Note My eyes get blurry, my faucet runs

I wait for my vision, but it never comes

I can’t give you the answers if I can’t see your hands

I’m driving blind through this barren land  Note (Grace Potter)


If anybody was waiting for clearer skies post the May PMIs…:

  • May U.S. ISM PMI down 1.7 to 49.0. New orders down 3.5 to 48.8.
  • May Markit U.S. PMI up 0.2 to 52.3. New orders up 1.8 to 53.3 with “large manufacturing firms recording the strongest increase in new orders for over a year”.
  • May Chicago ISM up 9.7 to 58.7. New orders jumped 4.9 to 58.1. The April report had declined 3.4, a 3 year low.
  • The Richmond Fed Survey “improved somewhat” from –0.6 in April to –0.2 in May, even though new orders worsened again to –10.
  • The Philly Fed survey decreased 1.3 to –5.2 with new orders falling 1.0 to –7.9.
  • China’s official PMI edged up 0.2 to 50.6 in May. New orders flat at 51.8.
  • The HSBC China Manufacturing PMI declined 1.2 to 49.2 in May. New orders declined modestly but new export orders fell for the second month in a row. “A number of panellists suggested reduced client demand, particularly in the U.S.
  • May Eurozone PMI improved a tiny 1.7 to 48.3 as “new export order inflows showed signs of stabilising in May”.

The only way to summarize manufacturing across the world is to say that, however confusing the data is, activity is spotty and weakish, directionless around the borderline between sluggish growth and contraction. Here’s how Markit summed it up as it reported that the JPMorgan Global Manufacturing PMI rose 0.2 to 50.6 in May:

Manufacturing continued to more or less stagnate in May, according to the worldwide PMI surveys. Modest expansions in the US, Japan and the UK offset downturns in China and in particular the euro area, leaving an overall picture of almost no growth.

And, for the first time in 2013, we are seeing signs of weaker U.S. demand at the manufacturing level. In fact, even Markit’s relatively more upbeat May survey revealed “the weakest expansion reported by U.S. manufacturers of consumer goods.”

Speaking of the all important U.S. consumer:

  • U.S. Real Personal Consumption expenditures, which rose at a 4.0% annual rate between November 2012 and February 2013, gained only 0.2% in March and 0.1% in April. Nominal disposable income was up 0.2% in March and down 0.1% in April and the savings rate stabilized at a low 2.5%.
  • U.S. weekly chain store sales are spotty but remain generally sluggish. Their 4-week moving average has declined in each of the last 5 weeks. It now stands at +2.8% YoY against the weakest period of 2012.

Say what you want, see what you can, the reality is that U.S. domestic demand is weakening at its core. The U.S. consumer cannot keep supporting the economy with little, if any, income growth, and a savings rate already near all time lows. The boost to Real DPI from yearend special bonuses and dividends has rapidly faded away. There are little savings left to sustain consumption in that context.



This explains the flattening out in new car sales since November 2012.


All those experts who had little faith in a housing recovery even one year ago now see the housing train as unstoppable. They could not see how very limited supply could end up driving prices up. They now cannot conceive that rising prices (house prices and mortgage rates) combined with declining income can eventually hurt demand. What will then happen to supply is hidden in the heads of all these hedge fund managers who have bought nearly 30% of the supply of the last several years…

The following charts plot actual median sales prices for NEW houses, up 23% over the last year to a new all-time high, and actual median EXISTING house prices which are up 10% YoY. While median prices can be influenced by changing mix, these nonetheless reflect actual transactions, i.e. real demand.



The housing recovery has come only because Americans have been trading up, and paying up. But that makes the recovery even more fragile as affordability can turn down quickly on these higher purchase prices.

I doubt that housing can keep pulling the U.S. economy under conditions of limited income growth and rising prices. Never mind rising mortgage rates!

Which brings us to the Federal Reserve folks who have recently been saying just about everything and anything about what the Fed will do next. These elite leaders are driving blind and are knowingly blinding investors along the way. They have no clue where the economy will be in 3, 6 or 12 months. And nobody can blame them, cause everybody is currently driving blind.

The difference is that the Fed knows it is driving blind, so it will keep its foot on the interest rates brake pedal to prevent another swoon.

Past periods of rising interest rates have dented home sales trends, even in the context of overall economic growth. A sharp rise of the 30-year mortgage rate from 7.07% at the beginning of 1994 to 9.20% by the end of that year, reversed what had been a robust housing rebound. Single-family home sales shifted from an annual gain of 13% in the year ending June 1994 to a 7% contraction by May 1995. A less severe example occurred just a couple years later when the mortgage rate started 1996 at 7.03%, before rising to 8.32% by June of that year. (Moody’s)

Equity investors, blindsided by the monstrous 25% rally since mid-December and confused by all the Fed talk and renewed media hype, are dreaming of a better world, oblivious to all the warnings signs along the road. Peter Oppenheimer, chief global equity strategist at Goldman Sachs, got a front page exposure in the FT for pretty hollow opinions such as this one:

First, much of the recent weakness in economic activity is likely to be temporary, and the prospects for a recovery late this year look good. Even in the eurozone, economic conditions should get less bad in the second half of this year and into next year, led by a recovery in Germany, and while Europe may not contribute much to the global economic recovery, it should benefit from one. (…)

Funnily enough, he later declares that

investors pay for what they can see rather than what they hope might happen.

What investors pay for is earnings. But the GS strategist fails to see that they have actually stalled over a year ago.

Q1’13 operating earnings came in at $25.76, up 6.3% YoY but still stuck below $26 and essentially flat for almost 2 years. As a result, trailing EPS have been stuck below $100 since early 2012.

image image

In spite of all the rhetoric that high profile strategists can use to explain equity markets, the plain reality is that stock prices = EPS x P/E. Earnings are the easy part, assuming you use trailing earnings, i.e. pay for what you see rather than what strategists hope might happen. Earnings have made zero contribution to rising equity prices over the past year.

Contribution from a rising P/E was significant as trailing P/Es rose from 13.8 to 17.1 since October 2011. This 3.3 point increase in trailing P/E boosted the S&P 500 Index by 35% to its recent peak.

What caused this P/E swell? Investment gurus provide us with a host of answers to this existential question. I humbly propose the Rule of 20’s answer: falling inflation. The U.S. inflation rate dropped from a high of 3.9% in September 2012 to its recent low of 1.1%. This 2.8% drop in inflation adds nearly 3 points to the Rule of 20 fair P/E (fair P/E = 20 minus inflation). More Oppenheimer wisdom:

Third, lower inflationary pressures continue to provide the cover needed for ongoing supportive monetary policy; this is both easing global financial conditions and supporting real asset prices.

Inflation has been so low recently that low, if not lower, inflation has become the acceptable norm. Yet, many measures of inflation suggest that it has not declined as much as the headline numbers say. Look closely at this table from the Cleveland Fed:


However you slice it, U.S. inflation is 2.0% so far in 2013. Core CPI, median CPI and the 16% trimmed-mean CPI have all risen at a 2.0% annualized rate since December 2012. The 0.5% jump in core CPI in Jan-Feb has not been followed by a decline. Rather, core prices have kept rising by 0.1% per month. The median CPI has gained 0.2% monthly in all of the last 6 months but one. All this to say that, in spite of strong desinflationary trends across the world, U.S. core inflation is showing no signs of slowing below 2.0%.

And be careful what you wish for. Very low inflation, let alone deflation, is not necessarily good for corporate profits. S&P 500 companies grew revenues only 1.3% in Q1’13. Ed Yardeni rightly sees the writing on the wall but, like most economists and strategists, remains willing to drive on even with his eyes wide shut (my emphasis):

May’s Manufacturing-PMI raises yet another warning flag about the flagging prospects for S&P 500 revenues. Nevertheless, I still expect that global nominal GDP will increase by 5% this year and 5% next year. Revenues should grow by at least as much. However, the latest data points aren’t supportive of this relatively upbeat outlook.

The M-PMI is highly correlated with the y/y growth rate in S&P 500 revenues. The purchasing managers’ index suggests that this growth rate might have worsened rather than improved during the second quarter, when I expected to see an improvement.

I monitor the consensus expectations for S&P 500 revenues and earnings per share based on weekly data compiled by Thomson Reuters I/B/E/S. Their revenue estimates for 2013 and 2014 have dropped sharply during the first four weeks of May to new lows. They now expect revenues to grow 2.2% this year and 4.4% next year.image

Dr. Ed goes even further:

The latest global trade data also aren’t comforting. The good news is that both the value and volume of world exports remained near their recent record highs. The bad news is that they aren’t growing.

The values of both world exports and US exports are highly correlated with S&P 500 revenues. US exports also are near their recent record high, and also not growing.


So, for those who don’t ignore their self-designed signposts, the outlook for revenue growth is not good and is actually getting worse. One can hope for better margins to keep earnings up but this is for the wishful thinkers driving on a road they assume straight for as far as the eyes can see, and beyond!

The reality as I see it with objective eyes is that:

  • profits have flattened out a while ago and offer no back wind for equities;
  • current profits are taxed at an abnormally low effective average rate and governments across the world are seeking ways to harmonize corporate taxation, a potential negative for many global companies;
  • revenue growth has slowed and looks weaker;
  • this is supported by weaker economic trends across the world, particularly at the consumer level;
  • objectively, the outlook is for very sluggish growth with the risk biased on the downside, not the upside;
  • central banks will not risk a swoon and they will keep pumping;
  • inflation remains stuck at the 2% level, even with soft demand.

In this context, the Rule of 20 says fair P/E is 18.5 (using 1.5% inflation, the mid-point between actual CPI and core inflation of 2.0%). On trailing 12-month EPS of $98.34, fair market value is 1819, 11% above yesterday’s 1635 close. If inflation is in fact 2%, fair value drops to 1770, 8% above current levels.


I am therefore cautious on this tortuous road. Without earnings pushing up, markets can be very fickle, especially when driven by blind liquidity looking for a relatively decent home, even if the home is actually pretty uncomfortable.

Just so you don’t take my view blindly, here’s a June 3rd WSJ story about a blind man who sees a rough ride ahead…but still refrains from acting on his vision.

The man behind the “Hindenburg Omen” said he’s prepping to bail out of the stock market after his ominous-sounding technical indicatorwas tripped last week for the second time in two months.

In a chat with MoneyBeat Sunday evening, Jim Miekka — a blind former high-school physics teacher and the newsletter writer who devised the Hindenburg Omen — confirmed all the criteria were met on Friday that triggered the indicator. He said he’s still invested in the market, for now, and is waiting for “a strong up day this week” before he gets out of stocks and potentially starts shorting the market.

“We’re on our way down from here,” Miekka said. “I’m hunkering down for a possible rough ride.”

The Hindenburg Omen – named after the 1937 disaster of a German passenger airship – uses a formula that parses data including 52-week stock levels and moving averages. Other criteria include a rising 10-week NYSE moving average and a negative technical indicator that measures market fluctuations. All these indicators must be tripped simultaneously on the same day for the Hindenburg Omen to take place. One occurred on April 15 and another took form on Friday, Miekka said.

The WSJ notes however

While the Omen foreshadowed significant drops in 1987 and prior to the 2008 financial crisis, it has proven to be a false alarm more often than not. Significant stock-market declines have followed the indicator just 25% of the time. That’s why some say the Omen sounds like little more than hocus-pocus.


Miekka, who devised the indicator in 1995, attracted a cult-like following in August 2010 when a cluster of Hindenburg Omens took place over several weeks. When Miekka’s indicator became the buzz of talk shows, trading floors and news articles, the market meltdown he was forecasting never came to fruition.

“Back in 2010 everybody was watching it, which I think is part of the reason why it didn’t work then,” Miekka said. “Now, everybody is ignoring it. From a contrary viewpoint, that’s why it could work.”

So Jim, why don’t you simply get the hell out and keep your mouth shut?

I suspect he is like Fed governors: the urge to say something, anything, is simply overwhelming.

Actually, why not hire him as the next Fed chairman given his credentials:

Despite being blind, he has become an avid target shooter. He said he created artificial-vision technology that uses sounds to help him identify targets better than many sighted shooters, a craft that he has been developing and perfecting for years.

If not Fed Chairman, why not chief global equity strategist at Goldman Sachs.


2 thoughts on “DRIVING BLIND

  1. Ouch – Denis – very brutal today. :-) But I agree with your GS comment. I read his commentary in the FT, and I am thinking to myself – what a load a crap! I could write this drivel.

  2. Great post, this one. Especially the commentary on housing. Affordability is dropping while supply is set to increase– this will mean the end of the real estate echo boom.

    Earnings are so far above trend (40% give or take) that future real earnings growth over the 5 next years is likely to be… (drum roll)…. negative and potentially substantially so. If that real decline comes with high inflation…

    Slap a rule of 20 on that one!

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