Since the panic melt down of the market in March, investors have seen quite an impressive melt up of the markets since then. This begs the question, Where does the market and where do investors stand?
What Has Changed?When asking the above question, the most important things to look at in this recession are credit conditions.
The TED Spread has improved dramatically since its severe spike in 08'.
The Yield Curve is Steep and yields on the long end have been steadily climbing as have TIPS, which are now at 2.125% on the 10-year (geez, if investors really feared inflation, wouldn't TIPS be higher?).
Mortgage Rates are steadily dropping, but have ticked up slightly in the past month:
(from
Bloomberg)
| CURRENT | 1 MONTHPRIOR | 3 MONTHPRIOR | 6 MONTHPRIOR | 1 YEARPRIOR |
| 30-Year Fixed | 4.97 | 4.88 | 5.27 | 6.07 | 5.76 |
| 15-Year Fixed | 4.63 | 4.61 | 4.92 | 5.73 | 5.36 |
| 5/1-Year ARM | 4.54 | 4.78 | 5.58 | 5.9 | 5.23 |
| 1-Year ARM | 4.61 | 4.74 | 5.36 | 5.63 | 5.9 |
| 30-Year Fixed Jumbo | 6.31 | 6.35 | 7.06 | 7.42 | 7.12 |
| 15-Year Fixed Jumbo | 5.92 | 5.75 | 6.18 | 6.68 | 6.47 |
| 5/1-Year ARM Jumbo | 5.11 | 5.19 | 6.1 | 6.08 | 6.04 |
Corporate bond yields have also improved from their highs in March.
Unfortunately, my access to CDS data is limited, but here is a chart from Bespoke Investment Group:
Spreads have come down from their panic highs, but are still elevated even above the early 08' levels, and CDS speads have been deadly accurate in predictive ability.
The stock market rally has been world-wide, with the Dow Jones World Stock Index having rallied nearly 40% from its lows.
What all of this data is telling us is risk appetite is returning and along with it an appearance of recovery. Is all of this sustainable? Have we embarked on permanent recovery?
A Brief Review Of The Fundamentals:Stocks - S&P 500 levelWith 95% of companies having reported 1st quarter numbers, the results aren't pretty despite "better than expected" earnings releases. Sales are down 13% YoY, with 123 beating last year and 340 falling short. Silly how so few pay little attention to those oh so important top line numbers. The spread between operating earnings and reported is enormous, despite FASB 157 adjustments. Operating earnings are down 64% YoY. S&P estimates Sep 09' as reported 12 mos. EPS will be negative for the first time ever! Let's recap my P/E overview at 919:
2009 forward annual P/E = 32.23
TTM P/E = 61.79
3 yr trailing P/E = 25.16
5 yr trailing P/E = 17.60
10 yr trailing P/E = 19.53
Got value? Now consider if we knock the price down to 500:
2009 forward annual P/E = 17.54
TTM P/E = 33.60
3 yr trailing P/E = 13.69
5 yr trailing P/E = 9.58
10 yr trailing P/E = 10.63
Not pretty.
Unemployment 8.9% at the fudged U-3 level, but 15.8% on the realistic U-6 level, with no sign of easing, especially considering dealership closings will flood the unemployment gates.
Commerical and Residential Real EstateThe Fed released
charge-off and
delinquency rates today.
Delinquency rates were 7.13% for all residential and commercial loans, get this, an increase of 101% year over year.
Residential stand at 7.91%, Commerical at 6.4%, credit cards at 6.5%. The total delinquency rate reached its peak of 7.47% in 1991 for comparison.
Charge-Off rates decreased from Q4 08' from 1.74% to 1.57% for residential and commercial loans. Ironcially, the decrease was in the commercial arena, in which fundamentals are deteriorating rapidly. Residential charge-offs are still increasing and credit card charge-offs are rapidly increasing, 63% year over year.
HousingStarts came in today at lower than expected numbers. This is good news, since last I checked there were still huge inventories (not counting shadow inventories and condos) still around 10 or 11 months supply, with 5 being considered normal.
US Housing Starts At Record Low:
Compared with the same month last year, housing starts were down 54.2% and permits down 50.2%.
Analysts were surprised by the weak numbers.
"It's just as I said a month ago - I can't imagine that housing starts and permits can get much weaker than they are. And you wait a month and they get weaker," said Hugh Johnson, chief investment officer at Johnson Illington Advisors.
They will continue to be weak for some time, until inventory is worked off, with a few false jumps here and there. Any increase in starts and permits must be viewed as negative.
GovernmentThe rally in not only stocks, but credit instruments, commodities and other asset classes like REIT's and precious metals is truly awe inspiring. Why do I say this in connection to government? Because the Fed has had a big hand in it (I suppose) and the Obama team is planning anti-capitalism measures.
Taxes -
Tax Increases Could Kill The RecoveryThe Obama budget calls for tax increases of more than $1.1 trillion over the next decade. Official budget calculations disguise the resulting fiscal drag by treating Mr. Obama's proposal to cancel the 2011 income tax increases for taxpayers with incomes below $250,000 as if they are real tax cuts. The plan to modify the Alternative Minimum Tax to avoid increases for some taxpayers is also treated as a tax cut.
But those are false tax cuts in which no one's tax bill actually declines. In contrast, the proposed tax increases are very real. And despite the proposed tax increases, the government's new spending and transfer programs would cause the annual budget deficit in 2019 to exceed $1 trillion, or 5.7% of GDP.
Mr. Obama's biggest proposed tax increase is the cap-and-trade system of requiring businesses to buy carbon dioxide emission permits. The nonpartisan Congressional Budget Office (CBO) estimates that the proposed permit auctions would raise about $80 billion a year and that these extra taxes would be passed along in higher prices to consumers. Anyone who drives a car, uses public transportation, consumes electricity or buys any product that involves creating CO2 in its production would face higher prices.
CBO Director Douglas Elmendorf testified before the Senate Finance Committee on May 7 that the cap-and-trade price increases resulting from a 15% cut in CO2 emissions would cost the average household roughly $1,600 a year, ranging from $700 in the lowest-income quintile to $2,200 in the highest-income quintile. Since the amount of cap-and-trade tax rises with income, the cap-and-trade tax has the same kind of adverse work incentives as the income tax. And since the purpose of the cap-and-trade plan is to discourage the consumption of CO2-intensive products, energy or means of transportation by raising their cost to consumers, the consumer-price increases would be the same for a 15% reduction in C02 even if the government decides to give away some of the CO2 emissions permits.
But while the cap-and-trade tax rises with income, the relative burden is greatest for low-income households. According to the CBO, households in the lowest-income quintile spend more than 20% of their income on energy intensive items (primarily fuels and electricity), while those in the highest-income quintile spend less than 5% on those products.
The CBO warns that the estimate of an $80 billion-a-year tax increase could be significantly higher or lower, depending on how the program is designed. The Waxman-Markey bill currently before Congress calls for reducing greenhouse gasses 20% by 2020 and by an incredible 83% by 2050. As the government reduces the amount of CO2 that is allowed, the price of the CO2 permits would rise and the pass-through to consumer prices would also increase.
The next-largest tax increase -- with a projected rise in revenue of more than $300 billion between 2011 and 2019 -- comes from increasing the tax rates on the very small number of taxpayers with incomes over $250,000. Because this revenue estimate doesn't take into account the extent to which the higher marginal tax rates would cause those taxpayers to reduce their taxable incomes -- by changing the way they are compensated, increasing deductible expenditures, or simply earning less -- it overstates the resulting increase in revenue.
Since the projected revenue from this source is already designated to be used for Mr. Obama's health plan, some other tax increases will be needed. Moreover, Mr. Obama's budget characterizes the projected $634 billion outlay for health-care reform as just a down payment on the program. The budget notes that there would be "additional resources and new benefits to be determined with Congress." Those additional resources would no doubt be even higher taxes.
The third major tax increase is the plan to raise $220 billion over the next nine years by changing the taxation of foreign-source income. While some extra revenue could no doubt come from ending the tax avoidance gimmicks that use dummy corporations in the Caribbean, most of the projected revenue comes from disallowing corporations to pay lower tax rates on their earnings in countries like Germany, Britain and Ireland. The purpose of the tax change is not just to raise revenue but also to shift overseas production by American firms back to the U.S. by reducing the tax advantage of earning profits abroad.
Not mentioned here are the possibilities of capital gain and dividend tax increases, silly soda pop taxes and any other ideas that might be floating out there.
The other most obvious government blunders are going on in the financial sectors now, where rules change daily and lies, deciept and fraud are the name of the game. Most striking here is the moral hazard created and forced industry consolidation, neither of which is good for taxpeyers of the sector in general. Taxpayers can't even count how many dollars they've committed to such fraud because Fed auditors don't know.
Health care costs are set to skyrocket. Don't believe me?
America Requires A Dose Of Health Care Reality:
Last week, after meeting groups representing hospitals and insurance companies, Barack Obama announced a breakthrough on reforming US healthcare. It was “a historic day”, he said. The providers had made “an unprecedented commitment” to curb the system’s costs, running at 16 per cent of gross domestic product. They had agreed, he said, to reduce growth in healthcare spending by 1.5 percentage points a year, enough to save $2,000bn (€1,480bn, £1,320bn) over the next decade.
...
Cost control can and should be part of the answer, but not the larger part. Too much is expected of a new emphasis on preventing illness, bringing information technology to bear and reforming the way services are delivered. All these should be done – to improve outcomes and value for money. Experience suggests that they will do little to curb spending.
The deepest of these delusions is believing that subsidies to make health insurance near-universal will pay for themselves, through fewer visits by the uninsured to expensive emergency rooms rather than relatively cheap primary-care doctors and nurses. There will be some savings of that kind, but wider insurance will raise the consumption of health services. That is the idea, after all. No health-policy scholar I am aware of believes this change will come close to paying for itself.
Near-universal healthcare will require higher taxes. The administration said so in its budget, setting aside a “downpayment” of $600bn over 10 years. Most analysts think that comprehensive reform will cost $1,500bn or more. Even without healthcare reform, Mr Obama’s long-term budget does not balance. So count on it: US taxes are going up.
I recommend reading the rest of the article. What is obvious, Obama's administration is set out to do the same capital killing central planning that Hoover and FDR carried out in the depression era, but even grander!
Monetary StimulusThere have been huge sums of money forced down the throats of banks to keep their pulse at the minimum to be technically among the living. There's a possibility some of this liquidity is finding its way into the capital markets in search that phat yield. Just a theory, and I'm not the first to postulate that. Frank Shostak, a respected Mises scholar, has recently written on the topic,
Obama's Stock Market Mini-Bubble:
According to the historical data, the yearly rate of growth of liquidity bottomed at negative 16.6% in May 1929. Yet it took a long time before the S&P 500 responded to this. It took over three years after the bottom in liquidity was reached before the S&P started to recover. The stock-price index bottomed in June 1932 at 4.43.
The time lag between the bottom in liquidity and the bottom in the stock market has been shorter in more recent history. Thus the yearly rate of growth of liquidity had bottomed at negative 5.7% in September 2000. It took twenty-five months before the S&P 500 bottomed at 815.28 by September 2002.
The current bear market that started in October 2007 was preceded by a peak in the liquidity rate of growth in June 2003 — a time lag of over four years. The yearly rate of growth of liquidity stood at 7% in June 2003. The S&P 500 climbed to 1,549.38 by the end of October 2007.
Observe that at the end of February 2009, the S&P 500 closed at 735.1 — a fall of 52.6% from the peak in October 2007. The yearly rate of growth of monetary liquidity hit bottom in January 2008 at negative 6.1%. By the end of April, the yearly rate of growth of liquidity stood at positive figure of 24.9%.
Please go and read the entire piece, there is much more to learn and consider. I will leave you with a part of his conclusion that speaks volumes:
We suggest that, at present, if the pool of real savings is still in trouble, then we are unlikely to have a sustained economic revival. If anything, all the rescue packages and all the massive pumping by the Fed has made things much worse as far as the underlying economic bottom line is concerned.
This in turn means that, despite lofty liquidity, bad economic fundamentals might force investors to direct their money towards other assets, such as Treasuries — and gold. If our assessment regarding economic fundamentals is correct, then the underlying downtrend in long-term Treasuries is likely to stay in force while the price of gold is likely to easily surpass the $1,000 mark.
I share those views as well. Mr. Shostak is keen to note the pool of real savings must increase still. Viewing it graphically can help:
There are years of savings to make up for. If Mr. Shostak's views are correct, then this rally will have limits, and eventually risk appetite will dwindle, instead flowing into "safe" treasuries and gold.
I outlined my own argument for deflation in Debt, Wealth & Keynesianim, however I left out a big piece of the puzzle, derivatives:
The amount of outstanding contracts linked to bonds, currencies, commodities, stocks and interest rates fell 13.4 percent to $592 trillion, the Basel, Switzerland-based bank said yesterday. That’s the first decline in 10 years of compiling the data. The amount of credit-default swaps protecting investors against losses on bonds and loans fell 27 percent to cover a notional $41.9 trillion of debt.
$592 trillion is a staggering figure. To believe only a 13.4% drop in notional value when other assets, including housing have all fallen more in percentage terms will resolve the derivatives issue is a bit optimistic.
In Summary, to answer my initial question - "Where does the market and where do investors stand?" - the jury is still out on how much longer the rally will last, but there is very little reason to believe this rally is anything other than a liquidity/risk driven bear market rally. But with such terrible fundamentals, how can it be sustained? The credit improvements are encouraging, but one has to wonder with so many headwinds how market driven many of the credit readings are.
