Wednesday, 23 July 2014

Stocks rally, US existing home sales rise

Global stocks rose on Tuesday.

The MSCI All-Country World Index rose 0.7 percent, the S&P 500 climbed 0.5 percent and the STOXX Europe 600 jumped 1.3 percent.

US economic data on Tuesday were positive.

Existing home sales rose 2.6 percent in June to an eight-month high, with the median house price hitting its highest level since 2007.

The consumer price index rose 0.3 percent in June, down from 0.4 percent in May. However, the 12-month inflation rate was unchanged at 2.1 percent.

Tuesday, 22 July 2014

US financial regulatory policy under test amid deterioration in loan quality

Earlier this month, Federal Reserve Chair Janet Yellen opined that regulation is the preferred way of combating excessive financial risk-taking, not interest rate policy.

However, it remains to be seen whether regulation is up to the task. From Bloomberg:

One of the Federal Reserve’s first post-crisis tests of its ability to quash excessive risk-taking using regulatory tools is so far looking like a failure.

The Fed’s Board of Governors told Congress last week that it’s engaged in “strong supervisory follow-up” to guidance given to banks in 2013 to improve their underwriting standards for high-yield loans. Despite those efforts, Chair Janet Yellen said she’s still seeing a “marked deterioration” in quality.

For the first time, more than half of the junk-rated loans arranged in the U.S. this year lack typical lender protections like limits on the amount of debt borrowers can amass relative to earnings. Yellen’s own easy-money policies are boosting demand for such high-yielding products at the same time that she tests her doctrine that financial bubbles should be constrained by supervisory actions, not a general rise in interest rates.

The full risks to financial stability are unlikely to become obvious until the US economy weakens significantly. And that has apparently not happened yet.

The Chicago Federal Reserve reported on Monday that its national activity index dipped to +0.12 in June from +0.16 in May. The three-month moving average fell to +0.13 from +0.28.

According to the Chicago Fed, the three-month reading shows that economic growth was somewhat above its historical trend.

Monday, 21 July 2014

Are measures of stock market valuation useful?

Many analysts think that the United States stock market is now overvalued.

A Bloomberg poll showed last week that forty-seven percent of financial professionals surveyed said that the equity market is close to unsustainable levels while fourteen percent already saw a bubble.

Federal Reserve Chair Janet Yellen told the Senate Banking Committee last week that equity valuations “remain generally in line with historical norms” even as the Fed's Monetary Policy Report accompanying her testimony noted that valuations for smaller companies in social-media and biotech industries appear “substantially stretched”.

However, on Friday, Cullen Roche at Pragmatic Capitalism wrote a post questioning the value of valuation measures for the stock market.

In the case of the stock market we’ve now seen a 20+ year period where stocks are “overvalued” by several metrics (Shiller CAPE, Tobin’s Q, Market cap to GDP, etc). So I think it’s worth asking yourself how useful all of these metrics really are. Can you afford to go through a 20 year period relying on a rear view mirror dataset assuming that the market is overvalued when the other participants might not be using the same gauge of “beauty” as you are?

John Hussman thinks that valuation measures can be useful though. In a post earlier last week, he showed a chart of various valuation measures for the stock market over the past few decades and correlated them with subsequent 10-year returns for the S&P 500.

He concluded that valuation measures have “provided clear guidance about expected market returns across a century of market history” and have “not failed at all even in recent decades”.

In any case, by most of the valuation measures commonly used, Hussman's chart showed that the stock market has not been obviously overvalued throughout the whole of the past 20 years. It was only so around 2000, when valuations reached a point which correlated with negative return for the next ten years.

Indeed, in late 2008 and early 2009, the stock market was actually undervalued, as Hussman noted in real time back in October 2008. From the latter post:

Stocks are now at the same valuations that existed at the 1990 bear market low. Relative to 30-year Treasury yields, the S&P 500 is priced to deliver the highest excess return since the early 1980's.

The current bull market in stocks took off from the base of undervaluation back in late 2008 and early 2009.

In any case, “overvaluation” is actually a subjective term, as Hussman explained last week.

A widespread misunderstanding comes in when people start using the phrase “fair value.” For any given set of expected future cash flows, if you tell me the price, I can tell you the long-term return, period. If you tell me the long-term return, I can tell you the price, period. Nothing changes this. If you want to say that lower interest rates “justify” a low expected return, and therefore justify a higher price, that’s fine. Just understand that the low expected return will still follow that higher price. If you want to say that in a zero interest rate world, stocks should be priced for zero expected returns over the next 8 years, I have no problem with the conclusion that under that assumption, stocks are at “fair value” here. Just understand that under that conception of “fair value” stocks can still be expected to return nothing over the next 8 years. What is emphatically not true, and not mathematically consistent, is to say that low interest rates “justify” a low expected return, and therefore justify a higher price, but then to turn around and say that since stocks are “fairly valued” under that assumption, they can be expected to achieve normal returns in the future.

It is useful to remember that when Hussman talked about expected return, he was referring to long-term return. In the short term though, valuation measures alone cannot determine when an “overvalued” market corrects.

Indeed, Hussman had written back in December 2006 that bull markets can end in a “speculative blowoff”. That turned out to be prescient. While Hussman noted that the stock market by then had already become overvalued, that cycle's bull market went on for almost another year before finally crumbling.

So while long-term returns correlate quite well with valuation measures, if the short term is the concern, Roche is probably correct in doubting whether valuation measures alone can be relied on to determine one's investment stance.

Saturday, 19 July 2014

Stocks rebound, US leading index rises, China home prices fall

After the tumble on Thursday, stocks rebounded on Friday, the S&P 500 rising 1.0 percent. The US 10-year yield rose three basis points while gold fell 0.6 percent.

US economic data on Friday were mixed though.

The Conference Board's US leading economic index rose 0.3 percent in June after having risen 0.7 percent in May.

However, the Thomson Reuters/University of Michigan's preliminary July consumer sentiment index came in at 81.3, down from 82.5 in June.

Meanwhile, there were signs on Friday that China's property market has cooled further. The National Bureau of Statistics reported that new home prices fell in June in 55 of 70 cities surveyed, up from 35 cities in May.

Calculations by Reuters showed that average new home prices in the 70 cities fell 0.5 percent in June, faster than the 0.2 percent fall in May.

Friday, 18 July 2014

Stocks fall amid geopolitical tension, bubble concerns and plunge in US housing starts

Thursday saw a flight to safety in financial markets as tension escalated in Ukraine and the Middle East. The S&P 500 fell 1.2 percent, the US 10-year Treasury yield fell six basis points to 2.46 percent and gold rose 1.3 percent.

The decline in stocks also comes as investors have become increasingly concerned about market levels. A Bloomberg poll showed that forty-seven percent of financial professionals surveyed said that the equity market is close to unsustainable levels while fourteen percent already saw a bubble.

Adding to the negative sentiment, US housing data on Thursday came out weak. Housing starts fell 9.3 percent in June to a nine-month low while building permits fell 4.2 percent, its second consecutive decline.

Thursday, 17 July 2014

Stocks rise, China's economy accelerates

Stocks returned to winning ways on Wednesday, helped by positive economic data around the world. The S&P 500 rose 0.4 percent and the STOXX Europe 600 jumped 1.3 percent.

A report on Wednesday showed that China's economy accelerated in the second quarter. It grew 7.5 percent in the second quarter from a year ago, faster than the 7.4 percent growth in the first quarter.

In June, industrial production rose 9.2 percent from the previous year, retail sales increased 12.4 percent and fixed asset investment rose 17.3 per cent in the first six months compared to the same period the previous year.

US economic data on Wednesday were also mostly positive.

Despite manufacturing production increasing by just 0.1 percent in June, industrial production rose at a 5.5 percent annual rate in the second quarter, the fastest since the third quarter of 2010.

The Federal Reserve's Beige Book found economic activity continued to expand in recent weeks, with manufacturing and consumer spending gaining traction.

The NAHB/Wells Fargo housing market index rose to 53 this month, the highest level in six months, from 49 in June.

The producer price index for final demand increased 0.4 percent in June after falling 0.2 percent in May.

In the UK, the unemployment rate fell to 6.5 percent in the three months to May from 6.6 percent a month earlier.

However, workers' earnings excluding bonuses rose by an annual rate of 0.7 percent in the three months through May, the slowest growth in regular pay since records began in 2001.