Getting Fresh with the Markets – Part 2

While I highlighted JP Morgan’s sexy charts in my last post, now it’s time for my sexy charts.  It’s really a whole document, which you can find uploaded here. 

Aside from being more colorful and handsome, my weekly charts attempt to capture the movements of multiple markets, how they are performing relative to other markets, and if they are more risky based on a historical metric I use, among other data.  In short, I use it to identify trends in broad based ETFs, so that we can apply that to our portfolio construction, accordingly.

So here is a quick summary based on weekly data at the close of November 15^th and monthly data as of October 31^st: 

• It’s really amazing how the risk indicator has worked with domestic investment grade bonds.  In October bonds rallied but failed to pierce the risk indicator.  Since then bonds have moved down; though, did rally last week.
• And bonds have by and large had a positive return over the last 12 weeks.
• Another thing to note is the AGG (Aggregate Bond US Bond Index) chart.  Look at that fall!  But how much is AGG down over the last year?  -1.71%.  So really not that big of a deal in my mind.  To me this indicates that even in rising interest rate environments (when interest rates rise bond prices fall), there is little risk of huge portfolio loss from holding bonds.
• Note, the duration (a measure of a bond’s sensitivity to interest rate changes) of the AGG is still under 5, so it’s not like there is huge interest rate risk holding AGG.  This is different for longer dated bonds though.
• Munis still continue to suck wind against corporates, despite their recovery over the last 3 months.
• High yield has been relatively immune to the rise in interest rates.  This isn’t surprising as high yield is usually negatively correlated with Treasuries. 
• A recent trend of late is the outperformance of SPY (large caps) vs. IWM (Small Caps), which are actually flat over the last month.  I wonder if this is the sign of a tired rally as typically riskier flare leads.
• Alternatively, Growth has outperformed Value over the last few months, which may be a short-term move, but is a directional change at least for the time being.
• Developed Market stocks are up, but are still underperforming SPY over the past 12 months (and every other period listed).
• Emerging Market stocks are all over the place.  I love their valuation, but to me still seems like the trend is against them.
• Commodities in general seem to be consolidating, though Oil looks could be in a downtrend.
• The same goes for Real Estate.  In my opinion, rising rates are probably more hazardous to IYR (Real Estate ETF) than to AGG.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Getting Fresh with the Markets – Part 1

I have mentioned this before, but JP Morgan’s Guide to the Markets is really full of awesome charts, graphs, and data.  The edition for Q3 (note all data as of 10/31) can be found here.  Below are some of things I found of interest and how they affect your portfolio:

• From the market bottom in March 2009, the S&P 500 is up 174% and 23% above the prior 2007 peak.
• Best sector YTD is Consumer Discretionary, which is bullish given its cyclical nature.  Further, it’s trailing and forward PEs are still below historical norms.
• Most valuation levels on the markets seem reasonable, thus it doesn’t seem that valuation will dislodge the rally.  Though there is the exception of Shiller Price to Earnings Ratio, but even he admits this isn’t a short-term metric.
• One big market worry is profits as a % of GDP.  This is at an all-time high.  So if this reverts and profits are hurt this could affect the market or on the other hand valuations could keep rising.  This undoubtedly ties to the poor employment picture.
• Interesting to note that when yields are below 5% and interest rates go up, generally stock prices have a positive return.
• Corporate balance sheets are very strong with higher % of cash and lower % of leverage.
• The earnings yield is the reverse of the P/E ratio, in other words, earnings divided by price: by this measure, the markets are cheap.  Further, even if we get to the average valuation level on the earnings yield ration markets have historically followed with positive moves.
• Consumer balance sheets are improving and debt payments as a % of personal income look to be close to an all-time low.  The household deleveraging cycle may be over, and consumers may begin to have disposable income, something which the economy has missed dearly.
• To me employment still looks ugly. Much of the drop in the unemployment rate is a result of people dropping out of the work force. On the other side of that equation, I also read elsewhere the following: if all 3M open positions in the US were filled, unemployment would drop into the mid 4% range. This is largely due to a skills gap.
• Inflation as reflected by the CPI is still tame, so the Fed is really under no pressure, and can be accommodative, which is bullish for stocks.
• Our oil imports our dropping, though we are the largest consumer.  We also produce 12% of the world’s oil, second only to Saudi Arabia, and are expected to surpass them in 2015.
• Looking at the long-run chart on interest rates, it’s tough to tell if we have bottomed.  Though I will say on a subjective note that the current interest rate move up has felt different. 
• While the spread (the difference between two bonds with similar maturity) on high yields makes them look rich, municipal bonds look attractive. 
• While domestic stocks have blown through their 2007 peak, Developed and Emerging Market stocks have not.  This indicates that while the trend still favors the US, on the long-term basis these markets might be more attractive.  Emerging Markets in particular; however this was the case last year at this time, and those who made that bet – we didn’t – have been very disappointed this year.
• Consumption in Emerging Markets is on the rise while US consumption is falling.  This is good for a more balanced world economy.
• Europe still has some gaudy unemployment numbers, particularly in Spain and Greece where they eclipse 20%.
• US stocks have crushed every broad asset class YTD.
• 2013 should be the first year since 2005 since domestic equity funds will have positive fund flows.  Glass half full - more flows from retail investors can push the market higher.  Glass half empty -- retail investors don’t really move the market as evidenced by negative flows since 2009 despite a huge bull market. 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

A Note on Unemployment

The employment picture is a huge economic headwind.  That is why each report gets so much attention.  Lack of employment = continued weak demand.  If the employment situation improves, consumption should pick, balance sheets will heal faster, the economy will improve, and then you get a positive feedback loop.  With that in mind, let’s take a look at the most recent report…

The Good:

• We added 163k jobs
• Better than consensus (100k forecast)
• The stock market appeared to like the number
• Indicates we aren't in a recession

The Bad:

• Other aspects of the report were more negative
• Unemployment actually rose to 8.30%
• U6, a broader range of unemployment rose to 15%
• Revisions in prior months and seasonality 

What it Means:

Nothing.  While I just said the report gets attention, it’s one report.  The trends remain not good and the employment picture is still poor.  Calculated Risk has some fantastic graphs that illustrate this:

• Deepest job loss and slowest job recovery in Post WWII recessions (here)
• Long-term unemployment, while decreasing, is still elevated (here)
• Note, if this doesn’t decrease it could indicate a more secular employment problem
• People ages 25 to 54 are underemployed relative to prior levels (here)
• People still aren’t participating in the labor force as they have in the past (here)

So to conclude, it’s good we are moving in a positive direction, continuing to heal, and seemingly not in a recession as of now.  Still, the report is not a game changer and does not augment the underlying key theme – the employment situation as a whole is weak.

Focus on the trends, not one reading.

Positive Employment News

While on hiatus, I came across a variety of good news on employment.  First, weekly unemployment claims continue to move downward:

Manufacturing hours continue to climb, at some point factories will have to start hiring as hours are maxed out.

Third, the unemployment rate is at 8.30% and moving down while the long-term unemployed rate is also going down. 

Lastly, the Washington Post recently noted that there is a shortage of skilled workers.   

If the employment picture continues to get better so will the economy.  That will in turn lead to more positive feedback loops that are self sustaining.  This is one of, if the not main reason, why I think we can have a really good year in the market – absent a large negative event (e.g. European credit about face, middle east escalation).

The Employment Problem

Recently I was alerted to two interesting bits of information:

1. As Italian yields moved higher, so did equities.  The opposite of what you would expect.
2. Despite the rash of headlines on the Eurozone, there appears to be a decent correlation between jobless claims and equities.

Does this mean that markets are being moved` solely by unemployment and are unaffected by Europe?  I have no idea.  I would guess no, but who knows what moves markets, these days? 

What the above links do demonstrate, in my opinion, is how important it is to create jobs for the economy (obviously) and the market.  Take a look at this graph via Calculated Risk:  

Two things standout:  

1. The job loss from the last recession is much larger than any at other time since WWII.
2. The recovery from the lost jobs will no doubt be much longer than any at other time since WWII.

As I have mentioned before, I think it will take time to go through the deleveraging cycle.   This jobs chart is an example of the sluggish growth that we have experienced and probably will experience for the next few years. 

That said, if we can figure out a way to create jobs the great likelihood would be not only a nice economic lift, but also a corresponding bounce in the stock market.