NEW$ & VIEW$ (25 NOVEMBER 2013)

Iran nuclear deal pushes oil prices lower Geopolitical tensions expected to ease and supply rise

Brent crude fell $2.29 to $108.76 a barrel and US-traded WTI was down $1.44 to $93.40 in response to the agreement between Iran and six world powers reached at the weekend to curb Tehran’s nuclear programme in return for the easing of sanctions.

However, some analysts warned that Iranian exports are unlikely to jump in the short term because key limitations on sales – including a ban on exports to the EU – will remain in place until a comprehensive deal is reached.

US-led sanctions have reduced Iranian exports from almost 2.5m barrels a day to just 1mb/d over recent years, squeezing crude supplies, while the prospect of an Israeli or US strike on Iran’s nuclear facilities has added a further risk premium to the market. (…)

Within the oil market the focus is growing on a sentence in a copy of the interim agreement posted on an Iranian news website, which says western powers will suspend sanctions on insurance and transportation services.

Fereidun Fesharaki, head of the FACTS Global Energy consultancy, said a relaxation of shipping and insurance sanctions could lead to an increase of between 200,000 and 400,000 b/d in Iranian export immediately. (…)

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Continued Signs of Healing in Labor Market

The job market isn’t healing quickly. But it is healing.

(…) Employers are still hiring close to a million fewer people every month than before the recession, and the pace of hiring has edged up only slowly in recent years. Millions of Americans are still looking for jobs, and millions more have given up looking. (…)

But there are signs that both workers and companies are becoming more confident about the state of the economy. The 3.9 million jobs posted in September is the most since the recession ended nearly four and a half years ago. Perhaps even more significantly, 2.3 million people quit their jobs voluntarily in September, 18.5% more than a year ago. Janet Yellen, President Barack Obama’s nominee to lead the Federal Reserve, has highlighted the rate of voluntary exits as a key measure of confidence — one that until recently had been lagging other measures of economic health.

Things are also looking up for the nation’s 11.3 million job seekers. There were 2.9 unemployed workers for every job opening in September, the best mark of the recovery and the second month in a row where the ratio fell under three to one; in the worst of the jobs crisis, there were nearly seven job seekers for every opening.

HOUSING WATCH

 

Weak October Sales Have Home Builders Fretting About Spring

A monthly survey of builders across the U.S. by John Burns Real Estate Consulting, a housing research and advisory firm, has found that respondents’ sales of new homes declined by 8% in October from the September level and by 6% from a year earlier.

Last month’s result marked the second consecutive month in which the survey yielded a year-over-year decline in sales volumes, the first dips since early 2011.

In addition, the percentage of builders disclosing that they raised prices continued to decline, registering 28% in October in comparison to 32% in September and 64% in July. Of respondents, 12% lowered prices in October, in comparison to 12% in September and none in July. (…)

The Burns survey found that sales volumes increased by 31% in the Northwestern U.S. in October from September. Other regions that notched gains included the Southeast, up 13%; Northern California, up 11%; and the Midwest, up 1%. Decliners included Texas, down 21%; the Southwest, down 16%; Florida, down 15%; the Northeast, down 12%; and Southern California, down 8%.

Hottest Housing Markets Hit Headwinds

Some of the nation’s hottest housing markets over the past year are cooling off as buyers balk at paying higher prices while faced with rising mortgage rates, according to a Wall Street Journal survey of market conditions.

In a number of cities across California, Arizona and Nevada—where price gains have been especially strong in the past year—sales are slowing and supply is rising.

Real-estate agents and economists attribute the current slowdown to rising prices and a jump in mortgage rates, which have made homes less affordable for prospective buyers and a less compelling deal for the investors that have played significant roles buying up cheap foreclosures and other distressed homes over the past two years.

For the 12-month period ending in September, values have climbed by more than 33% in Las Vegas and Sacramento, Calif., and by more than 20% in San Francisco, Phoenix, San Diego, and Orange County, Calif., according to Zillow Inc., the real-estate website.

But lately, those gains have moderated. For the July-to-September quarter, home values in Orange County rose just 1%; in San Diego, 2%; and in San Francisco, 3%. Those were the smallest increases in those markets since prices began to rise in early 2012.

(…) In Southern California, Mr. Wheaton said, “we’re seeing more price reductions than we are price increases.” (…)

Inventories are falling in Texas, the Midwest and the Northeast. Compared with a year ago, listings were down in around half of all markets, with big declines in Denver, where inventories were 26% below year-earlier levels, and Manhattan, where inventories fell by 22%.

Listings were down by 19% in Houston; 18% in Dallas; 14% in New York’s Long Island; and 13% in the northern New Jersey suburbs.

Broadly speaking, however, of the 28 major metro areas tracked in the latest Journal survey, nearly half saw inventories rise on an annual basis in September. That represents the highest share of markets showing a rise in supply in nearly three years, with notable increases in San Francisco, Phoenix, Las Vegas, Atlanta and Sacramento. (…)

As demonstrated in my June 2013 post U.S. Housing A House Of Cards?, real estate is a local business. National stats have little meaning for the actual supply demand equation in Houston, in Sacramento or Boca Raton.

France: The people see red

The scarlet hat has become the symbol of protest against François Hollande’s tax rises

In 1675 a popular revolt exploded in Brittany, the rugged north western region of France that juts into the Atlantic Ocean. It was against taxes imposed by Louis XIV, the Sun King, to finance war against the Dutch. The red-capped protesters were known as Les Bonnets Rouges. Nearly 440 years after the uprising was bloodily suppressed, people in Brittany have donned theirbonnets rouges once more. This time they are fighting a wave of taxes imposed not by a king, but by President François Hollande and his socialist government.

“It is another guerre de Hollande,” exclaims Thierry Merret, a bluff Breton vegetable grower, farming union chief and a leader of the new bonnets rouges.

Their challenge has added to a tide of discontent engulfing Mr Hollande. An Ifop poll this month showed his approval rating slumping to 20 per cent, a low no previous president has plumbed in the poll’s 55-year history.

The bonnet rouge has become a symbol of protest not just against taxes, but also the perceived inability of Mr Hollande to deal with a stuttering economy that has seen unemployment climb to nearly 11 per cent of the workforce. (…)

“The situation is unprecedented,” says Laurent Bouvet, professor of politics at Versailles-Saint-Quentin university. “A year and a half after the election, the left is in a potentially catastrophic situation. There is no capacity for movement on the economy or other questions.”

It is not just the business community that is expressing frustration. The bonnets rouges have brought together farmers, fishermen, traders, shopkeepers and workers.

Note Red: the blood of angry men!
     Black: the dark of ages past!
    Red: a world about to dawn!
                Black: the night that ends at last! Note
 
THERE’S ALSO ITALY:

In September, the seasonally adjusted retail trade index decreased by 0.3 per cent compared with August, with food goods falling 0.2 per cent and non-food goods 0.3 per cent. Year on year, retail sales were down an unadjusted 2.8 per cent. The monthly decline was the steepest for eight months, and on an annual basis it was also the biggest in three months.

In the third quarter, retail sales fell 1.2 per cent compared with the same period last year. The data are not adjusted for consumer price inflation, which stood at 0.9 per cent in September, based on the main index, suggesting that retail sales posted a much worse annual contraction in inflation-adjusted terms.

SENTIMENT WATCH

 

S&P Climbs Past 1800

The run to records continued Friday for stocks, with the S&P 500 closing above 1800 for the first time.

S&P Closes Above 1800, Posts 7th Consecutive Weekly Increase: Longest Streak Since 2007

The S&P 500 has now managed the longest weekly winning streak (7 weeks) since May 2007 (when it managed a 9% gain). Off the recent lows, the current run is an impressive 9.6% (for the S&P) (…).

Embarrassed smile Hugh Hendry Capitulates: “Can’t Look At Himself In The Mirror” As He Throws In The Towel, Turns Bullish

First David Rosenberg, then Jeremy Grantham, and now Hugh Hendry: one after another the bears are throwing in the towel. (…)

“I can no longer say I am bearish. When markets become parabolic, the people who exist within them are trend followers, because the guys who are qualitative have got taken out,” Hendry said.

“I have been prepared to underperform for the fun of being proved right when markets crash. But that could be in three-and-a-half-years’ time.”

“I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends.”

(…) Finally, Hendry’s “come to Bernanke” moment does not come easily:

The manager acknowledged his changing stance may be viewed by some investors as a ‘top of the market’ signal, but said he is not concerned by the prospect of a crash.

“I may be providing a public utility here, as the last bear to capitulate. You are well within your rights to say ‘sell’. The S&P 500 is up 30% over the past year: I wish I had thought this last year.”

Crashing is the least of my concerns. I can deal with that, but I cannot risk my reputation because we are in this virtuous loop where the market is trending.”

BUBBLE WATCH

The Four Horsemen of the Apocalypse are Pulling in the Same Direction. They are a Harbinger for More Stock Market Returns (Hubert Marleau, Palos Management)

Barring financial crises, stock market bull runs need the continuous blessing of four macro drivers. These are: Positive Economic Growth, Sustainable Price Stability, Reasonable Valuation and Accommodative Monetary Policy.

While I recognize that the US stock market is up 150% since the lows of March 2009 without any serious corrections, stock prices could go up more for investors are still selectively and mildly exuberant. A rotation towards equity has just started and it could last for several years.

Since the first quarter of 2009, investors have de-risked their portfolios by adding $1.3 trillion in bonds and selling $255 billion worth of equities. Lately, investors are now allocating somewhere around 20% of their new monies to the stock market. Before the financial crisis as much as 30% to 40% of investors’ capital found its way into stocks. Household balance sheets are much healthier, banks are profitable and settling their wrongdoings, and corporations are loaded with cash. In this context, even if the economy may not be doing as well as one would like a financial crisis is not looming.

Moreover, the four horsemen that choose the direction of the stock market are still bullish.

1) Positive Economic Growth: The level of economic output in the US has been steadily growing without any interruptions for 51 months since it bottomed during the second quarter of 2009. During the period under review, the US economy grew at the annual rate of change of 2.0%. In the past six months, the pace of the economy has accelerated to 2.7%.

2) Price Stability: A steady annual rate of increase in the general price levels between 1% and 3% is considered by the Fed and most seasoned market observers as price stability. Since the third quarter of 2009, the GDP Chain Price Index increased at the annual rate of 1.4%. For the period under review, the lowest quarterly annual rate was 0.6% in the second quarter of 2013 and the highest was 2.6% in the second quarter of 2011. During the third quarter of 2013, GDP Deflator printed a year over year increase of 1.3%. Based on recent developments in commodity prices, wages and output per hour, there is reason to believe that price inflation is going to remain stable for a prolonged period of time. Moreover, the gap between actual and potential output is sufficiently wide to prevent any upward cost pressure.

3) Accommodative Monetary Policy: The rate on Federal Funds has been near zero throughout the period under review. The Zero Rate Policy had three beneficial effects. It kept the level of real interest rate negative, the yield curve positive and the cost of capital below the return on capital. The latter is often called the “Wicksellian Differential”.

While we expect the Fed to start paring down the $85 billion-a-month bond purchase program in the coming months, the monetary authorities will continue to hold short term rates near zero until a higher participation rate and/or a lower unemployment rate firmly takes hold. The Palos Monetary policy index currently stands at 60 indicating that the interest rate stance of the Fed is not about to change. In this connection, the beneficial effect of ZIRP (zero interest rate policy) on real rates, yield curve and the Wicksellian spread is maintainable.

4) Reasonable Equity Valuation: The stock market is not necessarily cheap, but it’s not stretched by historical standards. Currently, the median 12-month forward price-to-earnings ratio of 16.0 times is consistent with other periods of earnings growth. Moreover, the spread between corporate bond yields and stock dividend yields at 250 bps are as narrow as they were in the 1950’s. One should also bear in mind that the EPS of the S&P-500 increased 125% from the first quarter of 2009 to the third quarter of 2013 closely matching stock market returns. Year over year, the same EPS is up 9.3% and forecast to increase another 5.1% in 2014.

In conclusion, what is not to like? In tandem, the major drivers are pulling the stock market up. It is not that stock prices will surge ahead over the next few years in a perpetual upward motion. However, stock market returns should continue to beat bond market returns.

Hubert is a good friend of mine, an excellent economist and a good strategist. I am not sure how investors can be “selectively and mildly exuberant” but I know Hubert can’t be only mildly exuberant.

The first chart below plots the S&P 500 Index PE on forward EPS, currently at 15.4x, 28% above its 60-year median of 12x and at the mid-point of the 1 standard deviation channel (10-20x).

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One can make a case for decent valuations here, even more so if the 60-year average of 15x is used instead of the median. Do it at your own risk, however, if you chose to ignore the statistical impact of recent bubble years. As to Hubert’s assertion that “the median 12-month forward price-to-earnings ratio of 16.0 times is consistent with other periods of earnings growth”, it does not verify in the 1991-92 period (profits troughed in mid-1992).

During the 1955-1972 period of prolonged high P/E multiples, earnings remained flat until 1962 before rising steadily through 1966. Inflation was quite volatile between 1955 and 1960, fluctuated narrowly within 1-2% up to 1966, then skyrocketed from 2% to 6.5% by 1970 before coming back to the 3% range by 1972.

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The 1961 to 1966 period most closely resembles the current environment of expected sustained low inflation. Earnings rose strongly and steadily until inflation peaked in late 1966. Equities dropped sharply in 1962 (Bay of Pigs crisis) but skyrocketed during the next 4 years. Throughout that period, forward P/Es fluctuated between 15x and 17x, partly validating Hubert’s comments.

Nevertheless, with forward P/Es, one must deal with the pitfalls associated with earnings forecasts. But even with trailing earnings, absolute valuations never looked really compelling during the 1960s except in late 1966 and in mid-1970 when trailing P/Es reverted back to their 60-year median value of 13.7. Waiting for even median valuation would have meant missing the near doubling in equities between October 1960 and December 1965.

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So Hubert has a point. But I have a better and stronger one. The Rule of 20 worked really well during the 1960’s while using actual trailing earnings and constantly taking account of inflation fluctuations.

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Using the Rule of 20, investors would have sold before the 1962 decline of 24%, bought back aggressively late in 1962, remained reasonably invested as the market rose 67% to December 1965 while flirting with “fair value” (20), suffered the 16% setback of 1966 if they were not mindful of rising inflation, bought aggressively again in the fall of 1966 to enjoy a 30% gain until getting entirely out of equities in mid-1968 just before the ending of the Nifty-fifty stocks era.

Freezing  Some Stock Bulls Tread Lightly

Stock-market strategists, typically a bullish bunch, are taking a cautious approach to the S&P 500.

(…) Forecasts center on gains in the mid-to-high single-digit percentages for the S&P 500 in 2014.

In large part this caution reflects expectations that investor enthusiasm for stocks will be restrained in an environment in which structural challenges continue to hold back the U.S. economy. The result, many strategists said, is that stocks are unlikely to see a continued rise in valuations against earnings growth as they did in 2013.

In addition, bullishness is being muted by a belief that the Fed will in coming months start to pare back the easy-money policies that many said have played a key role in driving stock prices higher this year.

But some strategists said it also reflects a conscious effort to present a tempered outlook.

 

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