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

BEARNOBULL’S WEEKENDER

FactSet StreetAccount Summary – US Weekly Recap: Dow (0.31%), S&P (0.44%), Nasdaq (1.70%), Russell 2000 (3.11%)
U.S. Secular Growth: Donkey or Racehorse? (Jeremy Grantham)

A few extracts from a letter well worth your time:

(…) Negligible growth in population and man-hours offered to the workforce is the most important brake to growth, with a net drop of fully 1% from the pre-2000 trend. Less capital investment and growing income inequality do not help. But the most underappreciated important factor, in my opinion, is the drag on growth from the loss of sustained cheap energy as oil has moved from a $16/barrel 100-year trend pre-1972 to today’s approximate $75/barrel trend price. (…)

I am still just about certain about three things: first, our secular growth rate in the U.S. is indeed about 1.5% (at least as stated in traditional GDP accounting, wherein expensive barrels of oil increase GDP; perhaps closer to 1% in real life); second, economists move their estimates slowly and carefully in order to stay near the pack and minimize career risk (despite the recent IMF heroics); and third, that we do not like to give or receive bad news and, when in doubt, we tend to be optimistic. (…)

The key point here is that in our strange, manipulated world, as long as the Fed is on the side of a strong market there is considerable hope for the bulls.(…) Yellen, like both of her predecessors, has bragged about the Fed’s role in pushing up asset prices in order to get a wealth effect. Thus far, she seems to also share their view on feeling no responsibility to interfere with any asset bubble that may form. For me, recognizing the power of the Fed to move assets (although desperately limited power to boost the economy), it seems logical to assume that absent a major international economic accident, the current Fed is bound and determined
to continue stimulating asset prices until we once again have a fully-fledged bubble. And we are not there yet.

To remind you, we at GMO still believe that bubble territory for the S&P 500 is about 2250 on our traditional assumption that a two-sigma event, based on historical price data only, is a good definition of a bubble. (…)

We could easily, of course, have a normal, modest bear market, down 10-20%, given all of the global troubles we have. If we do, then the odds of this super-cycle bull market lasting until the election would go from pretty good to even better. So, “2250, here we come” is still my view of the most likely track, but foreign markets are of course to be preferred if you believe our numbers. Stay tuned.

BTW, Grantham’s 2250 bubble target would be right where the Rule of 20 would also see it as a bubble based on current earnings and inflation parameter:

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Getting to 2250 from 2100 is +7.1%. Retreating to 1800 from 2100 is –14.2%. Here again, Grantham’s correction range would be validated by the Rule of 20.

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In all, the bubble blowout would give +7.1%. The “easy” correction would take –14.2%. Pretty simple to calculate this unfavorable reward/risk ratio!

MARKIT U.S. PMI STRONG DESPITE WEAK EXPORTS

April survey data from Markit indicated a loss of momentum in the U.S. manufacturing economy, following a strong end to the first quarter of 2015. Output and new orders increased at slower rates and new export business declined for the first time since November, partly linked to the strong dollar. The currency also generated downward pressure on import prices, and average input costs at manufacturers fell for the fourth month running as a result. That said, the underlying strength of business conditions remained solid, with backlogs and employment both rising further.

The seasonally adjusted final Markit U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) registered above the 50.0 no-change threshold in April, thereby signalling an overall upturn in business conditions. The index fell to a three-month low of 54.1, from March’s 55.7, but still signalled a solid rate of improvement and was above its long-run trend level of 52.2.

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Weighing most on the PMI in April was a slower rise in production. The rate of growth moderated to the weakest in 2015 so far, although it remained strong overall. Similarly, firms continued to increase their purchasing activity at a robust, albeit slower, pace. Suppliers’ delivery times lengthened further as a result, with ongoing mention of delays associated with the recent West Coast port shutdowns.

The other main factor contributing to the fall in the headline index during April was a slower rise in incoming new business. New order growth eased to a three-month low, but remained strong in the context of historic survey data. Weaker international demand linked to the strong dollar was evident as new export business declined for the first time since November.

Other survey indicators suggested the underlying health of the manufacturing sector remained firm. Employment rose for the twenty-second consecutive month, and at a robust pace. Meanwhile, backlogs of work rose for the fifth month running, while stocks of inputs also expanded as firms addressed order book requirements.

Price indicators from the latest survey continued to point to downward pressure on manufacturing input prices. Average input costs fell for the fourth month running, at a rate little-changed from March. Anecdotal evidence linked lower cost pressures to reduced prices for metals and oil-based inputs, as well as a general deflationary impact of the strong dollar on import prices. Output prices continued to rise, albeit at a fractional pace.

The slower rise in output in April reflected weaker expansions at small and medium-sized firms, while large firms (those employing more than 500 staff) registered the strongest rate of growth and the fastest expansion in 2015 to date. Large firms also registered stronger workforce growth than small and medium-sized companies.

By market group, consumer goods producers continued to drive output growth in April, followed by intermediate goods companies. Makers of investment goods recorded only a marginal increase in output in April, and also registered the slowest rate of job creation among the three monitored sectors.