Banking System Asset Quality

The FDIC released its quarterly report on the banking system earlier this week.  It showed that the banking system has healed substantially from an asset quality standpoint.  The major exception are real estate loans, which are still ~6% non-current.  Until these issues are totally resolved it's tough to see how the housing market will be able to make a sustained comeback.

Monetary Base Reached All Time High Last Week

Gold is down $70 today supposedly because Bernanke didn't signal a desire for more QE in front of congress this morning.  Despite the fact that there isn't technically new QE going on at the moment, the monetary base did reach a new all time high last week, as shown below.

Also, the Fed's printing presses may not be running full steam at the moment, but the ECB's certainly are, printing 500B euro just last night...

Fewest 1% Declines in the S&P 500 in a Year

If we hold the line today, the S&P 500 will have gone the first two months of the year without dropping more than 1% in a single day.  In the context of recent volatility, this is a pretty spectacular statistic, but what about in the context of history?

Below is a chart of the number of days per year that the S&P has dropped by more than 1% going back to 1957.  Last year there were 48 such days; there were 73 in 2008.  On average, the S&P drops by 1% or more 26 times per year. In 1961, 63 and 64 it dropped by 1% only 3 times, the lowest in the data-set.

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Durable Goods Orders Ex-Transports

The Durable Goods Orders numbers reported this morning were pretty poor, -3.2% excluding transportation companies.  The data is still in an uptrend though, and is only back to where it was in September of last year.  That said, Durable Goods Orders (which are a nominal number I believe) have not exceeded their pre recession peak.  That makes this data set one of the few nominal indicators that hasn't made a new high.

Sector SPDR Performance YTD

The S&P 500 is up an amazing 9.07% so far this year (on pace for a 68% gain).  Below is a table of how the individual sectors have done relative to the broad index (as shown by the SPDR Sector ETFs).  These are numbers that should make an investor happy for a full year, let alone two months.

Things That You Could Buy Instead of All The Gold in The World

In Buffett's most recent annual letter, he writes an interesting passage on the value of gold relative to other assets.  He writes that if all of the gold in the world were combined into a solid cube, it would fit roughly in the infield of a baseball diamond and be worth $9.6T.  He goes on to write that this is approximately equivalent to the value of all of the farmland in the US and 16 Exxon Mobils combined (plus another $1T of cash).

It's an interesting thought experiment, since few actually have $9.6T to spend, but here are some other big ticket items to compare to the price of Gold:

Global Oil Reserves: 1.3T barrels x ~$110 per barrel = $143T
Global Equities Market Capitalization: ~$55T
Total US Credit Market: $37.8T
US Real Estate Market: $18T
US Treasury Market: $10T

New Home Sales in the Last 10 Years

New home sales data for January was released this morning at 321k homes.  This was down 0.9% from a revised number for December.  Many commentators say that this is a sign of some improvement in the housing market, but 321k is still extremely depressed.  Below is a chart of new home sales data since 1973 to put the number in context.  There are still fewer homes being purchased than in any other period outside of the current housing collapse.  Of course, January is a period of heavy seasonal adjustment.

The red line on the chart is the rolling sum of new homes sold over a 10 year period.  It shows that over the last 10 years, there have still been more new homes sold than in other periods.  Over the last 10 years almost 10 million new homes were sold.  Up until the mid 90s, this figure was more like 8 million.  In order to normalize the 10 year number, new home sales may stay depressed for a bit longer.

The Perfect Year

Of all the anomalous years that have ever occurred in the markets, 1995 is one of the most interesting--not just because the S&P was up 35% that year, but more because of the fashion in which climbed.  In 1995 the market never stopped to catch its breath, and basically went straight up for 12 months.  Fast forward to 2012, in which the single biggest down day year to date has been a 0.6% drop.  A comparison of the two years is below (Indexed Jan 1=100).

Are we in for another perfect year? For fund managers who are underinvested, that's the fear that can keep pushing this market higher.

Small Business Contribution to GDP

Below is an interesting info-graphic from this week's Businessweek.  It shows the declining share of GDP produced by small businesses.  It's difficult for small businesses to have the scale to compete in increasingly concentrated industries walled off by economies of scale and regulatory hurdles.

Drivers of Dow 13,000

The Dow hit 13000 again today for the first time since May 20, 2008.  The performance of the individual components of the Dow since that day are shown below.

Yum Brands CEO on China Oppotunity

The CEO of Yum, David Novak, was interviewed in the Journal this morning.  He was asked a question about Yum's China opportunity; his response is below, which I thought was an interesting way of quantifying the road ahead.

WSJ: You entered China early and have quickly amassed a sizable presence. How much opportunity is still left for you in China?

Mr. Novak: When you look at Yum Brands in the U.S., we have 60 restaurants per million people. In China, we have three [per million people]. We believe that China is the restaurant opportunity of the 21st century.

Seasonal Adjustment in Jobless Claims

Initial unemployment claims fell again last week to 348,000 on a seasonally adjusted basis.  The non seasonally adjusted data also painted a positive picture showing jobless claims at 361,928.  The second week of February, which is the 6th week of the year ends a period of heavy seasonal adjustment for jobless claims.  The chart below shows the average effect of seasonal adjustment to jobless claims by week of the calendar year over the last 5 years.

As the data shows, the winter months have heavy negative seasonal adjustments to claims--in other words, claims are adjusted downward.  Often claims spike for weather related reasons in the early months of the year and because of factory closures in the late months of the year.  This year the weather was more mild in most of the country, so the seasonality could have skewed comparability against prior years.  For those who are skeptical of the numbers, the coming weeks will begin to have less seasonal adjustment and therefore provide better comparability.

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Dow 1,000,000

Earlier this week, Barrons made some headlines projecting that the Dow Jones would hit 15,000 by the end of next year.  It's a bold call to be sure, but is it as bold as predicting that the Dow will hit 1,000,000 by 2107?

If you compound the Dow ex-dividends at the historical rate of 4.7% then the math says that we should hit 1,000,000 sometime around then.  By then, the financial crisis and tech bubble would look like just a blip on the long term chart.

Insights on Investment Management From the Sequoia Fund

I'm currently reading the transcript of the Ruane, Cunniff and Goldfarb Investor day from May of last year.  RCG runs the Sequoia fund, which is one of the top performing mutual funds of all time.  This portion of the Q&A stood out to me for the way in which it highlights what the analyst function is like at a top money management firm.  

Question:

How do you evaluate your research team? What are your goals and expectations of them and how do you manage those goals and expectations?

David Poppe:

With a stick! We have a really bright team of people who are pursuing interesting ideas. A lot of stuff is bubbling up all the time. Our guys travel a fair amount; they see a lot of things. It’s incumbent on Bob and me but also on the other senior people here to voice our opinions — we think this idea is better than that one. Ultimately we’re the editors and we’re the ones who have to make the decisions on the ideas that bubble up. Their job is to present us with a good set of choices and our job is to pick the best of those choices. Sometimes we’ve been really risk-averse. Sometimes we’ve probably erred on the side of caution.

Analysts act primarily as a screen, the portfolio manager uses discretion to choose the best ideas.  The PM typically doesn't have the same ground level knowledge of the industry or business that the analyst does.  Good PMs focus on defending against what they don't know rather than capitalizing on what they do.

Stocks with a Higher Price than Apple

Apple hit $500 per share today, which is not much more than an arbitrary psychological level.  Still psychology is powerful, and even though any company at any time could make the price of their shares sell for almost any level, $500 can draw plenty of attention as an outlier.  Below is a list of all listed companies with a share price greater than $200.  There are only 5 companies with a higher share price than Apple.  None has a bigger market cap though.

Wilshire 5000 Total Market Cap Index

While the S&P 500 is still about 13% below its all time high, the total market cap of the 5000 companies which make up the Wilshire 5000 is approaching a new record high.  The difference is most likely a function of dilution, particularly in the financial sector, which issued billions of dollars in new equity during the financial crisis.

Importantly this implies that the aggregate nominal wealth of society held in US equities is near an all time high.

NFLX Sounds a Little Desperate

I was once a NFLX customer, but eventually decided to cancel after realizing I was throwing away $10 per month.  Every once in a while I receive one of these "please come back" emails from the company, which always sound to me like a plea from a desperate former girlfriend.  It hardly costs anything for NFLX to do this, of course, but I'm not sure how I feel about a company selling for 30x earnings begging for me to come back...

Chart of Operation Twist

Continuing with today's theme of Central Bank balance sheets, below is a visual representation of how the Federal Reserve's balance sheet has changed since operation twist.  The chart shows the Fed's treasury holdings broken down by maturity.  Notice the hook lower in September for maturities <5 years and the acceleration in holdings of maturities >5 years.  In November of 2011 long term holdings began to exceed short term holdings.  Total holdings of treasuries have been flat--meaning that QE is not formally in process.

Note that prior to 2008, the Fed held a relatively small percentage of its assets in maturities >5yrs.  In fact in 2007 50% of the treasury holdings were in maturities <1 year.  Today less than 10% of the treasury portfolio is in t-bills.

I guess if you're going to run a portfolio with lots of duration risk it helps to be the entity that controls interest rates.

Central Bank Balance Sheet Growth Comparison

With the BOE announcing another 50B pounds of QE and the ECB on the verge of a possible Trillion Euro LTRO, global central banks are at the printing presses once again.  Below is a chart comparing the relative growth of the ECB, BOE and Fed balance sheets.  Even though the ECB is making a big push to catch up to the Fed and BOE, it has not yet printed nearly as much money as the Fed and BOE have.

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Is another push from the Fed coming soon?  In order to keep relative exchange rate stability the Fed might have to.  Otherwise it's conceivable that the dollar could strengthen against the Euro and Pound simply because other central banks are beating Bernanke at his own game.

10 Year Treasury Yield

The 10 year treasury yield is back above 2%.  Just 1% more to go until the 10 year yield is at parity with the increase in CPI last year, which was 3%.

Bank of England Balance Sheet

The Bank of England announced that it would perform another 50B pounds of QE this morning.  This would increase the size of the central bank's balance sheet from 300B to 350B pounds.  This would be a 16% increase in the size of the balance sheet.  For comparison, if the Federal Reserve increased its balance sheet by another 16% from $2.9T it would be the equivalent of approximately $475B in QE.

Dick Bove on The Mortgage Settlement

The $26B mortgage settlement announced today will be celebrated by many as a victory against the exploitative banking system.  Dick Bove makes an argument below that the settlement is little more than political theater and that those benefitting from the settlement are precisely those who do not deserve to.

"I do not believe that the average American is an uneducated fool who is easily taken advantage of by the banking industry."

Investment Grade Credit Spreads

The Dow may be making new multi-year highs today, but one market that hasn't fully recovered from last year's decline has been corporate credit.  As shown below, BBB spreads are still elevated compared to where they were in May of last year.

Of course wider spreads have in part been driven by falling treasury rates, but the effective yield of this index hasn't returned to April 2011 levels either.

February Investor Letter

Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients.  It is reproduced here for informational purposes for the readers of this blog.

Dear Investors,

It’s already been a great year for stocks, and we’re only a month into 2012. January was the best first month of the year since 1997 with the S&P 500 finishing up over 4%. Historically, such a strong January has been a positive indicator for the rest of the year. Since 1957 there have been 17 times that the S&P 500 was up 4% or more in January. In those 17 years, the S&P was up an average of 21.5%, and returned double digits for the full year 16 out of 17 times. By comparison, the average return for all other years is only 8%.

While the historical patterns point toward a great year for stocks, my advice would be to temper one’s expectations. A 20%+ return would be a welcome-but-unlikely scenario for 2012. Even though I remain optimistic for the year ahead, it’s hard to envision returns exceeding high single digit or low double-digit levels. For reference, a 20% return would mean that the S&P 500 would close the year at around 1508, just 50 points away from its all time high. At that level valuations for stocks would be stretched, and would justify raising significant amounts of cash in our portfolios. Given the economic landmines scattered across the globe, I would be much more surprised if the S&P 500 touched 1550 than if it touched 1150 at some point this year.

For now these economic landmines don’t seem to hold the same gravitas that they did just a few months ago, but that shouldn’t be an indication that they have faded away completely. If January demonstrates anything, it’s that the opinions of the marketplace can swing rapidly. Sitting in August or September of last year, recession seemed a certainty. Sentiment changed though and now it appears that the US economy is in the clear. To think that we will go the rest of the year without that opinion swinging to a more negative outlook would be unrealistic. The unfortunate truth is that the higher the market climbs to start the year, the more likely that investors will be in for another wild ride to close it. This doesn’t have to be a negative situation though. As last year proved, careful investors benefited greatly from the chance to buy at discounts.

Focusing on our portfolios, I was quite pleased with our performance in January. Even though we hold high levels of cash, which should create a drag in an up market, almost all of our portfolios did better than the market did. This means that the individual investments that we hold have done particularly well. Specifically gold, which is the most widely held asset by clients, did very well to start the year. It reversed the lackluster performance that the commodity has suffered from since the beginning of September. Gold benefited from the same factors that pushed the rest of the market higher: global central banks signaled continue willingness to depress interest rates in order to boost asset prices. In December the European central bank performed LTRO operations, which are effectively a European form of Quantitative Easing. Meanwhile, in January the Federal Reserve promised to keep interest rates at zero for three more years--through 2014. This is not a promise that I expect the Fed to be able to keep as inflation picks up going forward, but for now it’s sparked a nice stock market rally. Just make sure not to get overly excited by it. 

Scott Krisiloff, CFA

Opinions voiced in the letter should not be viewed as a recommendation of any specific investment.  Past performance is not a guarantee or reliable indicator of future results.  Investing is subject to risk including loss of principal.  Investors should consider the suitability of any investment strategy within the context of their personal portfolio.  For more information on Avondale Asset Management, readers may be directed here.

VIX Near Multi-Year Lows

Seemingly for the first time in months, the VIX is actually up a little today at 17.91.  As the market has rallied, the index is still approaching multi year lows though.  As a contrarian indicator the VIX deserves some attention.  The last time the VIX got this low, volatility picked up a bit.

US Defense Spending Relative to GDP

Inspired to post this while reading some history on the Eisenhower administration and the military industrial complex.  The data only begins in 1947 so unfortunately it doesn't show WW2, but it does include the spike for the Korean war to almost 15% of GDP.  The increase in defense spending for the most recent conflict looks pretty benign by comparison.

Russell 2000 Scoreboard Check

Russell 2000 is already up 12.25% YTD.  I'm gonna go out on a limb and say that the pace slows between now and December 31.

Labor Force Participation Rate

The unemployment rate may be 8.3%, but as noted by many, the labor force participation rate continues to fall.  It's now just 63.7%

ISM Historical Chart

ISM was reported at a healthy 54.1 this morning.  Below is a chart to put the number in the context of the last 10 years of data.  It's hard to remember that this time last year the index was in the 60s.

S&P Performance After a Strong January

Yesterday, I wrote (tongue in cheek) that after January's hot start, the S&P is on pace to climb 66% for 2012.  With another big gain to start February, it's looking like that might not be too far off.  I'm still not a believer in 66%, but after looking at some historical data, I'm slightly more willing to believe that a double digit year might be in store.

Below are the instances of a greater than 4% return for January since 1957.

There has never been a negative year following such a strong January, and only in 1987 did the market return less than double digits.  The 21.5% average annual return is pretty spectacular.