Q-Ratio – It’s that time of the quarter again

As always, I turn to my favorite market gauge: the q-ratio. Regardless of whether you’re a value investor or growth, it’s worth noting this ratio, which is just a simple measure of the total price of the market divided by the replacement cost of all its companies.Viewing the remainder of this article requires a Subscription

MacroView

A bit later than usual…

As always, MacroView is produced in collaboration with MacroMan. To show the extent of our need to SEEK conflicting data, today’s MacroView has a number of charts showing support/resistance for inflation triggers. I’m not in the inflation camp for the time being. I see no wage pressures, a consumer slowdown, increased savings rate, lower velocity, lower housing, excess capacity, etc. That being said, one must always let the data lead, and I’m open to re-interpretation…

macroviewmarch17

The averages mask

There’s an old statistics adage: if you have your head in the oven and your feet in a bucket of ice water, then on average you’re comfortable. Similarly, indexes often mask significant underlying moves. For example, in last 1999, the major indexes were becoming narrower and narrower, and even as they rose, fewer stocks were participating, so that investors weren’t able to keep up. With that in mind, here’s an interesting chart:

This is the percentage of stocks on the NY stock exchange that are trading above their 50 day moving average. What it tells you is that many stocks are weak and that the averages, while they’ve faced a pullback, may be pulled down if these stocks continue to show weakness and or if other stocks break through their own 50 dma. Now, in anticipation of the emails, here’s a longer term chart so that you see just how much more room we have to go:

In other words, there are a lot of stocks left to pull us down further.

Relevant ETFs: IWM, RWM, SPY, SH

Gas prices across the country

Fun site to see what your friendly neighbors are paying at the pump:

http://gasbuddy.com/gb_gastemperaturemap.aspx

MacroView

I am not a technician by nature, but I do believe that charts can tell a story, show us historical context, and help us tease out complicated relationships. Enjoy today’s MacroView. As usual, it should give you a sense of key levels in key markets we’re following. It’s produced in collaboration with MacroMan, a long time contributor to THT.

macroview_3Mar11

Q-Ratio

This is an updated chart of Tobin’s Q and is a must-see (my thanks to Greg Mankiw for posting it):

Some of the charts I’m looking at

Egypt is still reigning supreme over the news channels, perhaps rightfully so; however, there are a lot of economic crosscurrents being felt, either as a result, or at least concurrently, that it’s worth stepping away from Al Jazeera.

For starters, let’s look at the 10 year yield:

What’s interesting to note is that it is not capturing the flight to safety. For that matter, neither is the USD:

The geopolitical instability, then, has not led investors into some traditional safety havens. Instead, the flight to safety has been captured by commodities:

Is this then the confirmation that inflationary pressures are rising? I read a quote somewhere yesterday (not sure of source) that said something along the lines of: “Going long commodities is shorting human ingenuity.” Maybe. Maybe people are just shorting the every-increasing rates of human ingenuity, or just taking a break from ingenuity. It’s an interesting way to describe the situation, and is pretty depressing.

The VIX meanwhile continues to languish has hope of equity stability and ever rising prices continues:

I have to admit that I am taking the other side of the trade. Insurance is relatively cheap and complacency rampant.

Delving into commodities more specifically, we mentioned rice last week as the only one of the four staples (wheat, soy, corn, rice) that hasn’t gone up significantly. It’s starting to now, but I think if it keeps going, China will step in to force it down. It’s one thing to have social unrest in Egypt, it’s a totally different scenario to have the staple of China go up too much.

Lastly, check out the percentage of stocks in the S&P 500 trading above their 200 DMA:

That does not look sustainable to me.

Relevant ETFs: FXE, EUO, GLD, SLV, GDX, TLT, TBT, SPY, IWM, RWM, SH, VXX, OIL, XLE, EGPT

Unemployment at 9.8%

The numbers came out and depending on your interpretation…well, actually, it’s tough to interpret these positively:

(From BLS) The unemployment rate edged up to 9.8 percent in November, and nonfarm payroll employment was little changed (+39,000). Temporary help services and health care continued to add jobs over the month, while employment fell in retail trade. Employment in most major industries changed little in November.

CalculatedRisk.com did a great job of putting all the numbers into charts and I encourage you to look there, but I want to highlight one in particular and the summary:

This graph shows the number of workers unemployed for 27 weeks or more.

According to the BLS, there are 6.313 million workers who have been unemployed for more than 26 weeks and still want a job. This was up from 6.206 million in October. It appears the number of long term unemployed has peaked, however the level is extremely high – and the increases over the last two months is very concerning.

Summary

Perhaps the worst news was the jump in the unemployment rate to 9.8% without an increase in the participation rate. If the participation rate had increased, at least that would mean people were becoming more confident and rejoining the labor force. Instead the Labor Force Participation Rate was flat at 64.5% and this is a very low level. Note: This is the percentage of the working age population in the labor force (here is the graph in the galleries of the participation rate).

Most of the underlying details of the employment report were weak. The positives included small upward revisions to the September and October payroll reports, a slight increase in average hourly earnings, and a slight decline in part time workers.

The negatives include the unemployment rate increasing to 9.8%, few payroll jobs added (only 39,000 jobs), the decline in the employment-population ratio, the steady participation rate at a very low level, and the increase in workers unemployed for over 26 weeks.

Equity markets behind the curve

I lost some faith in bond investors as yields got down to historic levels. I spoke out about it, but investors continued to believe that deflation leads to lower yields. Right about deflationary pressure, wrong about it leading to lower yields. In a ZIRP environment, after a credit bubble, we will see debt deflation lead the way lower in all major asset classes.

Check out the 10-year yield:

It’s almost a relief that it’s finally rising. It means bond investors are finally getting it – taking duration risk is not worth it when rates can’t go lower and the Fed’s policies become asymptotically ineffective. We have a long way to go before I start buying the dips on bonds.

Quick update: gold/euro chart

One of our subscribers rightfully pointed out that yesterday I mentioned gold in euros but did not provide a chart, so here it is:

It’s just under the highs, but with Ireland, Greece, and (soon) Spain undermining the stability of the entire eurozone, I anticipate it to go higher.

Is anything down today? Oh yeah, our sanity.

If the Fed was targeting stock prices, which seems to be the case, then at least for the time being he was successful. So let’s review, in a situation where money is already dirt cheap but not lending is happening, the Federal Reserve decided to target stock prices (call it, asset prices in general to give it the benefit of the doubt) that are held by relatively few people. Hmmm.

Gold is close to an all time high and certainly at a 20 year high:

Meanwhile, the dollar is down, although not at it’s lowest point:

But it doesn’t matter where you look today, it seems like the reflation trade is back on, deflationists be damned. Except, the yield on the 10 year is going down. What gives?

This is the result of investors front-running the Fed purchases.

I hate sounding like a downer, and I hate that I keep beating the negativity drum, and I’m certainly not any perma-bear. But this is not sustainable, valuations are not where you’d expect for any long term decent return on investment, and any quantitatively driven excess returns will be met with a more serious downside impact that will show up in future returns, but more importantly show up in future standards of living. We will look back at this period with astonished incredulity at our own lack of foresight.

In 1999, a relatively few advisors and analysts were pointing out that valuations were unsustainable. Then we pointed out that accounting gimmicks, such as recognition of revenues, channel stuffing, etc. were unsustainable and only represented “borrowing” sales from the future. We now have the same two factors in play. In terms of the latter, we are borrowing from future consumption and GDP growth, but eventually we will need to pay it back. We see it on the macro and the micro level. Financial institutions are “borrowing” earnings from reserves, while on the macro front we are literally borrowing some GDP growth.

Could it be my own bias that is keeping me from fully participating in this rally? I’ve been examining whether my own stance has led me to a position that is difficult to back down from, and therefore all the analysis is skewed to confirm my hypothesis. The answer is – maybe. I say maybe because maybe we are in a new world, but I seriously doubt it. ZIRP might mean that stocks are undervalued, but I don’t think so. $600 Billion might stimulate job growth that will compensate for the cost of the program, but I doubt it. The Fed might be effective in reaching their goal of a weaker dollar, but I don’t have any faith that they can be effective in anything other than causing uncertainty. Japan’s currency might continuously get stronger, but I doubt it. China might grow endlessly and not have a real estate bubble, but, again, I don’t think so. No matter where I look at the underlying fundamentals and money flows, there are disconnects that will need to correct. Certainly, some big investors disagree with me, so it is not without hesitation that I take the other side of their trades. However, as a disciplined fact-based investor, I can’t allow myself to be dissuaded from the research – and for now, all signs point to trouble.

Japanese Yen Strength – the best explanation I’ve found

In one of the most cogent reviews of the Japanese yen’s strength, Kieran Osborne shows why the yen might be at a turning point.

For many, the strength of the Japanese yen is a conundrum. How can the currency of a country with such a weak economy, such a high level of debt, weak leadership, poor demographics, combined with an ever deteriorating economic outlook be so strong? Many market participants did not anticipate that the yen would demonstrate such strength 24 months ago. Now, many commentators focus on Japan’s “safe haven” status as a key reason why the currency has appreciated. True, at the onset of the financial crisis the Japanese banking system was viewed as being amongst the soundest globally, but as risk came back into the markets in March 2009 through most of that year, the yen continued to appreciate. In a period where we witnessed a substantial reversal in risk aversion (the S&P 500 returned over 50% from the end of February 2009 through December 31, 2009), the Japanese yen’s safe haven status does little to explain its strength.

So what has driven the strength of the yen? While the reasoning behind currency price movements is inherently multi-faceted, we believe some of the more relevant drivers of Japanese yen strength have been: 1) weak leadership; 2) low reliance on foreign investment; and 3) relative attractiveness of Japanese yields.

For the full article, click here.

This is a must read.

China – The Mother of All Grey Swans

New post from Vitaliy Katsenelson on China and Japan. The short version is that China is COMMUNIST! and the numbers can’t be trusted, while Japan is past the point of no return.

On China: I already mentioned that Russia used to do the same thing with numbers and ghost towns that looked great to observers, but were shams.

On Japan: The government won’t have an internal market due to demographics, and as the savings rate decreases, the international community will not continue funding JGB’s at 0% rates.

http://contrarianedge.com/2010/10/30/china-the-mother-of-all-grey-swans/

Look at the presentation. Understand the dynamics of overcapacity in China. Understand that demographics doom Japan’s currency.

Invest accordingly.

What I’m watching

It’s Friday evening and the markets are closed.

“Bombs on UPS plane” barely registered, but I have to think that the terrorists have an awful sense of timing. Next weeks elections already look set to place more Republicans in power, and whether you agree with the different parties or not, as a terrorist, I have to assume you like the Democrats on the margin. Which begs the question – why would you put national security back at the top of the agenda? Same goes for North Korea, where there are reports of some shots being exchanged on in the DMZ. Why now?

In my little corner of the world, I’m reviewing. Let’s start with the yen. It’s at new highs…again! This is a 20 year chart of the yen index:

Why? There are things in this  world, Horatio…

I continue to maintain my short exposure, without much fear. I’m not levered, it’s a small position, and I’m confident that the long term prospects of the yen are even worse than the USD, even with the QEII that might be announced next week. The risk is still to the downside for the yen.

Back here in the US, I’m reviewing both the 10 year yield and the 10-30 spread.

Bill Gross came out and said two words about the end of the bull market and everybody suddenly listens. The Fed can announce QEII and commit to purchasing bonds ad nauseum; however, this market doesn’t need easing, it needs jobs and confidence, neither of which will be accomplished by Bernanke if they continue on their current path.

Take a look at the 10-30 yield spread. This is a monthly chart of the past 20 years:

It has spent most of its time in the 0.9 range, but hit all-time lows earlier this month of under 0.6. Now, where do you think the risk lies? For spread to continue getting weaker? No. The 30 is leading the way, but the 10 will follow.

Which brings me to Dr. Copper. I can’t tell you how many people bring up metals and commodities, with a view that there is no end to the upside potential. Maybe. Probably not.

Take a look at the S&P to the commodity equity index:

It doesn’t matter which representation you look at. Look at SPX to gold if you prefer:

What does it mean? It might mean that Dr. Copper is telling us that the recovery is full-steam ahead and that equities will start to outperform on the upside. I doubt that. The other option is that commodities are going to pull back and lead equities down with them, albeit not at the same rate. Considering that GLD is one of the most widely held securities in Merrills retail brokerage accounts, guess which way I think we’re going.

Meanwhile, financials are weak and facing continued weak real estate conditions, limited visibility on their portfolios, and weakening consumer lending conditions. Real estate and jobs continue to be the big macro hurdles. The elections are already done and the incumbents are screwed, even the ones that will stay in power will do so only through extremely difficult conditions – this is a non-story and already discounted.

What happens when everything happens?

The past couple of days have been a little odd, and they’ve left me less time to put pen to paper (keyboard to screen?) – what happens when the very things we anticipated start happening?

Let’s start with yields…For months we’ve been discussing the historic levels of the 10/30 spread:

It’s couldn’t get wider forever and as a value-guy at heart, I like finding these types of extensions and looking for reversions to the mean. We’re getting it, but there’s more to go.

What about on an absolute level? 10 year yields could go down to 2%, but the risk is definitely to the upside (for yields, downside for prices).

What about currencies? The USD index is finding some support, and I think it’s found a floor. There is a lot of speculative money that is short the USD (short USD/long equities was THE trade for the past few months).

Lastly, what about equities? Equities are overvalued on a fundamental basis. No matter what justification is used, bull markets do NOT start from these valuations. There could be rallies, and powerful ones at that, but we are looking at 10%-15% upside potential with 30-40% downside risk. That’s a bad trade and a recipe for permanent investment losses.

The arguments floating around that QE will push assets up are valid. I get them. The arguments that USD debasement will continue are valid. But they are flawed. The Fed believes these arguments and is basing their decisions on them. The idea is push asset prices higher to stimulate spending (the wealth effect) and get the economy going.

It will fail due to two gaping flaw: the market has already discounted the efforts and is valued based on those assumptions. In order to get prices higher, the Fed would need to surprise the market with ever increasing levels of QE. The second gaping hole is the assumption that prices will actually rise. Prices of real estate are poised for 20% more downside based on various valuation methods, or more in certain areas with excess inventory of up to 18 years worth of homes!! Prices of stocks are 30% overvalued based on the q-ratio, and at best fairly valued, so room for upside is limited. Prices of bonds are already extended and have no place to go but down. So you have the 3 main stores of wealth poised for declines. There is nothing the Fed can do to change that.