by Jeff Miller
GEI welcomes a new regular contributor, Jeff Miller, who will write on investment analysis and economics matters. Read Jeff's bio at the end of this article.
Change in Egypt came with less blood and better future prospects than most expected. This is good and important news. What remains to be watched is the follow-on. Will the temporary military government remain temporary? Will the high levels of poverty and unemployment among the young produce further disruption? Will democracy emerge or some new form of dictatorship, either secular or theological?
The Wider Middle East
First Tunisia, then Egypt and what is next? Is a third shoe about to hit the floor? Discussion centers on unrest in Algeria and Yemen. Others wonder about countries like Jordan and Saudi Arabia. Investors need to consider the possibilities because of the sensitivity of oil prices and availability to political disruption.
Earnings season continues to show strength - -not just in the bottom line but also in revenues and profit margins. Since expected earnings are the most important consideration in evaluating stocks, we need to watch this news very closely. Zacks Investment Research does a great job of monitoring earnings trends. Dirk Van Dijk's article, A Trillion Dollars in Earnings, is chock full of data you need to know. He provides some cautionary comments, but his look ahead deserves attention:
The early expectation is for 2012 to have total net income passing the $1 Trillion mark to $1.0113 Trillion. That will also put the “EPS” for the S&P 500 over the $100 “per share” level for the first time at $106.79. That is up from $57.71 for 2009, $82.93 for 2010, and $95.20 for 2011. In an environment where the 10-year T-note is yielding 3.63%, a P/E of 15.8x based on 2010 and 13.7x based on 2011 earnings looks attractive. The P/E based on 2012 earnings is 12.2x.
With almost two 2011 estimates being raised for each one being cut (revisions ratio of 1.88), one has to feel confident that the current expectations for 2011 will be hit, and more likely exceeded. Analysts are raising their 2012 projections at almost the same rate, with a revisions ratio of 1.83. While a lot can happen between now and the time the 2012 earnings are all in, upward estimate momentum means that the current 2012 earnings are more likely to be exceeded than for them to fall short.
The earnings story has been strong.
Last Week – The Good News
Most major economic indicators remain in positive territory. Last week I noted that the economic rally now has a self-sustaining character.
- Economic growth is still improving. The ECRI Weekly Leading Index hit a 39-week high and the growth index reached a 37-week peak. This is a signal of solid growth for as far ahead as they are willing to forecast.
- Risk as measured by the St. Louis Fed Stress Index, edged slightly lower, remaining at a very low level. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to .026, even lower than the .046 from last week. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now.
- Initial Jobless Claims. This is a noisy series, so I focus on the four-week moving average. Since I regularly cite the over 400K weekly numbers as "bad" it only seems fair to note the dramatic improvement last week to 383K. We shall see if this continues.
- Bank Loan Requirements. I have been pondering when to include this news (a decision on 1/25/11) in our weekly report. FASB has abandoned a plan that would have extended mark-to-market accounting to a wide range of loans in the portfolio. Instead, banks can now amortize performing loans while making a reasonable allowance for loan losses. Putting aside what you think of the merits of this decision, it certainly improves the chances for loans to new and small businesses. That makes it market friendly, which is my working definition for the "good" and the "bad."
Last Week - The Bad News
There is not much in the way of fresh bad news. There is a continuing problem on several fronts, a widely known "wall of worry" that is reflected in current market prices. Beyond the change in interest rates, I did not see anything that became notably worse during the last week, but feel free to offer comments.
Interest rates higher. Mortgage rates moved above 5% for the first time in more than a year. This is typical of rates all along the yield curve.
- Consumer Confidence. The Michigan Consumer Sentiment Index missed expectations and the ratings languish at levels normally associated with recessions. This highlights the fact that despite the recovery in many economic statistics and the strength in corporate earnings, there is a continuing gap between economic performance and the level needed for full employment. See Doug Short’s analysis.
Last Week – The Ugly News
To understand the current market, one must start with the popular perception -- a viewpoint that has been more negative than warranted by actual data for several years. The average person has an inadequate grasp of the facts. This limits understanding of issues. David Altig of Macroblog, one of our featured sources, tackles "...the tricky nature of the semantics of any discussion about 'inflation.'" In the most recent Pew News IQ poll, the worst score (14% correct) was the multiple choice question about the reported rate of inflation. You might also enjoy taking the quiz yourself. There are only 12 questions, and I expect the astute readership of "A Dash" to get near-perfect scores.
Why is public understanding of basic facts so low? It is a matter of what people read. Here are two stories from a single day last week, dramatically highlighted by the Grumpy Editor (HT Talking Biz News -- a featured source). Many news sources featured Lindsey Lohan’s latest personal difficulties and barely mentioned one of the largest highjackings in history, the Greek-flagged Irene SL grabbed in the Arabian Sea. The tanker contained 1/5 the U.S. daily oil import.
We have a terrible downward spiral both for print media and online sources. Those of us writing real substance feel like an obscure cable channel. In the old days -- a few years ago -- editors could decide what stories were important based upon the merits. If you were an editor, which of the stories would you feature?
Our Own Forecast
We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned cautious. Two weeks ago we said it was a close call, and switched to neutral. Last week it was still close, but we shifted back to bullish in the weekly Ticker Sense Blogger Sentiment Poll. We remained bullish this week. The poll is now conducted on Thursday night, so it does not reflect Friday trading or the bullish news from Egypt. Here is what we see:
- 68% of our 56 ETF's have a positive rating, up from 61% last week.
- 73% of our 56 sectors are in our "penalty box," equal to 73% last week, and an indication of significant short-term risk.
- Our universe has a median strength of +18, up significantly from +7 last week.
The overall picture is slightly bullish. We remained fully invested in trading accounts since there are several strong sectors, but we are watching the indicators quite carefully. This has been a very close call for several weeks.
An earlier and longer version of this article can be read at A Dash of Insight. Have a great week, investing and otherwise.
Michigan Consumer Sentiment Index Up Fractionally by Doug Short
USA High Labor Cost Not Primary Reason for Jobs Export by Steven Hansen
Jeff Miller has been a partner in New Arc Investments since 1997, managing investment partnerships and individual accounts. He has worked for market makers at the Chicago Board Options Exchange, where found anomalies in the standard option pricing models and developed new forecasting techniques. Jeff is a Public Policy analyst and formerly taught advanced research methods at the University of Wisconsin. He analyzed many issues related to state tax policy and provided quantitative modeling which helped inform state and local officials in Wisconsin for more than a decade. Jeff writes at his blog, A Dash of Insight.