Tuesday, October 9, 2012
AAPL's Last $100 Decline
At $633 per share, Apple is coming close to giving up $100 in share price for the first time in a long time. The only other time that the stock has hit a new three digit handle only to fall back to an old one was thanks to the financial crisis. At the end of 2007 Apple hit $200 but fell below $100 in 2008.
Monday, October 8, 2012
Federal Government Spending Per Capita
Alexis de Tocqueville is often misquoted as saying that "the American Republic will endure until the day Congress discovers that it can bribe the public with the public's money." Whether you agree with that sentiment or think that it's best that the government does provide social benefits to its people, below is the current price tag for Federal government services per capita. CPI adjusted we spend more today per person than we have at any time in the post-war period.
Friday, October 5, 2012
October 2012 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.
A lot changed in September.
The S&P 500 finished up 2.5% for the month and up 5.5% for the quarter, but if you blinked you may have missed most of the gain because almost all of it happened on two days. On September 6th and September 13th the index rose by a combined 52 points or about 3.7%. Counting that and the 33 point gain that happened on the last day of June, 85 out of the 193 points that we have rallied from the June lows have come on three trading days.
Each of those three days had an important commonality: central bankers drove the market. Back in June, the market rallied when Mario Draghi hinted that the ECB might be working on a new plan to save the Eurozone. On September 6th he rekindled that hope with a pledge to buy an unlimited amount of sovereign bonds if things got worse. Then on September 14th Ben Bernanke outdid him by not just threatening but committing to open ended bond purchases.
This most recent round of easing represents the most radical Fed move yet because it takes money printing from a finite proposition to an infinite one. The Fed has said that it won’t stop printing money until the economy is well into recovery, and has thus given everything it has left to try to stimulate near term economic activity. If this fails the only option remaining is to print even more rapidly or perhaps buy riskier securities.
If the economy reaches Bernanke’s goals, it will likely be in spite of QE3, not because of it. At its most fundamental level, the point of QE is to manage market psychology and awaken Keynes’ “animal spirits.” Bernanke is certainly changing market psychology, but I’m not sure that he is doing so for the better. I have yet to hear a CEO say that he or she is more likely to hire another worker because the Fed has pumped another trillion dollars into the economy. Unfortunately there is zero empirical evidence that money printing can lead to real economic growth. On the other hand, there is plenty of empirical historical evidence that it can lead to inflation.
QE3 creates more inflation risk than either of its predecessors because the economy is not nearly as impaired as it once was. We are no longer in the juicy part of the cycle when economic indicators can slingshot higher as the economy moves from a low level of capacity utilization to a high level. The “V” has occurred, and now earnings are beginning to flat-line. This doesn’t mean that they have to go down, but it does mean that the economy is reaching its potential output. High capacity utilization plus stimulus leads to CPI inflation.
For our portfolios this means that we will be making some significant adjustments before the year is done. In the near term, I continue to expect a market pullback on the realization that earnings growth is slowing, but in the long term, cash is quickly losing its status as a safe harbor, and we hold too much of it. Counter-intuitively, equities are becoming one of the safest assets to hold because earnings will eventually grow with inflation. However, most investors continue to pull money out of equities, which could create the right circumstances for a blast higher if individuals ever felt the need to get back into the market, like if rates started to finally move higher...
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.
A lot changed in September.
The S&P 500 finished up 2.5% for the month and up 5.5% for the quarter, but if you blinked you may have missed most of the gain because almost all of it happened on two days. On September 6th and September 13th the index rose by a combined 52 points or about 3.7%. Counting that and the 33 point gain that happened on the last day of June, 85 out of the 193 points that we have rallied from the June lows have come on three trading days.
Each of those three days had an important commonality: central bankers drove the market. Back in June, the market rallied when Mario Draghi hinted that the ECB might be working on a new plan to save the Eurozone. On September 6th he rekindled that hope with a pledge to buy an unlimited amount of sovereign bonds if things got worse. Then on September 14th Ben Bernanke outdid him by not just threatening but committing to open ended bond purchases.
This most recent round of easing represents the most radical Fed move yet because it takes money printing from a finite proposition to an infinite one. The Fed has said that it won’t stop printing money until the economy is well into recovery, and has thus given everything it has left to try to stimulate near term economic activity. If this fails the only option remaining is to print even more rapidly or perhaps buy riskier securities.
If the economy reaches Bernanke’s goals, it will likely be in spite of QE3, not because of it. At its most fundamental level, the point of QE is to manage market psychology and awaken Keynes’ “animal spirits.” Bernanke is certainly changing market psychology, but I’m not sure that he is doing so for the better. I have yet to hear a CEO say that he or she is more likely to hire another worker because the Fed has pumped another trillion dollars into the economy. Unfortunately there is zero empirical evidence that money printing can lead to real economic growth. On the other hand, there is plenty of empirical historical evidence that it can lead to inflation.
QE3 creates more inflation risk than either of its predecessors because the economy is not nearly as impaired as it once was. We are no longer in the juicy part of the cycle when economic indicators can slingshot higher as the economy moves from a low level of capacity utilization to a high level. The “V” has occurred, and now earnings are beginning to flat-line. This doesn’t mean that they have to go down, but it does mean that the economy is reaching its potential output. High capacity utilization plus stimulus leads to CPI inflation.
For our portfolios this means that we will be making some significant adjustments before the year is done. In the near term, I continue to expect a market pullback on the realization that earnings growth is slowing, but in the long term, cash is quickly losing its status as a safe harbor, and we hold too much of it. Counter-intuitively, equities are becoming one of the safest assets to hold because earnings will eventually grow with inflation. However, most investors continue to pull money out of equities, which could create the right circumstances for a blast higher if individuals ever felt the need to get back into the market, like if rates started to finally move higher...
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.
Thursday, October 4, 2012
Monetary Base Since QE3
The monetary base is an indicator which I always pay close attention to because it has been highly correlated with the price of oil and gold since 2009. Since QE3 was announced I have been paying even closer attention to the measure than usual, but it hasn't yet moved as one would expect it to. Over the last several weeks the monetary base has fallen as the Fed has purchased more MBS for reasons that I don't totally understand (likely some technicality and timing of the way assets are accounted for in the Fed's H.4.1 release). I would expect this to reverse in the coming weeks, but until it does, it may help to explain why oil has been weak since QE3 as well.
Wednesday, October 3, 2012
Duration of Economic Expansions
From time to time one may still hear analogies linking our current economic period to the Great Depression. Most know that the Depression consisted of two separate recessions, one which started in 1929 and the other in 1937. The intervening period was technically an expansion but wasn't much to write home about.
Our current economy is also often compared to the 1970s because the stock market went sideways for about a decade during that time as well before ultimately culminating in the early 80s inflationary recession.
If each of those periods are comparable and we sit in an economic purgatory between one recession and another, it might be at least mildly comforting to think that the next recession could still be a year away. The economic expansion between 1933-1937 lasted 50 months and the expansion from 1975-1980 lasted 58. Our current expansion is still only 39 months old. Just a babe! A full list of economic expansions can be found here.
Earnings Estimate Accuracy
Earnings season is set to pick up again starting next week, and it's an important season because earnings growth has begun to slow in recent quarters even as the market has risen. Analysts are expecting S&P 500 earnings to rise to $103 this year from $97 last year.
Below is a chart of analyst expectations for S&P 500 earnings vs. realized earnings. (The gray line shows the evolution of what analysts are forecasting for year end earnings throughout the year.) No surprise, analysts' mid year forecasts rarely end up being correct, but eyeballing the data, when earnings estimates are below their highest annual levels this late in the year, realized earnings typically end up disappointing early year estimates.
Monday, October 1, 2012
Historical Relationship of S&P 500 Earnings to GDP
The S&P 500 is up nearly 16% year to date, even though earnings are expected to grow 4-5% for the year. If earnings grow by that much, the growth rate would be roughly in line with nominal GDP growth, which was up 3.9% y/y in the most recent quarter (real annualized GDP growth was only 1.3%).
Below is a long term chart of S&P 500 earnings compared to GDP. Even though earnings are slightly more volatile than GDP, over the long term the growth of each has been about the same. Recently S&P 500 earnings have grown faster than nominal GDP as the economy has had a V shaped recovery. One might expect this circumstance to reverse, or at least temper itself going forward.
Below is a long term chart of S&P 500 earnings compared to GDP. Even though earnings are slightly more volatile than GDP, over the long term the growth of each has been about the same. Recently S&P 500 earnings have grown faster than nominal GDP as the economy has had a V shaped recovery. One might expect this circumstance to reverse, or at least temper itself going forward.
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