 | New Orders for Durable Goods Increased 3.3% in April |
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| Posted Under: Data Watch • Durable Goods |
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Implications: A very solid report out on durable goods this morning. New orders for durables rose 3.3% in April, with all major categories of orders up for the month. The largest gains were in the transportation sector – aircraft and autos – which is extremely volatile. However, orders were still up 1.3% excluding transportation, much better than the consensus expected. The worst news in the report was that shipments of “core” capital goods, which exclude defense and aircraft, were down 1.5% in April. This suggests business investment in equipment will be tepid in Q2, consistent with our forecast of 2.5% real GDP growth for the quarter. But new orders for core capital goods increased 1.2% in April and unfilled orders were up 0.9%. This hints at an acceleration in business investment beyond Q2. We expect orders to continue to trend upward over the next several months. Monetary policy is loose and, for Corporate America, borrowing costs are low and balance sheet cash and profits are at a record high. Meanwhile, the obsolescence cycle and higher capacity use should goad more firms to replace and build-out their capital stock. In addition, the recovery in home building should generate more demand for big-ticket consumer items, such as appliances. The bottom line is that today’s report shows the Plow Horse economy is moving along just fine and may even be starting to pick up its gait.
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| | Market Fears of Fed Tapering Makes a Great Buying Opportunity |
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| Posted Under: Bullish • Government • Home Sales • Markets • Fed Reserve • Stocks |
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Whoa! Everyone take a deep breath. The fact that the Fed is thinking about tapering bond purchases is a good thing, not a bad thing! The negative market reaction is unwarranted and those with eyes to see should view any sell-off due to tapering fears as a great buying opportunity. Here are three simple reasons why:
1.) The economy continues to improve:
It’s a Plow Horse economy. It continues to push forward despite the headwinds it faces; mainly in the form of big government and bad policy. And some evidence suggests the Plow Horse is picking up its gait.
In data released today, initial jobless claims for last week fell 23,000 to 340,000, while continuing claims fell below 3 million for the first time in 5 years (down 112,000 to 2.91 million). Add to this good housing data. Today, it was reported that new home sales rose 2.4% in April and are now up a whopping 29% from a year ago. The sales pace is at the second highest level since mid-2008 and median prices are up 14.9% from a year ago. Yesterday, April existing home sales were also reported as rising. Other housing news showed that the FHFA index, which measures prices for homes financed by conforming mortgages, increased 1.3% in March (seasonally-adjusted) and is up 7.2% from a year ago.
2.) QE is significantly less important than conventional wisdom believes:
The monetary base has expanded at a 25% annualized rate since QE began in late 2008 – from $840 billion in September 2008 to $2.97 trillion now. But, the M2 measure of the money supply remains stuck at a 6% annualized growth pace during the same period. In other words, high-powered Fed money creation is not boosting M2, but instead is boosting excess bank reserves. QE is not boosting stocks or the economy; rather it is boosting excess reserves, which is not lifting stock prices.
3.) Stocks are up because corporate profits are up.
Corporate profits are easily keeping up with stock prices. We are still awaiting Q1 2013 corporate profit data, which we will get our first look at next Thursday. But, from Q4 2008 through Q4 2012 corporate profits were up 107% while the total return for the S&P 500 with dividends reinvested from 12/31/2008 to 12/31/2012 was 72%. We do have the S&P 500 price/operating earnings ratio through Q1 2013. This stood at 15.92 in Q1 2013 compared to 18.24 in Q4 of 2008, showing that prices have not kept up with earnings.
Bottom line: The market is still substantially undervalued. The fact that the Fed is considering tapering is a good thing; do not let short term traders and the pessimistic media fool you.
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| | New Single-Family Home Sales Rose 2.3% in April to a 454,000 Annual Rate |
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| Posted Under: Data Watch • Home Sales • Housing |
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Implications: The new home market, which is typically the last piece of the housing puzzle to recover, is clearly improving. A lack of inventory in the existing home market appears to be driving buyers to the new home market, where sales were up 2.3% in April and up 29% from a year ago. By contrast, existing home sales are up 9.7% from a year ago. The months’ supply of new homes – how long it would take to sell the new homes in inventory – remained unchanged at 4.1, well below the average of 5.7 over the past 20 years and close to the 4.0 months that prevailed in 1998-2004, during the housing boom. As a result, as the pace of sales continues to rise over the next few years, home builders will have room to increase inventories. After a large reduction in inventories over the past several years, builders are getting ready for that transition. Inventories have increased in 7 of the last 9 months. Higher inventories aren’t something to worry about and are not leading to more vacant homes; the number of completed new homes still sitting in inventory is at a record low, as buyers swoop in quickly. No wonder prices for new homes are up 14.9% from a year ago. In other housing news today, the FHFA index, which measures prices for homes financed by conforming mortgages, increased 1.3% in March (seasonally-adjusted) and is up 7.2% from a year ago. Expect to see continued price gains across the country in the year ahead. On the employment front, initial claims for unemployment insurance fell 23,000 last week to 340,000. Continuing claims for regular state benefits fell 112,000 to 2.91 million, the fewest since March 2008. Plugging these figures into our models suggests nonfarm payrolls will be up about 180,000 in May. What we have here is a Plow Horse economy that is starting to trot. The fact that the Fed is considering tapering QE is a good thing, not bad. Equities will be noticeably higher at year end than they are today.
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| | Existing Home Sales Rose 0.6% in April to an Annual Rate of 4.97 Million Units |
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| Posted Under: Data Watch • Home Sales • Housing |
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Implications: Existing home sales rose slightly in April and reached the highest sales pace since November 2009, when sales were artificially boosted by an $8,000 homebuyer tax credit. Sales appear to have leveled off over the past several months but are still up 9.7% from a year ago. We expect sales to renew an upward push over the next few months. The months’ supply of existing homes (how long it would take to sell the entire inventory at the current selling rate) rose to 5.2 in April. However, this is no cause for worry and may even be more of a good sign as low inventories have probably been holding back the sales pace. Just a year ago, the months’ supply was 6.6 and was 9.3 two years ago, so a supply of 5.2 months is still relatively low. What we are probably seeing lately is some more marginal sellers coming back into the market as pricing power recovers. The 11% gain in median prices versus a year ago can be attributed to a couple of factors. First, low inventories while demand is picking up. Second, fewer distressed sales and more sales of larger homes. Homes priced from $0-$100,000 were down 9.8% from a year ago while $1,000,000+ homes are up 41.9%. In general, it still remains tougher than normal to buy a home. Despite record low mortgage rates, home buyers face very tight credit conditions. Tight credit conditions would also explain why all-cash transactions accounted for 32% of purchases in April versus a traditional share of about 10%. Those with cash are able to take advantage of home prices that are extremely low relative to fundamentals (such as rents and replacement costs); for them, it’s a great time to buy.
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| | Still Bullish |
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| Posted Under: Bullish • Gold • Government • Markets • Monday Morning Outlook • Interest Rates • Bonds • Stocks |
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Like Rip Van Winkle, imagine you went to sleep on October 9, 2007 and didn’t wake up until yesterday. On 10/9/2007, equities were at record highs: 14,165 for the Dow Jones Industrial Average and 1,565 for the S&P 500.
You slept right through a housing bust, a financial panic, the deepest recession since the Great Depression, the passing (and upholding) of Obamacare, multiple bouts of debt-limit brinksmanship, two fiscal cliffs, the European financial “crisis,” a tsunami in Japan, the BP oil fiasco, and a long list of other media-obsessions over the past 67½ months.
You woke up, and the Dow and S&P 500 were up 8.4% and 6.5%, respectively, from when you fell asleep, with both at new record highs. Including dividends, the S&P 500 has returned 3.3% per year since you went to sleep, while consumer prices rose 2% per year and short-term rates averaged 0.5%.
Now…imagine that no one would tell you what happened in the past six years. All you could do was compare current market data to what it was when you fell asleep. Would you buy equities, or sell them?
Corporate profits rose 34% during the deep sleep, so Price-to-Earnings (P-E) ratios are lower. Short-term interest rates were 4%, now they are near zero; yields on long-term Treasury notes were 4.5% back then, and now below 2%. Gold has jumped from $740 per ounce to $1,350; oil from $73 per barrel to $96.
In a nutshell, relative to fixed income and commodity markets, equities look significantly cheaper today than they did in 2007. There is even more reason to buy.
The unemployment rate was only 4.7% when you fell asleep: now it’s 7.5%. Believe it or not, that is good news. Historically, high unemployment means things are going to get better, while periods of low unemployment suggest things are about to get worse. We get the flu when we feel good; we get over it when we feel bad.
It was this focus on fundamentals that motivated our forecast that equity values would rise this year. At the beginning of 2013, we forecast the Dow at 15,500 and S&P 1700 by year-end. We felt that this higher-than-consensus forecast was realistic and, yet, conservative. We’ve been proven right. Equities have gone up even faster than we thought and we see no reason the bull market won’t continue.
As a result, we are raising our forecast. We now expect a year-end Dow of 16,250, with the S&P 500 at 1,765, a respectable gain of 5.8% from Friday’s close. That’s an annualized gain of almost 10% for the rest of the year, with dividends boosting the total return to 12% annualized.
This would boost the 2013 return for the Dow to 24%, the most for any year since 2003. So even though bearish forecasters are saying the 2013 increase in equity prices is “insane,” it is actually well within historical norms.
We use a capitalized-profits model to find fair-value for equities. We divide corporate profits by the current 10-year Treasury yield (1.95%), and then compare the current level of this index to each quarter for the past 60 years. This method gives us a fair-value for the Dow of 48,000 – three times the current level. Obviously, this is crazy.
But it’s what happens when the Fed holds interest rates at artificially low levels. So, we adjust by using a 10-year Treasury yield of 4.5% - the same as the Federal Reserve’s estimate of long-term growth in nominal GDP (real GDP growth plus inflation). Using 4.5% as our discount rate suggests a much more reasonable fair value of 21,000 on the Dow and 2,250 for the S&P 500.
But what if record high corporate profits –12.7% of GDP – revert to their historical norm of about 9.5%, at the same time the 10-year Treasury yield moves to 4.5%? If that happened, the fair value of the Dow would be 15,650, and the S&P 500 would be 1700. In other words, if profits fall 25% and interest rates more than double, broad stock market indices are still slightly undervalued. That said, this scenario is highly unlikely. If rates are rising, it will most likely be because the economy is doing well, which means corporate profits will not collapse.
This does not mean markets will rise in a straight line. Volatility is part of life. But, if you can find a way to sleep through the next few years, and be long equities at the same time, you should wake up wealthier. Stay bullish.
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| | Brian was on Bloomberg's "The Hays Advantage" Yesterday to Discuss the Impact of QE on the Markets |
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| Posted Under: Markets • Video • Bonds • Stocks • TV • Bloomberg |
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To listen to the full interview on the Bloomberg website, click here
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| | The Consumer Price Index (CPI) Declined 0.4% in April |
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| Posted Under: CPI • Data Watch |
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Implications: All remains quiet on the inflation front. Over the past three months, consumer prices are up at only a 0.5% annual rate and are up only 1.1% in the past year. The decline in CPI in April was due to energy prices, which are obviously volatile and which fell 4.3%. “Core” prices, which exclude food and energy, were up 0.1% in April and are up 1.7% from a year ago. Neither overall nor core price gains in the past year set off alarm bells. Instead, they suggest the Federal Reserve’s preferred measure of inflation, the PCE deflator (which usually runs a ¼ point below the CPI) will remain below the Fed’s target of 2% when that data comes out later this month. We don’t expect this to last. Inflation is bottoming out right now and will be noticeably higher a year from now. However, for the Fed, the key measure of inflation is its own forecast of future inflation. So even if inflation goes to roughly 3% in 2014, as long as the Fed projects the rise to be temporary it will not react by raising short-term interest rates. The Fed is more focused on the labor market and, we believe, is willing to let inflation exceed its long-term target of 2% for a prolonged period of time in order to get the unemployment rate down. The best news in today’s report was that “real” (inflation-adjusted) average hourly earnings rose 0.5% in April. In other news this morning, new claims for unemployment insurance increased 32,000 last week to 360,000. Continuing claims for regular state benefits dropped 4,000 to 3.01 million. These figures are consistent with continued payroll growth of about 150,000 jobs in May.
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| | Housing Starts Declined 16.5% in April to 0.853 Million Units at an Annual Rate |
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| Posted Under: Data Watch • Home Starts • Housing |
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Implications: Housing starts fell a whopping 16.5% in April but almost all of the decline was due to the multi-family sector, which is extremely volatile from month to month. For example, in March, multi-family starts rose 25.6% but fell 38.9% in April. Single family starts fell 4.5% in March and another 2.1% in April. We expect multi-family starts to bounce back in April while single family starts return to their upward trend, pushing up total housing starts. As you can see from the chart to the right, the underlying trend in housing is upward and we expect large gains for residential construction for at least the next two years, probably longer. Based on population growth and “scrappage,” housing starts will eventually rise to about 1.5 million units per year (probably by 2015). The best news today was that housing permits boomed in April with gains in both multi-family permits and single-family. Single-family building permits were up 3.0% in April and are up 27.5% from a year ago. The bottom line is that no one should get worked up over every zig and zag in the data. Sometimes one indicator ticks down, like housing starts; other times an indicator, like building permits, will surge up above the underlying growth trend. That’s what a recovery looks like. In other news this morning, the Philadelphia Fed index, a measure of manufacturing in that region, declined to -5.2 in May from +1.3 in April. We expect a rebound in the months ahead. It’s still a Plow Horse economy.
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| | The Producer Price Index (PPI) fell 0.7% in April |
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| Posted Under: Data Watch • PPI |
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Implications: Given the loose stance of monetary policy, higher inflation is eventually coming, but it sure isn't here yet. Wholesale prices dropped in April by the most in three years reinforcing the signal from yesterday’s report on prices for imports and exports. The main culprit behind the wholesale price drop was energy which declined 2.5% after falling 3.4% in March, helping to push overall producer prices down 0.7% in April. Energy prices are now down 13.3% at an annualized rate over the past six months. “Core” prices though, which exclude food and energy and which the Federal Reserve claims are more important than the overall number, were up 0.1% in April and are up 1.7% versus a year ago. Some analysts may suggest that with the overall PPI only up 0.6% from last year that the Federal Reserve has room for its latest round of bond buying. We think this is a mistake, and it seems like some more members of the FOMC are starting to think the same thing. Core inflation is likely to continue growing and, despite projections of bumper US crop yields, food inflation should continue moving upward given recent improvement in emerging economies. Monetary policy is loose enough already. The problems that ail the economy are fiscal and regulatory, not monetary. Adding even more excess reserves to the banking system is not going to boost economic growth. Yesterday’s inflation report showed import prices declined 0.5% in April and are down 2.6% from a year ago. Most of the decline is due to oil; excluding petroleum, import prices were down 0.1% in April and are down 0.3% in the past year. Export prices fell 0.7% in April and are down 0.9% in the past year. Farm exports were down 0.5% in April and are down 1.5% versus a year ago.
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| | Industrial Production Declined 0.5% in April |
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| Posted Under: Data Watch • Industrial Production - Cap Utilization |
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Implications: Not a pretty report for industrial production in April. Output at factories, mines, and utilities, fell 0.5%, the largest decline in 8 months (-0.8% including revisions to prior months). Worse, the drop can’t be attributed to the volatile mine and utility sectors; manufacturing production declined 0.4% (-0.5% including revisions to prior months). However, we believe the report is an outlier and expect a rebound next month. Production is up 1.9% over the past year and up at a 2.5% annual rate over the past three months, exactly what we would expect in a plow horse economy. The autos sector has led the manufacturing gains, up 5.2% in the past year, but even manufacturing outside the auto sector has done OK, up 1.1% in the past year. We expect the gap between those two growth rates to narrow considerably in the year ahead, with slower growth (but still growth!) in autos and faster growth elsewhere in manufacturing. Capacity utilization fell to 77.8% in April, not far off from the average of 79.0% in the past 20 years. Continued gains in production should push capacity use higher, which means companies will have an increasing incentive to build out plant and equipment. Meanwhile, corporate profits and cash on the balance sheet are at record highs, showing they have the ability to make these investments. In other news today, the Empire State index, a measure of manufacturing sentiment in New York, declined to -1.4 in May from +3.0 in April. On the housing front, the NAHB index, which measures confidence among home builders, rose to 44 in May from 41 in April. The indexes for future sales, foot traffic, and current sales all increased, another sign that the housing market continues to recover.
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These posts were prepared by First Trust Advisors L. P., and reflect the current opinion of the authors. They are based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.
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