Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

Month: December 2016

THE DAILY EDGE (22 December 2016): Effective Tweets!

U.S. Existing-Home Sales Rose in November to New Postcrisis High Homebuying activity increased in November to the strongest sales pace in nearly a decade, though rising prices and mortgage rates could pressure the U.S. housing sector in the new year.

Purchases of previously owned homes, which account for the vast majority of U.S. sales, edged up 0.7% from October to a seasonally adjusted annual rate of 5.61 million last month, the National Association of Realtors said Wednesday. That was the third straight monthly rise, beating economists’ expectations for a modest November decline, and the strongest sales rate since February 2007. (…)

Sales in November rose 15.4% compared with the same month a year earlier. The annual gain was exaggerated by a one-off plunge in sales during November 2015 that the NAR had blamed on new federal mortgages rules delaying closings.

First-time home buyers represented 32% of November sales. (…)

The total inventory of homes on the market declined 9.3% y/y to 1.850 million. (Chart from Haver Analytics)

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The Mortgage Bankers Association reported that its total Mortgage Market Volume Index increased 2.5% last week (-9.5% y/y), but made up just part of the prior week’s 4.0% decline. Since their peak early in July, applications have fallen by roughly one-third. Refinancing applications gained 3.0% w/w, yet were off by one-half versus the level early in July. Purchase applications increased 2.7% (0.9% y/y), but were 6.8% below the high early in June.

The effective interest rate on a 15-year mortgage rose to 3.73%, up from the July low of 2.97%. The effective rate on a 30-year fixed-rate loan rose to 4.52%, up from the 3.70% low in early-July. The rate on a Jumbo 30-year loan increased to 4.43%. For adjustable 5-year mortgages, the effective interest rate of 3.54% was higher than 2.87% roughly six months ago.

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Trump’s New Appointments Shake Up Trade, Regulation Donald Trump selected billionaire investor Carl Icahn and Peter Navarro, a critic of trade with China, for his economic team.

Donald Trump’s Win Sends Economic Optimism to Highest Level Since 2012 Donald Trump’s election has pushed confidence in the economy’s direction to its most favorable level in four years, according to the latest WSJ/NBC News poll.

Some 42% of respondents say they believe the economy will get better over the coming year, versus 19% who say it will get worse. The last time Americans were as optimistic about the economy came in October 2012, when 45% saw the economy getting better, compared with just 9% who saw it getting worse.

One year ago, some 24% of respondents believed the economy would improve over the following 12 months, equal to the share who believed it would worsen. (…)

In the WSJ/NBC News poll, the improving economic sentiment is driven largely by Republicans’ postelection enthusiasm. Some 68% of Republican voters see the economy improving over the next year, versus 6% who believe it will get worse. Last year, just 14% of Republicans saw the economy improving, compared with 34% who saw it getting worse.

Independent voters also believe the economy will improve by a 22-percentage-point margin, a reversal from last year, when independents saw the economy getting worse by a 15-percentage-point margin. (…)

Gallup’s survey is even more upbeat:

Gallup's U.S. Economic Confidence Index -- Weekly Averages

  • The Trump effect: the outlook soared post elections:

U.S. Economic Confidence Index Components -- Weekly Averages Since January 2016

Americans now need to translate that optimism into actions:

  • Total housing starts have been flat for nearly 2 years.
  • Core retail sales have been choppy in recent months and clearly weak in November.
  • Small biz owners have also reacted positively to Mr. Trump’s election but their capex plans actually declined in the November survey.
  • Sales of light vehicles have levelled off lately and are down 2.1% YoY.
U.S. Car Makers Idle Plants Amid Oversupply Concerns Detroit auto makers are pulling back on first-quarter production in response to a cooling in retail demand and a shift in consumer tastes, a speed bump for an industry that has laid the foundation for U.S. economic expansion in recent years.
Number of the Day
10.8%

Year-over-year decline in U.S. rail shipments of motor vehicles and auto parts last week, according to the Association of American Railroads.

All three domestic car companies this week said they have scheduled down time at some of their factories for as much as three weeks in January. Auto makers typically idle assembly plants for a week or two around the holidays—but shutting factories for multiple weeks in January is unusual.

The moves are an attempt to help clear inventory of certain models such as sedans and minivans, which have been stacking up on dealer lots at a rapid pace in recent months. Such cars have attracted paltry interest among buyers more interested in sport-utility vehicles. (…)

Auto makers produced 3.6% more vehicles in North America last month than November 2015, according to researcher WardsAuto.com, a sign that executives were optimistic U.S. auto demand would be buoyant heading into 2017. (…)

Wards on Wednesday projected December car sales would grow at a strong seasonably adjusted pace. Inventory, however, will continue ballooning, the firm said, mostly due to increases in stocks at dealers selling GM, Ford and Chrysler products. (…)

  • Number of the Day: 10.8%: Year-over-year decline in U.S. rail shipments of motor vehicles and auto parts last week, according to the Association of American Railroads. (WSJ)

There are now bulls everywhere. (Chart from Yardeni Research)

And these bulls are very relaxed and serene:

  • VIX Hits Lowest Intraday Level in More than a Year The CBOE Volatility Index, often touted as the stock market’s fear gauge, dropped to its lowest intraday level since August 2015, one sign that investors aren’t pricing big risks into the market.

(…) the relationship between S&P 500 sectors broken down since the U.S. presidential elections as investors bet on individual winners and losers under a Donald Trump administration. The result has been big volatility moves in certain corners of the market that balance out with little effect on the broader index, Mr. Chintawongvanich said. (…)

Jamie Dimon on Trump, Taxes, and a U.S. Renaissance
Trump Administration ‘Hell-Bent’ on Making Big Changes, Dalio Says
Boeing chief praises Trump after meeting over Air Force One costs Defence executives discuss projects with president-elect after cost criticism

Good PR from everybody. I don’t know why TWTR is not going up given how effective it is proving to be in managing a country. Maybe Twitter should be nationalized.

Boeing’s chief executive lavished praise on Donald Trump on Wednesday after a meeting to discuss the president-elect’s sharp criticisms of the cost of the US group’s Air Force One contract and other big defence programmes.

“It was a terrific conversation. Got a lot of respect for him. He’s a good man. And he’s doing the right thing,” Dennis Muilenburg said after the meeting, which was prompted when Mr Trump sent an angry tweet earlier this month threatening to cancel the Air Force One contract. (…)

Mr Muilenburg called the meeting “very productive” and said he was “very encouraged by the dialogue”. Of the $4bn cost estimate, he said: “We’re going to get it done for less than that . . . I was able to give the president-elect my personal commitment on behalf of the Boeing Company.” (…)

BA shareholders should tweet Muilenburg to ask him to personally guarantee Boeing will not lose money on AF1.

Mr Muilenburg had already spoken to the president-elect immediately after his tweet and told him that the cost of Air Force One was largely determined by government requirements for security, communications and other specifications. After Wednesday’s meeting, Mr Muilenburg said: “We’re all focused on the same thing here; we’re going to make sure that we give our warfighters the best capability in the world and that we do it in a way that is affordable for our taxpayers.” (…)

Mr. Trump is just as effective with female execs, making a move here from The Apprentice to So You Think You Can Dance?

The president-elect also met another US defence contractor that has felt the sharp side of his Twitter feed recently, Lockheed Martin’s chief executive Marillyn Hewson.

Mr Trump tweeted last week that “the F-35 program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after” his inauguration.

Asked whether he had secured any concessions from Ms Hewson, Mr Trump told reporters: “We’re just beginning, it’s a dance . . . but we’re going to get the costs down and we’re going to get it done beautifully.”

I am sure he’s a beautiful dancer. This last one is a beauty after all the above:

He also held a meeting with senior military leaders and praised them as “good negotiators”. The Pentagon this week pushed back against his criticism of the F-35, saying it has “basically been on schedule” and “on budget” since 2011. (…)

The President-elect should give tweeting lessons to these “good negotiators”.

RISING LONG-TERM RATES: THE SCARY FACTS!

In my December 15 post THE TRUMP LOVE-IN, I produced a 50-year chart showing how equity markets behaved during periods of rising long-term rates, concluding that

In the 12 periods of rapidly rising long-term rates between 1965 and 1996 (I grouped a few short periods on the chart), not one was accompanied with any meaningful gains in equities while most saw equities perform a really deep dive (average –14.5%).

(…) Since 1996, there were some instances when rising rates coincided with higher equity prices, like in 1998-2000, maybe 2005-06,  and 2010. The first two instances saw equity valuations truly explode as investors bought into “great stories”, only to totally deflate when the dreams turned into terrible nightmares.

A few days ago, I stumbled on a similar analysis by LPL Financial, a brokerage with over 14,000 financial advisors and a book of $500 billions, which appeared in a December 12 Weekly Market Commentary and which covered the past 55 years:

The results offer generally good news, as stocks have mostly interpreted rising interest rates as a signal of better economic growth rather than harmful inflation. During the 23 periods analyzed, the average gain in the S&P 500, excluding dividends, has been 5.7% (median 3.8%). The average duration of the periods is 1.06 years and stocks rose in 83% of the periods. (…)

Recent history has been better in general, as stocks have risen in all 11 rising rate periods since 1996, with an average gain of 9% (median 5.4%). These periods have been shorter in duration (average half a year) and seen slightly smaller rate moves, a reflection of the low inflation and low interest rate environment over the past 20 years.

Bottom line, we believe the bull market in stocks can coexist with the bear market in bonds and we interpret the move in rates as an indication of improving economic growth prospects rather than of worrisome inflation.

Same data, very different conclusions on a crucial matter.

Let’s look at the facts, all the facts.

In the following charts, I plot the S&P 500 Index and the 10Yr Treasury yields for each time-frame considered by LPL. The periods measured by LPL are within the red rectangles while the black rectangles cover the periods I find most relevant for a complete, objective and realistic analysis.

For those who would not want to peruse all 16 charts, my conclusion is that:

  1. Beginning and/or ending dates can make a big difference.
  2. Chosen periods can influence the analysis.
  3. Sometimes it is best to consider what happened immediately following the rate peaks. Unsurprisingly, the effects often carry beyond the end date.
  4. As Mark Twain said, facts are stubborn, but statistics are more pliable.
  5. I stick with my conclusion: beware rapidly rising long-term rates.
  • 1962-1966: LPL starts the period in December 1962 but I consider the 30 bps rise in rates between 12’62 and 06’65 to be inconsequential. The big move began in September 1965 when rates rose from 4.3% to 5.2% in August 1966 (month-end data only). Equities lost 14.4% during these 12 months.

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  • 1967-1969: there are really 2 periods here, the first producing flat equity markets and the second –17.5% (with a subsequent additional –14.3% through June 1970). LPL began the count mid-March 1967 and ended it December 29, 1969, producing a positive 1.3% return for the whole period.

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  • 1971-1974: I grouped 2 of LPL’S  periods here, which really are 3 for me. Nothing positive.

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  • 1974-1975: Strangely, LPL starts mid-December 1974 even though rates kept declining through February 1975, and ends mid-September 1975. From 03’75 to 09’75, equities were +2.4%, much different than LPL’s +22.5%.

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  • 1976-1980: Similar periods except that LPL’s ends Feb. 27, 1980 even though rates peaked end of March 1980. The volatile equities lost 10.5% during March 1980, resulting in a 4.7% loss for the whole period vs +5.1% during LPL’s period.

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  • 1980-1981: periods concur. Equities flat beginning to end.

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  • 1983-1984: periods concur. Equities –7.9%.

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  • 1986-1987: LPL’s period starts August 1986, even though rates staid flat for another 15 months while equities rose. Shockingly, LPL’s analysis stops October 16, 1987, the Friday before Black Monday when the S&P 500 collapsed 20%! How could LPL simply dismiss that? LPL’s analysis: equities +11.8%. My analysis: equities –13.7%.

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  • 1988: periods concur. Equities +1.0% using LPL’s specific dates. Using my month-end dates: –2.2%.

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  • 1989-1990: interest rates declined 32 bps after LPL stopped counting in early May 1990. But rates really peaked out in September 1990. Equities cratered 15.7% after LPL closed its books.

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  • 1993-1994: almost identical periods. Mine ends after rates peaked at the end of November 1994, a month during which equities lost 3.8%.

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  • 1996: LPL’s period: equities +6.7%. But equities lost 4.6% in July 1996.

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  • 1998-2000: identical periods. Equities up 45.8% to reach their most expensive levels of the 20th century. BTW, equities peaked in August 2000 and went on to deflate 20% before reaching the next chart…

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  • 2001-2002: technically, rising rates did not hurt equities during LPL’s specific period…but if you elected to stay in after the first 20% setback (above), this last rate burst terminated you…

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  • 2003-2006: I grouped 3 LPL periods on the same chart. Periods concur. Equities + 3.8%, +1.3% and + 3.6%. Risk vs reward???

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  • 2008: LPL breaks this period in two. In the mean time, peak to trough: –47.5%! Can’t miss a beat, can you?

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This is how LPL summarizes its analysis:

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A casual observer can only conclude that higher rates are clearly positive for equities. I wish LPL clients all the best for 2017.  They may think they have a strong edge. But with really poor odds, they better hedge.

Fingers crossed Unless this is the new normal because, maybe, this time is different. The last 3 spikes in LT rates did not stop equities:

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But this time is no different. Rising rates are not good for indebted governments, companies and individuals and not good for equities based on common sense backed by 55 years of data analysed objectively. Rising interest rates bring the sea level down, exposing all naked swimmers. There currently are quite a few of these out there…

Finally, if you are wondering what rising short term rates can do to equities, the complete, objective analysis is here: EQUITIES AFTER FIRST RATE HIKES: THE CHARTS SINCE 1954. Here’s the conclusion:

To be brief, in layman’s terms, in reality, there seems to be no consistent nor typical pattern after the first rate hikes.

However, digging a little more into the history book, I found that in 6 of the 8 years when the S&P 500 rose during the initial rate hike, inflation was actually diminishing or stable (2004). This did not verify in 1987, although the market eventually avenged itself and in 1999 when internet speculation blinded everybody.

Maybe we got ourselves a bit of a rule here: rate hike cycles are not damaging to equities in as much as inflation is not rising at the time. Since profits are generally still rising when the Fed takes its foot off the pedal, stable or declining inflation rates help sustain P/E ratios as demonstrated by the Rule of 20.

Contact: edgeandodds [at] gmail.com