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

Consumer Watch

NEW$ & VIEW$ (11 AUGUST 2014)

Earnings season recap. More debate on economic slack.

U.S. Productivity Rises at 2.5% Pace in Second Quarter

Nonfarm labor productivity, or output per hour worked, advanced at a 2.5% seasonally adjusted annual rate from April through June, the Labor Department said Friday. The gain failed to offset the 4.5% decline in the first three months of the year, the largest quarterly drop since 1981.

From a year earlier, productivity advanced 1.2%. That is only slightly ahead of the 1% average rate recorded in 2012 and 2013, and well off the better than 3% gains in the first year of the recovery. The pace of productivity gains the past two years have coincided with annual economic growth of a little better than 2%. Meanwhile, unit labor costs, a gauge of inflationary pressures, rose at a 0.6% annual rate in the second quarter following a 11.8% leap in the first quarter. From a year earlier, unit labor costs are up 1.9%, essentially in line with other inflation measures.

One bright spot in Friday’s report came in manufacturing. Productivity in the sector rose at a 3.6% pace during the second quarter and is up 2.1% from a year earlier. Both gains easily outpace the broader business sector. Meanwhile, unit labor costs in manufacturing have largely been contained, up 0.8% from a year earlier.

Comp. data have been quirky and noisy lately. Taking a 4Q moving average, one finds that comp. per hour was up 2.1% Y/Y in Q2.

Decline in ‘Slack’ Helps Fed Gauge Recovery

All are signs of an economy still healing from a deep downturn that created lots of economic slack: the gap between the resources we have and those we are using.

By many measures, such slack has narrowed considerably, but not completely, even five years after the recovery began. Conditions aren’t quite back to what was normal before the 2008 financial crisis.

Job Market Tilts Toward Workers as U.S. Enters Virtuous Cycle The balance of power in the job market is shifting slowly toward employees from employers.

(…) Americans who have been hunting for employment for more than six months are finding they’re having better luck landing a job, while people who had given up looking are returning to the labor force to resume their search.

Companies, meanwhile, are beefing up their in-house recruiting teams and increasingly using complicated computer algorithms to scour the Web for prospective job candidates. (…)

Employers in general have been “pretty stubborn” about increasing wages, said Jeffrey Joerres, executive chairman of ManpowerGroup (MAN), a Milwaukee-based staffing company with $20.3 billion in revenue last year. That may be about to change as the pool of available candidates shrinks.

“You can see a little anxiety among employers,” he said. “I can feel the inflection point is coming.”

Michael Durney, chief executive officer of Dice Holdings Inc. (DHX), agrees.

“I think you’re going to start to see wage inflation,” said Durney, whose company provides specialized websites that match employers with potential employees in industries such as technology and financial services. (…)

Businesses also are more inclined to hold onto staff. Conversions — giving full-time jobs to the temporary employees Manpower provides — are at a three-year high, according to Joerres. (…)

Express Employment had almost 90,000 job orders from employers in June, up from 62,000 a year earlier, Funk said.

More noise for Mrs. Yellen…

The WallStreetExaminer blog supports the doves as it deciphers the non-seasonally adjusted numbers to check on wage pressures:

Employment Cost Increases By SectorThe year over year gain in actual employment costs for all civilian workers was, are you ready for this–2%! That, indeed, is the highest it has been since 2011, when it spent the 2nd through 4th quarters rising at rates of 2-2.25%. Last year it never got above 1.9%. It’s a breakout! Or maybe not quite. This number is still within the same range of growth rates that it has been since the second quarter of 2010.

The gain, such as it was, was driven by gains of more than 2% in 6 major employment sectors. On the other hand, 4 broad sectors rose by less than 2%, and they can’t seem to get out of their own way. 3 of them have been wallowing below 2% since early 2011 and all 4 have been since early 2012.  Here’s a breakdown of the actual, not seasonally adjusted annual rate of gain by major sector.

Here’s how it looks on a graph.

Employment Costs By Sector- Click to enlarge

Before you get all outraged about government workers leading the increases, note that they got screwed in 2011 and 2012, falling below private sector workers for more than a year. The current surge looks like catch-up for that time when they were not getting raises. At about 16% of the workforce the government sector may be big enough that had it not been for this apparently compensatory increase, the total aggregate number for all employees may not have made it to a new 2 year high.

Another notable factor is that the 5 sectors that rose less than 1.75% comprise more than half of all US workers. The majority of US workers are experiencing compensation increases that do not even keep up with CPI, which we know, in addition, to be understated. (…)

Among the stronger sectors, Construction AND Extraction showed a gain of 2.1%. The problem there is that all of the gain is due to Extraction. Extraction means mining, and oil and gas production. Extraction is booming, while construction–not so much. In June, the BLS reported a year to year to year increase of 4.64% in average weekly earnings for mining and oil and gas extraction workers. But construction workers got virtually nothing, showing a gain of 0.24%. According to BLS data, there are approximately 850,000 employees in mining and oil and gas extraction. There are more than 6 million construction employees. How the BLS averaged those two together to come up with a 2.1% overall increase is beyond my ability to comprehend. I am the simple one.

So when you break these numbers down, recognizing the catching up of government workers which is probably temporary, and the likely overweighting of gains in mining and oil and gas extraction, that leaves just 4 sectors barely above a 2% increase.

One is Transport workers. They account for less than 3% of the US workforce. Their year to year increase is still below the peak levels of the past two years. The current uptick does not yet indicate that they’ve turned the corner.

Likewise those in another sector gaining more than 2%, Sales, saw an increase that remains well below the peaks of the past 2 years. Finally, managers and professionals and office and administrative workers have been flatlining at a 2% rate of increase for 2 years. There’s no breakout there either.

Looking at the 4 weaker sectors comprising the majority of US workers, the idea of a turn there is ludicrous.

Overall, private sector workers and those in education are not keeping pace with inflation, and the recent gains for non-education government workers could prove transitory. Considering the trends of the actual data in all of these major sectors, there’s no breakout here. The corner has not been turned. (…)

Good analysis. However, don’t forget that wages are a very lagging indicator. I side with David Rosenberg’s analysis which finds that

50 million American workers are in industries that are already at full employment. That is 35% of the workforce. A year ago, that number was zero. And 35% of the private workforce is also now in the process of enjoying accelerating wage growth. What is holding back the aggregate data are two sectors facing relentless downward pressure -construction and financial services.

But we have reached a critical mass where a rising share of the labour force is beginning up against a supply wall -wage growth for a significant and rising minority, enough to spin the dial on national income and spending is on the mend.

OECD Indicators Point to Slowdown in Germany

(…) But the outlook for Germany appears to be weakening, with the country’s leading indicator falling again during June in what the OECD said was a sign of “growth losing momentum.” After a strong first quarter, many economists estimate that the German economy contracted in the second quarter, in part because of an unusually large number of days being lost to vacation. (…)

The OECD said its leading indicators for France and Italy continue to point to stronger growth, as they have done for a number of months. However, those pickups have yet to materialize, leaving Spain as the only major euro-zone economy to enjoy a significant acceleration over recent quarters. (…)

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Sarcastic smile Where’s Italy’s recession on these charts?

Italy’s Problem Is Europe’s Problem

(…) Italy’s paralysis is all the more striking given the strengthening recovery in countries that have undertaken reforms. Spain is now the fastest growing economy in the euro zone, expanding by 0.6% in the second quarter. Citigroup expects the Greek economy to grow this year by 1.1%; Unemployment in Portugal has been falling for almost two years to 13.9% from a peak of 17.5%; Cyprus should return to growth in 2015, far sooner than predicted at the time of its financial collapse last year. (…)

That is why Italy’s stalled economy is a challenge for the European Central Bank too. For the past year, the ECB has come under growing pressure to embark on large-scale purchases of government bonds to address the euro zone’s low inflation rate. (…)

Germany adds to eurozone worries

Official data, due to be published on Thursday, are expected to show that growth in the eurozone stagnated in the second quarter. Economists polled by Reuters forecast growth of just 0.1 per cent between April and June, compared with 0.2 per cent in the first three months of the year.

German Economy Backbone Bending From Lost Russia Sales

Sad smile Leading to this chart from The Short Side Of Long:

China Loosens Monetary Conditions in Test of Credit Power

China loosened monetary conditions last quarter at the fastest pace in almost two years, a Bloomberg LP gauge showed, testing the waning effectiveness of credit in supporting economic growth.

Bloomberg’s new China Monetary Conditions Index — a weighted average of loan growth, real interest rates and China’s real effective exchange rate — rose 6.71 points to 82.81 in the second quarter from the previous three months. That’s the biggest jump since the July-September period of 2012, with May and June’s numbers the first back-to-back readings above 80 since January 2012.

New yuan loans in July will be a record high for that month, according to a Bloomberg News survey of analysts before data due by Aug. 15, suggesting officials are keeping the credit spigot open even as debt risks mount. While consumer inflation below the government’s goal allows room for more easing, economic data will determine how far policy makers go. (…)

China Inflation Tame in July

The consumer-price index rose 2.3% on year, in line with economists’ forecasts and unchanged from the previous month, according to data released by the National Bureau of Statistic. Prices rose 0.1% from a month earlier.

The CPI rose 0.1% M/M in July.

Meanwhile, the producer-price index, which tracks the prices paid to companies at the factory gate, has been stuck in deflation for more than two years, thanks to a combination of falling prices for raw materials and excess capacity in many Chinese industries.

The index logged a 29th straight month of declines in July, falling 0.9% year-over-year. But that is still mild compared to drops of 2% or more seen earlier this year. 

CANADA: Surprisingly negative jobs report supports low-rate stance

Statistics Canada’s monthly tally of hiring and firing produced a net gain of 200 positions last month, as a 60,000 increase in part-time jobs marginally outweighed a 59,700 plunge in full-time positions.

Canada’s unemployment rate dropped to 7 per cent from 7.1 per cent, but only because more than 35,000 people gave up looking for work, according to StatsCan’s report, released Friday in Ottawa. (…)

StatsCan estimates there were 17,820,900 people working in July, only 0.7 per cent more than a year ago. The labour participation rate, which measures the percentage of the population either working or seeking work, dropped to 65.9 per cent, the lowest since October 2001. Employment in goods-producing industries has shrunk by 56,000 positions this year, reducing the headcount to its lowest since January 2012, according National Bank Financial.

Speaking of National Bank Financial, their group of fine economists again provide the more insightful stuff:

Full-time employment has been particularly weak in Canada with a cumulative loss of 4,000 jobs so far in 2014. As today’s Hot Charts show, an unprecedented divergence has recently emerged between our country and the U.S. when it comes to full-time job creation: whereas the U.S. is growing at a robust 2% clip on a
year/year basis, Canada is actually contracting. What’s behind the weakness? The goods-producing industries has seen the destruction of 92,000 jobs over the past year with more than half of those losses coming from construction – the sector that spearheaded the rebound in job creation after the last recession.

As shown, a 3.7% annual drawdown in construction headcounts is extremely rare outside recessions. Is this development a harbinger of a much bigger slowdown in Canadian economic activity? We do not think so. For one, available data still point to a marked acceleration in real GDP in the coming months. For another, we doubt that the recent pace of layoffs in the construction industry can be maintained at a time when the value of new building permits is surging (we hit a record high in June). Should the upcoming report on new home starts show a level of around 180,000-to-200,000 units in July, a rebound in construction jobs could be in
store as soon as August.image

EARNINGS WATCH

Factset:

Overall, 446 companies in the S&P 500 have reported earnings to date for the second quarter with 73% reporting actual EPS above the mean EPS estimate. This percentage is slightly above the trailing 1-year average (72%). In aggregate, companies are reporting earnings that are 4.2% above expectations, which is also above the trailing 1-year (+3.2%) average. As a result of these upside earnings surprises, the earnings growth rate for the S&P 500 has improved to 8.4% today from 4.9% on June 30 and from 6.8% on March 31.

In terms of revenues, 64% of companies have reported actual sales above estimated sales and 36% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is well above both the 1-year (55%) average and the 4-year average (57%).

The blended revenue growth rate for Q2 2014 is 4.3%, which is above the estimated growth rate of 2.8% at the end of the quarter (June 30).

In aggregate, companies are reporting sales that are 1.7% above expectations. This surprise percentage is well above the 1-year (+0.6%) average and the 4-year (+0.6%) average.

All ten sectors are reporting higher earnings relative to a year ago. Five of the ten sectors are reporting double-digit earnings growth, led by the Telecom Services and Health Care sectors. On the other hand, the Financials sector is reporting the lowest earnings growth of all ten sectors.

At this point in time, 80 companies in the index have issued EPS guidance for the third quarter. Of these 80 companies, 56 have issued negative EPS guidance and 24 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the third quarter is 70% (56 out of 80). This percentage is above than the 5-year average of 64%.

But well below the 6-quarter average of 79%.

Analysts expect earnings growth for the S&P 500 for the second half of 2014 to be in the same range as the 8.4% growth currently being reported for Q2 2014. For Q3 2014 and Q4 2014, analysts are predicting earnings growth rates of 7.1% and 9.9%.

Note that the estimated growth rate from Q3 was cut from 9.0% on June 30 to 7.1%, in spite of these facts:

  • Q2 actual EPS growth of +8.4% is 4.2% above expectations and shared across all sectors with 5 of the 10 sectors recording double digit growth in Q2.
  • Q2 actual revenue growth of +4.3% is 1.7% above expectations.
  • Margins keep growing. Q2 margins at 10.2% leapt above the previous 5Q highs.

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S&P’s database of 452 company reports shows a 66% beat rate and a 21% miss rate, the former being in line with recent years while the latter is much lower than the 24.7% average of the past 8 quarters. Interestingly, only 3 of the 10 sectors meaningfully better the average beat. Excluding Health Care (82%), IT (73%) and Materials (70%), the beat rate drops to 61%.

Q2 EPS are expected to come in at $29.56, up from the suspicious $29.18 last week and +12.1% Y/Y. Revenues are up 5.8% Y/Y, a marked acceleration from Q1’s +3.4% and Q4’13’s +0.5%.

S&P also says that margins rose nicely form 9.5% in Q2’13 to 10.1% this year, another record.

Trailing 12-month EPS should total $112.05 after Q2, up a significant 12.9% Y/Y. Q3 and Q4 estimates receded a little to $30.21 (+12.2% Y/Y) and $32.38 (+14.6%) respectively.

In all, this will end up as a pretty good earnings season. The bears have little meat to feed on as revenues have accelerated, margins keep rising and guidance is not deteriorating. At 1932, the S&P 500 Index is selling at 17.2x trailing EPS, a clear premium on the average (and median) of 13.7x since 1927, 1953 and 1983. Only if you are using data since 1993 (18.5) can you affirm that equities are cheap. At your own risk however!

The more dependable Rule of 20 P/E is at 19.2, a mere 4% below the “20” fair value (2020 on the S&P 500 Index).

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The latest Investors Intelligence survey revealed that bulls fell sharply to 50.5% from 55.6% a week ago. It noted that the latest reading is almost out of the caution territory and represents a decline over 12 points from the multi-year high of 62.6% in mid-June. It added that the spread between the bulls and bears contracted to 33.4% from 39.4% in the last survey and nearly low enough to shift to a neutral.

I will come back to that shortly. 

A 1.4-acre property in Lake Tahoe sold on Thursday for $1.6 million in bitcoins, joining a handful of other real-estate transactions that used the virtual currency.

NEW$ & VIEW$ (4 AUGUST 2014)

Hiring Settles Into Steady Gains Hiring by U.S. employers remained robust in July, if a bit slower than previous months, with a broad-based rise in payrolls extending a half-year streak of strong employment gains. The jobless rate ticked up to 6.2%.

(…) That marked a downturn from the 298,000 jobs created in June, but was more than enough to yield the strongest six months of payroll gains since 2006. July was the first time since 1997 that employers added 200,000 or more jobs in six consecutive months. (…)

BloombergBriefs, using 12-month data, hits on the low wage growth hammer…

(…) of the 2.57 million jobs created during the last year, a mere 18,000, or 0.7 percent, were in the top wage earners. Three of the top four wage earning categories are also the smallest. Utilities boasts only 552,400 workers, while mining and logging employs 916,000. There are 2.6 million information workers and 7.9 million financial activities employees.

Not only are wages in the aggregate running at a flat real pace, but those high-paying industries are not creating many jobs. Until they do, a thriving economic recovery shouldn’t be expected.

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But the WSJ says more recent data is more hopeful:

Jobs Report Shows High-Wage Sectors Finally Digging Out
PARTICIPATION RATE BOTTOMING

If that is so, the labor force growth will accelerate to 190k per months vs 30k per month in the last 12 months. Mrs. Yellen would prove right in that the U Rate decline would slow, wage pressures would ease and the economy’s growth potential would increase.

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US Dancing to “Get On Up”

(…) Everyone focuses on payroll employment. Debbie and I focus on our Earned Income Proxy (EIP), which is payroll employment times average weekly hours worked times average hourly earnings, all in the private sector. It is highly correlated with private wages and salaries (a major component of personal income), and also with retail sales.

The EIP rose 0.2% during July, following a jump of 0.5% the previous month. It is at a record high. So is private wages and salaries, which rose 0.5% m/m and 5.8% y/y during June. This augurs well for consumer spending during the third quarter. (…)

U.S. Auto Sales Rose 9% in July

Car makers sold 1.435 million vehicles in the U.S. last month, up 9.1% from a year earlier and lifting the seasonally-adjusted annualized selling rate to 16.48 million, from 15.76 million vehicles in 2013, according to researcher Autodata Corp.

Underlying the momentum: bigger sales incentives. TrueCar Inc., TRUE -1.33% the Internet auto-pricing service and research firm, said incentive spending rose 8.4% overall from July 2013 and to the highest since July 2010.

I remain unconvinced that significant new highs will be seen this cycle (charts from CalculatedRisk)

Big U.S. Firms Get a Lift as Customers Come Back

(…) Overall revenue at the 500 largest U.S. companies by stock-market value is on track to climb about 4.3% from last year’s second quarter, based on earnings-season results for about three-fourths of the firms and analysts’ projections for companies that haven’t reported their results yet.

That would be the biggest percentage gain since 2012’s first quarter, according to Thomson Reuters. Profits are expected to increase 7.7% in the second quarter, the fastest growth since the fourth quarter of 2013. (…)

Revenue gains have been broad-based. The biggest improvements include revenue growth of 12% at big health-care companies, while technology firms are expected to have revenue growth of about 6.5%, according to Thomson Reuters. Revenue growth is expected to reach about 3% at telecommunications, basic materials and consumer-staples companies—and nearly 5% in the consumer discretionary sector.

The financial and utility sectors have lagged behind, with second-quarter revenue growth of 0.7% and 1.6%, respectively. (…)

EARNINGS WATCH

S&P updated its database as of July 31 with 359 reports tallied. Beat rate: 66%, pretty much in line with recent years. Miss rate: 20.6%, lowest in at least 2 years (avg: 24.7%). Still, estimates for Q2 have come down to $29.18 from $29.47 one week ago and $29.64 two weeks ago. Go figure!

This is surprising given that

  • Factset, with one additional day (17 companies) of data, calculates that companies are reporting earnings that are 4.1% above expectations.
  • The revenue beat rate is 65%, well above the 1-year (55%) average and the 4-year average (57%), and that companies are reporting sales that are 1.9% above expectations.
  • Factset finds that the blended earnings growth rate for the second quarter (blending actuals with estimates for companies yet to report) is 7.5% this week, above the growth rate of 6.6% last week, 5.4% the previous week and 4.9% at the end of the quarter.
  • The blended revenue growth rate for Q2 2014 is 4.1%, which is above the estimated growth rate of 3.0% at the end of the quarter.

Since S&P is the official stat provider, I must go with their numbers. Maybe Howard Silverblatt will eventually explain why his numbers are dropping while others are rising.

Trailing 12-month EPS are now estimated at $111.67 after Q2. With inflation at 2.0%, the Rule of 20 says that fair P/E is 18 giving a fair value of 2,010 for the S&P 500, 4.4% above current levels. (Click on charts to enlarge)

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Investors have again balked at crossing the “20” level, something they have done merrily in 7 out of 8 bull markets since 1956. The S&P 500 is currently sitting uncomfortably on its 100-day moving average. In February and April, it temporarily went through it only to strongly bounce back before even coming close to its 200-d m.a. (currently 1860, 3.4% lower). Note that all moving averages are still rising.

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On June 2, I wrote Showtime! in which I argued that

It is thus showtime for earnings and margins, showtime for the economy and showtime for P/E multiples.

The earnings show is actually underway and getting better, drawing a larger crowd. If margins actually break out and enter the show, the crowd should keep growing, especially if the economy also gets in the act.

But the big show, the one with fireworks, is the powerful spectacle of rising earnings, rising margins and rising confidence (P/Es), a combination not sighted for over a decade but which is typical of end-of-cycle shows.

Or, we may be in for an early sixties performance in which rising earnings and stable inflation steal the show to the economy and geopolitical risks and carry equities higher on multiples stabilized around fair value.

The worst case would be hints of a sustained economic slowdown potentially generating weaker revenue growth and declining margins. This is actually the bear narrative that has refused to materialize so far in this cycle.

The show is going quite well, indeed:

  • Earnings are better than expected, rising in the high single digits with accelerating revenue growth and still higher margins.
  • U.S. economic data is stronger without fostering much higher inflation, so far. Only housing remains weak. The news is good enough to keep earnings rising, and weak enough to keep the Fed patient and cooperative. Goldilock!
  • China is also looking better.
  • Only Europe looks weaker with a bleaker outlook given the harsh geopolitics in that region. The potential fallout on the U.S. is not significant enough to hurt the domestic economy. Meanwhile, the US dollar is rising.

But equity investors are nervous, trigger happy, one way or the other.

Ghost Three Signs That Point to a Stock-Market Tumble

Mark Hulber’s WSJ column last Saturday:

Over the past 45 years, the stock market has lost more than 20% each time three warning signs flashed simultaneously.

After a selloff this past week dragged the Dow Jones Industrial Average into negative territory for the year, it’s worth noting that all three are flashing today.

The signals are excessive levels of bullish enthusiasm; significant overvaluation, based on measures like price/earnings ratios; and extreme divergences in the performances of different market sectors.

They have gone off in unison six times since 1970, according to Hayes Martin, president of Market Extremes, an investment consulting firm in New York whose research focus is major market turning points.

The S&P 500’s average subsequent decline on those earlier occasions was 38%, with the smallest drop at 22%. A bear market is considered a selloff of at least 20%, with bull markets defined as rallies of at least 20%.

In fact, no bear market has occurred without these three signs flashing at the same time. Once they do, the average length of time to the beginning of a decline is about one month, according to Mr. Martin.

The first two of these three market indicators—an overabundance of bulls and overvaluation of stocks—have been present for several months. As long ago as December, for example, the percentage of advisers who described themselves as bullish rose above 60%, a level Investors Intelligence, an investment service, considers “danger territory.” Its latest reading, as of Wednesday, was 56%.

Also beginning late last year, the price/earnings ratio for the Russell 2000 index of smaller-cap stocks, after excluding negative earnings, rose to its highest level since the benchmark was created in 1984—higher even than at the October 2007 bull-market high or the March 2000 top of the Internet bubble.

The third of Mr. Martin’s trio of bearish omens emerged just recently, which is why in late July he advised clients to sell stocks and hold cash. That’s when the fraction of stocks participating in the bull market, which already had been slipping, declined markedly.

One measure of this waning participation is the percentage of stocks trading above an average of their prices over the previous four weeks. Among stocks listed on the New York Stock Exchange, this proportion fell from 82% at the beginning of July to just 50% on the day the S&P 500 hit its all-time high. (…)

Another sign of diverging market sectors: When the S&P 500 hit its closing high on July 24, it was ahead 1.4% for the month, in contrast to a 3.1% decline for the Russell 2000. (…)

A few observations are needed here:

  • “They have gone off in unison six times since 1970” and “In fact, no bear market has occurred without these three signs flashing at the same time.” Well, that does not jibe with the fact that since 1970, there have been 7 bear markets. Just for the record.
  • The author may have conveniently left out the fact that in 5 of the 6 occurrences a recession hit the U.S. economy. Recessions are always accompanied with bear markets.
  • It follows that Mr. Martin’s trio of bearish omens should also be great in forecasting recessions, a claim he is not making.
  • The reason may be that there are two pretty good recession warning indicators, the Conference Board’s LEI and the U.S. yield curve. None are close to indicating high recession risks for the next 9-12 months.
  • To me, using the Investors Intelligence bull ratio as a market timing tool is not serious. Just peek at this chart from Ed Yardeni:

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Not to totally dismiss Mr. Martin’s work. I have been flashing some of these excesses numerous times in the recent past and advising some caution given high valuations, particularly on small cap stocks and high yield bonds.

Here’s a more frightening chart:

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Just in case you are wondering, the Rule of 20 P/E at pre-bear market tops was 20.2 in 1973, 16.5 in 1976, 19.0 in 1981, 23.1 in 1987, 19.2 in 1990, 29.7 in 2000 and 21.3 in 2007. It is currently 19.2. That said, there are numerous instances when the rule of 20 P/E was at 20 without being followed by a bear market:

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To repeat myself: the Rule of 20, like all other valuation tools, should not be used as a market timing tool. It is rather an objective way to assess market risk against potential reward in order for each investor to structure his/her investment portfolio accordingly. A good case in point is high yield bonds which have been challenging their historical low spreads against treasuries for a while. Something finally cracked lately as this Bespoke Investment chart shows:

 

Why It’s Too Early to Call the Bottom After Thursday’s 317-point drop for the Dow Jones Industrial Average, the stock market is selling off again on Friday, further illustrating how the calm that pervaded financial markets for months has evaporated.

(…) “The market is modestly oversold, but we’re not ready to make the tradeable bottom call,” said Chris Verrone, head of technical analysis at Strategas Research Partners in New York. He noted that August is historically a difficult month of the year for stocks. “At the moment, we would be more inclined to fade a near-term bounce,” he wrote Friday morning before the jobs report. (…)

“We’re still ultimately in the ‘buy the dip’ camp, but it may take lower prices first,” he said. “Next S&P 500 support is in the 1900-1910 range, with the upward sloping 200-day average near 1860.”

But it’s a good idea to buy a floating device: Buoyant market for yachts as rich return Sales of luxury crafts at highest level since the financial crisis Winking smile

Bubble pressure
Investors blow froth off junk bond market

(…) Lured by the higher returns on offer from investing in the risky debt, investors have poured $80.7bn into US “high-yield” bond funds since the Federal Reserve began its emergency economic policies in 2009 – not far from the $126.3bn that went into global stocks in the same period. (…)

“We have been in extreme valuations for months,” says Marty Fridson, chief investment officer at LLF Advisors. “Investors are well aware that they’re not being compensated particularly well for their risk, but they don’t have a good alternative to meet their return requirements.” (…)

Average yields on junk bonds touched a record low of 4.82 per cent in June, according to Barclays data – a far cry from the 22.9 per cent seen in 2008. At the same time, sales of the debt totalled $210.8bn in the first seven months of the year – the highest period of issuance since at least 2000, according to Dealogic. (…)

Compounding matters is the fact that more than a third of US corporate bonds are now owned by “mom and pop” investors who have piled into fixed-income funds and exchange traded funds (ETFs) that offer instant access to the debt.

“There is no underlying bid in the [high-yield] market once people decide to start selling. That is compounded by the amount of ETFs issued backed by high-yield debt,” says Raymond Nolte, managing partner at SkyBridge Capital.

“A lot of that is in the hands of retail, which see ETFs as a resolution to liquidity problems. And they will be able to sell in a down market, but at what price?”

Despite such concerns, many fund managers say it may be too soon to fear a sell-off. Corporate default rates remain low and the Fed has said it is committed to keeping rates near zero until at least mid-2015.

In addition, a healthier US economy and buoyant stock market has traditionally been beneficial for junk-rated companies.

“High-yield bonds tend to do well in a stronger-economy, rising stock market environment,” says Sabur Moini, high-yield fund manager at Payden & Rygel. (…)

Mr. Moini obviously does not read me nor Moody’s. From last week’s New$ & View$:

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ELSEWHERE:
China Official Nonmanufacturing PMI Slips in July China’s official nonmanufacturing purchasing managers index fell to 54.2 in July from 55.0 in June, data from the China Federation of Logistics and Purchasing showed.

The subindex for services fell to 53.2 from 53.5 in June and the subindex for construction fell to 58.2 from 60.6, the federation said in a news release Sunday.

The new-orders subindex for the entire sector was unchanged at 50.7.

The federation’s official manufacturing PMI rose to 51.7 in July from 51.0 in June, it said Friday.

PBOC’s $162 Billion Loan Spurs Speculation on Easing A Chinese central bank loan that’s almost the size of the U.S. bailout of American International Group Inc. has spurred speculation that policy makers have adopted a new form of monetary easing to shore up growth.

While the People’s Bank of China warns debt is rising quickly, and credit expansion is already high, that didn’t stop it from extending what Chinese media reported is a 1 trillion yuan ($162 billion), three-year loan to a state development bank. By comparison, the AIG rescue amounted to $182 billion.

The loan, designed to lower financing costs for government-backed housing projects, marks a “qualitative” easing by Governor Zhou Xiaochuan, according to Citigroup Inc. economists. The move, which the PBOC has yet to confirm publicly, also takes the central bank deeper into fiscal-policy territory after it gave quotas for discounted lending for agriculture, small businesses and low-income housing. (…)

China repeats promise to increase investment, speed up reforms  China will increase investment in areas including the property sector, while authorities will advance wide-ranging economic reforms such as changing the fiscal and pricing systems, the country’s powerful economic planning agency said on Monday.

China will increase investment in areas including the property sector, while authorities will advance wide-ranging economic reforms such as changing the fiscal and pricing systems, the country’s powerful economic planning agency said on Monday.

The remarks from the National Development and Reform Commission were a reiteration of existing government policies.

Bumper German Pay Deals

(…) Bundesbank President Jens Weidmann estimates that wage increases negotiated by German unions are averaging about 3 percent this year. With the central bank forecasting inflation (ECCPEST) of 1.1 percent in 2014, that’s equivalent to a real rise in pay of 1.9 percent. Data compiled by theFederal Statistics Office shows that would be the highest since 1992.

It is “to be welcomed that wages and salaries are rising more strongly than in the days when the German ec nomy was in much poorer shape,” Weidmann said in comments published on the Bundesbank website last week. “We have close to full employment in a number of sectors and regions, and we are seeing more and more reports of labor shortages.”

(…) German chemical companies agreed early this year to a 3.7 percent pay rise over 14 months, after a union demand for 5.5 percent. The IG Metall labor union reached an agreement for an increase of 2.3 percent effective last month and 1.7 percent in May 2015 for about 75,000 steel workers in northwestern Germany. (…)

The government says it has identified labor shortages in 20 industries as diverse as nursing and machine fitting, and plans to start an initiative for skilled workers this year.

Growing French-German Divergence

(…) Germany was the only large euro-area economy to see its PMI manufacturing index improve in July. The reading rose to 52.4 from 52 in June. The new orders
component rose to its highest level since April. In stark contrast, the French index continued its free fall, dropping to 47.8 from 48.2 in June. That is the lowest level
since December and the third consecutive month indicating a contraction in activity.

The gap between the indexes for the two largest euro-area economies — together they make up almost half the currency union’s GDP — has been widening since
the end of the first quarter. It now stands at 4.6 points, up from 1.6 in March. This is because the French manufacturing PMI has declined every month in the period,
losing 4.3 points since its March peak of 52.1. In June, the French index even ranked worst of all the countries surveyed worldwide by Markit.(…) (BloombergBriefs)

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