurred a $2B loss from trading credit derivatives. Here’s the part that puzzles me. This loss is being spun as a hedge position gone bad. How’s that? Apparently JPM has a $2B trading loss because it bet the economy would improve and turned out to be wrong. Here’s the thing. If you employ derivatives (apparently in a big way) as a hedge and suffer a big loss because the economy doesn’t improve, that’s not hedging. In order for this to be hedging, JPM would have to have a considerably larger position that would rise in price if the economy worsened. Either that or its so-called derivatives hedge position was really not a hedge position at all, but was a speculative unhedged long bet that the economy would improve (more likely). If JPM had a big bet the economy would improve (and it did / and still does), keep that conflict of interest in mind when anyone from the firm is quoted indicating they see the economy improving. If they’ve got a big 1-way bet the economy is going to improve, what else would they say?
Big Picture: The European financial crisis is hitting additional headwinds as political risk increases. Let’s take stock. So far, seven countries have seen a changing of their political leaders / parties. The lowest paid, lowest skilled, and lowest educated people continue to suffer disproportionately, and are increasingly becoming a polarizing force. They are voting for extremist parties with an anti-EU or anti-globalization view. Financial system risk is increasing.
- As expected, a new President was elected, and he’s decidedly left of centre i.e., from the socialist party. The French economy is already majority-lead by the government (56% of GDP comes from the French government). Mr. Hollande plans to achieve a pre-ordained 3% fiscal deficit target for 2013 and to balance the budget by 2017 (it would be the first time in 43 years). But he plans to make headway by tax increases alone. Sadly, Mr. Hollande will likely fail. If the IMF estimates his policies would leave a 3.9% deficit next year, you know it will be closer to 4.5%. And what do you know, yesterday the EU forecast the 2013 French budget deficit to be 4.2%. That too will be optimistic. All governments are prone to use rose-colored glasses when estimating GDP growth.
- The dynamics of the existing Franco-German economic core are going to be impacted. But we’ll have to wait for the results of the French National Assembly elections in June to begin to handicap the mandate of the new French President. What odds do you give bond ratings agencies in granting France a continued AAA rating amid low chances of improving their deficit?
- The two main political parties were thrashed in last Sunday’s election. That said, the leader of the conservative New Democracy party (one of those 2 parties) won the most votes, but nowhere near enough to reach a majority.
- On Monday, the ND party leader handed back the keys after failing to form a coalition parliament with another party. This leaves the party with the second most number of votes (with a strong left of center bent) to form a coalition parliament. As of yesterday, they gave up as well.
- So Greece is going to see another election in June. The party with the best chances of winning is a hard left-of-center party whose platform is to nationalize Greek banks and essentially stiff the IMF, EU and everyone else.
- There’s zero chance a new Greek parliament will implement the harsh economic medicine required by the rest of the EU. In fact, the new parliament must find another 11B euro in spending cuts in the next month or risk being cut off by the EU – IMF sugar daddy. Do you hear the sound of printing presses warming-up? Drachma 2.0 is increasingly inevitable by the end of this year.
Spain: I’m sorry to keep beating up Spain, but there continues to be a gulf between reality and the views portrayed by politicians and bankers.
- Last week saw the 4th time in the past 3 years that Spain is saying they’ll clean up the bad real estate assets. Spain’s banks are sitting on 650B euro in real estate loans still marked at full value!!! That’s half the country’s GDP. And there’s another 300B euro owed by real estate developers.
- The 4th largest Bank – Bankia- was partially nationalized wherein 45% of the company will be owned by the state. And this is after a June IPO last year!
- Investors reacted with skepticism to last week’s proposals. The interest rate on the 10-yr note rose to over 6% as bonds sold off. Stocks followed suit.
- Here’s the Spanish stock market view. Stocks are back to their March 2009 lows. Ugly.
- More bank nationalizations and public capital injections merely shift the debt burden to the tax payer and deepen the recession. The EU released a report estimating Spain was in a 2-year recession and that it would miss 2012 & 2013 fiscal deficit targets. This is the same thing I’ve been writing for months — in stark contrast to what they’ve been saying so far. The EU forecasts a 6.3% deficit in 2013, not even close to the original target of 3%, and considerably higher than the recent slip to 5.3%.
- I’m sorry, but Spain is toast. The current bailout plans are nowhere near large enough to cope with this mess. I don’t know where the bailout money will come from, but come it will. And it will be freshly printed.
Britain: The QE taps are going to be shut off for a while because the damage inflicted by rising inflation is proving to be as large as the benefit it pumping up risk asset prices. The point of diminishing returns. You can bet the Fed is watching this experiment closely.
- Perhaps tired of being the party crasher, Wolfgang Schauble (Minister of Finance) indicated on Thursday that slightly higher inflation -in the 2-3% range- could be tolerated. Is this a crack in the German opposition to more currency printing? Maybe. Then again, maybe not. Friday saw the Bundesbank President – Jens Weidmann take an opposing view of allowing inflation to slip higher.
- The german 10-yr Tnote hit an all-time low yield of 1.49% this week (still think we won’t hit 1.5% on the US 10yr note?) as investors ran for cover.
- Italy: An office of the federal tax collection agency was fire-bombed today.
- The latest data shows the Chinese economy slowing its pace of growth more than expected in April. Industrial activity, retail sales, and investment all looked soft. All the more pressure to ‘do something’ to make things better. That this news comes while China is currently going through its toughest political turmoil since 1989 (Tiananmen) is worrisome (especially if you’re still subscribing to the view that China’s economy will do fine this year).
- The central bank will lower bank reserve requirements next week in an effort to support the economy.
- The BBC reports China is warning the Philippines with military conflict over the dispute regarding the Scarborough Shoal in the South China Sea. Is this a warm up act to China’s dispute with Japan over the Senkaku islands in the East China Sea?
- The latest trade data are not good. India continues to import 50% more than it exports – as seen in the April data. The government is responding with subsidies to exporters.
- The Indian rupee has been clobbered over the past year. It continues to trade at all-time lows versus the US dollar.