Tag Archives: Margin

3 Things: Bear Rallies, Dividends, Empathy

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Biggest Rallies Occur In Bear Markets

As expected, the market was oversold enough going into last Friday to elicit a short-term reflexive bounce. Not surprisingly, it wasn’t long before the “bulls” jumped back in proclaiming the correction was over.

If it were only that simple.

First, as I have discussed in the past, market prices remain in a “trend” until something causes that trend to change. This can be most easily seen by looking at a chart of the S&P 500 as compared to its 400-day moving average.

SP500-MarketUpdate-021716

As you will notice in the main body of the chart, during bull markets, prices tend to remain ABOVE the 400-dma (orange-dashed line). Conversely, during bear markets, prices tend to remain BELOW the 400-dma.

The one event in 2011, where all indicators suggested the market was transitioning back into a bear market, was offset by the Federal Reserve’s intervention of “Operation Twist” and eventually QE-3.

During cyclical bear markets, bounces from short-term oversold conditions tend to be extreme. Just recently Price Action Lab blog posted a very good piece on the commonality of short-term rebounds during market downtrends:

“The S&P 500 gained 3.63% in the last two trading sessions. About 75% of back-to-back gains of more than 3.62% have occurred along downtrends. Therefore, a case for a bottom cannot be based solely on performance.”

SP500-Downtrends-Rallies-021716

It may be seen that 73.85% back-to-back gains of more than 3.62% have occurred along downtrends, i.e., this performance is common when markets are falling. The sample size consists of 195 back-to-back returns greater than 3.62%.

Therefore, strong rebounds along a downtrend cannot be used to support a potential bottom formation.”

After a rough start to the new year, it is not surprising that many are hoping the selling is over.

Maybe it is.

But history suggests that one should not get too excited over bounces as long as the downtrend remains intact.

I Bought It For The Dividend

One of the arguments for “buy and hold” investing has long been “dividends.” The argument goes this way:

“It really doesn’t matter to me what the price of the company is, I just collect the dividend.”

While this certainly sounds logical, in reality, it has often turned into a very poor strategy, particularly during recessionary contractions.

A recent example was Kinder Morgan (KMI). In late-2014, as I was recommending that individuals begin to exit the energy sector, Kinder Morgan was trading around $40/share. The argument then was even if the share price of the company fell, the owner of the shares still got paid a great dividend.

Fast forward today and the price of the company has fallen to recent lows of $15/share (equating to a 62.5% loss in value) and the dividend was cut by 80%.

Two things happened to the investor’s original thesis. The first, was that after he had lost 50% of his capital, the dividend was no longer nearly as important. Confidence in the company eroded and the individual panic sold his ownership into the decline. Secondly, when a company gets into financial trouble, the first thing they will do is cut the dividend. Now you have lost your money and the dividend.

But it is not just KMI that has cut dividends as of late. Many companies have been doing the same to shore up internal cash flows. As pointed out recently by Political Calculations:

“Speaking of which, the pace of dividend cuts in the first quarter of 2016 has continued to escalate. Through Friday, 12 February 2016, the number of dividend cuts has risen into the “red zone” of our cumulative count of dividend cuts by day of quarter chart.”

Dividend-Cuts-021716

Importantly, while the media keeps rambling on that we are “nowhere” close to a recession, it is worth noting the following via NYT:

“The only year in recent history with more dividend cuts was 2009, when the world was staggering through a great financial crisis. A total of 527 companies trimmed dividends that year, Mr. Silverblatt’s data shows. Coca-Cola and other dividend-paying blue chips like IBM and McDonald’s were under severe stress in those days, too, but their financial resources were deep enough to allow them to keep the dividend stream fully flowing.”

Buying “dividend yielding” stocks is a great way to reduce portfolio volatility and create higher total returns over time. However, buying something just for the dividend, generally leads to disappointment when you lose your money AND the dividend. It happens…a lot.

Preservation of capital is first, everything else comes second.

Empathy For The Devil

Danielle DiMartino Booth, former Federal Reserve advisor and President of Money Strong, recently penned an excellent piece that has supported my long-held view on the fallacy of “consumer spending.” To wit:

“As for the strongest component of retail sales, it’s not only subprime loans that are behind the 6.9-percent growth in car sales over 2015. Super prime auto loan borrowers’ share of the pie is now on par with that of subprime borrowers – each now accounts for a fifth of car loan originations. What’s that, you say? Can’t afford that new set of wheels? Not to worry. Just lease. You’ll be in ample company — some 28 percent of last year’s car sales were made courtesy of leases, an all-time high. ”

Retail-Sales-021716

What has been missed by the vast majority of mainstream economists is that in a country driven 68% by consumer spending, there are limits to that consumption. A consumer must produce (work) first to be paid a wage with which to consume with. Each dollar is finite in its ability to create economic growth via consumption. A dollar spent on a manufactured good has a greater multiplier effect on the economy than the same dollar spent on a service. Likewise, a dollar spent on a manufactured good or service has a greater economic impact than a dollar spent on paying taxes, higher healthcare insurance costs, or interest payments.

The only way to increase the level of spending above the rate of income is through leverage. However, rising debt levels also suggests more of the income generated by households is diverted to debt service and away from further consumption. The chart below shows the problem.

Debt-GDP-021816

Over the 30-year period to 1982, households accumulated a total of $2 trillion in debt in an economy that was growing at an average rate of 8%. Wages grew as stronger consumption continued to push growth rates higher. Over the next 25-year period, households abandoned all fiscal responsibility and added over $10 trillion in debt as the struggle to create a higher living standard outpaced wage and economic growth.  Since the turn of the century, average economic growth has been closer to 2%. See the problem here.

The bailouts following the financial crisis kept households from going through a much needed deleveraging. Likewise, since banks were taught they would be bailed out repeatedly for bad behavior, no lessons were learned there either. Not surprisingly, as shown by the recent Fed Reserve 2016 Loan Officer Opinion Survey, lending standards are now back to levels seen just prior to the financial crisis.

Loan-Officer-Mortage-Survey-021816-2

Loan-Officer-Mortage-Survey-021816

What could possibly going wrong? The problem is the consumer is all spent out and all leveraged up. While you shouldn’t count the consumer out, just don’t count on them too much.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Billions Lost, Tax Withholding, Yield Curve

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Companies Lose Billions On Stock Buybacks

I recently wrote an article about why “Benchmarking Your Portfolio Is A Losing Bet.” In that missive, I discussed all the things that benefit a mathematically calculated index versus what happens in an actual portfolio of securities. One of those issues was the impact of share buybacks:

“The reality is that stock buybacks are a tool used to artificially inflate bottom line earnings per share which, ultimately, drives share prices higher. As John Hussman recently noted:

The preferred object of debt-financed speculation, this time around, is the equity market. The recent level of stock margin debt is equivalent to 25% of all commercial and industrial loans in the U.S. banking system. Meanwhile, hundreds of billions more in low-quality covenant-lite debt have been issued in recent years.”

Note the surge in debt to fund those buybacks.

Hussman-StockBuyBacks-Debt-113015

“The importance of buybacks cannot be overlooked. The dollar amount of sales, or top-line revenue, is extremely difficult to fudge or manipulate. However, bottom line earnings are regularly manipulated by accounting gimmickry, cost cutting, and share buybacks to enhance results in order to boost share prices and meet expectations. Stock buybacks DO NOT show faith in the company by the executives but rather a LACK of better ideas for which to use capital for.”

The entire article is worth a read to understand how indices and your portfolio are two very different things.

I bring this up because surges in stock buybacks are late bull market stage events. This is something I have repeatedly warned about in the past it is a false premise that companies repurchase stock at high prices because they have faith in their company. Such actions eventually lead to rather negative outcomes as capital is misallocated to non-productive resources.

Bernard Condon via AP picked up on this issue:

“When a company shells out money to buy its own shares, Wall Street usually cheers. The move makes the company’s profit per share look better, and many think buybacks have played a key role pushing stocks higher in the seven-year bull market.

But buybacks can also sap companies of cash that they could be using to grow for the future, no matter if the price of those shares rises or falls.

Defenders of buybacks say they are a smart use of cash when there are few other uses for it in a shaky global economy that makes it risky to expand. Unlike dividends, they don’t leave shareholders with a tax bill. Critics say they divert funds from research and development, training and hiring, and doing the kinds of things that grow the businesses in the long term.

Companies often buy at the wrong time, experts say, because it’s only after several years into an economic recovery that they have enough cash to feel comfortable spending big on buybacks. That is also when companies have made all the obvious moves to improve their business — slashing costs, using technology to become more efficient, expanding abroad — and are not sure what to do next to keep their stocks rising.

‘For the average company, it gets harder to increase earnings per share,’ says Fortuna’s Milano. ‘It leads them to do buybacks precisely when they should not be doing it.’

And, sure enough, buybacks approached record levels recently even as earnings for the S&P 500 dropped and stocks got more expensive. Companies spent $559 billion on their own shares in the 12 months through September, according to the latest report from S&P Dow Jones Indices, just below the peak in 2007 — the year before stocks began their deepest plunge since the Great Depression.”

While buybacks work great during bull market advances, as individuals willfully overlook the fundamentals in hopes of further price gains, the eventual collision of reality with fantasy has been a nasty event. This is shown in the chart below of the S&P 500 Buyback Index versus the S&P 500 Total Return.

Buyback-Index-021016

If this was the Dr. Phil Show, I am sure he would ask these companies;

“Well, how is that working out for you ?”

Tax Withholding Paints Real Employment Picture

I always find the mainstream media and blogosphere quite humorous around employment reporting day. The arm waving and cheering, as the employment report is released, reaches the point of hilarity over some of the possibly most skewed and manipulated economic data released by any government agency.

Think about it this way. How can you have the greatest level of employment growth since the 1990’s and the lowest labor force participation rate since the 1970’s? Or, how can you have 4.9% unemployment but not wage growth? Or, 95.1% of the population employed but 1/3rd of employable Americans no longer counted?

The importance of employment, of course, is that individuals must produce first in order to consume. Since the economy is nearly 70% based on consumption, people need to be working to create economic growth. Of course, there is another problem with the data. How can you have 4.9% unemployment and an economic growth rate of sub-2%?

A recession is coming and a look at real employment data, the kind you can’t fudge, tells us so. David Stockman recently dug into the data.

“If we need aggregated data on employment trends, the US government itself already publishes a far more timely and representative measure of Americans at work. It’s called the treasury’s daily tax withholding report, and it has this central virtue: No employer sends Uncle Sam cash for model imputed employees, as does the BLS in its trend cycle projections and birth/death model; nor do real businesses forward withholding taxes in behalf of the guesstimated number of seasonally adjusted payroll records for phantom employees who did not actually report for work.

My colleague Lee Adler…now reports that tax collections are swooning just as they always do when the US economy enters a recession.

The annual rate of change in withholding taxes has shifted from positive to negative. It has grown increasingly negative in inflation adjusted terms for more than a month and it is the most negative growth rate since the recession.”

Tax-Withholding-021016

“Needless to say, the starting point for overcoming the casino’s blind spot with respect to the oncoming recession is to recognize that payroll jobs as reported by the BLS are a severely lagging indicator. Here is what happened to the headline jobs count in just the 12 months after May 2008. The resulting 4.6% plunge would amount to a nearly a 7 million job loss from current levels.”

Employment-Post-2008

Good point.

Is The Yield Curve Indicator Broken?

As one indicator after another is signaling that the U.S. economy is on the brink of a recession (see here and here), the bulls are desperately clinging to the yield curve as “proof” the economy is still growing.

There are a couple of points that need to be addressed based on the chart below.

Yield-Curve-GDP-021116-3

  1. As shown in the chart above, the 2-year Treasury has a very close relationship with the Effective Fed Funds Rate. Historically, the Federal Reserve began to lift rates shortly after economic growth turned higher. Post-2000 the Fed lagged in raising rates which led to the real estate bubble / financial crisis. Since 2009, the Fed has held rates at the lowest level in history artificially suppressing the short-end of the curve.
  2. The artificial suppression of shorter-term rates is likely skewing the effectiveness of the yield curve as a recession indicator.
  3. Lastly, negative yield spreads have historically occurred well before the onset of a recession. Despite their early warnings, market participants, Wall Street, and even the Fed came up with excuses each time to why “it was different.” 

Just as the yield spread was negative in 2006, and was warning of the onset of a recession, Bernanke and Wall Street all proclaimed that it was a “Goldilocks Economy.” It wasn’t.

Here is the point, as shown in the chart above, the Fed should have started lifting rates as the spike in economic growth occurred in 2010-2011. If they had, interest rates on the short-end of would have risen giving the Fed a policy tool to combat economic weakness with in the future. However, assuming a historically normal response to economic recoveries, the yield curve would have been negative some time ago predicting the onset of a recession in the economy about…now.  Of course, such would simply be a confirmation of a majority of other economic indicators that are already suggesting the same.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Fed Late, Rate Review, Pricing In “R”

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


The Fed Is Behind The Curve…Again

Over the last couple of months, I have been discussing the technical deterioration of the market that is occurring beneath the surface of the major indices. I have also suggested there is more than sufficient evidence to suggest we may be entering into a more protracted “bear market cycle.”

The caveat to this, of course, has been the potential for a renewed round of Central Bank interventions that would theoretically once again postpone the onset of such a decline. To wit:

“The top section of the chart is a basic ‘overbought / oversold’ indicator with extreme levels of ‘oversold’ conditions circled. The shaded area on the main part of the chart represents 2-standard deviations of price movement above and below the short-term moving average.”

SP500-MarketUpdate-020416

“There a couple of very important things to take away from this chart.

  • When markets begin a ‘bear market’ cycle [which is identified by a moving average crossover (red circles) combined with a MACD sell-signal (lower part of chart)], the market remains in an oversold condition for extended periods (yellow highlighted areas.)
  • More importantly, during these corrective cycles, market rallies fail to reach higher levels than the previous rally as the negative trend is reinforced.

Both of these conditions currently exist.

Could I be wrong? Absolutely.

This entire outlook could literally change overnight if the Federal Reserve leaps into action with a rate cut, another liquidity program or direct market intervention.”

This is just the most recent observation. I begin discussing the deterioration in the markets beginning last summer as early signs of the topping process began and I lowered portfolio model exposures to 50% of normal allocations.

However, despite the fact that interest rates have continued to trend lower, economic data and corporate profits have deteriorated, and inflationary pressures non-existent; most Fed speakers have sounded consistently hawkish and steadfast in their views of 4-rate hikes in 2016.

I have been steadfast in my claims that hiking rates given the current economic conditions is a mistake and will rapidly push the markets and economy towards a reversion. To wit:

“Looking back through history, the evidence is quite compelling that from the time the first rate hike is induced into the system, it has started the countdown to the next recession. However, the timing between the first rate hike and the next recession is dependent on the level of economic growth at that time.

When looking at historical time frames, one must not look at averages of all rate hikes but rather what happened when a rate hiking campaign began from similar economic growth levels. Looking back in history we can only identify TWO previous times when the Fed began tightening monetary policy when economic growth rates were at 2% or less.

(There is a vast difference in timing for the economy to slide into recession from 6%, 4%, and 2% annual growth rates.)”

Fed-Funds-GDP-5yr-Avg-Table-121715

“With economic growth currently running at THE LOWEST average growth rate in American history, the time frame between the first rate and next recession will not be long.”

It is now becoming quite apparent that the majority of economists, analysts, and Fed members have been quite mistaken in their assessments of the impact of global turmoil and the collapse in commodity prices on the domestic economy. (Read my previous commentary on oil and China)

From Market News: (Via ZeroHedge)

“Top Federal Reserve policymakers are leaving little doubt the financial turbulence and souring of the global economy could have significant implications for U.S. monetary policy, but they are loathe to draw too many conclusions about the appropriate path of interest rates at this juncture.

One thing is for certain: The tightening of financial conditions that has taken place since the Fed began raising short-term rates in mid-December is a matter of considerable concern to the Fed, New York Federal Reserve Bank President William Dudley said in an exclusive interview with MNI Tuesday.

But, it was supposed to signal the US economy is ‘strong enough’ to sustain a lift off and decouple from the rest of the world which is scrambling to cut rates. Guess not.

As MNI adds, “a weakening of the global economy accompanied by further appreciation in an already strong dollar could also have “significant consequences” for the U.S. economy, Dudley told MNI.”

“I can give you my own interpretation,” the committee’s vice chairman replied. “I read that as saying we’re acknowledging that things have happened in financial markets and in the flow of the economic data that may be in the process of altering the outlook for growth and the risk to the outlook for growth going forward.”

But it’s a little soon to draw any firm conclusions from what we’ve seen,” he cautioned.”

If history serves as any guide, with the entire flow of data from economic underpinnings, high-yield markets, commodity prices and deteriorating profits screaming for help, by the time the Fed “draws any firm conclusions” it will be far too late to make any real difference. 

Interest Rate Predictions Come To Fruition

Well, that didn’t take long.  At the beginning of this year, I wrote in the 2016 Market Outlook & Forecast the following:

“With the Federal Reserve raising interest rates on the short-end (Fed Funds), it will likely push the long-end of the curve lower as the economy begins to slow from the effects of monetary policy tightening.

From a purely technical perspective, rates have been in a long-term process of a tightening wedge. A breakout to the upside would suggest 10-year treasury rates would soar to 3.6% or higher, the consequence of which would be an almost immediate push of an economy growing at 2% into recession. The most likely path, given the current economic and monetary policy backdrop, will be a decline in rates toward the previous lows of 1.6-1.8%.(Inflation will also remain well below the Fed’s 2% target rate for the same reasons.)

InterestRate-Update-020416

“Of course, falling rates means the ongoing “bond bull market” will remain intact for another year. In fact, if my outlook is correct, bonds will likely be one of the best performing asset classes in the next year.”

When I wrote that missive, rates were at 2.3%. Yesterday, they touched 1.8% and intermediate and long duration bonds have been the asset class to own this year.

While rates will likely bounce in the short-term, I still suspect rates will finish this year closer to the low-end of my range.

Have Stocks Priced In A Recession?

I have read a significant amount of commentary as of late suggesting that the current decline in stocks have “priced in” the economic and earnings weakness we are currently witnessing.

Such is hardly the case.  There are two primary indicators that warrant such skepticism.

The first is valuations.

CAPE-5yrAvg-020416

The chart above is a 5-year Cyclically Adjusted Price Earnings (CAPE) ratio (data source: Dr. Robert Shiller.)  By speeding up the time frame from 10-years to 5-years, we find that valuation changes have shifted from being more coincident prior to 1970, to more leading currently. As shown, the downturn in valuations has been a leading indication of more severe market corrections particularly since the turn of the century.

The second is profits.

SP500-Ann-Pct-Chg-Earnings-020416

While still early into 2016, it already appears that earnings will post an annual decline for the second year running. Annual declines in earnings have historically been more evident during recessionary economic cycles (which only makes sense as consumption slows.)

It is not just me suggesting that risk is currently high either. Here is a note from RBC:

“Based on current valuations, the prices of most stocks don’t appear to have factored in a recession scenario, ‘hence the downside should we see a recession could be rather severe,’ RBC Capital Markets’ global equity team wrote in a research note to clients who believe the shares of most companies could still fall another 50% or more from current levels.”

Such declines have been consistent with past economic/earnings recessions as “overvaluation” reverts back to “undervaluation.”

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Fed Error, Houston R/E, No Bounce?

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


The Potential Of A Policy Error Has Risen

Yesterday, the Fed clearly showed they are trapped in their decision to raise rates. Despite an ongoing deterioration in the underlying economic and financial market fabric, Yellen & Co. stayed firm in their commitment to a gradual increase in interest rates.

What is most interesting is their focus on headline employment data while ignoring their very own Labor Market Conditions Index (LMCI) which shows a clear deterioration in the employment underpinnings.

Employment-LMCI-012816

But here is the potential problem for the Fed’s dependence on current employment data as justification for tightening monetary policy – it is likely wrong. Economic data is very subject future revisions. While the current employment data has indeed been the strongest since the late 1990’s, there is a probability that the data is currently being overestimated.

The reason is shown in the chart below.

Employment-FullTime-LFPR-012816

If the employment gains were indeed as strong as the Fed, and the BLS, currently suggest; the labor force participation rate should be rising. This has been the case during every other period in history where employment growth increased. Since the financial crisis, despite employment gains, the labor force participation rate has continued to fall.

This suggests that at some point in the future, we will likely see negative revisions to the employment data showing weaker growth than currently thought.

The issue for the Fed is by fully committing to hiking interest rates, and promoting the economic recovery meme, changing direction now would lead to a loss of confidence and a more dramatic swoon in the financial markets. Such an event would create the very recession they are trying to avoid.

Inflation expectations are also a problem which compounds the probability of a policy error at this point. As Danielle DiMartino Booth, who left the Fed earlier this year, stated:

“Less anticipated was the adamancy of Committee members that inflation would hit their stated goal of ‘two percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.’

‘Strengthens further?’ Anyone bother to share the last few weekly jobless claims reports with monetary policymakers?

As for inflation’s prospects, a year and a half into crashing oil prices, the FOMC’s use of the word ‘transitory’ leads one to wonder if they are stuck in some space age time warp. Or maybe they declared it Opposite Day but failed to share that with the rest of us.

While the Fed clearly remains giddily detached from reality, the bond market communicated unequivocally what it thinks about the economy’s prospects: the 10-year Treasury closed below the two percent line in the sand that’s been drawn since the start of the year.

 

With fourth quarter GDP likely to be closer to 0% than 2%, the Fed has clearly gotten on the wrong side of the economic landscape. This puts the possibility of a monetary policy error at extremely high levels, the outcomes of which have historically been severe.

Houston Has A Problem – Commercial R/E

In February of 2015, I penned the following missive discussing the coming real estate crisis for the Houston market:

“Houston has a problem when it comes to tumbling oil prices.

As oil prices rise and fall so does the number of rigs being utilized to drill for oil which ultimately also impacts employment. This is shown in the chart below of rig count versus employment in the oil and gas sector of the economy.”

Oil-RigCount-Employment-012816

“Obviously, the drawdown in energy prices is going to start to weigh on the Texas economy rather sharply over the next several months. Several energy companies have already announced layoffs, rig count reductions and budgetary cuts going into 2015. It is still very early in the cycle so it is likely that things will get substantially worse before they get better.”

While much of the mainstream media continues to tout that falling oil prices are good for the economy, (read here for why that is incorrect ) the knock-off economic impacts are job losses through the manufacturing sector and all other related industries are quite significant.

However, most importantly as I pointed out at the beginning of 2015:

“One of those areas is commercial real estate.  If you look in any direction in Houston, you see nothing but cranes. The last time I saw such an event was just prior to 2008 when I commented then that overbuilding was a sign of the maturity of the boom. The same has happened yet again, and not surprisingly, the “sirens song” has been “this time is different.” 

Unfortunately, not only is this time not different, the economic impacts are likely to much more substantial, not only in the Houston economy, but nationwide. To wit:

“The jagged skyline of this oil-rich city is poised to be the latest victim of falling crude prices. As the energy sector boomed in recent years, developers flocked to Houston, so much so that one-sixth of all the office space under construction in the entire U.S. is in the metropolitan area of the Texas city.”

office-construction

But here is the economic problem:

“And as a reminder, every high-paying oil service jobs accounts for up to 4 downstream just as well-paying jobs. Case in point:

The rush of building has created thousands of jobs—not only at building sites, but also at window manufacturers, concrete companies, and restaurants that feed the workers.

But just as the wave of office-space supply approaches, energy companies, including Halliburton Co. , Baker Hughes Inc., Weatherford International and BP PLC, have collectively announced that more than 23,000 jobs would be cut, with many of them expected to be in Houston.

Fewer workers, of course, means less need for office space.

No one believed me then. However, here is the latest update from real-estate services firm Savills Studly via Business Insider:

“New sublease blocks are expected to hit the market in 2016, particularly in the CBD [Central Business District]. Shell is projected to vacate 250,000 sf in One Shell Plaza and EP Energy, likewise, is anticipated to leave 100,000 sf in the Kinder Morgan Building. Shell would likely also shed space at BG Group Place should its pending $70-billion acquisition of BG Group clear governmental hurdles and finalize.

Many large tenants who paid at the very top of the market in the last few years warehoused space in anticipation of continued headcount growth. As a result, many firms had surplus space even prior to the implementation of layoffs in the last year. In 2016, the office market should see more shadow space listings….

Occupancy, after five years in a row of increases, fell by 1.4 msf (“negative absorption”), the biggest decrease in occupancy since 2009. Going forward, M&A and bankruptcies “will contribute to additional negative absorption” and will hit the vacancy rate. It already spiked to 23.2%.

After a tremendous building boom in 2013 and 2014, a total of 17 msf is expected to hit the market over the next few years, with 7.9 msf scheduled for completion in 2016. Only about two-thirds have been pre-leased. Some of these pre-leased properties will enter the shadow inventory as soon as they’re completed. But 5.5 msf has not been leased.

These new buildings will hit the market at the worst possible time, competing with 7.9 msf of sublease space and large amounts of shadow inventory, during a period of negative absorption.

While the media and mainstream analysts discount the negative economic impact of falling energy costs, I have personally witnessed it in the mid-80’s, the late 90’s and just prior to 2008. In all cases, the negative outcomes were far worse than predicted which left economists scratching their heads as to what went wrong with their models.

This time won’t be different.

Markets May Not Bounce

Over the last few weeks, I have suggested the markets would likely provide a reflexive rally to allow investors to reduce equity risk in portfolios. This was due to the oversold condition that previously existed which would provide the “fuel” for a reflexive rally to sell into.

I traced out the potential for such a reflexive rally to weeks ago as shown in the chart below.

SP500-MarketUpdate-012816

The oversold conditions that once existed have been all but exhausted at this point due to the gyrations in the markets over the last couple of weeks without the markets making any significant advance.

Just as an oversold condition provides the necessary “fuel” for an advance, the opposite is also true. This almost overbought condition comes at a difficult time as I addressed earlier this week:

“February has followed those 20 losing January months by posting gains 5-times and declining 14-times. In other words, with January likely to close out the month in negative territory, there is a 70% chance that February will decline also.

The high degree of risk of further declines in February would likely result in a confirmation of the bear market. This is not a market to be trifled with. Caution is advised. “

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: “R” Signs, Looks Like 2008, QE-4

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Warning Signs Of A Recession

In late 2007, I was giving a presentation to a group of about 300 investors discussing the warning signs of an impending recessionary period in the economy. At that time, of course, it was near “blasphemy” to speak of such ills as there was “no recession in sight.”

Then, in December of that year, I penned that we were either in, or about to be in, the worst recession since the “Great Depression.” That warning too was ignored as then Fed Chairman Ben Bernanke stated that it was a “Goldilocks Economy.” The rest, as they say, is history.

I was reminded of this as I was reading an article by Myles Udland, via Business Insider, entitled “The US economy is nowhere near a recession.” 

It is an interesting thought. However, the problem for most analysts/economists is that they tend to view economic data as a stagnant data point without respect for either the trend of the data or for the possibility of future negative revisions. As shown in the chart below, this is why it SEEMS the financial markets lead economic recessions.

SP500-NBER-RecessionDating-012016

However, in reality, they are more coincident in nature. It is just that it takes roughly 6-12 months before the economic data is negatively revised to show the start of the recession. For example, the recession that started in 2007 was not known until a year later when the data had been revised enough to allow the NBER to make its official call.

The market decline beginning this year is likely an early warning of further economic weakness ahead. I have warned for some time now that the economic cycle was exceedingly long given the underlying weakness of the growth and that eventually, without support from monetary policy, would likely give way. The following charts are the same ones I viewed in 2007, updated through the most recent data periods, which suggested the economy was approaching a recessionary state. While not all are in negative territory yet, they are all headed in that direction.

PCE-Imports-012016

LEI-Coincident-Lagging-012016

LEI-vs-GDP-012016

SP500-Ann-Pct-Chg-Earnings-012016

SP500-NetProfit-Margins-012016

Retail-Sales-012016

Is the economy “nowhere near recession?” Maybe. Maybe not. But the charts above look extremely similar to where we were at this point in late 2007 and early 2008.

Could this time be “different?” Sure. But historically speaking, it never has been.

The Topping Process Completes

For the last several months I have repeatedly discussed the topping process in the markets and warned against dismissing the current market action lightly. To wit:

“Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.

The chart below is an example of asymmetric bubbles.

Asymmetric-bubbles

The pattern of bubbles is interesting because it changes the argument from a fundamental view to a technical view. Prices reflect the psychology of the market which can create a feedback loop between the markets and fundamentals.

This pattern of bubbles can be clearly seen at every bull market peak in history.

Take a look at the graphic above, and the one below. See any similarities?

SP500-MarketUpdate-012016

As you will notice, the previous two bull-market cycles ended when the topping process ended by breaking the rising support levels (red line). The confirmation of the onset of the “bear market” was marked by a failed rally back to the previous rising support level. Currently, that has not occurred as of yet.

The next chart is another variation of the above showing the break-down of the rising bullish trend in the market.  In all cases, investors were given minor opportunities to reduce equity risk in portfolios well before the onset of the bear market decline. 

SP500-MarketUpdate-012016-2

I have been asked repeatedly as of late whether or not the markets will provide a similar “relief rally” to allow for escape. The answer is “yes.” However, as in the past, those relief rallies tend to be short-lived and don’t get investors “back to where they were previously.”

The risk to the downside has risen markedly in recent weeks as the technical, fundamental and economic deterioration escalates. This is not a time to be complacent with your investments.

“One & Done Yellen” And The Rise Of QE4.

Back in December, when Janet Yellen announced the first hike in the Fed Funds rate in eleven years from .25% to .50%, the general mainstream consensus was “not to worry.”  It was believed that a rate hike by the Fed would have little impact on equities given the strong economic recovery at hand. Well, that was what was believed anyway as even Ms. Yellen herself suggested the “odds were good” the economy would have ended up overshooting the Fed’s employment, growth and inflation goals had rates remained at low levels.

The problem for Ms. Yellen appears to have a been a gross misreading of the economic “tea leaves.” With economic growth weak, the tightening of monetary policy had a more negative impact on the markets and economy than most expected. As I wrote previously:

“Looking back through history, the evidence is quite compelling that from the time the first rate hike is induced into the system, it has started the countdown to the next recession. However, the timing between the first rate hike and the next recession is dependent on the level of economic growth at that time.

When looking at historical time frames, one must not look at averages of all rate hikes but rather what happened when a rate hiking campaign began from similar economic growth levels. Looking back in history we can only identify TWO previous times when the Fed began tightening monetary policy when economic growth rates were at 2% or less.

(There is a vast difference in timing for the economy to slide into recession from 6%, 4%, and 2% annual growth rates.)”

Fed-Funds-GDP-5yr-Avg-Table-121715

“With economic growth currently running at THE LOWEST average growth rate in American history, the time frame between the first rate and next recession will not be long.”

Given the reality that increases in interest rates is a monetary policy action that by its nature slows economic growth and quells inflation by raising borrowing costs, the only real issue is the timing.

With the markets appearing to have entered into a more severe correction mode, there is little ability for Ms. Yellen to raise interest rates any further. In fact, I would venture to guess that the rate hike in December was likely the only one we will see this year. Secondly, we are likely closer to the Federal Reserve beginning to drop “hints” about further accommodative actions (QE) if conditions continue to deteriorate.

It is important to remember that in 2010, when Ben Bernanke launched the second round of QE, the Fed added a third mandate of boosting asset prices to their roster of full employment and price stability. The reasoning was simple – create an artificial wealth effect encouraging consumer confidence and boosting consumption. It worked to some degree by pulling forward future consumption but failed to spark self-sustaining organic economic growth.

With market pricing deteriorating sharply since the beginning of the year, it will not take long for consumer confidence to slip putting further downward pressure on already weak economic growth. With Ms. Yellen already well aware she is caught in a “liquidity trap,” there would be little surprise, just as we saw in 2010, 2011 and 2013, for the Fed to implement another QE program in hopes of keeping consumer confidence alive.

SP500-QE-012016-2

The issue is at some point, just as China is discovering now with failure of their monetary policy tools to stem the bursting of their financial bubble, the same will happen in the U.S. With the Fed unable to raise rates to reload that particular policy tool, a failure of QE to stabilize the markets could be deeply problematic.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: Fiction, Oil Error, Selling Off

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


Peddling Fiction

On Tuesday, as I watched the President’s State of the Union Address, the President made the following statement.

“Anyone claiming that America’s economy is in decline is peddling fiction.”

While I certainly understand the need to put a positive spin on the current economic backdrop during your last SOTU address, there is a good bit of misstatement in that comment.

The President is correct when he stated that the impact of technology on wage growth and jobs was not a recent development. It is, in fact, an impact that has been occurring since the 1980’s as shown in the chart below.

GDP-Avg-Growth-Cycle-011416

While the big driver of the decline in economic growth since the 1980’s has been a structural change from a manufacturing based economy (high multiplier effect) to a service based one (low multiplier effect), it has been exacerbated by the increase in household debt to offset the reduction in wage growth to maintain the standard of living. This is shown clearly in the chart below.

GDP-Debt-LivingStandard-011416

The problem for the President is that while sound-bytes of optimism certainly play well with the media, the average American is well aware of their current plight of the lack of wage growth, inability to save and rising costs of living.

The decline of economic growth is, unfortunately, a reality and an inevitable outcome of decades of deficit spending and debt accumulation. Can it be reversed? I honestly don’t know, but Japan has been trapped in this cycle for 30-years and has yet to find a solution.

Here’s Real Fiction – Low Oil Prices

Over the last couple of years, economists from Wall Street, to the Federal Reserve, to the White House have repeatedly made the following statement:

“Falling oil prices are great for the consumer as it gives them more money to spend.”

I have written many times over the past couple of years, as oil prices fell, that such was not actually the case. To wit:

“The argument is that lower oil prices lead to lower gasoline prices that give consumers more money to spend. The argument seems to be entirely logical since we know that roughly 80% of households in America effectively live paycheck-to-paycheck meaning they will spend, rather than save, any extra disposable income.

The problem is that the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.

Example:

  • Gasoline Prices Fall By $1.00 Per Gallon
  • Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
  • Gas Station Revenue Falls By $16 For The Transaction (-16)
  • End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere. This is the equivalent of ‘rearranging deck chairs on the Titanic.'”

Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend and whatever “savings” there may be at the pump, it gets quickly absorbed by rising costs of living – like health care.

Most importantly, the biggest reason that falling oil prices are a drag on economic growth, as opposed to the incremental “savings” to consumers, is the decline in output by energy-related sectors. 

Oil and gas production makes up a hefty chunk of the “mining and manufacturing” component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve.

The obvious ramification of the plunge in oil prices is eventual loss of revenue leads to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all CapEx expenditures in the S&P 500), freezes and/or reductions in employment, and declines in revenue and profitability.

The issue of job loss is critically important. Since the financial crisis the bulk of the jobs “created” have been in lower wage paying areas such as retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc. In fact, each job created in energy-related areas has had a “ripple effect” of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.

Simply put, lower oil and gasoline prices may have a bigger detraction on the economy than the “savings” provided to consumers.

Why do I remind you of this basic economic reality – because it only took the Federal Reserve 18-months to figure it out. In a recent speech San Fran Fed president John Williams actually admitted the truth.

 “The Fed got it wrong when it predicted a drop in oil prices would be a big boon for the economy. It turned out the world had changed; the US has a lot of jobs connected to the oil industry.”
No S*^t!

Markets Crash When Oversold

Earlier this week, I discussed the oversold nature of the market and the likely of a “bounce” to “sell into.” 

“With all of the alarm bells currently triggering, the initial ‘emotionally’ driven response is most likely an urge to go look at your portfolio statement and start pushing the ‘sell’ button. Don’t Do It!

On a short-term basis, prices oscillate back and forth like a rubber band be pulled and let loose. Physics state that a rubber band stretched in one direction, will initially travel an equal distance in the opposite direction when released.

Take a look at the chart below.”

SP500-MarketUpdate-011216

“In particular note the top and bottom portions of the chart. These two indicators measure the ‘over-bought’ and ‘over-sold’ conditions of the market. As with the rubber band example above, you will notice that when these indicators get stretched to the downside, there is an effective ‘snap back’ in fairly short order.

With the markets having issued multiple sell signals, broken very important support and both technical and fundamental deterioration in progress, it is suggested that investors use these ‘snap back’ rallies to reduce equity risk in portfolios.”

I reiterate this point because the market continued to slide on Wednesday which led to several comments about the inability of the markets to get a sellable bounce. There is an important “truism” to remember.

“Markets crash when they’re oversold.”

Let’s step back and take a look at the past two major bull markets and subsequent bear market declines.

SP500-MarketUpdate-011416

(Note: I am using weekly data to smooth volatility)

The top section of the chart is a basic “overbought / oversold” indicator with extreme levels of “oversold” conditions circled. The shaded area on the main part of the chart represents 2-standard deviations of price movement above and below the short-term moving average.

There a couple of very important things to take away from this chart. When markets begin a “bear market” cycle [which is identified by a moving average crossover (red circles) combined with a MACD sell-signal (lower part of chart)], the market remains in an oversold condition for extended periods (yellow highlighted areas.)

More importantly, during these corrective cycles, market rallies fail to reach higher levels than the previous rally as the negative trend is reinforced. All of these conditions currently exist.

Does this mean that the markets will go straight down 20% without a bounce? Anything is possible. However, history suggests that even during bear market cycles investors should be patient and allow rallies to occur before making adjustments to portfolio risk. More often than not, it will keep you from panic selling a short-term market bottom.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

3 Things: China, Margin, & Technicals

“3 Things” is a weekly post of thoughts I am pondering, usually contrarian, with respect to the markets, economy or portfolio management. Comments and thoughts are always welcome via email,  Twitter, and/or Facebook.


China Matters

Over the past few days I have repeatedly heard the following statement:

“China isn’t that important as it is only 7% of the U.S. economy.”

While that may be a true statement in relation to the economy, it is a far different matter when it comes to the financial markets.

With financial markets so closely correlated, what happens in China has a direct and immediate impact on U.S. markets. Beginning in 2014, China financial markets went parabolic as investors levered up to speculate. This is not the first time this happened, and is a sharp reminder of why the perils of leverage should not be readily dismissed.

The problem is, as shown in the chart below, that what happens in China is not isolated just to China. As money flees those markets, it also rapidly exits the U.S. markets as fears of contagion spread.

China-SP500-010706

While the Chinese government has injected liquidity, suspended trading in almost half of the listed equities and encouraged pension funds to buy securities, arrested short-sellers and “disappeared” corporate executives, these actions have done little to stem the decline as investors “panic sell” in a rush to safety.

That collapse, if history is any guide, is likely not done as yet which suggests that the financial rout in other markets are only just beginning.

Speaking Of Margin

Last year, margin debt in China reached $264 Billion. After adjusting for the size of the two markets, is about double that of the roughly $500 billion in margin debt in the U.S.

This difference in relative size was given as a prime example about how margin debt is not a problem for the U.S. This is incorrect, and just another example of the MSM’s willful blindness to the facts. The fact is that the relative size of margin debt in the past has not been a “safety net” that investors should rely on. As shown, the level of real (inflation-adjusted) margin debt as a percentage of real GDP has reached levels only witnessed at the peaks of the last two financial bubble peaks in the U.S.

Margin-Debt-GDP-010716

The same is seen in the raw levels of margin debt with respect to the financial markets.

Margin-Debt-010716

While no single indicator should be relied upon as a measure to manage a portfolio, it should be well understood by now that leverage is a “double-edged sword.” While rising margin debt levels provide the additional liquidity to drive stock prices higher on the way up, it also cuts just as deeply when prices fall.

China is clearly showing the consequences of the unwinding of leverage. Despite government actions to stem the decline, investors are finding ways to extract their capital back out of the market in fears of a repeat of the 2008 crash. It is a lesson that should be studied and learned, again, by investors today.

Just as the Federal Reserve encouraged investors to jump into the financial markets by providing liquidity and suppressing interest rates, China also encouraged their population to do the same. Instead of taking actions to control the rise, they (both the U.S. and China) encouraged it. The problem is that when the “bubble” pops – it becomes uncontrollable.

As investors, it is our job to analyze the data and understand the inter-relationships between various data points and our portfolios. While margin debt is but only one “breadcrumb” on the trail, when combined with declining momentum, excessive deviations from long-term means, and weak economic growth, a larger picture of overall “risk” begins to emerge.

Does this mean that investors should “panic sell” immediately and run into the safety of cash? No. However, it does suggest that investors should be much more cautious about portfolio allocations and the degree of risk being undertaken as it relates to long-term investors objectives.

Technical Supports Under Attack

Earlier this week, I discussed the importance for the market to hold support at 1990 on the S&P 500. That level is under critical attack this morning as the market slides over concerns of China.

“Importantly, the ongoing topping process continues in earnest. As shown in the two charts below, the current topping process is very akin to the processes witnessed at the previous two major market peaks in 2000 and 2007.

You can clearly see the topping process being made over the last 18 months in the market. Until, or unless, the market can break out of the current downward trend, the risk of lower asset prices remains elevated.”

SP500-MarketUpdate-010516-3

More importantly, if we step back to a “weekly” view of the markets we get a better picture of the level of deterioration currently in progress. As shown in the chart below, not only have both lower sell signals been triggered by deterioration in price momentum, the short and long-term moving averages have now crossed.

SP500-MarketUpdate-010716-2

Since the turn of the century, the two primary moving averages have only crossed three other times – at the peak of the markets in 2001 and early 2008, and in 2011. The difference in 2011 is that while the sharp decline in the prices due to the debt ceiling debate caused the moving averages to cross, the two lower sell signals were not triggered. This kept portfolios allocated more towards equities at that time.

The current topping process, as discussed on Tuesday, is more akin to that seen in 2000 and early 2008. With primary moving averages now crossed, sell signals in place and markets trading below supports, rallies in equities should be used to rebalance portfolios and reduce risk. 

While the markets are not “technically” in a “bear market” currently, it is important to remember that they weren’t in 2001 and early 2008 either. Waiting to make adjustments until after full recognition of the event doesn’t leave you many options.

Just some things to think about.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In