Martin Feldstein on Fed policy, stocks, economy

 EmailPrint This Post Print This Post

Martin Feldstein, a professor of economics at Harvard University, talks about the impact of Federal Reserve monetary policy on the stock market. He also discusses the outlook for the U.S. economy.

Source: Bloomberg, May 5, 2012.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

OverSeas Radio Network

Keep a close eye on institutional cash

 EmailPrint This Post Print This Post

I find the assets of institutional money-market fund, published by the Fed on a weekly basis, an extremely useful tool in determining the direction of the U.S. stock market. Institutional money-market funds comprise approximately 65% of all money-market funds but to focus on liquidity in terms of value per se may be misleading, though, as the asset allocation including liquidity of retirement funds is highly regulated. The actual liquidity of regulated funds in terms of value is therefore likely to grow in line with the overall value of retirement funds in rising stock markets.

Although not scientifically correct, I express the institutional money-market funds as a percentage of the total U.S. stock market capitalization as represented by the Wilshire 5000 Price Index as a proxy of total institutional funds to get a better picture of institutional fund liquidity, and named it the institutional liquidity ratio. In the graph below it is evident that the liquidity ratio remained virtually unchanged from 1991 to end 2000, meaning that liquidity moved in line with the broad stock market. Since the end of 2000 the face of fund management changed as five major events rocked investors: 1) the ICT bubble finally burst; 2) 9/11; 3) U.S. corporate scandals; 4) the housing bubble; 5) Lehman/great financial crisis. The events in 1, 2 and 3 took the liquidity ratio to 15% while the Lehman Saga and the subsequent global financial crisis saw the liquidity ratio peak at 35%.

Sources: FRED; I-Net Bridge; Plexus Holdings.

The value of the liquidity ratio lies in its smoothed annualized growth rate that is calculated by using linear smoothing − similar to how I estimate ECRI in calculating the smoothed annualized growth rate of the WLI.  When the growth rate surged in the third quarter of 2000 it indicated a change of heart by fund managers as they upped their liquidity at the cost of stocks, resulting in the ensuing bear market in stocks. When they slashed their liquidity levels in favor or stocks in the second quarter of 2003 it happened to be the bottom of the market. In 2006 the first warning signals appeared as the growth rate of the liquidity ratio turned positive. In the fourth quarter of 2007 the growth rate of the liquidity ratio jumped as institutions again favored liquidity ahead of stocks. When the growth rate of the liquidity ratio turned negative again, indicating that institutions were again favoring stocks, the downtrend in the S&P 500 since the start of 2008 was finally broken. It is also clear that the institutions have favored equities ahead of cash since then, except for a slightly positive move in the liquidity ratio’s smoothed growth in October last year.

Sources: FRED; I-Net Bridge; Plexus Holdings.

At this stage it is evident that despite calls from some of my fellow commentators that another bear market is in the offing, the institutions continue to favor stocks ahead of cash.

What I find most interesting as well is that the smoothed annualized growth rate of the liquidity ratio is more reliable than the WLI smoothed annualized growth rate. The liquidity ratio did not give the same false calls in 2010 and 2011 as the WLI did. To my mind the liquidity ratio is a comprehensive indication of institutions’ feeling towards all risk markets, while the WLI is probably a fixed weighted index of the risk markets and does not necessarily reflect institutions’ attitude towards risk assets.

Sources: FRED; I-Net Bridge; Dismal Scientist; Plexus Holdings.

I always wondered what following Robert Shiller had with his PE10 that is based on 10-year trailing earnings. Well, the following graph says it all.

Sources: FRED; Robert Shiller; I-Net Bridge; Plexus Holdings.

It is noteworthy that the liquidity ratio started to increase many weeks before the stock market’s rating was slashed at the start of 2008. That is because the institutions watch the Conference Board’s Consumer Confidence Index very closely and adjust their liquidity ratios according to the main indicator of the underlying economy! (Please note the reverse order of the liquidity ratio in the graph.)

Sources: FRED; I-Net Bridge; Plexus Holdings.

My conclusion is not to call a bear market at this stage. It does seem that the market is overextended, especially if one looks at the gap between consumer confidence and the liquidity ratio. In a recent article I also warned about the PE10 getting ahead of itself, but we could be in for a prolonged period of an overbought stock market.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

More on this topic (What's this?) Read more on Mutual Funds at Wikinvest
OverSeas Radio Network

Rosenberg, Lee debate outlook for U.S. stocks

 EmailPrint This Post Print This Post

Thomas Lee, chief U.S. equity strategist of JPMorgan Chase, and David Rosenberg, chief economist and strategist of Gluskin Sheff & Associates, talk about the outlook for U.S. stocks and their investment strategies. 

Source: Bloomberg, March 23, 2012.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

OverSeas Radio Network

US stocks: Tread carefully through the minefields

 EmailPrint This Post Print This Post

The S&P 500 Index is anticipating too much too soon. Robert Shiller’s PE10 based on 10-year trailing earnings is currently at 22.85 compared to lows of 18.91 in August and 19.37 in November last year. While the PE10 is still at reasonable levels compared to the state of the underlying economy as measured by the Conference Board Consumer Confidence Index, some clouds are appearing on the horizon.

U.S. long-term bond yields have jumped in recent weeks and there is ample scope for further significant rises at the long end of the curve. In previous articles I alluded to the fact that the long end of the bond market was out of sync with the underlying economic fundamentals as a result of the Fed’s Twist program. The chickens are coming home to roost as the catch-up with the economy is under way. To normalize, the yield of the 10-year government bond has to rise by another 100 basis points from the current 2.39%.

Rising bond yields are not a real threat to the stock market, though, as the trend of the bond yield is normally an excellent indicator of the outlook for the underlying economy. Some divergence between bond yields and the valuation of the S&P 500 Index occurred in the second half of last year but it can be ascribed to the Fed’s buy-back of long-dated bonds in Operation Twist. The action per se resulted in the valuation levels not dropping off too sharply.

Sources: Robert Shiller; FRED; I-Net; Plexus Holdings.

But what is the threat to the stock market, you may ask. The answer lies in mortgage rates. Over the past few weeks mortgage rates have remained virtually unchanged in the face of a major about-turn of approximately 50 basis points at the long end of the bond market. The gap between the 30-year fixed mortgage rate and the yield on the 30-year government note has closed to approximately 47 basis points.

Sources: FRED; I-Net; Plexus Holdings.

It therefore seems to me that banks and financial institutions are more willing to accept higher risk in their lending. That explains why there is a relationship between Robert Shiller’s PE10 and the gap between the fixed mortgage rate and the bond yield (please note the reverse axis). It can be argued that the closing of the gap is bullish for stocks but it has to be watched very closely as the gap in fact leads the valuation levels of the S&P 500 Index at major turning points. In 2005 the gap diverged from the PE10 until the PE10 eventually followed when the market crashed in 2008. At the end of 2008 the gap closed rapidly but the stock market’s valuation continued lower until it bottomed two months later.

Sources: Robert Shiller; FRED; I-Net; Plexus Holdings.

The stock market has led the gap between the mortgage rate and bond yield since September last year and the gap has caught up with the stock market valuation in recent weeks.

Sources: Robert Shiller; FRED; I-Net; Plexus Holdings.

My concern is that all indications are that the stock market (S&P 500) is currently priced for perfection compared to the underlying economy and the gap between mortgage rates and yields at the long end of the yield curve. Yes, I still see a PE10 of 25 by the end of this year but the market has reached levels where it is highly susceptible to any global economic setback. We still have to find our way through minefields in the market place this year. How will the impact of the austerity measures in the Eurozone affect the global economy? Will China be able to shrug off the weak global economy? Will the U.S. be able to build further on the fragile economic recovery? Where is the oil price heading? Will Iran’s aggression result in an all-out war? The bottom line is that the stock market is no longer cheap. Yes, it can go higher and clock 25 or more on Robert Shiller’s PE10 scale but that would be bordering on irrational market behavior. It seems to me that more investors share my view as the inverse of the PE10 or EY10 (trailing 10-year earnings yield) has not followed through on the further drop in the VIX to 15.

Sources: Robert Shiller; CBOE; Plexus Holdings.

The above analysis argues in favor of increasing positions in non-cyclical stocks at the cost of cyclical stocks as I believe that is where opportunities will present themselves in coming months.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

More on this topic (What's this?)
The Bond Bull Market Is Coming To An End
Stocks and Bonds: Which Market is Wrong?
Read more on Bond Investing at Wikinvest
OverSeas Radio Network

Emerging-market stocks have more upside, but in need of correction

 EmailPrint This Post Print This Post

In past articles I referred to the relationship between the MSCI Emerging Market Index expressed in Swiss francs and China’s CFLP Manufacturing PMI. By using arguably one of the world’s only non-fiat currencies the influence of currency movements on the MSCI Emerging Market Index is minimized.

The graph below illustrates just how out of line and inexpensive emerging-market equities were compared to the state of the world’s growth locomotive in the latter half of 2011 as the Eurozone debt crisis spooked investors. The market returned to rationality as the crisis eased in recent months, with the MSCI Emerging Market Index in line with February’s PMI of 51.0.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Holdings.

But where to from here?

After collapsing to 48.3 in November last year my seasonally adjusted CFLP Manufacturing PMI for China increased for the third consecutive month to 51.9 in February, with the drop in the reserve requirement rate (RRR) of Chinese banks filtering through to the economy. As the global economy is not out of the woods yet, the further cut in the RRR in February is likely to lend additional support to the seasonally adjusted PMI and therefore China’s economy in coming months.

Sources: CFLP; Li & Fung; NBSC; Plexus Holdings.

After being held in check by the Golden Week celebrations of China’s lunar New Year from the second half of January through mid-February, the unadjusted CFLP Manufacturing PMI is likely to receive a significant seasonal boost in March and April.

Sources: CFLP; Li & Fung; Plexus Holdings.

I therefore argue that the MSCI Emerging Market Index in terms of Swiss francs is likely to be underscored by the expected seasonal strength in the unadjusted PMI, as well as the acceleration in growth as reflected in the seasonally adjusted PMI, on the back of the reduced RRR of Chinese banks.

In a previous note I pointed out that changes in the direction of China’s banks’ RRR were soon followed by directional changes in the Shanghai Composite Index. In the following graph the cumulative change in the RRR was quantified where a 0.5% change in RRR amounts to approximately US$60 billion. When depicted against the MSCI Emerging Market Index in Swiss francs it is evident that changes in direction in the RRR are followed by major changes in direction of the MSCI Emerging Market Index in CHF. The cuts in the RRR in the last quarter of 2008 were followed by a bottom in the MSCI Emerging Market Index in the first quarter of 2009. The hike in the RRR in the first quarter of 2010 was initially followed by the topping out of emerging-market equities, while further increases led to a slump in equity prices. Although equity prices showed an improvement at the start of the fourth quarter last year the cut in the RRR pulled equity prices out of the doldrums.

Sources: NBSC; I-Net Bridge; Plexus Holdings.

The MSCI Emerging Market Index has significantly outperformed the MSCI World Index since December last year and is currently in line with China’s unadjusted CFLP Manufacturing PMI.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Holdings.

The Shanghai Composite Index in terms of U.S. dollars relative to the S&P 500 Index has moved completely out of line with the unadjusted CFLP Manufacturing PMI, though.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Holdings.

The appearance of another black swan will alter my view but as things are I am of the opinion that the rally in emerging-market equities is likely to continue over the next few months. That said, the market has had a huge run and, being overbought, it is in desperate need of consolidation or even a major correction. I continue to favor the Chinese stock market above other emerging markets and developed markets.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

OverSeas Radio Network

Time to add the VIX to your equity portfolio?

 EmailPrint This Post Print This Post

The interim solving of the debt crisis in Greece has restored calm in the markets, with the CBOE S&P 500 Volatility Index (VIX) settling at 17.3 compared to its long-term average of 20.0. The big question now is whether the VIX will return to the low levels of 1991-1996 and 2004-2006.

Sources: CBOE; Plexus Holdings.

But why is it important? The two periods mentioned coincided with sustained strong rising equity markets. Let us take a look at the period 2004 to end 2006. The VIX fell to an average of approximately 13 over that period, while valuation levels as measured by Robert Shiller’s PE10 increased significantly. Please note that in the graph below I used the inverse of the PE10, which is in fact the earnings yield or EY10. The period was marked by strong steady global economic growth on the back of China’s fortunes, strong corporate profit growth and a significant increase in risk appetite.

Sources: Robert Shiller; CBOE; Plexus Holdings.

At this stage the market’s rating reflects the VIX, but where to now? While similar strong economic growth etc. may await us further down the road the same cannot be said for the next two years, let alone this year, as the weak global economic environment (a much weaker Chinese economy, the Eurozone’s continued woes and the relatively weak U.S. economy)  is likely to persist. I am therefore of the opinion that a VIX of around 20 and a PE10 of 22 can be seen as fair value. These compare with the current VIX of 17.3 and PE10 of 22.6. Yes, optimism may drive the VIX down to 15 again and the PE10 to 25 but to me that will indicate a significant selling opportunity. Similarly, the more regular occurrence of black swans has led to a significantly changed investment environment. Yes, it has led to the VIX being more volatile than in the past.

So much for volatility, but what about the underlying economic fundamentals? I have often referred to the relationship between consumer confidence and market valuation. Consumer spending is the backbone of the U.S. economy and is therefore the reason why consumer confidence gauges are closely watched by the major market players. At this stage it is evident that the S&P 500 Index at a PE10 of 22.6 is fully reflecting the Conference Board Consumer Confidence Index and therefore the underlying economy as it stands.

Some may argue that the employment situation in the U.S. remains dire and is likely to lead to another fall-off in consumer confidence. Well, my research indicates that consumer confidence in fact leads the U.S. unemployment rate by approximately nine months. With the Conference Board Consumer Confidence Index at 61.1 in January, it points to an unemployment rate of approximately 8% in the third quarter of this year compared to 8.3% in January this year.

Sources: I-Net; FRED; Plexus Holdings.

The valuation levels of the S&P 500, or PE10, lead the unemployment rate by approximately six months and are currently pointing to an unemployment rate of below 8% in the third quarter of this year.

I still hold the view that consumer confidence will improve to approximately 80 through end 2012 and that the valuation of the S&P 500 Index will improve to a PE10 of 25, meaning further upside of approximately 10% from the current levels. The going will be tough, though, as I think volatilities will remain high, resulting in the VIX ranging between 15 and 30 and the PE10 between 20 and 25.

Time to add the VIX to your equity portfolio? I think so.

Did you enjoy this post? If so, click here to subscribe to updates to Investment Postcards from Cape Town by e-mail.

More on this topic (What's this?)
(ETN) High Anxiety
Chart of the Day: VIX Reversal
Smushed VIX
Read more on Volatility Index (VIX) at Wikinvest
OverSeas Radio Network

Top 100 Financial Blogs

Recent Posts

Charts & Indexes

Gold Price (US$)

Don Coxe’s Weekly Webcast

Podcast – Dow Jones


One minute - every hour - weekdays
(requires Windows Media Player)
newsflashr network
National Debt Clock

Calendar of Posts

April 2014
MTWTFSS
« Jan  
 123456
78910111213
14151617181920
21222324252627
282930 

Feed the Bull