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

NEW$ & VIEW$ (16 JUNE 2014)

Real Estate Major Obstacle as China Engineers Stability for Now

China’s economy showed signs of stabilization in May. A contracting real estate sector and softening global demand mean it may be short lived. Industrial output, the main monthly measure of China’s growth, was up 8.8 percent year on year in May, edging up from 8.7 percent in April and in line with expectations. Fixed asset investment edged down and retail sales strengthened, reflecting higher prices.

Real activity indicators also pointed to stabilization. Output of electricity rose 5.9 percent on the previous year, up from 4.4 percent in April. Early signs in June are
positive, with prices for steel and other industrial commodities paring their falls from a year earlier.

The latest monthly indicators suggest growth momentum has been sustained over the course of May. Bloomberg’s monthly Nowcast of GDP continues to register 7.4 percent year-on-year growth, unchanged from April. (…) (BloombergBriefs)

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Total electricity consumption rose 5.3% Y/Y in May, after 4.6% in April.  First 5 months: +5.2%. All of 2013: +7.3%.

Ninja But, just in case, China is making sure …:

China Reserve-Ratio Cut Extended to Merchants, Industrial China’s central bank extended a reserve-requirement cut to some national lenders including China Merchants Bank Co. and Industrial Bank Co. as officials try to support growth without unleashing broader stimulus.

BTW, ISI’s China survey keeps falling…

Smile Outlook Improves for PCs

Last week, chip maker Intel Corp. INTC +6.83%, citing a surprising surge in commercial PC purchases, boosted its financial forecast for the first time in nearly five years. The Silicon Valley giant said revenue in the current quarter would be about $700 million greater than it expected, sending its stock up nearly 7% on Friday.

CENTRAL BANKS WATCH

(…) This seems unlikely, because the US economic recovery is still lagging that in the UK. Nevertheless, the parameters within which investors view forward guidance, including the Fed’s “dots” showing the future path for interest rates, may have been somewhat shaken.

The BoE will no doubt argue that they never gave the markets any cast iron reason to believe that the first rate rise would be delayed far into 2015 or 2016. “When conditions change, I change my mind”, was the gist of what Mr Carney said at the Mansion House. But the central banks do seem to want it both ways: the main point of forward guidance, according to many economists, was to pre-commit to policies that would not change when conditions changed.

Everyone knew all along that forward guidance suffered from a serious problem of time inconsistency. What was convenient for the BoE and the Fed to say when they were at their most dovish in 2012/13 may not be convenient to deliver when the situation has changed in 2015/16. The BoE has now reminded the markets that the fine print in forward guidance needs to be read very carefully indeed.

What are the similarities, and the differences, between the UK and US situations?

 

(…) In the UK, the BoE has said repeatedly that it expects labour productivity growth to bounce back as the economy recovers, thus allowing the productive capacity of the economy to expand alongside demand. This has not happened so far, and it is one of the key reasons why several members of the MPC are clearly getting jumpy.

In the US, the equivalent issue is the puzzle about labour force participation. Chair Yellen has been very clear that she believes that a significant proportion of the decline in participation will be reversed if the economic expansion is maintained, but recent data have shown no sign whatsoever that this is happening. If not Ms Yellen herself, then several other members of the FOMC are likely to start worrying about this before too long. In fact, James Bullard has already led the way on this.

(…) Even if the controlling members on the FOMC remain inclined towards dovishness, as they almost certainly do, there must be a risk that they will change their minds in response to incoming economic data, in the same way that the BoE has done.

There is no risk premium protecting against this possibility built into the path for US forward short rates. In fact, following the bond rally that has occurred this year, the market seems vulnerable to a sudden re-assessment of the Fed’s basic dovishness, just as it was before the taper tantrum last year.

I do not expect these similarities to become apparent at the FOMC meeting and the press conference this week. The committee is still in the phoney war phase (or perhaps it should be called the phoney peace), in which tapering is continuing along a pre-ordained path, almost regardless of economic events.

That will not change until tapering ends in October. After that, the hawkish surprise administered by the BoE last week might become a great deal more relevant for Fed watchers.

Meanwhile:

(…) What if we were to look not at what Ms Yellen says, but at what Ms Yellen has done? We might then conclude that the Fed’s first rate hikes could indeed happen sooner than expected.

This is the intriguing premise of a tool being used internally at BlackRock, the world’s largest fund manager, which it has nicknamed “the Yellen index”. It is a measure that suggests, on the economic indicators favoured by Ms Yellen, monetary tightening is already overdue and the Fed falls further behind the curve with every passing day. (…)

There is a lot of secret sauce in the Yellen index that BlackRock will not share, but it blends together economic indicators which the Fed chair has referenced as important considerations for policy makers, together with the unemployment and inflation targets already set out by the Fed.

The firm has been tracking whether those indicators are above or below the point at which monetary policy has been tightened in the past. On the premise that the Yellen Fed will behave consistently with the Ben Bernanke Fed, where she was a prominent voice and later vice-chairman, the index has been flashing that policy tightening is imminent since around the turn of the year. (…)

BlackRock’s innovative approach to monitoring and predicting monetary policy does not stop with the Yellen index; it has also created a “Stein index” based on the yields of corporate credit, junk bonds and commercial mortgage-backed securities, markets where Mr Stein has expressed concern.

(…) The Stein index, like the Yellen index, is flashing red for tightening soon. (…)

Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions.

“A cluster of central banking investors has become major players on world equity markets,” says a report to be published this week by the Official Monetary and Financial Institutions Forum (Omfif), a central bank research and advisory group. The trend “could potentially contribute to overheated asset prices”, it warns. (…)

China’s State Administration of Foreign Exchange has become “the world’s largest public sector holder of equities”, according to officials quoted by Omfif. Safe, which manages $3.9tn, is part of the People’s Bank of China. “In a new development, it appears that PBoC itself has been directly buying minority equity stakes in important European companies,” Omfif adds. (…)

In Europe, the Swiss and Danish central banks are among those investing in equities. The Swiss National Bank has an equity quota of about 15 per cent. Omfif quotes Thomas Jordan, SNB’s chairman, as saying: “We are now invested in large, mid- and small-cap stocks in developed markets worldwide.” The Danish central bank’s equity portfolio was worth about $500m at the end of last year. (…)

EARNINGS WATCH

Although the growth rate for the second quarter has dropped since March 31, analysts have cut earnings estimates over the first two and a half months of the quarter by the lowest amount since Q2 2011. The percentage decline in the Q2 bottom-up EPS estimate (which is an aggregation of the earnings estimates for all 500 companies in the index and can be used as a proxy for the earnings for the index) was 1.2% over the first two and a half months of the quarter. This decline in the EPS estimate was lower than the trailing 1-year (-3.1%), 5- year (-2.0%), and 10-year (-3.8%) averages for the first two and a half months of a quarter. In fact, this marked the lowest decline in the bottom-up EPS estimate during the first two and a half months of a quarter since Q2 2011, when the bottom-up EPS estimate actually increased by 1.0%. (Factset)

With only two weeks left to quarter end, so far, so good. No additional pre-announcement last week. Still 75% negative pre-announcements this quarter, the lowest in more than 2 years. Combined with low analysts revisions, it seems that companies feel no need to taper expectations any more.

The First Call earnings revision index has also been rising lately.

Much has been written in the past week on the Q1 decline in corporate profits from current production. Here’s Moody’s take on that:

The likelihood of a further upturn by the rate of industrial capacity utilization weighs against a yearlong contraction by 2014’s core profits. Capacity utilization offers a macro view of operating leverage, where profits tend to move in the direction taken by the capacity utilization rate.

Early June’s consensus calls for an upturn by the annual growth rate of industrial production from 2013’s 2.9% to 3.7% in 2014 and 3.6% in 2015. As inferred from the production projections and assuming annual increases of 2.3% for industrial capacity, the average annual rate of industrial capacity utilization should steadily rise from 2013’s 77.9% to 79.1% in 2014 and 80.1% in 2015.

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Ordinarily, profits grow when capacity utilization rates rise. For a sample beginning with Q1-1968 and ending in Q1-2014, the yearly changes of (i) the moving yearlong average of core profits and (ii) the industrial capacity utilization rate moved in the same direction in nearly 79% of the 182 quarterly observations. Thus, Q1-2014’s percentage point yearly rise by the capacity utilization rate and its projected 1.1 point average annual increase over the next seven quarters very much disputes a continuation of Q1-2014’s -3.0% yearly decline by core profits, never mind a deeper decline of -3.5% for yearlong 2014.

SENTIMENT WATCH

In my Monday article (click for link) I highlighted how the market’s advance was strengthening and broadening out as the biggest sectors of the market that had lagged for the greater part of the year were beginning to gather momentum and become short-term leaders. Although this is a constructive development, I warned how the market was getting a little overheated as several of my intermediate-timing gauges had reached frothy levels, implying we either consolidate or experience a small pullback.

This was further confirmed this week as a number of major market indices received a Bloomberg TrendStall “sell signal” (see red triangles) as shown below.

market top

(…) The five investment advisers with the best records over the past decade at calling market turns believe stocks are headed higher. They currently are recommending that 83% of their clients’ U.S. equity portfolios be invested in stocks, with the balance allocated to money-market funds. (By contrast, the average figure was 66% for the market timers among the more than 200 advisers tracked by the Hulbert Financial Digest.)

It’s worth considering their views, since each has exhibited a rare ability to capture rallies and sidestep declines in the portfolios they recommend to clients. (…)

But Mr. Schannep says that anxiety about a correction should not dictate investment decisions. “Far more money has been lost by investors trying to anticipate corrections than has been lost in all the corrections combined,” he says, quoting Peter Lynch, who for two decades through the mid-1990s managed Fidelity Magellan, then the top-performing U.S. stock-mutual fund.

How long will the current bull market last before it eventually succumbs to a correction—or worse? Mr. Schannep says it’s impossible to know. He says that indicators are more important than targets, and for now his indicators continue to point up.

Among the other market timers we track, there is concern about the widespread complacency—if not exuberance—currently prevailing on Wall Street. Mr. Sullivan says that optimism isn’t an automatic kiss of death, and that there have been many times in the past when a strongly bullish consensus turned out to be right.

He believes this will be one of those times, since his technical models—both for the shorter and longer terms—are in a bullish mode.

We chose the past decade as the time period over which to identify the best and worst timers, since it includes not only the strong bull market over the past five years but also the punishing 2007-09 bear market. Regardless, the top performers for any period, from as short as the past 12 months to as long as the past 20 years, are bullish.

What’s more, the 10% of market timers with the worst records—when measured over all time periods from short- to long-term—are quite bearish right now, both in their own right and relative to the top-performing timers. To be out of the stock market right now, you therefore have to bet that those timers who in the past have been most wrong are now uncharacteristically going to get it right.

The implication: Stay invested in stocks. Mr. Sullivan believes that this advice applies even to those who have missed out on the run-up in recent years by being in cash. It isn’t too late, in other words, to invest in this bull market, he says. (…)

(…) With a rather anaemic economy, the central bank is willing to trade higher financial instability down the road for greater economic healing in the present; and it believes (or more accurately hopes) that the recent strengthening in macroprudential regulation will prove sufficient to limit such financial instability should it materialise.

All this suggests that, rather than continuously increasing exposure to ever rising markets, it is time for highly exposed investors to gradually take some chips off the table.

They also need to monitor the liquidity of portfolios carefully, as it makes less and less sense to give up their flexibility to reposition for what is a low reward for assuming large liquidity risks. And, in taking long positions in markets, they should guard against falling hostage to a “relative” valuation mindset that overwhelms any assessments of the overall compensation for risk.

In their efforts to promote growth and jobs, central banks are trading the possibility of immediate economic gains for a growing risk of financial instability later. This does not necessarily mean investors should rush for the exits, immediately and in size. But it does call for the type of incremental prudence that today’s marketplace appears overly hesitant to adopt given the recent evolution of market prices.

(…) And with the 2014 calendar nearly half way done, and the macro hedge fund community not only underperforming the S&P 500 for the 6th year in a row, but generating a negative return YTD, what is a macro hedge fund universe to do? Why lose all pretense of being sophisticated fundamental trend pickers and do what Bernanke and Yellen have been forcing everyone to do from day one: go all in stocks of course! According to JPM as of this moment there is no difference in the positioning of both traditional long/short hedge funds and macro funds, both of which have increased their equity exposure to the highest since May 2011!

From JPM:

Our hedge fund beta monitor shows a proxy for Macro and Equity long/short hedge fund equity exposure. This proxy is constructed by the rolling 21-day beta of macro hedge fund returns with respect to returns on the S&P500 index. Macro hedge funds are a $500bn plus universe and account for around 19% of total hedge fund assets. This beta shows that both macro hedge funds and equity long/short hedge funds have increased their equity exposure recently to the highest since May 2011.

What does this mean? Well, unless corporate buybacks are about to have their greatest quarter in history, virtually all the “macro hedge fund” money on the sidelines, to use the most idiotic phrase in existence, was just allocated to stocks in the past three weeks. Which also means that there is nobody left to buy. However, with the global geopolitical situation getting worse by the day, there may suddenly be quite a few willing to sell.

  • Growth is not particularly strong anywhere, but it’s positive everywhere. (ISI)

Meanwhile, some buyers keep seeing value out there…

Priceline Latest in High-Premium Buyers

Priceline Group Inc. has become the latest in a string of companies paying high premiums for acquisitions as the M&A market heats up.

The online travel service agreed to buy restaurant booking service OpenTable Inc. on Friday for $103 a share. That represents a 47% premium to OpenTable’s share price a week earlier. Surprised smile

The premium is higher than the average 34% one-week premium paid by acquirers in deals over $100 million this year, according to Dealogic. That’s up from the 29% average from this point last year. (…)

Priceline’s chief executive Darren Huston said the company’s management spent “a lot of time” evaluating OpenTable and decided the price was worth it.

However, he and finance chief Daniel Finnegan provided few details to analysts in a morning conference call. Mr. Finnegan, for example, said the transaction would be “slightly accretive” this year, but didn’t say by how much.

The $2.6 billion in cash Priceline is paying represents about 51 times forward earnings for the 16-year-old company, which provides online-reservation systems to restaurants.

Let’s hope they have spent enough time evaluating because they are paying $2.6B in cash! Hopefully, the fact that it is “slightly accretive” was not the clincher. Cash earns so little these days that just about any deal using cash is accretive (PCLN is full of cash). The key question to PCLN management is what does the deal do to return on capital.

PCLN sells at 5.5x assets which return 21%. It is buying OPEN at 7.7x assets returning 11%. Better have lots of synergies to offset the dilution…

Winking smile Chart Of The Day: All The President’s Golf Games

 

For his defense, George W. was busy reading.

NEW$ & VIEW$ (13 JUNE 2014)

Sluggish Retail Sales Cloud Hopes for Breakout Growth

Retail and food sales rose a seasonally adjusted 0.3% from the prior month, the Commerce Department said Thursday. That largely reflected a 1.4% jump in auto sales. Sales of other goods rose just 0.1% from April.

March and April saw stronger spending as the economy rebounded from a harsh winter. Retail sales—not adjusted for inflation—over the past three months were up 4.3% from a year earlier, on par with the 4.2% rise in sales during 2013 but lagging behind the 5.1% rise in 2012. (…)

May retail sales were lower than economists had expected, but April sales were revised up to a 0.5% gain from the initial estimate of 0.1%.

Don’t be mislead by headlines, sales are strong: +1.5%, +0.5% and +0.3% in the last 3 months. That’s +9.5% annualized. “Control” sales (ex autos-related and building supplies), last 3 months sales are up 4.9% annualized. Markit agrees:

imageRetailers are on course for their best calendar quarter in terms of sales for over three years, providing further evidence that the US economy is warming up from the cold spell earlier in the year. So far in the second quarter, retail sales are up 2.0% on the first quarter, which would be the strongest quarterly gain since the first quarter of 2011.

The increase follows a modest 0.2% rise over the first quarter as a whole, a weakening that had been widely linked to shoppers being deterred by extreme winter weather across many states.

Weekly chain store sales continue to show Y/Y growth rates in the 2.7% range, up from the 1.5% range during the first 4 months of the year:

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WSJ Survey: Economists Optimistic Stage Is Set for Pickup in Wage Growth Economists are increasingly looking for wage growth to pick up in coming months, a long-awaited development that would put more money in the pockets of consumers and could spur accelerated growth in the broader economy.
U.S. Producer Prices Fall 0.2% in May A gauge of U.S. inflation ticked lower last month, a sign that price pressures remain tame amid subdued economic growth.

May producer prices were up 2% from a year ago.

May’s report showed inflationary pressures slackening after building in the prior two months. Producer prices in April rose 0.6% from the prior month and 2.1% from a year earlier. April’s annual pace of increase was the fastest in two years.

Weakening inflationary pressures were broad based in May, though the price declines were led by food and energy prices. Excluding food and energy, May producer prices were down 0.1% on the month.

U.S. Import Prices Up Slightly on Oil Costs U.S. import prices posted the first year-over-year gain in nearly a year last month, a sign of a slight increase in inflation pressures across the U.S. economy.

U.S. import prices increased 0.1% from the prior month, the Labor Department said Thursday. From a year earlier, prices were up 0.4%—the first annual gain since last July.

Nonpetroleum import prices declined 0.1% on the month. (…)

The small gain in consumer prices coincides with costs for products imported from China increasing 0.3% in May. That was the largest monthly increase since October 2011. Still, from a year earlier prices for Chinese goods are up only 0.5%. (…)

Non-petroleum import prices are down 0.1% in the last 3 months.

Container Exports Weak

imageOcean container exports fell 1.5 percent in May after falling 8.7 percent from March to April. Exports to China ticked up 1.4 percent this month after four months of decline, but are still 31.5 percent lower than just five months ago. Domestic demand in China has been slower than predicted. Additionally, exports to the Asian
region as a whole, including Taiwan, South Korea, Japan and Singapore, experienced double‐digit declines. Exports dropped to 16 of our top 25 trading partners in May. Overall, ocean container exports have fallen 7.3 percent in 2014.

The International Longshore and Warehouse Union (ILWU) is engaged in contentious labor talks with the Pacific Maritime Association as their current contract expires at the end of June 2014. It is unlikely that these issues will be settled before the contract expires, so many shippers are accelerating orders in anticipation of service disruptions. In fact, carriers serving West Coast ports have already announced a congestion surcharges between $800 to $1,000 in the event of a work stoppage or slowdown. The last ILWU contract dispute, in 2012, resulted in a 10‐day work shutdown before the President invoked the emergency provisions of the Taft‐Hartley Act to force everyone back to work. Expect to see an uptick in containers moved in June and even early July as workers are likely to continue to work without a contract if talks are still progressing. Canadian ports are the likely benefactors in the event of a strike U.S. (Cass)

Mixed Picture for China Economy China’s economy is struggling to find equilibrium, with government stimulus measures gaining traction last month while the vital housing market continues its swoon.

(…) Value-added industrial production, which measures an economy’s manufacturing, mining, utilities and other output, rose 8.8% in May from a year earlier, compared with the 8.7% year-over-year increase in April, according to the National Bureau of Statistics. Industrial production also increased 0.71% in May from April, bureau data showed. In April, it climbed 0.82% from the preceding month. (…)

Retail sales posted a 12.5% rise from the year-earlier period, slightly better than an 11.9% year-over-year increase in April, according to the bureau.

Housing sales in the five months ended May fell 10.2% year-over-year to 1.97 trillion yuan ($317.3 billion). This compares with sales of 1.53 trillion yuan in the four months ended April–down 9.9% from the same period of 2013. The statistics bureau doesn’t issue data for individual months.(…)

Property investment in the first five months of this year rose 14.7% to 3.07 trillion yuan compared with 16.4% growth in the first four months, while construction starts in the January-May period measured by project size fell 18.6% to 599.1 million square meters. This compared with a decline of 24.5% to 311.8 million square meters in the first four months. (…)

On other fronts, fixed-asset investment in nonrural areas of China rose 17.2% in the January-May period compared with the same period a year earlier. The rise in the closely watched indicator of construction activity was a tad slower than the 17.3% increase recorded in the January-April period.

More from the WSJ:

The labor market, which is difficult to gauge because of defects in official government measures, seems to be holding up, if not robust. A quarterly survey of over 4,000 employers by Manpower Group found the hiring outlook eroded slightly, but remains above six-month ago levels. Zhaopin.com, an online recruitment firm, said job listings in May grew 41% from a year earlier.

The leveling off is thanks to a series of government measures. A slight loosening of the lending taps saw credit growth, known as total social financing, rebound in May. There was also accelerated government spending, which grew 25% last month over last year’s level, after rising just 10% through the first four months of the year. That fed into increased spending on infrastructure projects. A rebound in exports, supported by the yuan’s weakness this year also might be at play.

The crucial property market continues to suffer, though slightly less than before. New-home sales declined 11% in May compared with a 15% decline in April. Property starts dropped 7.9%, less dire than April’s 15% drop and March’s 22% drop. That said, unsold inventory of apartments rose again last month, and is now a quarter higher than a year ago. Prices have only started to drop in many cities.

Chinese Cities Quietly Loosening Shackles on Housing

Shh! As the country’s property market starts to deflate, China’s cities may be relaxing their property curbs. But it doesn’t mean they want too many people to know about it.

(…) Larger Chinese cities like Shenyang are relaxing their property policies, but want to do so quietly. Officials are loath to publicize their efforts to ease curbs for fear it would seem a tacit acknowledgement that the local economy has hit the rocks.

This week, Shenyang—an economic hub and the capital of north China’s Liaoning province—grabbed the spotlight in local news and online, after property consultants and agents said that the city had revoked restrictions on multiple home purchases. (…)

Commodity-Backed Loans Add to Surge in China’s Borrowing

(…) As Chinese authorities tightened credit at home in the past year, local firms instead looked abroad for financing. Asian-Pacific banks alone had $1.2 trillion in loan exposure to China at the end of 2013, up two-and-a-half times from 2010, according to Fitch Ratings.

A chunk of the borrowing has been by Chinese firms taking out short-term overseas loans backed by commodities, part of an effort to lock in gains by borrowing offshore at lower rates, and investing the money at higher rates on the mainland.

This lending has complicated Chinese policy makers’ attempts to slow rapid credit growth in the nation’s so-called shadow banking sector, a network of lenders outside of formal channels. Because many of the loans are denominated in foreign currencies, the use of offshore funds could also increase borrowing costs for Chinese companies if the yuan depreciates further this year. (…)

Foreign banks have stepped up commodity-backed lending to China in recent years, a profitable business that now is looking increasingly shaky. These banks, including Standard Chartered STAN.LN -1.69% PLC and Citigroup Inc., C -1.11% have made loans worth hundreds of millions of dollars backed by collateral held in Qingdao port, according to people familiar with the matter. A portion of these loans were made to entities linked to Decheng Mining Ltd., a Qingdao trading company, the people said. The lenders are trying to determine whether Decheng Mining used the same collateral for multiple loans. (…)

Concerned by developments—and the possibility of widespread multiple pledging of collateral—foreign banks have begun to withhold new letters of credit used in commodity-backed lending, Western bankers and Chinese metal traders say. (…)

Chuck Clough on China

(…)  it is clear that the boom in China’s “shadow banking” has raised much concern but, as HSBC reported recently, the size of this sector is still small relative to the size of the Chinese economy. Shadow banking in China is just 25.8% of GDP as compared to 165.9% in the United States, 183.7% in the Euro area and even 354.4% in the UK. Therefore, we see no reason to panic and believe that the current challenges need to be put into perspective. China’ economic conditions are certainly not ideal but they look less fragile than in the past and the risks were much higher in previous crisis than now. China is now much more able to respond to shocks: the fiscal policy could be flexible if needed, since public finances look healthy. The average budget deficit has been just 1.2% of GDP since 1980 and government revenues grew 18.6% per year between 1994 and 2013 – faster than the 15.1% nominal GDP growth. Foreign reserves have now reached almost $4.0 trillion, and even monetary policy could be loosened if necessary as the large commercial banks reserve requirement ratio stands at a 20% high level.

The government’s bottom line is employment, which for now remains strong. We know that according to current calculation, each percentage point of real GDP growth creates 1.6mn jobs. A 7% GDP growth rate remains the minimum growth rate to absorb the 7 million new graduates arriving to the labor market every year plus other new job seekers and maintain stable unemployment. Urban unemployment remains very low at around 4.3%. So this looks to be the floor under which we can expect that the growth rate of the economy for now. This also explains why the government intends to give a more decisive role to the private sector since it is estimated to generate 90% of new jobs created in the country and account for 80% of urban employment. We expect more measures in favor of the expansion of the private sector to be announced in coming months. As they will contribute to support the economy, they should be welcome by investors whose sentiment
currently looks disconnected from the reality.

In the U.K.:
SENTIMENT WATCH

Rothschild Wealth Management:

Although valuations are starting to look stretched following an extended period of strong returns, we continue to favour equities as the most attractive asset class for the following reasons:

  • Abundant liquidity and repressed interest rates in our “muddling through” and “economic renaissance” scenarios continue to support the markets.
  • Improved earnings prospects in our “economic renaissance” scenario should also boost equity prices despite the prospect of higher interest rates.
  • This pattern applies particularly to the US market. It is the most overvalued region but equity prices could continue to rise if our “economic renaissance” scenario becomes increasingly likely.
Equity bulls rest case on low inflation Risks to watch for are higher oil prices and lower euro

(…) From the perspective of bulls, all the ingredients for an extended rally over the summer are blending nicely.

The improving tone of the economy, led by the jobs market, is behind much of the recent optimism for equities, with investors more confident that growth during the second half of the year will rise north of 3 per cent. Even this week’s disappointing retail sales report for May was mitigated by an upward revision for the prior month.

Helping investors look on the bright side of each data release is their faith that current valuations for the S&P look appealing once the low level of inflation is taken into account. With earnings growth still forecast to rise sharply in the second half of the year, valuations are seen having the capacity to run higher, providing a tailwind for the market.

Scott Minerd, global chief investment officer at Guggenheim Partners, says past periods of inflation running below 2 per cent have been accompanied by the average price to earnings ratio being around 19.6 times, versus the current ratio of 17 times. (…)

Punch Sounds like somebody has heard of the Rule of 20…

Benign Fed policy entails keeping market volatility anchored near its present low level, while a current market mantra among bulls states how, in past interest rate cycles, the S&P has rallied some 20 per cent during the year before rate hikes finally begin.

The current supportive tone of central bank policy in the US, and particularly in the eurozone, matters greatly for equity sentiment. Another talking point at the moment is how bull markets usually end at the hand of rate hikes or, in the words of Sir John Templeton, “mature on optimism and die on euphoria”. (…)

The obvious question is what are the bulls missing? While the usual suspects for a hefty market correction appear dormant, what other forces could spark a bumpy summer?

For starters, rising oil prices and a sharply weaker euro could jolt equities, argues Nicholas Colas at ConvergEx Group. (…)

A dramatically weaker euro in the region of $1.20 will reduce unhedged foreign earnings for a host of large-cap S&P 500 companies. (…)

Sad smile Short-Term Breakout for Oil

As shown in the chart below, oil has had trouble getting above the $105 level so far this year.  $105 has finally broken today, though, as the situation in Iraq has traders bidding the commodity up.

Looking at oil from a longer-term perspective shows that it has a few more resistance hurdles to clear before a major breakout occurs.  That being said, it has been making lower highs and higher lows for the past few years, which eventually leads to a big move in one direction or another when the channel breaks.  If it breaks to the upside, watch out.