I am nervous. I think it’s nervous time. While the market is probably okay, it’s getting dangerous. I’m not saying go short. Just don’t go too friggin long. (David Tepper, Appaloosa Management)

Declining long-term interest rates are making people nervous. The weak housing market helps in that regard.

U.S. HOUSING

U.S. Housing Starts Rose 13.2% in April

Housing starts rose 13.2% in April to a seasonally adjusted annual pace of 1.07 million, the Commerce Department said Friday, though the bulk of the gain came in the volatile multifamily segment. The overall gain was still the strongest showing in five months.

Newly approved applications for building permits, a bellwether of future construction, grew 8% in April from the prior month to a pace of 1.08 million, reaching the highest level since summer 2008. (…)

Much of the demand for new homes has been coming from upper-end buyers rather than those purchasing their first home. The median price of a new home rose to $290,000 in March, the highest level on record, as builders targeted wealthier borrowers, according to an earlier government report. Many first-time buyers, who may have blemishes on their credit records, have a hard time getting a mortgage, so builders have been focusing on larger, more expensive homes. (…)

In Friday’s report, housing starts were up 26.4% from a year earlier. The pace of construction for March was revised lower, showing a 2% gain from the previous month, compared with an initially reported 2.8% increase.

The overall increase in housing starts was fueled by a jump in multifamily homes rather than the single-family market, which provides a bigger lift to the overall economy.

The figures for multifamily homes, including condominiums and apartments, are volatile from month to month. Construction of multifamily homes with at least two units rose by nearly 40% in April, the report said. Construction of single-family homes was up 0.8%, reaching the fourth-highest level since the start of 2009. (Charts below from Haver Analytics)

 

Single family housing needs first-time buyers to get going, However, …

• …Logan Mohtashami, senior loan manager at AMC Lending Group, says first-time homebuyers are struggling to buy homes because they have high debt levels and many of them cannot afford the 20% down payment that is now required. He says the first part of 2014 has been one of the worst times for this category of buyer that he has seen in 14 years. (Bloomberg interview) (H/T Doug Short)

• …Congratulations to Class of 2014, Most Indebted Ever

The average Class of 2014 graduate with student-loan debt has to pay back some $33,000, according to an analysis of government data by Mark Kantrowitz, publisher at Edvisors, a group of web sites about planning and paying for college. Even after adjusting for inflation that’s nearly double the amount borrowers had to pay back 20 years ago.

 

Meanwhile, a greater share of students is taking on debt to finance higher education. A little over 70% of this year’s bachelor’s degree recipients are leaving school with student loans, up from less than half of graduates in the Class of 1994.

The good news for the Class of 2014 is that they likely won’t hold the title of “Most Indebted Ever” very long. Just as they took it over from the Class of 2013, the Class of 2015 will probably take it from them.

But as the debt burden of college graduates continues to rise faster than inflation, it begins to complicate the question of whether a bachelor’s degree is worth the expense. So far, that answer is a firm “yes.” College graduates have a lower unemployment rate and make more money than their contemporaries without a degree. Of course, some majors pay more than others, but in just about every industry workers with college diplomas are paid more than their counterparts without one. And the more education a person has, the greater the pay advantage becomes. (Although, that also often means more loans. “About 15% of graduate and professional school students graduate with six‐figure student loan debt, compared with only 0.3% of undergraduate students,” Mr. Kantrowitz says.)

But will the debt associated with a college degree always be worth it? That’s a little less clear. “A good rule of thumb is that undergraduate and graduate students should borrow no more for their entire education than their expected salary at graduation,” Mr. Kantrowitz says. For the average borrower, that’s still a pretty good bet right now. Granted, not everyone has the same debt, and not everyone gets a job at graduation. But if we compare student debt for young college graduates and salaries for young people with degrees, we can get a sense of where we stand.

(…) A report this week from the New York Fed looked at how student debt is affecting entry into the housing market. Researchers Meta Brown, Sydnee Caldwell, and Sarah Sutherland found that a smaller proportion of people at age 30 have mortgages than at any time in a decade. But for the first time starting in 2012, having student loans made it less likely that a 30-year-old would have a mortgage. (…)

Housing, an important driver of overall economic growth, has bounced back from the lows following the recent recession. Mortgage debt increased in 2013, according to separate research from the New York Fed, which is good news for the overall economy. But all of the growth came from people under 40 years old. If student debt is putting a ceiling on that growth, it’s bad news for the broader economy.

Why Interest Rates Are Falling

(…) The macroeconomist’s explanation is that the U.S. economy isn’t improving as quickly as hoped, and that the Federal Reserve is recognizing this by stressing the need for ongoing policy accommodation rather than any rush to raise short-term rates.

Markets expect the European Central Bank to start another round of quantitative easing soon, which trimmed Italian 10-year bond yields to 2.9% last week and German yields to 1.3%. Surely, Treasuries offer better value than either. Meanwhile, stocks are stalling, pension funds keep buying longer-dated bonds, and the conflict between Russia and the Ukraine hasn’t gone away.

Market insiders, however, say technical factors were mainly responsible for last week’s bond surge. Investors had broadly braced for rising rates by betting against Treasuries, the way one might short a stock, by selling borrowed securities and hoping for a price decline before buying them back to repay the loan. As bond yields kept falling, and prices kept rising, investors got nervous and bought bonds to close out those short positions and prevent further losses. Apply this behavior broadly and you get a short squeeze on the order of what we saw last week.

The rally is a boon for bondholders for now, but with rates stuck in a rut, bond mavens are increasingly telling investors to keep their future return expectations low – very low. Bill Gross, chief investment officer of Pimco, last week warned that bond investors should expect roughly 3% annual returns over the next five years. He thinks the 10-year Treasury yield will only rise to 2.7% by year-end, while Pimco predicts a “new neutral” scenario in which persistently sluggish global growth induces central banks to keep policy rates lower for longer than many currently expect.

“The journey to the ‘new neutral’ doesn’t come easy to savers one way or the other,” Gross told Barron’s on Friday. “Either you’re looking at a 2% federal funds rate over the long term, keeping yields low, or else the Fed raises the rate… to 4% and does damage to bond prices in the near term. The only way investors can beat this is to lever this extraordinarily low borrowing rate and become a borrower rather than a saver.”

Gross says leverage comes in many forms, in everything from hedge funds to closed-end funds, noting that most corporations have some sort of balance sheet leverage, making stocks effectively leveraged too. He sees prudent use of such leverage as the way to eke out anything resembling a decent return across asset classes in the coming years.

“You’re looking at returns of 3% to 5%, unless you’re taking extraordinary risk in terms of leverage or quality,” Gross says. “It’s too bad for investors.”

GERARD FITZPATRICK, CHIEF fixed-income investment officer at Russell Investments, says bonds’ recent strength underscores how quickly market sentiment can shift.

“The fear trade is to buy Treasuries,” he says. “If you’re short [Treasuries], there’s a flight-to-quality risk that could be sparked from anywhere in the world, and at any moment that flight to quality can wipe out the longer view that rates will rise.”

So the “new normal” has just given way to the “new neutral”. I have done equities all my working life but may I humbly submit that for most investors, most of the time, bonds are held to earn a positive return after inflation neighbouring 2-3%.

But what do I know? And why am I showing my age like that? In this week’s Barron’s Income Investing column, three fixed income strategists display today’s analytics for bonds investing, citing things like “cleaner positioning”, “short covering”, “short duration position”, “thematic investing”, “derisking” and, best of all,  “downside consolidation”. Downside consolidation? Guru stuff, evidently.

Another guru, the father of the “new normal”, explains the unexpected drop in global interest rates:

Mohamed El-Erian: ‘Lowflation’ serves up bond market surprise

(…) Three major factors have come together to deliver such unexpected outcomes.

First, persistent concerns about the failure of American and European growth to “lift off” – including last week’s sluggish first-quarter eurozone data – have been amplified in recent weeks by spreading worries about “lowflation”. That is, inflation that is too low for too long and, as a result, risks pulling the rug from underneath inflationary expectations. (…)

Second, central banks have signalled continued willingness to repress interest rates longer in order to stimulate growth and reduce the threat of deflation. The ECB is expected to introduce a new range of stimulus measures when its governing council next meets on June 5. Mark Carney, governor of the Bank of England, reiterated last week that he is in no rush to raise interest rates notwithstanding concerns about a booming housing market.

Meanwhile, across the Atlantic, while the Federal Reserve is phasing out its monthly asset purchases, officials are strengthening their forward policy guidance that seeks to keep interest rates abnormally low for an even longer period.

Third, market positioning has turbocharged economic and policy factors. Few traders were ready for lower interest rates, let alone a flatter yield curve. As such, the recent yield moves have triggered market stops, forcing them to buy bonds to limit their mounting losses. Meanwhile, the lower the interest rates, the harder it has become for some long-term institutional investors to remain underweight bonds given the longer-dated nature of their liabilities.

(…) Sudden drops in interest rates raise concerns about the health of the global economy, leading to fundamentally-driven sell-offs in equities and other risky assets – a worry that is amplified by the extent to which the earlier equity rally had decoupled prices from more economic sluggish conditions. (…)

Since we’re with gurus, Ben Bernanke surely knows what’s going on:

In a series of quarter-million-dollar dinners with wealthy private investors, Ben Bernanke has been clearer than he ever was as chairman of the Federal Reserve on his expectations that easy-money policies and below-normal interest rates are here for a long time to come, according to some of those in attendance.

Bernanke, who retired from the U.S. central bank in January, has predicted the Fed will only very slowly move to raise rates, and probably do so later than many forecast because the labor market still has a lot more room to recover from the financial crisis and recession. (…)

At least one guest left a New York restaurant with the impression Bernanke, 60, does not expect the federal funds rate, the Fed’s main benchmark interest rate, to rise back to its long-term average of around 4 percent in Bernanke’s lifetime, one source who had spoken to the guest said. (…)

Another dinner guest was moved when Bernanke said the Fed aims to hit its 2 percent inflation target at all times, and that it is not necessarily a ceiling.

“Shocking when he said this,” the guest scribbled in his notes. “Is that really true?” he scribbled at another point, according to the notes reviewed by Reuters. (…)

“He’s being paid … for sharing his wisdom and predictions, and presumably not to exert his influence on the Fed,” he added. This will go on “until he’s proven to not be all that clairvoyant.” (Reuters)

Now, here’s my FREE comment: Ben has been very wrong before and, unless Americans start moving again, there are signs that he may be wrong again. A few of these signs for your own consideration:

• Jobless rates fall below 6% in half of U.S. states as hiring picks up

(…) Twenty-five states now have unemployment rates of 5.9 per cent or lower. The Federal Reserve considers “full employment” to be between 5.2 per cent and 5.6 per cent. Rates at that level are considered “full employment” because if they fell lower, inflation could rise. But the relationship isn’t exact. The national rate fell to 3.9 per cent in late 2000 without causing a spike in prices. (…)

Hmmm…here’s what really happened in 2000: as the unemployment rate kept declining, inflation actually spiked from 1.5% to nearly 4% in 18 months. It declined when the u-rate spiked back up during the recession.

Digging deeper into the BLS data, one would find that 31 states had a u-rate below the 6.3% national average in April and their u-rate averaged 5.0% (unweighted). The Globe & Mail article adds:

Many of the states with low unemployment are small. North Dakota continues to have the lowest rate nationwide at 2.6 per cent. Vermont’s rate of 3.3 per cent is the next lowest.

But some larger states are also seeing improvement. Texas’ unemployment rate fell to 5.2 per cent in April from 5.5 per cent in March. Employers added 64,100 jobs last month, the most of any state.

The unemployment rate in Pennsylvania, the nation’s sixth-largest state by population, declined to 5.7 per cent from 6 per cent as the state gained nearly 11,000 jobs. Ohio, the seventh-largest, saw a similar improvement. Its rate fell to 5.7 per cent from 6.1 per cent, with employers creating 12,600 new jobs.

One more sign,

• this one contributing to the hot and important debate on whether “the labor market still has a lot more room to recover” as Bernanke puts it. In other words, are there structural factors behind the decline in the labor participation rate? Here’s a good NPR story on the The startling rise of disability in America (thanks Michel). A few excerpts:
• In the past three decades, the number of Americans who are on disability has skyrocketed. The rise has come even as medical advances have allowed many more people to remain on the job, and new laws have banned workplace discrimination against the disabled.
• The vast majority of people on federal disability do not work. Yet because they are not technically part of the labor force, they are not counted among the unemployed.
• As far as the federal government is concerned, you’re disabled if you have a medical condition that makes it impossible to work. In practice, it’s a judgment call made in doctors’ offices and courtrooms around the country. The health problems where there is most latitude for judgment — back pain, mental illness — are among the fastest growing causes of disability.
• Over and over again, I’d listen to someone’s story of how back pain meant they could no longer work, or how a shoulder injury had put them out of a job. Then I would ask: What about a job where you don’t have to lift things, or a job where you don’t have to use your shoulder, or a job where you can sit down? They would look at me as if I were asking, “How come you didn’t consider becoming an astronaut?”
• There used to be a lot of jobs that you could do with just a high school degree, and that paid enough to be considered middle class. I knew, of course, that those have been disappearing for decades. What surprised me was what has been happening to many of the people who lost those jobs: They’ve been going on disability.

Part of the rise in the number of people on disability is simply driven by the fact that the workforce is getting older, and older people tend to have more health problems. But disability has also become a de facto welfare program for people without a lot of education or job skills. (…) Once people go onto disability, they almost never go back to work. (…) People who leave the workforce and go on disability qualify for Medicare, the government health care program that also covers the elderly. They also get disability payments from the government of about $13,000 a year. This isn’t great. But if your alternative is a minimum wage job that will pay you at most $15,000 a year, and probably does not include health insurance, disability may be a better option.

• As I got further into this story, I started hearing about another group of people on disability: kids. People in Hale County told me that what you want is a kid who can “pull a check.” (…) Then I looked at the numbers. I found that the number of kids on a program called Supplemental Security Income — a program for children and adults who are both poor and disabled — is almost seven times larger than it was 30 years ago.
• A person on welfare costs a state money. That same resident on disability doesn’t cost the state a cent, because the federal government covers the entire bill for people on disability. So states can save money by shifting people from welfare to disability.

Another sign, from real life:

• Alcoa, USW Reach Labor Deal Alcoa said it had reached a tentative new labor deal with the United Steelworkers union covering 6,100 workers at 10 U.S. plants.

The five-year contract guarantees raises of 2.5% for each of the first three years and 3% for the final two years, according to United Steelworkers officials. In addition, current workers will retain company pensions and new hires will be offered pensions rather than private 401(k) investment plans. Union officials said health-care premiums, which the company sought to increase, were kept at current levels.

FYI, in the previous two 4-year contracts, Alcoa employees opted to protect benefits over wages. The balance of power seems to have shifted enough for workers to gain on both wages and benefits this time around. And it’s not because the aluminum industry, or Alcoa itself, are enjoying such a great time…

BTW, unit labour costs, the price of labour per single unit of output, surged at a 4.2% rate in the first quarter of 2014. But, no worry, that was because of the weather.

If I were Bernanke’s biz manager, I would advise him to give as many $250k speeches as he can. Demand sometimes simply disappears.

Meanwhile, demand for credit is reaccelerating:

And capex appears finally set to grow faster:

Corporate America is planning a big boost in capital spending. Some 250 companies accounting for much of last year’s capital spending have released their capex plans this year, and together that suggests capital spending could increase by 7% in 2014, notes Goldman Sachs strategist David Kostin, up from 2% last year. The spenders include a who’s who of American corporations, including Ford Motor , which said it would increase spending by 14% this year. (Barron’s)

Also making people nervous:

China Housing Deal Points to Dangers

(…) The convoluted financing of the Laodong Road housing project, pieced together through stock-exchange filings and information on corporate websites, shows the deepening connections among three of the fastest-growing and most worrisome parts of the Chinese financial system: local-government debt, corporate borrowing and shadow banking.

Called build-transfer, the strategy employed by Anshan has become increasingly popular among heavily indebted local governments. The use of shadow banking to fund local-government expenditures has also surged.

“The issue in China, whether it’s build-transfer or even shadow banking, isn’t the size of the industry or volume of debt; it’s the fast growth and the lack of regulation, provisions and capital reserves,” said Sam Le Cornu, senior portfolio manager at Macquarie Investment Management in Hong Kong.

Local-government debt in China grew by 67% from 2010 to 2013, and build-transfer transactions and trust products accounted for 40% of that growth. The two now account for 16% of local-government debt, up from zero in 2010.

Corporate borrowing in China rose 97% from the end of 2009 to the third quarter of 2013, according to the Bank for International Settlements. The use of build-transfer has boosted that debt. Net debt at the builder of the Laodong Road project, Metallurgical Corp. of China Ltd., has nearly doubled since 2008.

The project also shows how borrowers can get funding when state-owned banks say no. Anshan got financial help from two state-owned companies. MCC, a state-owned engineering, construction and mining company, agreed to the build-transfer arrangement and developed the project, while state-owned financial conglomerate Citic Group set up the trust to pay back MCC. (…).

EARNINGS WATCH

From Facstet:

With 93% of the companies in the S&P 500 reporting actual results for Q1 to date, the percentage of companies reporting EPS above estimates is above recent historical averages, while the percentage of companies reporting revenue above estimates is in line with recent historical averages.

Overall, 467 companies have reported earnings to date for the first quarter. Of these 467 companies, 75% have reported actual EPS above the mean EPS estimate and 25% have reported actual EPS below the mean EPS estimate. The percentage of companies reporting EPS above the mean EPS estimate is above the 1-year (71%) average and above the 4-year (73%) average.

In aggregate, companies are reporting earnings that are 5.3% above expectations. This surprise percentage is above the 1-year (+3.1%) average, but below the 4-year (+5.8%) average. If this is the final percentage for the quarter, it will mark the highest earnings surprise percentage since Q1 2012 (5.3%).

The blended earnings growth rate for Q1 2014 is 2.1%.

In terms of revenues, 54% of companies have reported actual sales above estimated sales and 46% have reported actual sales below estimated sales. The percentage of companies reporting sales above estimates is equal to the 1-year (54%) average, but below the 4-year average (58%).

In aggregate, companies are reporting sales that are 0.7% above expectations. This surprise percentage is above the 1-year (+0.3%) average and above the 4-year (+0.6%) average.

The blended revenue growth rate for Q1 2014 is 2.7%.

For Q2 2014, Q3 2014, and Q4 2014, analysts are predicting earnings growth rates of 5.9%, 9.7%, and 10.1%. For all of 2014, the projected earnings growth rate is 7.8%.

At this point in time, 93 companies in the index have issued EPS guidance for the second quarter. Of these 93 companies, 67 have issued negative EPS guidance and 26 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the first quarter is 72%. This percentage is above the 5-year average of 65%, but below the percentage recorded for Q1 2014 at the same point in time (81%).

Five companies preannounced last week. all negative. Nonetheless, the 26 positive preannouncements are the best we have had over at least 2 years and the 72% negative ratio is the lowest over that period.

This may explain why Q2 estimates have only declined 1.0% since March 31.

During the past year (4 quarters), the average decline in the EPS estimate through the mid-point of the quarter has been 2.7%. During the past five years (20 quarters), the average decline in the EPS estimate through the mid-point of the quarter has been 1.6%. During the past ten years, (40 quarters), the average decline in the EPS estimate through the mid-point of the quarter has been 2.7%. Thus, the decline in the EPS estimate recorded through the mid-point of the Q2 2014 quarter was lower than the trailing 1-year, 5- year, and 10-year averages.

In fact, this marks the lowest decline in the bottom-up EPS estimate during the first half of a quarter since Q2 2011, when the bottom-up EPS estimate actually increased by 1.5%.

Trailing 12-m EPS are now $108.94 (as per S&P) and are forecast to rise 10% to $119.81 for all of 2014. On that basis, the Rule of 20 P/E is now 18 (20 minus inflation of 2.0%), giving a fair value level of 1960 for the S&P 500 Index, 5% above current levels. If estimates hold, fair value would rise to 2155 by February-March 2015, 15% above the Index current level. This is pretty appealing given that the U.S. economy seems to be strengthening. Importantly, even though analysts estimates for Q2 are implying that net margins will rise from 9.6% last year to a new record of 10.1%, corporate managers do not seem anxious to reign in these optimistic estimates, at least so far.

Such earnings acceleration would help mitigate the impact that rising inflation is having on P/E ratios. If inflation rises to 2.5% during the next 6 months, the Rule of 20 P/E would decline to 17.5x but that would still imply 2100 on the S&P 500 Index (on expected EPS), 12% above current levels. However, how the Fed would react to such a trend has yet to be “communicated” to market participants .

SENTIMENT WATCH

There are many ways to skin a cat. Here’s the gloomy narrative on earnings:

Corporate Earnings Leave U.S. Stocks Wobbly

Behind the stock market’s anxious ups and downs of late lies the fear that a weakening U.S. and global economy could dash hopes for an uptick in corporate earnings.

For the first quarter, earnings season is nearly done. More than 90% of big companies have reported results and they were lackluster.

Most beat analyst estimates, but only because expectations were rock bottom.

Profit gains for S&P 500 companies were just 2.1% overall compared with a year earlier, well below the previous quarter’s 8.5% rise, FactSet said.

Now investors are seeing soft reports on industrial production, housing starts, consumer sentiment and European economic growth, and they are growing anxious.

Investors had expected results to improve in the second quarter. Analysts are forecasting a 6% profit gain.

Yet of companies offering guidance, 72% have warned that second-quarter results could fall short of Wall Street expectations, which isn’t great but is better than the 80% level of the past three quarters.

Now, investors are worrying they may have been too hopeful. (…)

Hopes that future earnings would benefit from improved U.S. and world economic growth helped major stock indexes inch up to new records this spring. But the latest economic data have showed weakness in Europe and China.

Now, the U.S. indicators look uncertain as well. Especially troubling to market veterans was the sharp decline in yields of U.S. Treasury bonds. If the economy were strengthening, they reasoned, market interest rates should be rising.

That is especially true because the Federal Reserve is gradually ending the bond-buying program that helped hold down Treasury yields. Instead, yields have fallen: The yield of the 10-year Treasury note was 2.52% Friday, down from 3% at the start of the year. Yields fall as prices rise.

“I think the bond market is a better leading indicator than the stock market,” said David Joy, chief market strategist at Ameriprise Financial Inc., which oversees $783 billion.

Mr. Joy still counts himself among the optimists who expect the U.S. economy to rebound from its weather-damped first quarter. Unlike Mr. Pavlik, he hasn’t changed his investment recommendation.

But he is growing concerned and is reminding people to keep investments balanced among holdings such as stocks, bonds and cash, “in case I am wrong.”

Many already are hunkering down.

Global money managers have boosted cash to an average 5% of portfolios from less than 3% at the start of last year, according to a May survey by Bank of America Merrill Lynch. That is the highest cash level since June 2012.

Just 37% reported higher-than-usual stockholdings, down from 45% in April. The percentage taking less risk than normal doubled to 22% from 11% in April.

The money managers said they still expect world economic growth and corporate earnings to improve, but they worried that the gains could be subpar.

They also worried that short-term crises could disrupt markets. Among their biggest concerns: possible business-debt defaults in China or a geopolitical crisis.

(…) For stocks to get out of their funk, investors want proof that the economy and corporate earnings actually are strengthening. (…)

“For stock prices to move higher, you need good economic growth to get those earnings up, and growth is in question now,” Mr. Joy said.

Wall of Worry Rebuilt as Nasdaq Rout Sends Cash to High

(…) Global money managers raised cash holdings to a two-year high this month and say America is the worst place to invest, a Bank of America Corp. survey published last week shows. Investors have pulled about $10 billion from funds that buy U.S. equity this month, set for the biggest outflows since August, according to data compiled by Bloomberg and the Investment Company Institute.

After embracing stocks last year for the first time since the bull market began, individuals are showing signs of reverting to the skepticism that led them to pull more than $400 billion from mutual funds from 2009 through 2012. (…)

Since 2000, there had been 12 instances when money flows to mutual funds turned negative following at least three months of deposits. On average, the S&P 500 was 2.2 percent higher 60 days later, compared with a mean increase of 0.6 percent for all comparable periods, according to data compiled by Bloomberg. (…)

The Internet gauge has slipped 1.2 percent in May, poised for a third month of declines, the longest stretch since 2008. About one-fifth of Nasdaq-listed shares, including Seattle-based Amazon.com Inc. and Whole Foods Market Inc. in Austin, Texas, dropped more than 20 percent this year. (…)

The concern was echoed by Bank of America’s survey of 218 global money managers, who cut U.S. equities in the past month and boosted cash holdings to the highest level since June 2012. Funds held an average 5 percent in cash, according to the survey, which was conducted during the week through May 8. (…)

The proportion of respondents citing the U.S. as the least attractive destination for investments doubled to 18 percent in May from a month ago, Bank of America’s survey found.

Investors prefer Europe, saying their stocks are undervalued, according to the survey. The S&P 500 is trading at 16 times estimated profits, compared with the multiple of 15 for the Stoxx Europe 600 Index, data compiled by Bloomberg show.

Besides lower valuations, European stocks get more support from the central bank, according to Hayes Miller, the Boston-based head of multi-asset allocation in North America at Baring Asset Management Inc. (…)

Investors pulled $7.7 billion out of U.S. equity ETFs in the first half of May, data compiled by Bloomberg show. They withdrew almost $2 billion from mutual funds during the week through May 7, according to an estimate by ICI. In the previous three months, deposits totaled $35 billion.

Reversals like this preceded stock gains nine out of the 12 times since 2000, data compiled by Bloomberg show. The last time fund flows turned negative in January, the S&P 500 advanced 5 percent over the next two months. (…)

Buyout surge pushes prices to new highs European private equity deals average 10.4 times ebitda

In Europe, private equity groups have paid an average price equivalent to 10.4 times earnings before interest, tax, depreciation and amortisation (ebitda) for companies this year, according to Standard & Poor’s Leveraged Commentary & Data. That figure compares with 8.7 times last year, and 9.7 times in 2007 at the top of the credit boom.

US deals have been valued at about 9.2 times on average this year, up from 8.8 times last year and approaching the 2007 peak of 9.7 times.

Blackstone paid 14 times for one-fifth of Italian fashion group Versace in February, and Charterhouse Capital bought US-based teaching software maker Skillsoft in March for 11 times, or $2bn including debt.

Private equity dealmakers from Carlyle’s co-founder Bill Conway to UK-based 3i chief Simon Borrows and EQT’s boss Thomas von Koch of Sweden have recently complained about inflated asset prices, which makes it harder for them to do deals.

“Paying 13 or 14 times ebitda for a good asset is not unusual these days; 12 times is the new 10 times,” says Laurent Haziza, a Rothschild banker who advises private equity groups in Europe. “This is largely due to an unbalance between the amount of cash available for acquisitions, which is high after private equity groups raised new funds, and a poor supply of deals.”

Volumes of buyouts worth more than $500m have shrunk 35 per cent globally to $56bn this year, compared with the same period a year earlier, according to Thomson Reuters. Meanwhile “dry powder” available for acquisitions in buyout funds has risen 11 per cent to $380bn, according to research firm Preqin.

Buyout groups seeking to exit an asset tend to opt for a public listing rather than a sale because stock markets are offering higher valuations – rarefying the source of secondary deals in which private equity groups sell assets to each other. (…)

Debt used to finance deals has increased this year, to 5.5 times ebtida in Europe and 5.6 times in the US, according to S&P’s LCD. That is lower than in 2007, when the figures were 6.12 times and 6.1 times, respectively.

INSIDE INFORMATION

• Jérôme Kerviel turns himself in Ex-Société Générale trader will serve three-year jail sentence

• Former SAC Capital Manager Steinberg Sentenced to 3½ Years in Prison The sentence for Michael Steinberg, the most senior former employee of SAC Capital to be convicted of insider trading, wasn’t as long as prosecutors had wanted.

• Former KPMG Partner Scott London Gets 14 Months for Insider Trading Former KPMG partner Scott London, who pleaded guilty to an insider-trading scheme, was sentenced to 14 months in prison.

• Rajat Gupta Agrees to Surrender to Prison Former Goldman Sachs director Rajat Gupta will begin a two-year sentence on June 17 for leaking corporate secrets Galleon hedge-fund founder Raj Rajaratnam.

Rumour is that together they will shortly launch a new, totally legit fund, based on “inside information”.