At 53.8 in May, the seasonally adjusted Markit Flash U.S. Manufacturing Purchasing Managers’ Index™ (PMI™) fell from 54.1 in April and signalled the weakest improvement in overall business conditions since the start of 2014. Slower new order growth was a key factor weighing down on the headline index in May, while faster job creation was the main positive development since the previous month.


Latest data indicated that overall new business growth softened for the second month running and was the weakest since January 2014. Moreover, new export sales decreased marginally in May, with a number of manufacturers noting that the strong dollar had a negative influence on competitiveness in external markets. In terms of domestic demand, survey respondents noted that energy sector investment spending remained a key area of weakness in May.

Manufacturing output growth eased further from March’s six-month high, which firms largely attributed to softer new business gains. The latest increase in output volumes was the slowest recorded so far in 2015, but still broadly in line with the post-recession average.

Meanwhile, latest data signalled the slowest pace of backlog accumulation across the manufacturing sector for four months. Lower pressure on operating capacity was linked to a combination of weaker new business gains and robust job creation.

Higher levels of manufacturing employment have been recorded in each month since July 2013. The latest upturn in payroll numbers was the fastest for six months, which firms attributed to the launch of new products, long-term investment plans and efforts to boost production volumes.

Suppliers’ delivery times lengthened in May, although the latest deterioration in vendor performance was much less marked than February’s recent low. There were reports that some supplier bottlenecks have persisted after the port strikes earlier in 2015. However, the latest survey indicated the slowest rise in pre-production inventories for 11 months, suggesting a lower propensity among manufacturers to build safety stocks in May.

On the prices front, manufacturers indicated an increase in their average cost burdens for the first time since December 2014. That said, the rate of inflation was only marginal, with survey respondents noting that low oil prices continued to help reduce cost pressures, while a number of firms commented on falling steel prices. Meanwhile, factory gate charges rose at the most marked pace for six months, but the rate of inflation remained subdued in comparison to the average seen since the survey began in 2007.

NEW$ & VIEW$ (22 MAY 2015): Q2 Bounce?

U.S. Existing-Home Sales Decline 3.3% in April

Existing-home sales declined 3.3% last month from March to a seasonally adjusted annual rate of 5.04 million, the National Association of Realtors said Thursday. Sales for March were revised up to 5.21 million from an initially reported 5.19 million.

Sales in April were up 6.1% from the same month a year earlier.

Total housing inventory at the end of April increased 10%, to 2.21 million existing homes available for sale.

NAR chief economist Lawrence Yun blamed the drop in sales on a lack of supply, which in turn is driving up prices. In April, 40% of properties sold at or above their asking price, suggesting bidding wars are becoming common in many parts of the country, Mr. Yun said.

The median sale price for a previously owned home was up 8.9% from a year earlier to $219,400 in April, the biggest increase since January 2004, NAR said. That price is just shy of the peak reached in 2006, when the median sale price for the year was $221,900. (…)

Stephen Stanley, chief economist at Amherst Pierpont Securities, also noted that existing home sales aren’t recorded until contract closing. Thus, “the April reading is still possibly reflective of purchases that were agreed to in February and March, when weather was still an issue,” Mr. Stanley said.


From CalculatedRisk:

Also, the NAR reported total sales were up 6.1% from April 2014, however normal equity sales were up even more, and distressed sales down sharply.  From the NAR (from a survey that is far from perfect):

Distressed sales — foreclosures and short sales — were 10 percent of sales in April, unchanged from March and below the 15 percent share a year ago. Seven percent of April sales were foreclosures and 3 percent were short sales.

Last year in April the NAR reported that 15% of sales were distressed sales.

A rough estimate: Sales in April 2014 were reported at 4.75 million SAAR with 15% distressed.  That gives 712 thousand distressed (annual rate), and 4.04 million equity / non-distressed.  In April 2015, sales were 5.04 million SAAR, with 10% distressed.  That gives 504 thousand distressed – a decline of about 29% from April 2014 – and 4.54 million equity.  Although this survey isn’t perfect, this suggests distressed sales were down sharply – and normal sales up around 12%.

When we look at recent data (charts above), existing home sales and inventory look low. When we take a longer-term perspective to look beyond the 2003-2006 bubble, things don’t look all that abnormal.

Chicago Fed National Activity Index Improves

The Chicago Federal Reserve reported that its National Activity Index (CFNAI) during April moved up to -0.15 from -0.36, revised from -0.42. The three-month moving average remained negative at -0.23, the lowest indication since November 2012. During the last ten years, there has been a 76% correlation between the Chicago Fed Index and the q/q change in real GDP.

The three-month moving average of the CFNAI held fairly steady at its recent low, the weakest indication since October 2012. The Fed reported that 38 of the 85 component series made positive contributions to the total while 47 made negative contributions.

The CFNAI is a weighted average of 85 indicators of national economic activity. It is constructed to have an average value of zero and a standard deviation of one. Since economic activity tends toward trend growth rate over time, a positive index reading corresponds to growth above trend and a negative index reading corresponds to growth below trend.

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Philadelphia Fed Business Conditions Index Furthers Its Sideways Movement

The Philadelphia Federal Reserve Bank reported that its General Factory Sector Business Conditions Index for May slipped to 6.7 from an unrevised 7.5 in April. It’s been near that level all year, remaining well below the high of 40.2 reached in November. Expectations averaged 8.0 in the Action Economics Forecast Survey. The seasonally adjusted figure, constructed by Haver Analytics, also slipped to 50.3 and remained in this year’s range. It was down, however, from November’s high of 58.7. It is comparable to the ISM Composite index. During the last ten years, there has been a 71% correlation between the adjusted Philadelphia Fed index and real GDP growth.

The new orders, shipments and unfilled orders series improved while inventories, delivery times and the average workweek eased. The employment index also weakened slightly following strength in the prior three months. During the last ten years, there has been an 81% correlation between the employment index level and the m/m change in factory sector employment.

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Conference Board Leading Economic Index Increased Again in April

The Conference Board LEI for the U.S. increased again in April, with building permits and the yield spread making large positive contributions. In the six-month period ending April 2015, the leading economic index increased 2.0 percent (about a 4.0 percent annual rate), considerably slower than the growth of 3.5 percent (about a 7.2 percent annual rate) during the previous six months. However, the strengths among the leading indicators remain more widespread than the weaknesses.   [Full notes in PDF]

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Eurozone export boost contrasts with disappointment in US, China and Japan

May’s flash PMI survey data painted a downbeat picture of worldwide manufacturing trends, with economies struggling in the face of sluggish global trade flows. However, eurozone exporters, benefitting from the single currency’s depreciation, are outperforming in terms of export gains.

Weak exports were the key to disappointing manufacturing trends in both China and Japan. At 49.1, the flash PMI for China signalled a deterioration in business conditions for a third successive month, fuelled by the steepest drop in export orders for almost two years. Factory output fell for the first time since December as a result. The survey paints a picture of industrial production growth weakening in China from the already sluggish 5.6% annual rate seen in April, edging closer to the low of 5.4% seen at the height of the global financial crisis.

In Japan, the flash PMI rose from 49.9 to 50.9, signalling a modest return to growth. However, although inflows of new order books picked up for the first time in three months, the increase was only modest due to a near-stagnation of export orders for a second successive month.

The poor export performance is a major disappointment, given the weakness of the yen, and suggests further stimulus should not be ruled out from the Bank of Japan.

It wasn’t only in Asia where exports were a notable weak spot in the PMI result. In the US, the flash PMI fell to a 16-month low of 53.8, with growth in the manufacturing economy dragged down by a second successive monthly downturn in export orders. The strong dollar was widely cited as a key cause of disappointing export sales, alongside weak demand, especially from Asia.

There was a brighter picture in the eurozone, however, where the manufacturing PMI rose to a 13-month high of 52.3. The improvement was driven in part by an upturn in new exports orders, which likewise hit a 13-month high (though note this measure includes intra-eurozone trade flows). Companies commonly reported that exports were being buoyed by the euro’s depreciation. Especially welcome was the first (albeit minor) increase in exports from France, which has lagged the wider-region’s recovery, since April of last year.

Less positively, the upturn in the euro area’s manufacturing sector was offset by slower growth in the services economy, though the region remains on track for a 0.4% expansion of GDP in the second quarter.

The impact of currency movement was not confined to exports. The weaker euro was partly to blame for eurozone goods producers reporting that steepest rise in input costs for three years. In contrast, input costs fell in China and rose only very modestly in the US and Japan, despite upward pressure from rising oil prices.

Bird Flu Outbreak Decimates Egg Supply The financial toll of the worst U.S. bird-flu outbreak in history is soaring. The fast-spreading virus has resulted in the deaths or extermination of at least 38.9 million birds. About 10% of the U.S. egg-laying flock has been wiped out.

Egg companies—the sector hit hardest by the virus—and turkey producers are spending millions of dollars to try to contain the disease. With eggs in particular, the problem is greatly complicated by the way the American industry is concentrated in the hands of relatively few producers.

The U.S. government has earmarked nearly $400 million to help compensate poultry farmers for culled birds, cleanup and disease testing. (…)

The wholesale price of “breaker” eggs—the kind sold in liquid form to restaurants like McDonald’s Corp., food-service supplier Sysco Corp. and packaged-food producers—nearly tripled in the past month to a record $2.03 a dozen on Thursday, according to market-research firm Urner Barry. Meanwhile, U.S. prices for wholesale large shell eggs, those sold at the grocery store, have jumped about 85% to $2.20 a dozen in the Midwest. Wholesale turkeys cost $1.14 a pound for a frozen 16-pound bird, 4.5% higher than the price a year ago, according to Urner Barry. (…)

The egg-supply squeeze is pinching profits for some food makers. Post Holdings Inc. warned last week that avian flu has affected about 25% of its egg supplies, forcing it to discontinue some product lines under its Michael Foods business, which makes liquid egg whites and egg product ingredients. Earlier this month, it estimated that fiscal 2015 operating earnings would be reduced by $20 million due to the bird-flu outbreak. (…)

Producers will be reeling for years, egg-industry officials said. One of the major challenges will be the cost to repopulate egg-laying facilities that together house millions of birds on some farms. (…)


Jawad S. Mian, a young fund manager who writes Stray Reflections recently penned about Ed Viesturs who can teach us a lot about risk management:

About Ed ViestursAmerica’s preeminent high-altitude mountaineer, Ed Viesturs, knows all about risk. He is the only American (and 12th person overall) to have successfully climbed all of the world’s 14 mountains over 8,000 meters, and only the sixth person to do so without the aid of an oxygen tank (which he feels can be burdensome). Over a 23-year span, Viesturs went on 29 Himalayan expeditions and summited mountain peaks of over 8,000 meters on 21 occasions. He stood atop Everest seven times, with his first successful ascent of the mountain in 1990 and his last in 2009. (…)

What makes his track record so remarkable is his generally conservative nature with respect to risk in the mountains. He never lost a team member on a climb, and no one was ever seriously injured, which is an astounding feat. (…)

In 1987, on his first Everest attempt, Viesturs backed off just 300 feet below the summit because the conditions were not right. It was this steadfast commitment
to safety that allowed him to climb mountains with such great success. As he says, “Getting to the top is optional. Getting down is mandatory.”

Viesturs believes most accidents and deaths on the high peaks are due to human error, with ambition and desire overpowering common sense. What some people
call “summit fever,” he calls “groupthink,” which is when a majority of the group, desperate to reach the top, disregards dangerous weather, route conditions, or other important factors. The least experienced climber tags along thinking if everyone else is going, then it should be just fine.

According to Viesturs, “It’s almost a lemming-type effect. People get swept up in it, it’s that psychological feeling of safety.” No one gives any thought to the acceptable level of risk.

Quoting from a 2010 interview Viesturs gave to Slate magazine titled “Into Thin Error”, recounting a 1992 expedition to K2 in Pakistan:

About halfway into the day, the clouds below us slowly engulfed us, and it started to snow pretty heavily. I always contemplate going down even as I’m going up, and I was thinking, “You know what? Six, seven, eight, nine hours from now, when we’re going down, there’s going to be a tremendous amount of new snow, and the avalanche conditions could be huge.”

I talked to my partners and they were like, “What do you mean? This is fine.” So I was kind of alone in my quandary. I knew I was making a mistake; I knew I should just simply go down… I kept saying, “Well, let me go on for another 15 minutes and then I’ll decide.” And then after 15 minutes I’d say, “Let me go on another 15 minutes and then I’ll decide.” And I just couldn’t make a decision, and I put it off so long that I got to the top.

Even though we succeeded, I don’t ever want to do that again. We just got really, really lucky. There were moments I was convinced we weren’t going to make it down, when I said [to myself], “Ed, you’ve made the last and most stupid mistake of your life.” When we got to camp, I was just so angry with myself….

… It doesn’t matter how long you’ve been there, how much money you’ve spent, how much energy you’ve expended. If the situation isn’t good, go down. The
mountain’s always going to be there. You can always go back.

Since 2009, we have climbed several mountains in the investment world and it is fair to say that in both the fixed income and the equity markets, we are pretty close to an eventual summit. As we get higher and higher, the fog gets thicker, making the tops difficult to see clearly. But being into thin air, we know we are getting close.

Mian quotes again from Viesturs’ book:

When I am climbing, I listen to the mountain. All the information is there, which helps me decide what to do. Arrogance and hubris need to be put aside, and humility and thoughtfulness are essential. I truly believe that is how I survived so many expeditions into a dangerous arena.

What information is there for us these days?

  • The U.S. domestic economy has slowed from already low growth rates in spite of very low interest rates, much reduced oil prices, rising real wages and a strong stock market.
  • U.S. exports are suffering from a strong dollar and generally slow global economies.
  • Profits have stalled under weak revenue growth and lower margins.
  • Inflation remains below the Fed’s target. In fact, all central banks in the world are aiming at higher inflation.
  • The Fed has stopped injecting liquidity into the economy and is prepared and willing to raise interest rates.

American sherpas, headed by Janet Yellen, are now warning us all about potential dangers ahead, a radical change from their strong push toward aggressive risk taking since 2009. They are already rationing oxygen and threaten to take it completely out pretty soon if we keep climbing up.

European sherpas are providing ample oxygen to their climbers but they are just getting started from base camp. They are on a very slow, difficult walk up, aggravated by complex group dynamics and some handicapped climbers.

Chinese sherpas are at the crossroad between a dangerous shortcut or a long and winding road to the summit. They are likely to go the slower way unless their large crowd of climbers gets too restless.

That said, many investors remain optimistic, even while being accused of succumbing to “summit fever,” or “groupthink”.

In fact, after exposing Viesturs’ risk management philosophy, Jawad Mian pits himself in the keep climbing group. From his apparent vantage point, the outlook appears very beautiful to him:

Now, the global macro stage is beautifully set.

The US household debt-to-income ratio is back to its 2002 level, and the decline in interest rates has brought down the cost of servicing this debt to affordable levels. Credit growth has revived, and business confidence has healed, which should now bring about a resumption in capital spending.

With the unemployment rate at 5.4%, labor markets are strong enough to boost wage inflation. (…) Job and income gains have encouraged housing demand to return. (…)

Strong momentum in the labor market, ongoing recovery in the housing market, and the sharp decline in energy prices should combine to generate robust consumer-led growth. (…)

Mian’s unbridled optimism spans across the world. Europe is turning around thanks to the ECB and faster credit growth from recapitalized banks. Japan has entered a “virtuous cycle of positive change and rising asset prices” and the weaker yen has given the country its most competitive position in 40 years.

The roaring bull market in Chinese stocks on record volume and breadth implies that the Chinese economy is not as bad as the pervasive gloom suggests and might indeed surprise positively in the year ahead. A stock market rise of such scale is certain to have powerful effects on the real economy. This will likely lend support to Asian and emerging economies more generally as well.

Even commodities have firmed up in the last month, particularly industrial metals, which may indicate that the Chinese economy is stabilizing, at the very least. Real
interest rates in China are among the highest in the world, so there is significant scope to ease its monetary policy stance.

This year promises to be the first year since the 2008 crisis where the odds are moving decisively in favor of a fortuitous synchronized global growth upcycle.
Economic prospects are slowly brightening and macro risks diminishing, rather than intensifying. From a cyclical vantage point, I believe both new information and
a changing interpretation of existing information will be beneficial for stocks, to the detriment of government bonds in general. (…)

I wouldn’t be surprised to see stocks become even more richly priced in the current cycle. Although valuations for the US stock market have risen sharply in recent years, global equity valuations are not unduly high by historical standards. If I’m right about the global growth upcycle, then valuations have room to climb much further. I see no reason why US stocks can’t trade at 20 times earnings over the next several years.

Frankly, given the slow and fragmented nature of this recovery, it is still too early in the investment cycle to worry about valuations. Historically, valuation is a poor timing tool, and valuation considerations only matter once the economic expansion looks exhausted, which is certainly not the case right now.

Considering the current low-yield environment, the US equity risk premium remains fairly generous. If we assume the fair value for the real 10-year yield to be 1% (it is currently only 0.25%), then the S&P 500 earnings yield today would need to be 5% to generate the same average equity risk premium of 4% that prevailed over the 1960 to 2007 period. As it happens, the current earnings yield for the S&P 500 is closer to 6%, which suggests US stocks still have meaningful upside.

This is a truly beautiful view: synchronized growth from all corners of the world, robust consumer-led U.S. growth, accelerating wages, rising commodity prices, controlled inflation and fairly stable interest rates. In such context, Mian sees “no reason why US stocks can’t trade at 20 times earnings over the next several years.”

I suspect Ed Viesturs would not be very keen following Mian much higher into thin air. He would quickly point out that U.S. stocks have very rarely traded at or above 20 times earnings over the past 70 years. Climbing rarely used paths can be very dangerous as history has amply demonstrated…


Viesturs might also suggest that synchronized growth, accelerating wages and rising commodity prices are expressions generally not combined with other expressions such as controlled inflation and stable interest rates. Mian would need to chose only one of these routes since Nirvana has not been attained just yet.

Viesturs might also frown at statements like

  • “since 2008, the world has never looked as good as it does today”
  • “Don’t let memory get in the way of such a jolly market.’
  • “investors should adapt to the new reality”
  • “The market is telling you something completely different”
  • “valuation is a poor timing tool”
  • “Although margin debt is at all-time highs, I don’t view it as a sign of concern”
  • “From an Elliott Wave perspective…”

Youth is so dangerously wonderful!

From Business Week…

This is the longest period of practically uninterrupted rise in security prices in our history… The psychological illusion upon which it is based, though not essentially new, has been stronger and more widespread than has ever been the case in this country in the past. This illusion is summed up in the phrase ‘the new era.’ The phrase itself is not new. Every period of speculation rediscovers it… During every preceding period of stock speculation and subsequent collapse business conditions have been discussed in the same unrealistic fashion as in recent years. There has been the same widespread idea that in some miraculous way, endlessly elaborated but never actually defined, the fundamental conditions and requirements of progress and prosperity have changed, that old economic principles have been abrogated… that business profits are destined to grow faster and without limit, and that the expansion of credit can have no end.

…late in 1929. This was via John Hussman who adds:

“This time” is not different. There’s no question that investors have come to believe that somehow quantitative easing has durably changed the world – that central banks have (or even can) put a floor under the markets as far as the eye can see. But if you examine the persistent and aggressive easing by the Fed during the 2000-2002 and 2007-2009 plunges, it’s clear that monetary easing has little effect once investor preferences shift toward risk aversion –which we infer from the behavior of observable market internals and credit spreads. Monetary easing only provokes yield-seeking speculation when low-interest money is viewed as an inferior asset.

I will also mention that while margin debt is not a direct cause of market downturns, it certainly acts as a magnifier of the downturns as margin calls trigger more and more selling. Similarly, while high corporate debt levels have a positive effect on growth in good times, they can have a devastating impact during economic downturns. Viesturs is so right: summit fever, or “groupthink” is when a majority of the group, desperate to reach the top, disregards dangerous weather, route conditions, or other important factors. The least experienced climber tags along thinking if everyone else is going, then it should be just fine.

The reality is that deleveraging has ways to go as these charts show:


Low interest rates have driven investors towards higher risk instruments while market makers have been de-risking. When the music stops…


James Paulsen (Wells Capital Management) recently wrote an interesting article (Has Stock Market Stability Increased Vulnerability?) which received little media attention and obviously escaped Jawad Mian:

The emotional state of investors has long been recognized as central to the stock market’s overall risk-return profile. Typically, stocks do best when the investor community is something less than comfortable. A culture of anxiousness about the future tends to keep portfolio exposures low and valuations reasonable augmenting stock market prospects. Conversely, an exuberant or even comfortable investor is typically less discriminating about values, more focused on good stories rather than good fundamentals, and is often already “all in,” mentalities which simultaneously elevate risks and lower prospective returns. (…)

Lately, the U.S. stock market has trended steadily higher with remarkably low volatility. Indeed, during the last 36 months, the stock market has experienced one of its most stable advances since 1900! While this steady stock market action has improved investor sentiment, it has also probably worsened the near-term outlook for stocks. Since 1900, the median annual percent change in the U.S. stock market has been about 8% and it has suffered annual declines only about 34% of the time. However, when this measure of investor sentiment has been as high as it is today, the U.S. stock market has historically declined in the coming year more than half the time suffering a median percent decline in the next 12 months of about 1.5%.

Paulsen measured investor sentiment using the degree of stability exhibited by the stock market.

The R-squared derived from a regression of the stock market against time provides a good measure of stock market volatility and thereby a good proxy of investor sentiment. R-squared ranges between 0 and 100 and measures the portion (in percent) of the total variability of the stock market which can be explained by its trendline. (…) Essentially, stock markets that produce a high R-squared (i.e., are highly predictable) imply positive investor sentiment whereas a low R-squared connotes a stock market with bearish investor overtones.

(…) by this measure, investor sentiment is currently at one of its highest levels since 1900! There have been only 14 periods since 1900 when the R-squared has risen above 90% and today it is near an all-time high record at slightly above 97%!


For eight of the 13 signals, the stock market either immediately or fairly soon suffered a bear market (i.e., 1906, 1929, 1937, 1946, 1956, 1965, 1987, and 2007). After both the 1926 and 1998 signals, the stock market eventually suffered a correction and after both the 1952 and 1994 signals, the stock market was essentially flat and volatile during the subsequent two years. Only the caution suggested by the 2003 signal proved inappropriate. Finally, the timing of a few signals were remarkably clairvoyant (i.e., September 1929, September 1987, and December 2007).

Forecasting equity returns is a fools’ game. The smart game is to assess probabilities of rising or falling markets. While the U.S. stock market has declined 34% of the time since 1900 (on a yearly basis), Paulsen’s R-squared readings reveal that when the R-squared has been above 90%, the stock market has declined in the coming year almost 52% of the time!


Paulsen’s measure missed many other bad markets, proof that investor sentiment is not a pre-requisite to negative equity returns. The Rule of 20 valuation method has a much more consistent track record.

Interestingly, in all but 3 of the 90%+ R-square periods, the Rule of 20 also showed equities as overvalued. It correctly rated equities as very cheap in 1926 and 1952, having a rare miss in 1956. The Rule of 20 shows U.S. equities currently 5% overvalued but on their way to much more dangerous territory.


After several bounces off the “20” fair value line, U.S. equities have finally traversed into overvalued territory, generally a pre-requisite to most equity market downturns. Based on trailing 12-month EPS of $111.62 after Q1’15 and 1.8% core inflation, the S&P 500 Index is selling at a Rule of 20 P/E of 20.9 (trailing P/E of 19.1 + inflation of 1.8%), some 5% above fair value, the highest premium since September 2008.

We are walking along a crevasse high on the mountain. Given current forecasts for Q2 and Q3 earnings, trailing EPS will decline 0.7% to $110.84 after Q2 and regain 0.3% to $111.22 after Q3. The earnings tailwind will not reappear until Q4’15 earnings season next February, assuming current forecasts hold.

We thus need lower inflation to keep us close to fair value. Otherwise, we must rely on a tight grip from a Fed which is much more inclined to let us loose.

That assumes that the economic reading from Mrs. Yellen et al. is correct and that the economy accelerates along with inflation. Experienced bull David Rosenberg, very aware of the nearby valuation crevasse, goes out of his way to reassures us that Goldilocks will take care of us on the way up:

Even with the Q1 setback, real GDP growth is running just below 3% on an annual basis and core inflation is running at +1.8% YoY.

Going back to 1960, this has been the best growth-inflation backdrop for the S&P 500 – when GDP growth is 2-3% and core inflation was 1-2%, the S&P 500 tends to advance, on average, at over a 15% annual rate.

Hmmm…55 years of data might seem impressive but a quick look at the chart below reveals that 1-2% inflation periods are concentrated before 1965 and after 2009 and only account for 20% of the period.


  • The S&P 500 troughed in June 1962 at 15.7x trailing EPS (Rule of 20 P/E of 17.0) and, from these cheap levels, gained 70% to December 1965 when the trailing P/E reached 18.3 and the Rule of 20 P/E ended the year at 20.
  • The S&P 500 troughed at 666 in March 2009 when the trailing P/E was 14.6 and the Rule of 20 P/E was at 10.2. Equities multiplied by 3.2x since.

This is where Rosie’s 15% average growth rate comes from. Given that the current trailing P/E is 19.1x and the Rule of 20 P/E is 20.9, he must also see no reason why US stocks can’t trade at 20 times earnings over the next several years..

Then, there is the GDP growth rate Goldilocks. The U.S. economy has grown erratically to average 2.2% since 2010. Growth was within 2-3% in 7 of the last 21 quarters. Even good economists like Rosenberg can’t really forecast GDP growth 4-8 quarters ahead.


What we know, however, is that despite a tepid overall economy, the Fed has its finger on the trigger and is only waiting for a few economic signals to start raising interest rates to more normal levels. But not to worry says David Rosenberg:

(…) in the past 6 decades, the average length of time from the first tightening to the end of the business cycle is 44 months; the median is 35 months; and the lag from the initial rate hike to the end of the bull equity market is 38 months on average, 40 months for the median. (…)

This means that even if the Fed begins the eventual move off from the ZIRP this Fall, the historical record would suggest that the next downturn would not start until Q3’18 and the stock market won’t begin to price this until late the spring of that year at the earliest.

Hmmm…More averages and medians…I extensively researched this in 2014 (EQUITIES AFTER FIRST RATE HIKES: THE CHARTS SINCE 1954):

(…) It is thus shocking to see how uncooperative the S&P 500 was in 7 out of the surveyed 15 rate hike cycles (1965, 1967, 1971, 1974, 1977, 1983 and 1994).

(…) in each of 1961, 1965, 1980, 1983 and 1987, the first 25% of the tightening cycle was, in fact, the best part of the stock market cycle. Not because equities rose appreciably, but rather because of what happened during the next 75% of the cycle…

(…) in reality, there seems to be no consistent nor typical pattern after the first rate hikes.

However, digging a little more into the history book, I found that in 6 of the 8 years when the S&P 500 rose during the initial rate hike, inflation was actually diminishing or stable (2004). This did not verify in 1987, although the market eventually avenged itself and in 1999 when internet speculation blinded everybody.

Maybe we got ourselves a bit of a rule here: rate hike cycles are not damaging to equities in as much as inflation is not rising at the time. Since profits are generally still rising when the Fed takes its foot off the pedal, stable or declining inflation rates help sustain P/E ratios as demonstrated by the Rule of 20.

Let’s not forget one of the main objectives of the current Fed: get inflation above 2%. Actually, this is the goal of every major central bank in the world today. I would put my money on their eventual success.

By the way, from the April 20th NEW$ & VIEW$:

The various measures used by the Cleveland Fed suggest that core inflation is running at +0.2% per month, nearly +2.5% annualized.

In the May 19 NEW$ & VIEW$:

Curiously, this Eurostat inflation release got very little space in mainstream media this morning. Yet, it reveals that deflation has given way to inflation in 2015. Core inflation in the Euro area has sharply accelerated this year:

  • January –1.8% MoM
  • February +0.6%
  • March +1.4%
  • April +0.3%
  • Last 4 months: +0.5% or +1.5% annualized (-0.9% annualized in Germany, +1.2% in France, +1.5% in Italy)
  • Last 3 months: +2.3% or +9.5% annualized (+ 3.6% annualized in Germany, +7.4% in France, +15.6% in Italy)

As a result, April YoY core inflation reached +0.6% in the Euro area (+1.1% in Germany, +0.5% in France, +0.3% in Italy).

Let’s all agree that there is no recession out there. But equities can and do correct, often severely, even without a recession as this Doug Short chart illustrates:


Some drops out of thin air:

  • -22% in 1966 after the Rule of 20 P/E hit 20.
  • -10% in 1971 after the Rule of 20 P/E hit 24.
  • -19% in 1977-78 even with a Rule of 20 P/E around 15.
  • -9% in 1984 even with a Rule of 20 P/E around 15.
  • -34% in 1987 after the Rule of 20 P/E hit 23.
  • -16% in 1998 after the Rule of 20 P/E hit 27.
  • -22% in 2011 after the Rule of 20 P/E hit 19.2.

When valuations are high, investors are generally on their toes looking for reasons to sell and lock profits in. Reasons for corrections can be very diverse, often unpredictable and self-feeding, especially when margin debt is high. However, rising inflation, what our central bankers are shooting for, is generally not equity friendly as we saw in 1977-78 and in 1984.

John Hussman now receives little media and investor attention after crying wolf throughout this bull market. Among the chorus of bulls out there, it is important to keep listening to the smart, hard working bears:

The last week of December, the NYSE registered 478 new highs and 72 new lows. Last week [May 11-15], with the S&P 500 registering a marginal record high, the NYSE registered only 198 new highs, with 118 new lows. Since December, in weeks when the S&P 500 has declined, NYSE trading volume has increased from the prior week by an average of 351 million shares. In weeks that the S&P 500 has advanced, NYSE trading volume has contracted by an average of 565 million shares. On broad indices, the general pattern resembles a narrowing wedge with a relatively flat overhead resistance area and increasingly shallow dips. What we observe here is a market that continues to struggle internally and shows persistent signs of distribution, but is still keeping its best foot forward, for now.



Valuation may be a poor timing tool, among all other tools. But valuation is the best tool to navigate in high altitude and avoid summit fever, “group think”, which is currently as prevalent as it was back in 2009.

Viesturs motto has always been that climbing has to be a round trip. All of his planning and focus during his climbs maintains this ethic and he is not shy about turning back from a climb if conditions are too severe. His story is about risk management as well as being patient enough for conditions to allow an ascent. Ultimately, in his words, “The mountain decides whether you climb or not. The art of mountaineering is knowing when to go, when to stay, and when to retreat.”

The goal is not to sell right at the top, rather to objectively listen to the mountain and safely descend when danger is near so we can climb again when conditions improve.

NEW$ & VIEW$ (21 MAY 2015)

Fed Looks Past June for First Rate Rise Federal Reserve officials at their April policy meeting said in the most explicit terms yet that they are unlikely to start raising short-term interest rates in June.

Many officials “thought it unlikely that the data available in June would provide sufficient confirmation that the conditions for raising the target range for the federal funds rate had been satisfied, although they generally did not rule out this possibility,” the minutes said.

While the minutes suggest a rate increase isn’t completely off the table, only a few Fed officials thought they would have enough confidence to begin raising interest rates at the June 16-17 meeting. (…)

Still, while they acknowledged their uncertainty had risen after the first-quarter stumble, the officials and Fed staff struck a generally upbeat stance about the medium-run outlook, the minutes showed. The staff revised up the growth outlook because the dollar had weakened—which could help exports—and interest rates were expected to stay low longer than previously expected.

Moreover, many officials wrote off the first quarter to temporary factors. (…)

Officials also pointed to statistical quirks in government data that have resulted for several years in weak first-quarter growth readings and stronger figures later in the year. “This tendency supported the expectation that economic growth would return to a moderate pace over the rest of this year,” the minutes said.

Still, longer-term factors are starting to weigh on Fed officials’ thinking and creating seeds of doubt in their outlook.

“A number of participants suggested that the damping effects of the earlier appreciation of the dollar on net exports or of the earlier decline in oil prices on firms’ investment spending might be larger and longer-lasting than previously anticipated,” the minutes said.

Other concerns are creeping in.

A discussion about how high rates might go in the long-run led some officials to ask whether the Fed should do more now to stimulate the economy and wait longer before raising interest rates.

Another discussion about market conditions led some to worry about how Fed rate increases might affect bond markets. In 2013, when Fed officials started talking about winding down a bond-purchase program, bond yields rose sharply—pushing up mortgage rates and stirring a slowdown in the housing market.

Some Fed officials worried at the April meeting of a repeat of that event, known in markets as the 2013 “taper tantrum.” Though the Fed ultimately ended the bond-purchase program without more turbulence in markets, Fed officials worry that an interest-rate move could lead to more bond market volatility that damages the expansion they’re hoping has taken hold.

Architecture Billings Remain Stuck in Winter Slowdown

Riding a stretch of increasing levels of demand for thirteen out of the last fifteen months, the Architecture Billings Index (ABI) dropped in April for the second month this year. As a leading economic indicator of construction activity, the ABI reflects the approximate nine to twelve month lead time between architecture billings and construction spending. The American Institute of Architects (AIA) reported the April ABI score was 48.8, down sharply from a mark of 51.7 in March. This score reflects a decrease in design services (any score above 50 indicates an increase in billings). The new projects inquiry index was 60.1, up from a reading of 58.2 the previous month.

“The fundamentals in the design and construction industry remain very healthy,” said AIA Chief Economist Kermit Baker, Hon. AIA, PhD. “The fact that both inquires for new projects and new design contracts continued to accelerate at a healthy pace in April points to strong underlying demand for design activity. However, April would typically be a month where these projects would be in full swing, but a severe winter in many parts of the Northeast and Midwest has apparently delayed progress on projects.” (CalculatedRisk)

Vehicle Miles Traveled: Away We Go!

The Department of Transportation’s Federal Highway Commission has released the latest report on Traffic Volume Trends, data through March.

“Travel on all roads and streets changed by 3.9% (9.8 billion vehicle miles) for March 2015 as compared with March 2014.” The less volatile 12-month moving average is up 0.31% month-over-month and 2.64% year-over-year. If we factor in population growth, the 12-month MA of the civilian population-adjusted data (age 16-and-over) is a smaller change, up 0.24% month-over-month and up only 1.48% year-over-year.

Here is a chart that illustrates this data series from its inception in 1971. It illustrates the “Moving 12-Month Total on ALL Roads,” as the DOT terms it.

Click to View

Oaktree’s Marks Says Europe Better Bet Than ‘Highly Priced’ U.S.

Howard Marks, co-chairman of the world’s biggest distressed-debt investor, Oaktree Capital Management, said Europe has become more attractive than the U.S. even with “virtually all assets trading above their intrinsic value.”

“Europe is offering us somewhat better opportunities,” Marks, 69, said in an interview in London. “We are seeing some opportunities that — on a like-for-like basis — offer better risk-adjusted returns than in the U.S. at the moment.” (…)

“We are at a point in the cycle where we feel virtually all assets are trading above their intrinsic value; some are in ‘highly priced’ territory, and there are few absolute bargains available,” said Marks. “However, on the basis of our history with cycles, we believe there’s somewhat further to go before we reach peak exuberance, and thus peak prices.” Fingers crossed

Signs of a Recovery in Eurozone Profits

The forward earnings of the EMU MSCI seems finally to be turning up as both 2015 and 2016 earnings estimates have stopped falling recently. NERI turned positive during April (1.3) and rose to a five-year high in May (4.0) following 48 consecutive months of negative readings. The upturn is widespread including Germany, France, and Spain, though not Italy so far.

The weaker euro finally might be starting to boost profits in the Eurozone. There is probably more upside for the region over the rest of the year barring a Grexit.

This American VC Thinks He’s Getting Out of China Just in Time

(…) “As a startup investor, if I’m paying seven times or less than my U.S. counterparts, I’m going to be okay,” Bell said. “But once I start paying the same? I’m like, no way.” (…)

Bell isn’t the only one with concerns about valuations.

“Angel investing is almost on par with the U.S.,” said Rui Ma, partner for 500 Startups, a Silicon Valley-based fund. “They have the same prices as the U.S. but less traction, the companies are less mature.” (…)