Category Archives: Commentary
“Last July, when stocks weren’t doing so hot and the Dow Jones Industrial Average rested below 12,900, Seth Masters, chief investment officer of Bernstein Global Wealth Management, made a bold call.
He predicted the Dow would reach 20,000 by the end of the decade. And he’s sticking to his guns, The New York Times reports, even though the prediction isn’t quite so controversial with the Dow closing at 15,091 Monday.
“It seems we’re somewhat ahead of schedule, but I think we’re still on track for Dow 20,000 by the end of the decade,” Masters told the paper. “The odds have just gotten better.”
He still thinks stocks are cheap as compared with bonds.
“It’s not that the expected return on stock right now is really that high,” he said. “It’s that the return on government bonds is indubitably very low.”
The 10-year Treasury yield stood at 1.92 percent early Tuesday morning.
To be sure, the rise in stocks won’t be straight up, Masters says. “I don’t think the path to Dow 20,000 will be linear. … There will be declines, you can count on that.” …”
During his appearance, he held up a chart from the blog Liberty Street Economics, which is a blog hosted by the New York Fed.
The chart he shows shows the Equity Risk Premium, which is the gap between expected return on stocks vs. bonds.
Based on traditional measures of the Equity Risk Premium (ERP) stocks are about as cheap as they’ve been in 50 years, a function somewhat of ultra-low bond yields.
From the Liberty Street Economics blog, here’s an explanation of the ERP and the chart which shows that stocks are really cheap.
We surveyed banks, we combed the academic literature, we asked economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years. But how do they reach this conclusion? Why is it that the equity premium is so high? And more importantly: Can we trust their models?
The equity risk premium is the expected future return of stocks minus the risk-free rate over some investment horizon. Because we don’t directly observe market expectations of future returns, we need a way to figure them out indirectly. That’s where the models come in. In this post, we analyze twenty-nine of the most popular and widely used models to compute the equity risk premium over the last fifty years. They include surveys, dividend-discount models, cross-sectional regressions, and time-series regressions, which together use more than thirty different variables as predictors, ranging from price-dividend ratios to inflation. Our calculations rely on real-time information to avoid any look-ahead bias. So, to compute the equity risk premium in, say, January 1970, we only use data that was available in December 1969…..”
Asmussen called today for the European Union to create a central agency and a common backstop for handling failing banks by “the summer of next year.” This is in marked contrast to warnings from German Finance Minister Wolfgang Schaeuble that the bloc cannot venture into such territory without changing its current treaties, and should instead target a less ambitious, networked approach.
“We want a single European resolution regime together with a single resolution agency and a single resolution fund that is financed by a levy on the banking industry,” Asmussen told reporters in Brussels before a meeting of EU finance chiefs. This should happen in parallel with the ECB’s planned assumption of bank oversight powers next year, he said.
EU leaders began work on a banking union last year to break the cycle of contagion between nations and their banks that has plagued the euro area since the region’s financial crisis emerged in Greece in 2009. They started by giving the ECB oversight powers, and committed to accompany this with a single “mechanism” for bank failures.
“European policy makers expressed a willingness to consider new ways to revive their ailing economy as they confronted fresh U.S. pressure to take action.
The bloc’s finance ministers and central bankers left weekend talks of the Group of Seven signaling that they’re poised to scale back austerity, are open to increased monetary aid and looking to unfreeze bank lending. European officials will meet in Brussels today to discuss the economy and review aid payments for crisis-struck nations from Greece to Spain.
Europe’s governments are in the midst of a policy rethink after three years of slimming budgets as they face up to a deepening recession in the euro area and a record unemployment rate that’s exceeded 12 percent. Still in doubt for economists is what kind of stimulus will actually be delivered and what effect it could have in the crisis-torn 17-member currency bloc.
“The new ‘fiscal realism’ is in evidence,” Mark Wall, co-chief European economist at Deutsche Bank AG in London, said in a report to clients. “Austerity may have reached its political limits and markets are happy to see some rebalancing. The key remains economic growth.”
Yields on sovereign debt that soared during the crisis have eased with the European Central Bank’s pledge to do whatever it takes to defend the euro. The single currency was little changed at $1.2986 as of 9:03 a.m. today.
“Returns from the U.S. equity bull market that started four years ago are matching those from the last half of the 1990s even as valuations are 28 percent lower.
The Standard & Poor’s 500 Index has gained 26.2 percent annually including dividends since March 2009, the same as during the last 50 months of the technology bubble, according to data compiled by Bloomberg. Shares in the index now trade at 18.6 times annual profit, below the average 25.7 multiple in the 1990s rally led by Internet companies.
For bulls, the valuations show stocks will keep rising after the S&P 500 advanced 164 percent as individuals scarred by the worst financial meltdown since the Great Depression return to equities. Bears say the price-earnings ratios mean investors lack confidence in the economy and corporate profit growth. They also note that the last time returns were this high, the bubble popped and more than $5 trillion was erased from the value of U.S. stocks, according to data from the World Bank.
“The size of this rally’s not what keeps me up at night,” Paul Zemsky, the New York-based head of asset allocation for ING Investment Management, which oversees about $170 billion, said in a May 8 phone interview. “That was a tremendous rallythen, too, but I’m not getting all nervous based on the size of the rally this time, because we’re not there yet in terms of valuation.”
“Now seems like a great time to invest in the stock market, which has continued its bullish ways this year. But then why has stock ownership reached a 15-year low?
Gallup’s annual Economy and Finance survey, conducted April 4-14, found that only 52% of Americans currently are playing the market. That’s the lowest rate since at least 1998, when Gallup began tracking stock ownership. Even that figure is deceptive because about half of Americans who do own stock do so only through pension funds, mutual funds and other accounts they don’t control.
Meanwhile, the Dow Jones Industrial Average reached 15,000 recently, for the first time ever….”
“With U.S. stocks hitting all-time highs and bond yields under pressure, bubble talk is rampant. But you shouldn’t pay any attention to it, according to Princeton economics professor and New York Times columnist Paul Krugman.
In his Friday column, Krugman writes that there “definitely” is no bond bubble and is “probably not” a stock bubble, either.
The Nobel laureate takes a stab at defining a bubble, calling it a situation in which asset prices appear to be based on implausible expectations for the future. Think of dot-com prices in 1999 or housing prices in 2006. In the latter case, housing prices only made sense if you thought home prices would continue to significantly outpace buyers’ income for years.
When it comes to bonds, you wouldn’t want to buy a 10-year Treasury at a yield of less than 2% if you believed the Fed would be raising short-term rates to 4% or 5% soon, notes Krugman notes, who then asks why you’d believe any such thing:
The Fed normally cuts rates when unemployment is high and inflation is low — which is the situation today. True, it can’t cut rates any further because they’re already near zero and can’t go lower. (Otherwise investors would just sit on cash.) But it’s hard to see why the Fed should raise rates until unemployment falls a lot and/or inflation surges, and there’s no hint in the data that anything like that is going to happen for years to come.
There are several reasons for the bubble fears, but one may have something to do with what he describes as a “deep hatred” for U.S. Federal Reserve Chairman Ben Bernanke “and everything he does.” ….”
“Investors are overlooking Facebook‘s potential at their own peril, Leon Cooperman of Omega Advisors said Thursday on CNBC.
“We think that people are underestimating the mobility opportunity that exists in Facebook,” he said. “We think ultimately they could achieve a market cap comparable to a Google, which would make the stock very, very rewarding.” …”
“Global central bankers are poised to ease monetary policy even further after a wave of interest-rate cuts from India to Poland.
As Group of Seven finance chiefs gather in the U.K. today with monetary policy on their agenda, economists at Morgan Stanley and Credit Suisse Group AG are among those predicting policy makers will keep deploying stimulus amid weak global growth, slowing inflation and the need to thwart currency gains.
“Most central banks in our coverage universe still have a bias to ease,” Morgan Stanley economists led by London-based Joachim Fels said in a report to clients yesterday. “Given this disposition, it doesn’t take much in terms of downside surprises in growth or inflation to tip the balance for more central banks to pull the trigger for more easing.”
South Korea’s rate cut yesterday was the 511th reduction worldwide since June 2007, according to Bank of America Corp.’s tally, done before Vietnam and Sri Lanka today said they’re lowering their policy rates. While the liquidity has sent stock markets surging, it has yet to prove as effective in generating economic growth.
“Central banks are our best friends not because they like markets, but because they can only get to their macro objectives by going through the markets,” Mohamed El-Erian, chief executive officer at Pacific Investment Management Co. in Newport Beach, California, said in a May 8 telephone interview. “The hope is that improving fundamentals will validate what central banks have done.” …”
“Degrowth embraces the ongoing devolution of paid work and wealth that cannot be reversed.
The anti-consumerism Degrowth movement is gaining visibility and adherents in Europe. Degrowth (French: décroissance, Spanish: decrecimiento, Italian: decrescita) recognizes that the mindless expansion of mindless consumption fueled by credit and financialization is qualitatively and quantitatively different from positive growth.
Degrowth is based on a number of principles:
1. Consumerism is psychological/spiritual junk food (French: malbouffe) that actively reduces well-being (bien-etre) rather than increases it.
2. Better rather than more: well-being is increased by everything that cannot be commoditized by a market economy or financialized by a cartel-state financial machine– friendship, family, community, self-cultivation–rather than by acquiring more. The goal of economic and social growth should be better, not more. On a national scale, the cancerous-growth measured by gross domestic product (GDP) should be replaced with gross domestic happiness/ gross nation happiness (GNH).
3. A recognition that resources are not infinite, despite claims to the contrary. Even if fossil fuels were infinite and low-cost (cheerleaders never mention costs of extraction and refining or the external costs), fisheries, soil and fresh water are not. For one example of many: China Is Plundering the Planet’s Seas (The Atlantic). Indeed, all the evidence suggests that access to cheap energy only speeds up the depletion and despoliation of every other resource.
4. The unsustainability of consumerist consumption dependent on resource depletion and financialization (i.e. the endless expansion of credit and phantom collateral).
5. The diminishing returns on consumption. Investing in clean air and water, public transit, universally accessible knowledge/information–these forms of consumption yield high returns in public health, affordable mobility, etc. Buying clothing to wear once or twice and then throw away does not.
The investment in the rule of law, public infrastructure and universal access to clean air, water and education moves nations from developing to developed and greatly improves the material lives of the residents. Beyond this, consumption of resources offers diminishing returns up to a point of social/spiritual/ psychological derangement. Consumption beyond this point actively reduces well-being.
6. The failure of neoliberal capitalism and communism alike in their pursuit of growth at any cost.
7. We have reached Peak Consumption (video 27:30 minutes).
The Degrowth movement explicitly questions what John Michael Greer calls the religion of progress (i.e. growth). The civil religion that growth equals progress is akin to the Cargo Cult of Keynesianism, the notion that growth is so essential that expanding debt exponentially to drive diminishing returns of growth is necessary….”
“Last Friday’s surprisingly strong April jobs report and today’s unexpected drop in initial unemployment claims were welcome developments in the beleaguered U.S. labor market.
However, the underlying details of the labor market continue to be troubling.
Last week, veteran economist David Rosenberg gave a lengthy 59-slide presentation on the Federal Reserve’s failed efforts to get the economy on track.
Much of the presentation focused on the dynamics of the U.S. workforce.
Rosenberg argued that despite the high unemployment rates, there’s actually a shortage of qualified labor, which is resulting in labor hoarding….”
“This extraordinary stock market is driven by characteristics that defy conventional valuation techniques. I receive emails from people who tell me that the market is overextended, overvalued, and trading way above its 50- or 200-day moving average. If you look at the metrics, the market is all of those things.
I receive other emails that talk about the valuation of the market. Is it reasonably “fair?” If you look at earnings expectations and the price of stocks this year and compare them to a metric, you would say the market is reasonably priced.
The math goes something like this. The S&P 500 Index will earn an estimated $105-$110 for 2013. That puts it at a multiple of about 15 times earnings. Those earnings are being reported by companies that have minimal distortions due to inflation or accounting mechanisms. Thus the earnings are of a higher quality in terms of reporting than they have been in the past. They do not reflect the bubble of the 2006 and 2007 financials. And they are more representative of the diversity of American companies. Our metric would say the market is reasonably priced. Not a great market, but certainly not excessive.
The next metric ties the relationship between stocks and interest rates. We use a number of vehicles to make this comparison. I like the calculation of the equity risk premium that says how much you get paid for owning stocks versus riskless debt instruments. If you compute an equity risk premium against an interest rate next to zero, the valuation of stocks could be infinite. Anything compared to near-zero has a huge bulge in its multiplier.
If you compare stock valuations against the 10-year riskless Treasury note, the equity risk premium is still very high by any historical measure. Why? Because the Treasury interest rate is so low.
If you try to compare the equity risk premium against what you believe to be the normalized 10-year Treasury interest rate, you still get a fairly reasonable equity risk premium.
The math is straight forward….”
“NEW YORK (Reuters) - Goldman Sachs Group Inc has slashed its capital pledges to investment fundsby nearly half since the Volcker rule was signed into law in 2010, as it prepares its principal investment business for restrictions on investing its own money, according to regulatory filings.
The Wall Street bank has reduced future commitments to hedge funds and funds that invest inprivate equity, credit and real estate, by $5.8 billion since June 2010, the last period before the Volcker rule was included in the Dodd-Frank financial reform act. That represents a reduction of 48 percent, according to data in filings with the U.S. Securities and Exchange Commission.
The Volcker rule – which has not yet been finalized or implemented – will prevent banks from investing more than 3 percent of Tier 1 capital in hedge funds or private equity funds, or from contributing more than 3 percent of capital from those funds.
Goldman’s existing hedge fund and private-equity fund holdings represented 14 percent of its Tier 1 capital as of March 31, according to its most recent filing on Thursday. Including future private-equity fund commitments, that ratio goes up to 17 percent.
It is not clear how the Volcker rule will treat credit funds or real-estate funds, or how much time banks will get to come into compliance with the law. Regulators are expected to release a final rule by the end of this year, after reviewing hundreds of letters from industry groups and the public about a proposal they released in October 2011….”
“Every earnings season, companies share the details of their financial performance. Additionally, many managers will reveal what they are seeing and what they are expecting for the economy.
The view out of Q1 2013?
Things have turned a corner, but it’s still slow going.
For instance, China is slowing down, but not so much that it will disrupt markets.
North America is looking great, especially in Mexico.
Among regions, it’s really just the European Union that’s really struggling — but even there, we may have bottomed out.
Consumer sentiment remains solid, even in the face of the sequester. And at least one company believes we’d be able to weather a pullback in dovish monetary policy.
Some companies are seeing scattered softness.
But overall, the snapshots indicate strength.
“……The S&P has been up 56 of the 88 trading sessions so far,” writes Cashin. “That rate of success is not only extremely rare, it is, borderline, unprecedented. Fifty years of experience suggests streaks ultimately end – just ask Joe DiMaggio. For now, enjoy the ride; be wary of rumors; stay very nimble and have a great weekend.”