Today’s News
Posted by Eddy Elfenbein on November 14th, 2013 at 2:22 pm

The following paragraph is all you need to know about today’s trading:

“Stock prices have risen pretty robustly but I think if you look at traditional valuation measures – the kind of things we monitor akin to price-equity ratios – you would not see prices that suggest bubble-like conditions,” Yellen said.

Janet Yellen’s Congressional Testimony
Posted by Eddy Elfenbein on November 14th, 2013 at 10:17 am

Here’s Janet Yellen’s testimony. The Fed watchers think they’ve spotted a “dovish” angle which helped the market rise to an all-time high yesterday.

Chairman Johnson, Senator Crapo, and members of the Committee, thank you for this opportunity to appear before you today. It has been a privilege for me to serve the Federal Reserve at different times and in different roles over the past 36 years, and an honor to be nominated by the President to lead the Fed as Chair of the Board of Governors.

I approach this task with a clear understanding that the Congress has entrusted the Federal Reserve with great responsibilities. Its decisions affect the well-being of every American and the strength and prosperity of our nation. That prosperity depends most, of course, on the productiveness and enterprise of the American people, but the Federal Reserve plays a role too, promoting conditions that foster maximum employment, low and stable inflation, and a safe and sound financial system.

The past six years have been challenging for our nation and difficult for many Americans. We endured the worst financial crisis and deepest recession since the Great Depression. The effects were severe, but they could have been far worse. Working together, government leaders confronted these challenges and successfully contained the crisis. Under the wise and skillful leadership of Chairman Bernanke, the Fed helped stabilize the financial system, arrest the steep fall in the economy, and restart growth.

Today the economy is significantly stronger and continues to improve. The private sector has created 7.8 million jobs since the post-crisis low for employment in 2010. Housing, which was at the center of the crisis, seems to have turned a corner–construction, home prices, and sales are up significantly. The auto industry has made an impressive comeback, with domestic production and sales back to near their pre-crisis levels.

We have made good progress, but we have farther to go to regain the ground lost in the crisis and the recession. Unemployment is down from a peak of 10 percent, but at 7.3 percent in October, it is still too high, reflecting a labor market and economy performing far short of their potential. At the same time, inflation has been running below the Federal Reserve’s goal of 2 percent and is expected to continue to do so for some time.

For these reasons, the Federal Reserve is using its monetary policy tools to promote a more robust recovery. A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases. I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy.

In the past two decades, and especially under Chairman Bernanke, the Federal Reserve has provided more and clearer information about its goals. Like the Chairman, I strongly believe that monetary policy is most effective when the public understands what the Fed is trying to do and how it plans to do it. At the request of Chairman Bernanke, I led the effort to adopt a statement of the Federal Open Market Committee’s (FOMC) longer-run objectives, including a 2 percent goal for inflation. I believe this statement has sent a clear and powerful message about the FOMC’s commitment to its goals and has helped anchor the public’s expectations that inflation will remain low and stable in the future. In this and many other ways, the Federal Reserve has become a more open and transparent institution. I have strongly supported this commitment to openness and transparency, and will continue to do so if I am confirmed and serve as Chair.

The crisis revealed weaknesses in our financial system. I believe that financial institutions, the Federal Reserve, and our fellow regulators have made considerable progress in addressing those weaknesses. Banks are stronger today, regulatory gaps are being closed, and the financial system is more stable and more resilient. Safeguarding the United States in a global financial system requires higher standards both here and abroad, so the Federal Reserve and other regulators have worked with our counterparts around the globe to secure improved capital requirements and other reforms internationally. Today, banks hold more and higher-quality capital and liquid assets that leave them much better prepared to withstand financial turmoil. Large banks are now subject to annual “stress tests” designed to ensure that they will have enough capital to continue the vital role they play in the economy, even under highly adverse circumstances.

We have made progress in promoting a strong and stable financial system, but here, too, important work lies ahead. I am committed to using the Fed’s supervisory and regulatory role to reduce the threat of another financial crisis. I believe that capital and liquidity rules and strong supervision are important tools for addressing the problem of financial institutions that are regarded as “too big to fail.” In writing new rules, however, the Fed should continue to limit the regulatory burden for community banks and smaller institutions, taking into account their distinct role and contributions. Overall, the Federal Reserve has sharpened its focus on financial stability and is taking that goal into consideration when carrying out its responsibilities for monetary policy. I support these developments and pledge, if confirmed, to continue them.

Our country has come a long way since the dark days of the financial crisis, but we have farther to go. Likewise, I believe the Federal Reserve has made significant progress toward its goals but has more work to do.

Thank you for the opportunity to appear before you today. I would be happy to respond to your questions.

Morning News: November 14, 2013
Posted by Eddy Elfenbein on November 14th, 2013 at 6:52 am

Euro Zone Economy Stagnates as Growth Slows in Germany

Top Japan Banks’ Second-quarter Earnings Leap Thanks to ‘Abenomics’ Bull Market

JPMorgan’s Fruitful Ties to a Member of China’s Elite

Spy Scandal Weighs on U.S. Tech Firms in China, Cisco Takes Hit

New Catfish Inspections Are Posing a Problem for a Pacific Trade Pact

Yellen Says Economy Performing Far Short of Potential

Rejecting Billions, Snapchat Expects a Better Offer

Swiss Chocolate Maker Barry Callebaut Opens Factory in Japan in Rare Foreign Investment Coup

Macy’s Reverses Lackluster Quarter, Helped by Ad Campaign

EADS Third-Quarter Profit Rises on Higher Airbus Jet Deliveries

Apple Sticks to Winning Script in Samsung Damages Retrial

Italy Investigates Apple for Alleged Tax Fraud

Investment Manager Explains Why 99.5% of Americans Can Never Win

Edward Harrison: The Deflationary Forward Guidance Threshold

John Hempton: The FDA, Statistics and Fundamentalism

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The Surge In Consumer Services
Posted by Eddy Elfenbein on November 13th, 2013 at 11:38 am

Here’s something I didn’t anticipate (which is a large category of things). The Consumer Services Sector has soared over the past few years, and it’s gotten stronger every day.

What’s interesting is that this sector had basically kept up with the broader market for years. Starting in mid-2008, it started to break away. The index has barely taken a break in the last two years.

Note that this is the Dow Jones U.S. Consumer Services Index which is similar (I believe) to the what the S&P calls its S&P 500 500 Consumer Discretionary Index.

Morning News: November 13, 2013
Posted by Eddy Elfenbein on November 13th, 2013 at 6:12 am

U.K. Unemployment Falls to 7.6% in Move Toward BOE Threshold

Central Banks Risk Asset Bubbles in Battle With Deflation Danger

House Stalls Trade Pact Momentum

Dollar Rises to 2-Month High Versus Yen on Fed Bets

Gary Gensler’s Successor Has His Work Cut Out for Him

It’s Getting Closer to Panic Time for Healthcare.Gov

Starbucks Concludes Packaged Coffee Dispute With Kraft

Baidu Faces Lawsuit Over Video Piracy

CNPC, PetroChina to Buy Peru Oil, Gas Assets From Petrobras for US$2.6 Billion

WTI Trades Near Five-Month Low as U.S. Supplies Seen Rising

Jos. A. Bank Tries to Look Like a Catch for Men’s Wearhouse

Rosneft Beats Rivals to Grab Enel’s $1.8 Billion SeverEnergia Stake

Samsung Says It Will Supply Half Of The Smartphones In Africa This Year

Joshua Brown: Everything You Need to Know About Stock Market Crashes

Epicurean Dealmaker: The Invention of Leisure

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The Effect of Inflation on Real Stock Returns
Posted by Eddy Elfenbein on November 12th, 2013 at 11:54 am

I’ve been doing more splicing of the Ibbotson data. Today, let’s look at the effect inflation has had on real stock returns. This may seem counter-intuitive but the more consumer prices rise, the worse stock prices have done. This makes sense since stocks are in competition with bonds, not consumer prices, and bonds do worse as inflation rises. At the other end, real stock markets have done very poorly under deflation. Historically, what the market appears to like best is low, stable inflation.

Now let’s look at some numbers. I took all of the monthly returns from 1925 to 2012 and broke them into three groups; there were 75 months of severe deflation (greater than -5% annualized deflation), 335 months of severe inflation (greater than 5% annualized), and 634 months of stable prices (between -5% and +5%).

The 75 months of deflation produced a combined real return of -46.77%, or -9.60% annualized. The 335 months of high inflation produced a total return of –70.84%, or -4.32% annualized. The 634 months of stable prices produced a stunning return of more than 177,000%. Annualized, that works out to 15.21%, which is more than double the long-term average.

Here’s an interesting stat: The entire stock market’s real return has come during months when annualized inflation has been between 0% and 5.1%. The rest of the time, the stock market has been a net loser.

One Full Year Above the 200-DMA
Posted by Eddy Elfenbein on November 12th, 2013 at 10:50 am

This Saturday will mark the one-year anniversary of the S&P 500’s last close below its 200-day moving average. This run represents both the market’s climb and its low volatility. The end result is a steady march upward.

Morning News: November 12, 2013
Posted by Eddy Elfenbein on November 12th, 2013 at 6:32 am

U.K. Inflation Slows More Than Forecast to Least in a Year

Compared to CFTC, Heading TARP May Have Been Easy Job

U.S. Nears Energy Independence by 2035 on Shale Boom, IEA Says

Gold Extends Drop to Three-Week Low on Outlook for U.S. Stimulus

Dollar Holds Most Gains

Alibaba Breaks Sales Record Amid China Singles-Day Rebate

Here Are Six Reasons Twitter’s Stock Will Be Volatile

Shire of Ireland to Pay $4.2 Billion for U.S. Drug Maker

Vodafone Adds to Network Spending as Sales Miss Estimates

News Corp Misses Revenue Target As Australian Income Slumps

Transocean Yields to Icahn, Pursuing a Trendy Strategy

World Trade Center Tower Debuts in Manhattan Leasing Test

More Anxious Retailers Will Open Earlier on Thanksgiving

Cullen Roche: Hatzius: Baseline for Taper is March 2014

Credit Writedowns: Low Inflation is Creating a QE Trap

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Transocean Soars
Posted by Eddy Elfenbein on November 11th, 2013 at 5:22 pm

I had been looking at Transocean ($RIG) as a possible candidate for next year’s Buy List. Unfortunately, a lot of RIG’s big discount evaporated over the past few days.

The company said Monday that it has agreed to support a dividend of $3 per share and reduce the size of its board. It is also looking to boost margins by $800 million through cost-cutting efforts and other measures. Transocean’s stock jumped 3.8% to $55.47 in early Monday trading.

Icahn, a minority shareholder in Transocean, had previously pushed for a $4 per share dividend but Transocean’s shareholders rejected it. Icahn, known for shaking up companies in which he invests, had also wanted several board changes.

Transocean isn’t out of the running for the Buy List, but its candidacy obviously isn’t as strong.

Are We in a Bubble?
Posted by Eddy Elfenbein on November 11th, 2013 at 10:44 am

The latest rage on Wall Street is to pronounce that stocks are in a bubble. This is rather unusual in that true bubbles are very rare. This is, of course, different from stocks dropping in a routine lousy market. That happens every few years.

Do I think that stocks are in a bubble? Honestly, I don’t know. And more importantly, I don’t much care. Let me explain.

For one, it’s odd to make a judgment about the aggregation of 6,000 publicly traded stocks. Our Buy List is pretty well diversified and that’s just 20 stocks. Where the entire S&P 500 is headed isn’t that important for a disciplined stock picker.

Also, even if the market is about to plunge, it’s very difficult to get the timing just right. Lots of people saw the housing bubble but they were very early. The bubble kept on going. Recently I noted that if an investor bought an S&P 500 index fund just prior to the Financial Crisis, say in March 2008, and held on to today, they would have made a decent return by historical standards. Time may not heal investing wounds, but it sure can help a lot.

When looking at valuation metrics, I urge investors to look at as many as they can, but never be a slave to just one. I’m particularly leery of metrics like the Cyclically Adjusted P/E ratio, also known as CAPE. The CAPE looks at the stock market’s current value weighted against the last ten years of earnings. The idea is to smooth out the economic cycles. I think this is a bad idea because stocks and earnings are themselves cyclical.

Also, the inclusion of so much prior data is, in my opinion, an unfair anchor to carry. The historic plunge in corporate earnings in 2008-09 will still be a part of CAPE for another five years. If we look at operating earnings or dividends, we can see what an outlier that profit data is. Interestingly, the market’s dividend yield has remained fairly consistent for the last decade, except for the worse parts of the Financial Crisis.

After two of the biggest bear markets in history is precisely when so many people are scared of another bubble. I’m reminded of people saying that shortly after 9/11 was actually the safest time to fly. Bubbles are now, apparently, everywhere.

I think the best way to look at the issue is to divide bear markets into two categories. One is where price shoots far above value. That’s your classic bubble ala 1987 or 2000. The second is when value crumbles beneath price. That happened in 1990 and 2008.

You might be surprised to hear me say that 2008 wasn’t a bubble. That’s right; stock valuations really weren’t that excessive. It was the fundamentals that turned out to be terrible. Believe it or not, stock valuations were above average in 1929, but not out of sight. The frothiest part of the bull market occurred in the last six months. The 1920s was not a decade of stock euphoria.

I think there’s a natural tendency to reverse engineer a narrative that the world was enthralled to greed and everyone bought stocks without thought. That describes the feeling about Tech stocks in 1999, but it’s not an accurate description of today’s environment. The S&P 500 is going for about 17 times this year’s earnings. That’s about normal. The P/E Ratio has risen over the last two years, but it’s really gone from low to average, not from normal to nose-bleed territory.

Analysts currently estimate that the S&P 500 will earn $120 per share next year. Now’s the time for skepticism. For one, analysts don’t have a great forecasting track record. The critical question is, could fundamentals soon fall apart? Are there hidden factors that might make the S&P 500 earnings, say, $90 or even less next year? This is the question to worry about.

It’s also hard to predict things that are unexpected because, well, they’re not expected. If they were expected, they probably would be much less interesting. Also, it’s the unexpectedness of an event that makes it important.

The things that worry me are the things we aren’t thinking about. For one, corporate profit margins are very high. I think it’s reasonable to expect that earnings growth will be below economic growth over the next several years. Though the high profit margins probably aren’t a reflection of corporate greed, rather they’re a natural byproduct of slow growth and low interest rates.

Earnings recessions generally don’t announce themselves beforehand, but there are some useful warning signs. One good indicator is the yield curve. When short-term rates rise above long-term rates, the economy often runs into trouble soon after. For now, the yield curve is far from inverted.

Another late cycle indicator is rising inflation. According to the latest numbers, that’s not a problem either. I also like to follow the monthly ISM reports. A reading below 45 is often a sign of trouble. Once again, we’re in the safe zone.

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