April 5, 2010
Markets Post Positive Q1... Now What? Global equity markets closed out the quarter in fine fashion, with all major world indices except China posting positive quarterly performance. The recovery in equities since last year’s March 9th low is remarkable. Earnings improvements, dramatic P/E expansion, and a slowly recovering global economy all contributed to the run-up.
Data Source: Plexus Asset Management
Data Source: Metastock from Equis International
The market rally momentum also shows little signs of slowing, as illustrated by a comparison of the 50-day to 200-day moving averages (here shown for the S&P 500 index).
Several potentially dark clouds, however, float across an otherwise sunny investment sky. One is simply a function of the extended market rally and corresponding expansion in market P/E ratios. By several indicators β specifically the “Tobin Q ratio” (a measure of market value to company asset replacement value), the Shiller 10-year P/E ratio, and the Market Cap to GDP ratio β the market seems to be veering into over-valued territory.
Source: Advisor Perspectives
Why does this matter? Because realized equity market returns are influenced significantly by the price you pay to get into the market. Regardless of underlying fundamental and economic strength, buying “the market” at a high price (as measured by the P/E ratio) has historically meant lower realized returns in the future. The current 10-year trailing P/E ratio hovering near 20x may warrant muted expectations for returns going forward.
Source: John Mauldin and Plexus Asset Management Economic Recovery muted but r
Source: John Mauldin and Plexus Asset Management
Economic Recovery Muted but Real Despite the downward revision of Q1 GDP from 5.9% to 5.6% (a non-sustainable number significantly influenced by inventory restocking), the economy seems to be in recovery. A variety of indicators illustrates this recovery. On April 1st, the Institute for Supply Management (ISM) reported an improvement in its benchmark manufacturing economic activity index, the PMI, to 59.6%. This is the strongest number since July 2004, an improvement from the 56.3% level in February, and the 8th straight month of expansion. Any level above 50% is considered expansionary.
Interestingly, even the strong ISM PMI index carries seeds of a future and for-so-long-dormant challenge to the economy β inflation. CPI remains muted, and the Fed remains in a fully “anti-deflation” mode, but a strengthening manufacturing sector has historically been a leading indicator of upward price pressure in raw materials (as measured by the PPI). Weekly jobless claims fell by 6,000 to 439,000 last week, and the 4-week moving average fell to the lowest level since September 2008. Declining jobless claims is considered to be good indicator of economic recovery.
Source: The San Francisco Chronicle and Clusterstock
Additionally, while the unemployment rate level released on Friday showed no change at 9.7% (and the underemployment rate continues to hover near 17%), investors were buoyed by the report of 162,000 new non-farm jobs created β the most in 3 years. Close to 50,000 of these new jobs, however, are temporary census workers.
Offsetting this positive development was the ADP National Employment Report (which tracks only private nonfarm employment β no government jobs), which showed a decrease of 23,000 jobs from February to March. In the glass-half-full category, this represented the smallest monthly loss of jobs since February 2008. The Case Shiller residential real estate index also improved (results through January), indicating a continued stabilization of that important real estate sector (the commercial real estate sector’s woes continue unabated).
Source: CalculatedRiskBlog
Since this is a half-full / half-empty commentary, it must be pointed out that this improved price index is somewhat offset by a troubling increase in default rates at Fannie Mae, the now nationalized mortgage lender.
Source: CalculatedRiskBlog
Longer term, the increasing federal deficit and debt load will one day come home to roost. This should not be an issue for 2010 (except perhaps as it affects consumer sentiment and confidence), but the exploding federal debt level is clearly unsustainable.
Source: John Mauldin
Despite the over-heated rhetoric on both sides of the political aisle to the passage of ObamaCare, the market reaction was largely muted. Several firms immediately wrote down profits as the legislation calls for the elimination of a partial subsidization of employee and retiree health benefits. By some estimates these various corporate write-downs could total $14 billion, further putting a crimp in the budding economic recovery. Congressional reaction to the write-downs was swift β the CEOs of the “offending” firms were called to Washington to explain themselves. We can expect further events of this kind as the details and ramifications of the legislation become clear. One interesting note on the passage of ObamaCare was the stark influence of unions on the “reconciliation” package passed to amend the existing Senate bill approved by the House last week. According to Deloitte, under the Senate bill 37% of the cost of the health care “reform” package was to be paid for by a tax on so-called “Cadillac plans” β high benefit plans largely enjoyed by unions (highlighted in light green in the nearby pie charts).
Source: DeloitteThe The “reconciliation” package that “fixed” the Senate bill decreased this to just 7%, with the bulk of the cut allocated to “high income” (more than $250,000) earners highlighted in dark blue in the above mentioned pie charts. It will be interesting to see how long it takes before the definition of “high income earner” is defined downward in an attempt to cover the-almost-certain massive cost over-runs of the program once it is fully implemented. The Week Ahead
The ISM Non-Manufacturing Index (NMI), comes out on Monday. While somewhat overshadowed by the manufacturing-driven PMI, the NMI is important because of the dominant role that service firms play in the overall economy. Investors will want to see a continuation of the above 50% level the index has shown since early this year.
The impact on rates from the scheduled shutting down of the Federal Reserve $1.25 trillion program to purchase Mortgage-Backed Securities will become more apparent next week. In addition, the Treasury Department holds four auctions next week, and there is some concern over market receptivity and rate demands. The yield on the 10-year Treasury has increased steadily over the past few weeks from roughly 3.6% on March 1st to just under 3.9% on April 1st.
The weekly jobless claims will come out on Thursday, we will get insight on the ongoing lending environment with the Consumer Credit report on Wednesday, and investors will look for further signs of an improving economy when Chain Store Sales come out on Thursday. About Fortigent Fortigent, LLC delivers a fully integrated and customizable business-to-business outsourced wealth management solution to banks, trust companies, and independent advisory firms. Services include a comprehensive investment platform with particular expertise in alternative investments, a flexible unified managed account program, and consolidated wealth reporting. Fortigent's web-based portal interface allows access to proposal and rebalancing tools, client portfolio reporting and accounting, as well as industry articles, research papers, and other practice management and business development resources. For more information, please visit our website at http://www.Fortigent.com.
The information provided is general in nature and is not intended to be, and should not be construed as, investment, legal or tax advice. Fortigent makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, the information. The information is subject to change and, although based upon information that Fortigent considers reliable, is not guaranteed as to accuracy or completeness.
Not FDIC Insured No Bank Guarantee May Lose Value Source: The San Francisco Chronicle and Clusterstock
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