Tuesday, January 31, 2012

S&P 500 on pace for 66% gain in 2012

Following a great January in which the S&P was up 4.36%, the S&P 500 is now on pace to have a 66% gain for 2012.  Since 66% is not a particularly likely scenario, it's more likely than not that there will be some give-back in coming months.

Friday, January 13, 2012

Misery Index

The misery index measures the squeeze on general standards of living as the sum of the unemployment rate and the inflation rate.  It is a nice simple measurement of how much pain there is in the American economy at any given time.  Currently, the index is around 12, which while elevated isn't close to where it was in the 80s.

CPI is used for the inflation rate in this chart--it's arguable whether that gives an unbiased view of the inflation rate so it's possible this metric should be higher.

Thursday, January 12, 2012

2011 Retail Sales

Retail sales for December were reported this morning mostly flat m/m which means that overall retail sales were up 6.5% y/y for 2011.

In nominal terms, it was a pretty good year for retail sales, which hit a new all time high at $4.69T.  It was the 8th largest increase in 18 years since 1993--not bad for a year in which the S&P 500 was flat.  There is quite a difference between nominal and real retail sales though.  Even though Americans are spending more dollars, those dollars are buying them fewer goods.  Real retail sales have still, 4 years later, not reached pre-recession highs.

*Millions of Dollars; Inflation adjustment to December 2011 is estimated

Wednesday, January 11, 2012

Pork Bellies, I knew It...

Orange juice futures are making headlines today, down 9% after screaming higher yesterday.

"Here in New York they trade everything, Gold, Silver, Platinum, Heating Oil, Cocoa and Sugar, and, of course, Frozen Concentrated Orange Juice."

Major Holders of US Treasuries

Continuing on the treasury theme, below is a chart of the major holders of US Treasuries.  Of 10T marketable securities, Foreign holders own $4.5T and the Federal Reserve is the largest single holder at $1.6T.

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S&P 500 vs. Ten Year Treasury Yield

Even though the S&P 500 is getting closer and closer to reclaiming the 1300 level, the interest rate on the 10 year treasury hasn't rebounded quite as much.  The last time the S&P 500 was at 1300, the 10 year treasury was at 3%.  Today, the bond is still struggling to get over 2%.

Perhaps this is a sign that operation twist, announced in September, continues to have an effect on the longer end of the curve?

Tuesday, January 10, 2012

Breakdown of the US Budget

As an addition to the previous post: a graphical representation of the US Federal budget.  57.8% of the Federal budget is spent on Health Care, Social Security and Income Security.  How does the government accomplish any of these services better than the private sector would?

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Government Consumption Spending as Percent of Total

While looking at some GDP numbers, I noticed something interesting that I hadn't ever before.  Government expenditures in the GDP report are smaller than those reported in the budget report.  While the budget reports government spending at ~$3.7T annually, the GDP report only reports federal expenditures at $1.25T.  This is because the budget report takes into account all expenditures, but the GDP report only takes into account government consumption expenditures (not entitlement expenditures).  Below is a chart of the ratio of government consumption expenditures (primarily defense spending) to total expenditures.  It shows the way in which entitlement spending has engulfed the Federal Budget since the 1950s.

The missing $2.5T represents the direct shift in the consumption line of GDP from the working population to the non-working population.  Apparently this amount isn't enough for the Occupy Wall Street folks.

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Dogs of the Dow

It's still pretty early in 2012, but so far last year's Dow losers have been performing pretty well.  On average the 10 worst performing Dow components of 2011 are up 5.6% this year (as of yesterday's close).  By contrast, the Dow is up 1.43% ytd.


Changing Driving Habits in Young People

An interesting info-graphic in the Journal today about younger people getting fewer driver's licenses.  The article cites social media as one of the factors behind the declining license rate, but I'm not so sure.  This seems like a question for the Freakonomics guys.

Friday, January 6, 2012

January Investor Letter

Below is a letter that is written monthly for the benefit of Avondale Asset Management's clients.  It is reproduced here for informational purposes for the readers of this blog.

Dear Investors,

I’m not sure that the change of a calendar year holds as much significance to any other profession as it does to the professional investor.  Investors are by practice intensely aware of cyclicality and the elapse of time, and so the start of a new calendar year represents a well-deserved milepost to catch a quick breath and take stock of the year behind and the year to come.

The year behind was as wild as it gets for one in which the S&P 500 was effectively flat.  The S&P finished the year down 0.0028% despite plenty of volatility.  At one point the index was down over 11% for the year, but the best 4th quarter since 1999 saved a flat end.  All the noise of the market masked a pretty strong year for US companies, which are on pace to grow earnings by 14% vs. 2010.  This is a great sign for the year ahead because as earnings have grown stocks have gotten cheaper.  Valuation is the single most important factor in forecasting future returns and as of now stocks are extremely cheap.  Analysts are predicting that corporate earnings will grow another 10% this year, which means that the S&P 500 finished 2011 selling at a little over 11x forward earnings.  In comparison, the index sold for 44x earnings in 1999.  Although the market has been flat for the last decade, this discrepancy in valuation should show that the environment has changed a lot.  Given the current valuation, I would not be at all surprised to see a double digit return from the S&P this year.

Despite favorable valuation and my own optimism, there are certainly reasons why the coming year could be just as difficult a year as the last one was.  For one, Europe is still a concern.  Last month I wrote that until the European Central Bank prints money without restraint, it’s unlikely that the Eurozone will exit the headlines.  In December there were signs that the ECB is ready to do this, but it has done so in such a convoluted way, that I’m not sure the market fully recognizes it. 

The second area of concern in 2012 was also the biggest area of surprise in 2011: the US Treasury market.  Despite the fact that the US government lost its AAA credit rating in August, the 30-year US Treasury bond was the best performing asset of the year.  It returned a staggering 31% as interest rates fell from 4.5% to 3%.  I do not expect a similar performance in 2012, but to be fair I didn’t expect such a performance in 2011 either.  If anything, 2011 reinforced that US treasury bonds are dangerously overvalued.  Unfortunately it’s hard for me to see how this can be remedied without creating some turbulence in equity markets. 

Still, it’s tough to say whether 2012 will be the year that the bond market finally wakes up or if that’s further down the line.  Given that 2012 is an election year, it is actually likely that rates won’t rise as politicians do what they can to maintain a stimulative environment.  Eventually the US government will have to stop running trillion dollar deficits, but given congressional gridlock, they may wait until the bond market forces them to act.  However, unlike the late 90s it’s not the equity markets that are the focus of concern, it’s the debt markets.  This means that equities should fare better than debt when this eventually comes to pass.  So, while I remain positive on investing in US equities, there are areas of concern, which is why we will continue to hold higher levels of cash and some gold as we wait for the horizon to clear. 

Scott Krisiloff, CFA

Opinions voiced in the letter should not be viewed as a recommendation of any specific investment.  Past performance is not a guarantee or reliable indicator of future results.  Investing is subject to risk including loss of principal.  Investors should consider the suitability of any investment strategy within the context of their personal portfolio.  For more information on Avondale Asset Management, readers may be directed here.

Thursday, January 5, 2012

Three Housing Charts

With some calling for 2012 to be the bottom in the housing market, below are three housing market charts based on data from the Fed's Flow of Funds report.  I tried to put together some less mainstream ratios for a broader view of the housing market.

#1 Total Value of US Residential Real Estate Relative to GDP

It's not obvious what the natural level for this ratio should be, but over the long term, housing probably shouldn't appreciate much faster than GDP grows.  This implies that over the long term the line should be flat rather than having any positive trend.  This is not a positive for housing price outlook.

#2 Mortgage Debt Relative to Total Real Estate Market Value

The amount of mortgage debt outstanding relative to home values is still near record highs.  Falling housing prices make de-leveraging more difficult.  It's tough to see credit growth in mortgages accelerating any time soon, which should continue to pressure housing prices.

#3 Real Estate as a Percentage of Assets

Housing doesn't represent quite as large of a portion of the US consumer's balance sheet as it has in the past.  Going forward consumer spending may be less sensitive to swings in housing prices.

Global Historical CPI Pre 20th Century

Milton Friedman's famous quote on inflation explains that inflation is "always and everywhere a monetary phenomenon."  The attached chart should come as no surprise therefore, that prior to the advent of strong central banks in the 20th century, global inflation was nearly non-existent.

Global Historical CPIs

The chart, which shows global CPIs since 1750 demonstrates that chronic inflation is a 20th century phenomenon.  If anything, one could argue that CPI is in a mildly deflationary state for the 150 years between 1750 and 1900.  This makes sense, as technological advancement makes the real price of goods and services fall.  If the integrity of the currency is maintained then nominal prices should fall too.

Initial Jobless Claims

Initial claims were at 372000 for the week ended December 31.  Claims have been below below 400k since the beginning of November--a good sign but also pretty heavily influenced by seasonal adjustments.  Follow through of this trend in January would be more encouraging.  For reference, below is a time series of the claims data.

Wednesday, January 4, 2012

Comparing S&P 500 returns 2003-2005 vs. 2009-2011

The performance of the S&P 500 over the last three years has been remarkably similar to the performance of the index coming out of the last recession.  Comparing the performance of the S&P 500 from 2003-2005 to 2009-2011 shows that not only did both 3 year periods return approximately 40%, but the pace and timing of both rallies have been extremely close as well.

2003 and 2009 were both V shape recovery years in which the S&P bottomed around March and rallied heavily for the remainder of the year.  2004 and 2010 were both negative for most of the year up until the September/October time frame in which powerful late year rallies salvaged positive returns.  2005 and 2011 meanwhile were both years that the index basically ended flat--albeit with a little more volatility in 2011.

Will 2012 look like 2006?  If so, we're in for a nice year.

Tuesday, January 3, 2012

DVY Making New Highs

While the S&P is rallying 23 points today, it's still not quite back to its 2011 high.  In contrast, DVY an etf tracking large cap dividend paying stocks is making new highs.  Being defensive has paid off over the last few months.

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