Yesterday we told fear-sellers to take their rubbish commentary and shove it!
They have nothing.
A big fat doughnut… and yet they love to tell us why we should all buy gold and just run to the hills.
Sell your lousy subscriptions somewhere else…
Today I wanted to follow up with a few charts and pour more acid on their poor analysis (not that we really need to).
To be honest, if I look at the macro scene of late, there isn’t a whole lot going on.
But I guess these guys need to write ‘something’ to sell pixels right?
The Bigger Picture…
As I was saying yesterday, the global economy is just muddling along.
Things could be better but they could be a hell of a lot worse too.
I will share a couple of compelling charts shortly…
From mine, inflation is still relatively low and stable (largely opposite a doggedly low oil price) — and the equity market is no longer cheap but neither is it overly optimistic.
I think the latter point is one often missed.
The scaremongers will cling to their historical “don’t buy above a PE of 15.5x” argument – but fail to recognise (a) we are still in a zero rate environment; and (b) perform any kind of yield comparison to risk-free assets.
With respect to Washington DC… it’s a dog’s breakfast (as we like to say in Australia).
Trump’s team appears to making some slight headway opposite reducing excessive regulatory burdens — however his major legislative initiatives (ie tax and healthcare reform) are not going anywhere.
The left-wingers won’t have a bar of it. Such is the way with these things.
Allow me to digress for a moment…
It kind of makes you wonder what battles you choose with politics.
If I was ever in that position (and I doubt I will ever will be) — I would target the low-hanging fruit first to get traction. In fact, it’s a strategy I use in business if initiating any new project.
Get some runs on the board. Establish data points. Iterate and scale.
For example, reducing the corporate tax rate is an easy one which the Democrats would most likely concede (after a lame counter argument).
But if you dive head first into a beast like repealing and replacing the one issue closest to socialists hearts (eg Obamacare) – forget it!
They are going to dig in like you would not believe.
It would not be too different to trying to dilute Medicare in Australia. Turnbull thought about it for a millisecond and look what happened! Political suicide.
Labor knew that going in and almost pulled off an upset (just on that issue alone).
Elections are won and lost on social (emotional) issues… less so economic arguments.
But back to the lower hanging fruit — reducing the corporate tax rate is something most (smart) folks get.
And if you were to reduce it – you would unleash a new wave of investment (ie what the US (and Australian) economies are so desperately lacking.
Assuming the investment was productive – then comes growth. With growth – greater tax revenue and so on.
That is, this would help ease the way for other reforms (possibly).
But the shenanigans in Washington DC regarding reform will continue. And who knows – maybe they will find something to agree on. Or maybe not… they are politicians after all.
For the US to get any real economic traction (ie growth) – reform will need to get through. Otherwise we should expect more of the same.
The market was very excited earlier this year about the prospect of pro-growth policy – but now it’s lost some of that enthusiasm. Reality has set in.
Regular readers will recall me saying months ago that “timing is the key issue”
That is, the longer it takes, the more the market will pull back.
And whilst we have seen the market take a pause… on a positive note are still seeing tighter credit spreads (ie the market not concerned about default risk), strong manufacturing ISMs, rising industrial commodity prices, rising real yields (ie lower bond prices), and increased global trade.
The perma-bears won’t mention any of these data points – as it flies in the face of their “we are all going to hell in a hand-basket” argument.
Yes, we have seen some negative data like softer housing starts and poor auto sales. They will be quick to jump on those!
My view is the former far outweigh the latter.
Put it in reverse…
For example, let’s say we saw record high car sales and housing starts — however credit spreads were widening… bond yields were plummeting… interest rates falling… the yield curve inverting… and global trade stalling!
Then I would be worried.
But it’s not what we see… let’s take a look at just a couple of charts to make my point.
ISM versus Real GDP
Whilst GDP is not where it should be (ie due to lack of incentive to invest) — ISM manufacturing is doing quite well.
Now historically, if we see a strong ISM number, it translates into stronger GDP:
Here we see the two diverging in the near-term – which is a positive.
We had a very strong June result — so don’t be surprised to see GDP in Q2 hit 3.0% (note: the Atlanta Fed currently estimates Q2/17 growth to be about 2.7%)
Hardly what I would call recessionary or an imminent “crisis”.
But remember, Q1 was a weak 1.4% growth, therefore on average we could call it around 2% for the first half. Not great. But not dire either.
Choose your lens.
5-Year CDS Spreads
Now yesterday I talked a little too credit default swap spreads (CDS).
I said they were low (very low) which tells me the market is not pricing in any imminent risk our friends at the Daily Reckoning love to warn us about (year after year after year).
Take a look at this chart…
There are two reasons I wanted to share this chart:
The first, is 5 Year CDS spreads are an excellent and highly liquid proxy for the financial health of corporations.
These spreads are at relatively low levels, and that in turn belies concerns that corporations may be over-leveraged or that the economic outlook may be deteriorating.
This is an argument the perma-bears cling to… but it’s false.
The second one is the argument around crude prices (and them being “destroyed”).
CDS’ in higher-yield debt (red line) is what we see with energy markets. Now previously when oil collapsed – these yields jumped.
Things are in pretty good shape despite the lower oil price.
Crisis case closed (again).
Putting it All Together…
We drove a “Mack Truck” through the bearish argument yesterday… today we reversed over it (for good measure).
The bears like to hang their hat on things such as excessive debt; what we see opposite GDP; and my favourite — why PE’s should be below 15x before buying stocks.
But as we have explained at length in the past – if you look at PE ratios in the context of the current yield on risk-free bonds, then stocks are still cheap(ish).
It’s a no-brainer as to where money is likely to flow.
In the past we have subtracted the approx 2.3% yield from the 10-year treasury note from the earnings yield (the inverse of the PE ratio) on the S&P 500… and what we illustrated was typical stocks offer an earnings yield that is about 230 bps higher than the 10-year.
It’s also quite unusual – especially given equities have a higher expected return (ie being much more risky) than Treasuries. Put another way – the market is also suspicious of how much further corporates can grow earnings.
But this is good news…
Because it also tells me that market is not being irrationally exuberant as our friends often like to claim. It’s moving higher… but in a measured way.
… trade the tape
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