Market Bumps

January 26th, 2014

In a holiday shortened week, the market opened higher than the previous Friday but fell a bit more than 3% by week’s end.  On this same week in 2012, the market lost 2.5% in 3 trading days.  As I mentioned last week, there were few economic reports this past week to detract from the focus on corporate earnings.

IBM opened up the week by beating profit estimates but missed revenue estimates by $1 billion, or about 3%, and were about $1.5 billion less than the final quarter of 2012.  The 4th quarter is usually IBM’s strongest quarter each year; lower revenues from this giant indicate a cautious business investment outlook.  IBM is selling for the same price now that it did in mid 2011, a price earnings ratio of 12.

The following day, China announced that the country’s industrial production has fallen just below the neutral mark.   The reaction to the news was exaggerated by sharp declines in some emerging market currencies, which started a cascade of selling. See SoberLook blog for some charts. Similar weakness out of China last summer prompted a much more subdued reaction.

On Thursday, McDonald’s reported weak sales growth, which added to concerns.  After a run up of 30% last year, many traders were on high alert for any negative news.  The U.S. stock market has enjoyed a tail wind from Federal Reserve stimulus policy, but a global economy is largely outside of the Fed’s influence.

A 14 month support trend line that has been in place since November 2012 sets a mark at about 1760.  Dropping below that would signal a short to mid term shift in market sentiment.  The SP500 index closed at 1790 on Friday, 1.7% above that support trend line.  The 10 month average of the index is 1700.  A drop below that mark would signify a change in mid to long term sentiment. A few weeks ago, I noted that the market was close to 10% over its 10 month average.  This week’s decline puts that percentage at a bit over 5%.


Existing home sales notched up a bit in December but the yearly percent gains were relatively flat.  The 4 week average of new claims for unemployment declined to 331,000.  Several weeks ago it was close to the psychological 350,000 mark.  Mitigating the decline in new claims, continuing claims have been rising lately and are approaching the 3 million mark.

To put that 3 million people in historical perspective, take a look at the chart below.

The number of long term unemployed is ever a concern.


In early October I noted the relative sluggish performance of retail stocks vs the larger market index of the SP500 ahead of the Christmas buying season.  Below is an updated chart of a retail index ETF vs the larger market.

Shortly after that post, renewed hopes for a strong Christmas season led to higher prices for the group.  Disappointing sales gains announced as the season ended deflated that balloon.  Since the new year began, a composite of retail stocks has lost 8%.

Typically retailers report their earnings in mid to late February.  Traders have already priced in a rather disappointing earnings season for the retailers.  In the context of a longer time frame, retail stocks are still up 25% year over year.  If an investor had bought this composite on this date seven years ago when the economy was strong and retail stocks were at a high, she would still have doubled her money, easily outpacing the 38% gains in the larger market since then.  The resilience of consumer demand, despite an extremely severe downturn when unemployment and falling house prices put a brake on consumer spending, has helped make this sector a sure footed long term winner.  

Housing, Unemployment and CPI

January 19th, 2014

A strong retail report for December and an improvement in sentiment among small business owners buoyed the market at the start of the week.  Both reports continue a trend that indicates a healthy economy:  results are at at the upper bound or above expectations.

The latest report of  jobless claims at 325,000 pulled the 4 week average further down away from the psychological mark of 350,000.  This is sure to reassure short to mid term traders.  The weak BLS employment report released a week ago may have just been an anomaly.  Other employment indicators, as well as retail sales and business production simply do not confirm the headline numbers from the BLS.

The Consumer Price Index for December showed a mild 1.5% year over year increase and will reassure the Fed that its stimulus program poses little danger of igniting inflation.

The National Assn of Homebuilders reported continued strong growth in their Housing Market Index.

Featured on one of the blogs that I link to is a chart of the annual returns of the SP500.  Double digit gains in the index, like the one we had last year, are rather common, occurring about 40% of the time.  A reassuring takeaway for the longer term investor is that the market goes up in 75% of the years for the past eighty years.

The number of unfilled job openings in November was the highest since March of 2008, indicating continuing strengthening in the labor market.  Job openings have been above the ten year average for over a year now.

The number of people who voluntarily quit their jobs continues to climb over the past year.  Employees quit when they feel more confident about job prospects. While this metric has been improving, it is only at the lowest levels of the past decade.

Housing starts declined slightly in December to a million but is still growing from the lows of the bust.

Let’s get a bit of perspective. There is a decided shift downward from the post war building boom.  Below is a graph of  housing starts adjusted for population growth.

Adjusted for population growth, the multi-family component of housing starts has reached the normal levels of the past two decades.  This is the more stable component of housing starts.

Starts of single family homes have not yet reached the lows of past recessions.  The words “improvement” and “recovery” should be viewed in the context of these abysmal lows.

The Consumer Price Index (CPI) for December showed a year over year increase of 1.5%.  I believe this understates current inflationary pressures on consumers but it is the official rate, one that the Federal Reserve will use to guide policy.  The low rate will help allay fears that continuing stimulus will spur inflation in the near term.

Stock prices will be driven largely by earnings reports at this time.  About 10% of SP500 companies have reported this past week, too few to get a solid feel yet for the past quarter.  62% of companies have beat expectations, a bit less than the more normal 70%.  The market is largely trading sideways as it digests both the past quarter’s results and the forward guidance that companies give when they report.  IBM, Johnson and Johnson, and Verizon kick off this holiday shortened week when they report earnings on Tuesday. McDonald’s, Microsoft, Proctor and Gamble, and Netflix are due to report this week as well.  There don’t appear to be any significant market moving economic reports coming up this week.  Existing Home Sales on Thursday might have some minor impact and traders will be watching the continuing trend in new unemployment claims.

Labor’s Journey

January 12th, 2014

A dramatic decrease in new orders, mostly for export, for the non-manufacturing sector of the economy offset other positives in the December ISM report.  The composite non-manufacturing index dropped slightly but is still growing.  A blend of the manufacturing and non-manufacturing indexes, what I call the CWI, declined from its peak as expected. A month ago I noted the cyclic pattern in this index, and the shorter time between peaks as the economy has formed a stronger base of growth. Most businesses are reporting expansion, or strong growth.  Some respondents to the survey noted that the severe winter weather in December had an impact on their business.


Ringing in the New Year, the private payroll firm ADP issued a strong report of employment growth before the release of the BLS figures on Friday.  The reported gain in jobs was above the best of expectations.  In the past few months,  several reports in production and now in employment have exceeded expectations or come in at the upper bounds of estimates.


Wells Fargo announced that they will be offering non-conforming mortgages to selected buyers who present a low risk.  Non-conforming mortgages may be interest only, or have loan to values that don’t meet guidelines. Reminiscent of the “old days,” Wells Fargo intends to hold onto the mortgages instead of selling the paper in the secondary market.

The Gallup organization announced their monthy percentage of adults who are working full time, what Gallup calls the P2P.  I call this the “Carry the Load” folks, those people whose taxes are supporting the rest of the population.  At 42.9%, it is down a percentage point or two from previous winters.

The 4 week average of new unemployment claims is still below 350,000 but 20,000 higher than a month ago.  As I mentioned last week, this metric will be watched closely by traders in the coming weeks.  Although there is little statistical significance between a 349,000 average and a 355,000 average, for example, there is a psychological boundary marked in 50,000 increments.

Friday I woke up and found that somebody stole the ‘1’s at the Bureau of Labor Statistics.  The BLS reported net job gains were 74,000 and I thought that there was a smudge on my computer screen blocking the ‘1’ of 174,000 and reached out to wipe it off.  There was no smudge.  It is difficult to interpret the discrepancy between the ADP report and the BLS report.  Some say that the particularly harsh winter weather in the midwest and east caused many people to stop looking for work or that many businesses returned their BLS survey late.  If so, we may see some healthy upward revisions to the employment data when the February report comes out. Here’s a look at total private employment as reported by BLS and ADP.

As you can see there is a growing divergence between the two series.  As a percentage of 120 million or so employed in private industry, the divergence of a few hundred thousand is slight.  The BLS assumes a statistical error estimate of 100,000.  But people closely watch the monthly change in employment as a forecast of developing trends in the overall economy, changes in corporate profits and consequently the price of stocks.  Here is a chart of the difference in private employment as measured by the BLS and that measured by ADP.  A positive number means that the BLS is reporting more employment than ADP.

As with any estimates, I tend to average the estimates to get what I feel is a more accurate estimate.  This averaging works well when bidding construction jobs and some statistical experiments have proven the method reliable.  Averaging the two estimates for private payrolls gives us an estimate of job growth that is still above the replacement threshold of about 150,000 net job gains per month needed to keep up with population growth.

The figures above do not include 22 million government employees, or about 14% of total employment.  Flat or declining employment in this sector has dragged down the headline job gains each month.  Adding in net job gains or losses in the government sector gives us a net job gain of about 150,000 in December.

For those of you interested in more analysis of the employment report, Robert Oak at the Economic Populist presents a number of employment charts similar to the ones I have been doing in past months.

For the past 5 – 10 years, much has been written about the growth in income inequality during the past 30 to 40 years. I’ll call income inequality “Aye-Aye” because the abbreviation  “II” looks like the Roman numeral for “2” and because Ricky Ricardo used to exclaim “Aye, Aye, Lucy!” on that much loved comedy series.  Those on the left blame former President Reagan,  British Prime Minister Thatcher, and deregulation for Aye-Aye.  Those on the right blame increasing regulation that disincentivises businesses from taking chances, from making capital and people investments to pursue robust growth. The expansion of social welfare programs makes people ever more dependent on government and less likely to take jobs that they don’t want.  Economists cite the aging of the population as a cause of the growth of Aye-Aye.  Few I know of seriously challenge the idea that Aye-Aye has been happening.  The argument is over the causes and the solutions.

Thomas Piketty’s Capital in the 21st Century will add to the debate.  The English translation will be published in March.  A book review in the Economist outlines some of the ideas in the book.  Piketty’s analysis of almost 150 years of data from several countries indicates that the slower an economy grows, the more unequal the distribution of income.  One might think that the U.S. would have the most unequal income distribution, but Piketty reveals that it is France that tops the list.

Piketty’s rule of thumb is that the savings rate divided by a country’s growth rate will approximate the ratio of capital wealth to gross income.  As this ratio increases, more of the national income goes to those with capital wealth. So, if the savings rate is 8% and the growth rate is 2%, then capital wealth will be about four times gross national income.  Furthermore, he finds that population growth accounts for about half of economic growth over the past century and half.  Slowing population growth in the developed nations therefore leads to greater inequality of income.  If this rule of thumb is fairly accurate, stronger economic growth is the only way to lessen the inequality of income that has grown steadily over the past thirty to forty years.

If you are familiar enough with French, you can read a preview here or pre-order the English version here.  The book is sure to spark some lively discussion between those in the economic growth camp and those in the demographic camp.  The topic has long been a topic of discussion in emerging economies.  I will quote from an Asian Pacific policy journal published in 2003, “The most important determinant of inequality is not [emphasis mine] economic growth, however, but rather changes in demographic age structure.”

Year In Review

January 5, 2013  2014

The start of any year presents an opportunity for reflection on the past year as well as the upcoming one.  At the start of the year, few, if any, analysts called for such a strong market in 2013.  The S&P500 closed the year at 1850, a 30% gain. After a correction in May – June of this year, the index rose steadily in response to better employment data, industrial production, GDP increases, and the willingness of the Federal Reserve to continue  buying bonds and keep interest rates low.

I was one of many who were mildly bullish at the beginning of the year but got increasingly cautious as the index pushed past 1600.  Yet, month after month came not only positive or mildly positive reports but a notable lack of really negative reports.  Leading economies in the Euozone, teetering on recession, did not slip into recession.  Fraying monetary tensions in the Eurozone did not explode into a debt crisis.  China’s growth slowed then appeared to stabilize.  Although the attention has been on the Eurozone the past few years, the sleeping dragon is the Chinese economy, its overbuilt infrastructure, the high vacancy rate in commercial buildings in some areas of the country and the high housing valuations relative to the incomes of Chinese workers.

A year end review is an exercise in humility for most investors.  Some fears were unfounded or events unformed which confirmed those fears.  People are story tellers – stories of the past, imaginings of the future.  An investor who keeps all their money in CDs or savings accounts is predicting an unsafe investing environment for their savings.

Perhaps the best strategy is the one that John Bogle, the founder of Vanguard, advocates.  He doesn’t try to predict the future or be the best investor.  He aims for that allocation of stocks, bonds and other investments that, on average, forms a suitable mix of risk and reward for his goals, his age and the financial situation of his family.  He looks at his portfolio once a year.  I do think that a good number of individual investors had adopted the same outlook as Mr. Bogle advocates – until the 2008 financial crisis.

Since the financial crisis, too many investors have adopted a paralyzed strategy, a “deer in the headlight” reaction to the financial crisis that has been hugely unrewarding. Part of this year’s rise in the stock mark can be attributed to individual investors moving cash back into the stock market but I would guess that many of those investors are ready to pull it back out at the first sign of any trouble.  This shows less a confidence in the market but a frustrating lack of alternatives.

Long term bond prices took a significant hit in the middle of the year on fears of an impending rise in interest rates.  Bond prices had simply become too high, driving down the yield, or return, on the investment. Lower bond yields and meager CD and savings rates provided little return for investors, leaving many investors with little choice but to venture back into the stock market.

The Coincident Index of Economic Indicators remains level and strong.  A decline in this index below the 1% average growth rate of the population indicates the start of or an impending recession.

Note the index in 2002 – 2003 as it fell back, never rising above the 1% level.  I have written about this economic faltering before.  Much of the headlines were focused on the lead up to and start of the Iraq war.  The recovery from the recession of 2001 and 9-11 was very sluggish.  Fears that the country was entering a double dip recession similar to that of the early 1980s prompted Congress to pass the Bush tax cuts in 2003.  It was only the increased defense spending of 2003 that offset what would have been a decline in GDP and another recession.

A worrisome rise in new unemployment claims has puzzled some analysts.  Typically, new claims for unemployment decline at the end of the year, particularly in a year such as this one when reports of strong economic growth have been consistent.  Since 2000, rises in claims at the end of the year have been a cautionary note of things to come.  Mid-term investors and traders will be paying attention to this in the weeks to come.

However, the decline this year may be more of a leveling process that has been forming for most of the year.  On a year over year basis, the long term trend is down – which is up, or good.

In March 2013, I wrote “when unemployment claims go up, the stock market goes down … On a quarterly basis, this negative correlation has proved to be a reliable trading signal for the longer term investor.  When the y-o-y percentage change in new unemployment claims crosses above the SP500 change, sell.  When the claims change crosses below the SP500 change, it’s safe to buy. ”  The percent change in SP500 is still floating above the change in unemployment claims.

Sales of motor vehicles in November were above even the most optimistic expectations.  The ISM manufacturing index showed a slight decline but is still in strong growth mode and the already robust growth of new orders continues to accelerate.  The manufacturing component of the composite index I have been following since last June is at the same vigorous levels of late 1983 and 2003 when the economy finally breaks free of a previous recession.  I’ll update the chart when the non-manufacturing report is released this coming Monday.

In a healthy economy, the difference between real GDP and Final Sales Less the Growth in Household Debt (Active GDP) stays above 1%, which incidentally is the annual rate of population growth.  As the chart below shows, this difference dropped below 1% in late 2007.  Finally, six long years later, the difference has risen above 1%, indicating a healthy, growing economy.

And now a brief look at the year in review.

At the end of 2012, the price of long term bonds had declined slightly from the nose bleed levels of the fall but there was more to come.  I wrote “As this three decade long upward trend in bond prices begins to turn, bond prices can fall sharply as investors turn from bonds to stocks and other investments. We are approaching the lows of interest yields on corporate bonds not seen since WW2. Investors are loaning companies money at record low rates and companies are sucking up all that they can while they can. Sounds a lot like home buying in the middle of the last decade, doesn’t it?”

During the past year, long term bonds declined another 10%.  They seem to have formed a base over the past several months.  Intermediate term bonds are less sensitive to interest rate changes so they are the safer bet.  They lost about 6% in price over the past year.  Short term corporate bonds are a good alternative to savings accounts.  They pay about 1% above the average savings account and they usually vary very little in price so that the principal remains stable.

At the end of 2012, I wrote “the underlying fundamentals of the economy give reason for cautious optimism.” A month later, “As the saying goes, ‘The trend is your friend.’ When the current month of the SP500 index is above the ten month average, it’s a good idea to stay in the market.”  In January 2012, the monthly close broke above the 10 month average. This is a variation of the Golden Cross that I wrote about in January and February 2012.

Let’s look at this crossing above and below the 10 month average.    When this month’s close of the SP500 index crosses above the 10 month average of the index, it indicates a clear change in market sentiment.  I have overlayed the percent difference between each month’s close and the ten month average.

As you can see, the close near the end of December is near 10% above the 10 month average.  If the above chart is a bit too much information for you, here is a graph of the percent difference only.

Is the market overheated?  As you can see the market has sustained a robust (or some might call it exuberant) 10% for 6 – 9 months in 2003, 2009, and 2010-2011.  From 1994 to 1999, the market spent a lot of time in the 10% percent range. Some pundits are talking about this market as a bubble but we can see that this market has not penetrated the 10% mark.  At the end of January 2013, the market closed at more than 7% above it’s 10 month average, over the 4 year positive average of 5.6% (the average when the difference is positive).  The market is 20% up since then.

In March I introduced the “Craigslist Indicator,” the number of work trucks and vans for sale in a local area, as a gauge of the health of the construction industry.  It was a funny little indicator that indicated a growing strength in the construction industry at the beginning of the year.  Now for the amended version of the Craigslist Indicator: when there are a lot of older work trucks and vans advertised for sale on Craigslist, that indicates a robust construction market.


On March 24th, 2013 I wrote ” For the past year, the Eurozone has been in or near recession, yet some are hopeful that increased demand in this country and some emerging markets are helping to balance the contractionary influence of decreased demand in the Eurozone. Let’s hope that this surge in the first part of the year does not fade as it did in 2012.”  Instead, emerging markets began to contract and the Eurozone expanded slightly. Investors who bought emerging markets in March 2013 witnessed a more than 10% decline during the summer but the index ended the year at about the same level as nine months ago.

I thought that home prices in the early spring has reached a peak and wrote on March 31st, “The upturn in home prices is still above the trend line growth of disposable income and until personal income can resume or surpass a 3% growth rate, any rise in home prices will be constrained.” The Purchase Only House Price Index (HPIPONM226S) rose steadily throughout the year.
In late summer, I noted the falloff in single family home sales that began in the spring.  But prospective buyers were incentivized to make the deal as interest rates began to climb from their historically low levels.  Home sales surged upward; a lack of inventory in many cities also formed a support base that propped up prices.

A sobering note in September, “Rising home values are good for those who own a home but increasing valuations make it that much more difficult for buyers trying to buy their first home.  People in their twenties and early thirties who are most likely to be first home buyers have been hit hard by the recession.”

After a decline in the stock market in June, I wrote “For the long term investor, periods of negative sentiment can be an opportunity to put some cash to work.”  Although I took my own advice, I wished I had acted with more conviction.  Of course, if the market had declined 10%, I would have been patting myself on the back for my cautious stance.  Smiley Face!!

In July I noted the rather dramatic decrease in the value of securities held at the nation’s largest banks “Recently rising bond yields have contributed to banks’  operating profit margins but the corresponding value of banks’ bond portfolios has fallen quite dramatically.  This decline in asset value affects bank capital ratios, which makes them less likely to increase their lending … [and] will be an impediment to economic growth.”  The rising stock market and a respite in the decline of bond prices helped stabilize those portfolios in the second half of the year.

In September, I noted “Despite all the daily and weekly responses to political as well as economic news, the SP500 stock market index essentially rides the horse of corporate profits.”  Profits have more than tripled in the past ten years.  We should stay mindful of that stock price to profit correlation as we look out on the investment horizon.

From time to time I comment on the venality of our elected representatives.  Although they might appear to be idle rants to some readers, they are a caution.  Politicians make promises to get votes.  People become more dependent on those promises.  Inevitably, the day comes when the promises can not be met – as promised.  Those nearing or in retirement become increasingly dependent on political promises and should leave themselves a cushion – some wiggle room – if possible, when they make income and expense projections.  This Washington Post article on proposed budget cuts to military pensions is a case in point.  As long as “they” come for the other guy, we don’t pay too much attention – until they come for us.  Over the next ten to twenty years, we can expect many small cuts to promised benefits.  The cuts have to be small or target a small sector of the population so that they don’t anger voters too much.  In several blogs, I have shown how a simple recalculation of the Consumer Price Index eats away at the incomes of workers and retirees.  Expect more of these “recalculations” in the future as politicians follow a long standing tradition of making promises to win votes and bargain patronage to gather financial support for their campaigns.

We have the midterm elections to look forward to this year!  OK, calm down. Republicans will be hoping to take the Senate and make President Obama’s life miserable for the following two years.  I am guessing that the political campaigns for some Senate seats will vacuum in more money than the GDP of a lot of small and poor countries.