Tuesday, September 27, 2016

Liquidity and effect on goods and services [VIDEO]

Monday, September 12, 2016

It's not going to be pretty

We have a situation where most people in Europe and North America have seen declines in their purchasing power for over a decade.

When we get enough perspective—we’re going to find that this whole situation with negative nominal interest rates and with very aggressive monetary policy—has not done much for economic growth, [with] all the confusion this has created.

I wish we could pull out the crystal ball and see what is going to come out of this. I rather suspect that it’s not going to be pretty to go through.

Tuesday, September 6, 2016

Storm coming for financial markets globally

Global growth is weak, and will be eroded further by Brexit. Oil prices are low, and likely to plunge further. The world has excess capacity and a wage-depressing labor surplus. Corporate profits are shaky. And deflation is laying bare the impotence of central banks. So where would you logically expect financial markets to be going, given that economic, financial and political environment?

You’d expect to see increased demand for safe-haven U.S. Treasuries, a soaring dollar, falling commodity prices, and increasing investor aversion to junk bonds, emerging market debt and equities and other low-quality securities. But that’s not the case.

The 10-year Treasury yield has been flat for months, as has the dollar against the euro. Commodity prices in general and oil in particular have risen this year. Money has poured into emerging market bonds as well as junk bonds, depressing their yields. How can current security prices be justified in the face of the fundamental picture, at least as I see it?

Well, maybe they can’t. The most likely outcome to my mind is a major market correction to bring prices back into line with economic fundamentals. Distortions such as negative interest rates and slow economic growth in the face of super-aggressive monetary policies in many countries suggest that things are way out of alignment, and that the resolution may be a very painful process, and a big shock for many market participants.  

Nevertheless, there may be some forces at work that might help explain current market conditions even if they don't justify valuations, which in turn could lessen the blow of an abrupt reversal.

U.S. stocks may still be cheap despite historically high price/earnings ratios. Looking at dividend yields on the S&P 500 index against those available on 10-year government debt, equities remain attractive:

If the dividend yields dropped to match the Treasury yield, the price/earnings ratio of the S&P would be closer to 63 than its current level of about 20. Following this logic, stocks are arguably undervalued by more than 60 percent.

Investors may also take comfort once the U.S. presidential election is settled with a win for Hillary Clinton. Despite all of her baggage of dishonesty, raw ambition and pandering for votes, she’s the devil they know -- and maybe preferable to Donald Trump, the devil they’ve yet to see in action.

There’s also the prospect of a fiscal stimulus program to revive growth. With even central bankers tacitly admitting that monetary policy has failed to generate meaningful economic growth, the pressure on politicians to do their bit will grow, in the euro zone as well as the U.S.

Once a new president is in place, infrastructure spending might be a feasible middle ground for both political parties. The U.S. certainly needs major refurbishing and expansion of roads, bridges, public transportation and other infrastructure. The most recent Global Competitiveness Ranking from the World Economic Forum rates the U.S. third overall in competitiveness but 13th for infrastructure quality as a whole, 14th for roads, 15th for railroads and 16th for electricity supply system. It’s estimated that aging roads and bridges are costing an extra $377 annually per driver. Infrastructure spending would not only create jobs and economic activity but also enhance lagging productivity.

The National Association of Manufacturers calls for major infrastructure spending of $100 billion per year for each of the next three years. It noted that outlays grew 2.2 percent per year between 1956 and 2003, but fell 1.2 percent annually from 2003 through 2012. Total spending for roads and streets fell 19 percent between 2003 and 2012.

Even if the political climate improves after the election, and the spending taps are turned on in the U.S., investors may still be too relaxed about the outlook. The VIX index, a measure of expected future stock market volatility, remains at historically low levels. The S&P 500 index is up about 6.2 percent this year.

But Europe offers an example of what might happen if things reverse. The region’s benchmark Stoxx 600 index is down more than 5 percent this year, erasing almost all of 2015’s gains. In this environment, investors should hold universally large cash positions until there’s a clearer picture of what comes next. 

Thursday, September 1, 2016

Many stock investors do not believe in Treasuries

Many stock bulls haven’t given up their persistent love of equities compared to Treasury's. Their new argument is that Treasury bonds may be providing superior appreciation, but stocks should be owned for dividend yield.

That, of course, is the exact opposite of the historical view, but in line with recent results. The 2.1% dividend yield on the S&P 500 exceeds the 1.50% yield on the 10-year Treasury note and is close to the 2.21% yield on the 30-year bond. Recently, the stocks that have performed the best have included those with above average dividend yields such as telecom, utilities, and consumer staples.

Then there is the contention by stock bulls that low interest rates make stocks cheap even through the S&P 500 price-to-earnings ratio, averaged over the last 10 years to iron out cyclical fluctuations, now is 26 compared to the long-term average of 16.7. This makes stocks 36% overvalued, assuming that the long run P/E average is still valid. And note that since the P/E has run above the long-term average for over a decade, it will fall below it for a number of future years—if the statistical mean is still relevant.

Instead, stock bulls point to the high earnings yield and the inverse of the P/E, in relation to the 10-year Treasury note yield. They believe that low interest rates make stocks cheap. Maybe so, and we’re not at all sure what low and negative nominal interest rates are telling us.

We’ll know for sure in a year or two. It may turn out to be the result of aggressive central banks and investors hungry for yield with few alternatives. Or low rates may foretell global economic weakness, chronic deflation and even more aggressive central bank largess in response. We’re guessing the latter is the more likely explanation.