Daily Insight

The S&P 500 made a run for positive territory several times yesterday but to no avail, until the final push of the session moved the broad market fractionally to the plus side; the Dow and NASDAQ Composite managed slightly more substantial gains.

A strong manufacturing report out of the Chicago region appeared to do more harm than good as it led to some speculation the Fed will withdraw stimulus measures sooner than previously believed. I don’t know how many times Bernanke & Co. have to explicitly state that they’ll keep monetary policy floored for a while still, but we remain in this what’s-bad-is-good environment (bad is good because it means the easy money trade rolls on) so I guess the reaction, stocks struggling to move higher on a strong report, shouldn’t be terribly surprising.

Tech was the leading sector on the session; consumer discretionary shares the worst performing group. The 10 major sectors were spilt, with five in the green and five in the red.

The seven-year Treasury auction was well–received, as the rise in yields of late seemed to support this week’s $118 billion in debt sales.

We’ve got one session left before getting this decade in the market behind us. The S&P 500 has fallen 23% since the end of 1999 (that’s on a simple-price basis, not including dividends), the first decline for a decade since 1930-1939. Including dividends, the index lost roughly 10% since 1999 (0.9% per year), the first negative annualized return over a 10-year stretch in the index’s history, which goes back to 1927, according to S&P’s Howard Silverblatt.

Market Activity for December 30, 2009
Chicago Purchasing Managers Index

The Chicago PMI (a gauge of manufacturing activity from the nation’s largest factory region) jumped to 60.0 in December, the highest level in nearly four years, from 56.1 in November. The reading easily surpassed expectations, which had the figure slipping to 55.1. The Chicago region is the main factory corridor for the auto sector, so vehicle assemblies to restore what have been low inventory levels for this segment of manufacturing was likely the catalyst. Chicago does involve a good level of electronic-goods production also, the holiday shopping season surely played a supporting role as well.

Nearly all of the sub-indices of the report looked really good, The new orders index remained hot, hitting 63.5 (highest level since May 2007) after 62.8 in November; order backlogs entered expansion mode for the first time since August 2008, hitting 53.0 after 46.5 in the previous month – this is an important gauge to watch, if it remains above 50 for several months it’s one signal current workers are getting stretched and new hires will be necessary; the employment figure jumped to 51.2 from 41.9, the first move into expansion since November 2007; and supplier deliveries remained at a good level, slipping but just slightly to 56.2 from 57.4 in November – this is another key gauge as a sustained stay above 50 will also signal workers are stretched by new orders.

Unfortunately, the inventory reading remained in contraction mode, but it improved and that is all it takes to offer a boost to GDP. The reading rose to 39.4 from 34.9 – this is a depressed level, remaining below the average since the recession officially began (40.3) and below the average for the decade of 45.9.

So, we now have two of the major regional factory gauges that have posted strong results (Chicago and Philly) for the month of December, while two have shown deterioration (New York and Richmond). Now we wait for the nationwide look at manufacturing via the ISM data, which arrives on Monday. The market expects a reading of 54, which would be good. Chicago is predicting something more, but it hasn’t been the best indicator of late – normally it is an excellent signal for what’s to come from ISM.

Ticking

Last week, I think it was, we talked about the trouble brewing within the Chinese real estate market. Over the past 12 months apartments in Beijing have more than doubled in price and speculators have driven the high-end market up by 55% in the nine months ended September in Shanghai; housing starts have nearly tripled over the past 12 months.

It will be interesting to watch when exactly the Chinese banking bomb blows, they’ve had problem loans on their books for a while but nothing like the problems that arise when their real estate bubble pops. The escalation in Chinese RE prices appears to dwarf what occurred here in the U.S.

One indicator of economies becoming overheated, not a great one for those serious about this issue but interesting nonetheless, is the Skyscraper Index put together by Andrew Lawrence of Dresdner Kleinwort (it follows through on the Skyscraper Indicator, created by Ralph Elliot in the 1930s). The index holds that the impulse to build the world’s tallest structures is a strong indication that an economy is about to run into deep trouble. As Lawrence states, the planning for the Singer and Met Life buildings foretold the Panic of 1907; the Chrysler and Empire State buildings, the Great Depression; the Petronas Tower in Malaysia, the Asian Crisis. The tallest building in the world at the present is the Burj…in Dubai.

Next on the list? The Shanghai Tower, currently under construction. Heads up!


Have a great day and Happy New Year!


Brent Vondera, Senior Analyst

PEG ratio

The P/E ratio (or price-to-earnings ratio) is one of the most well-known valuation tools, but some people neglect to consider the impact of future earnings growth on this ratio.

The price/earnings-to-growth ratio (or PEG ratio), provides a forward-looking perspective and allows investors to compare the relative attractiveness of a stock in the context of the firm’s earnings growth outlook. Similarly to the P/E ratio, a lower PEG ratio means that the stock is more undervalued.

Calculating the PEG ratio is quite simple – divide the P/E ratio by the three- or five-year earnings compound annual growth rate. To better understand how to use the PEG ratio, consider these two technology firms.

• Hewlett-Packard (HPQ) has a P/E ratio of 13.82 and a growth rate of 11.8%
  
• Apple (AAPL) has a P/E ratio of 33.70 and a growth rate of 18.8%
  

Hewlett-Packard is clearly the cheaper company based on P/E ratio alone, but an investor might argue that Apple’s high P/E is justified by its superior growth. Apple has gained a reputation for introducing cutting-edge products and, accordingly, Apple is projected to grow earnings at an annual rate of 18.8%. Hewlett-Packard, on the other hand, is projected to grow earnings at 11.8% rate.

But after calculating both firm’s PEG ratios (Hewlett-Packard is 1.17 and Apple is 1.79) we discover that that Apple’s growth rate, although higher than Hewlett-Packard, does not justify its higher P/E. In other words, Hewlett-Packard’s stock is a better value (even if Apple makes better computers).

As you can see, the PEG ratio is useful for determining whether a firm’s high growth potential justifies their valuation.

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks bounced between gain and loss on several occasions yesterday, but unlike Monday when a late session move higher delivered the broad market to the upside a move lower in the final minutes ended a six-day winning streak. Overall, the beginning of this holiday-shortened week has turned out as uneventful as maybe it was expected to as the last two sessions canceled one another out.

The day’s economic data was really not enough to push stocks higher. The latest housing report showed prices rise month-over-month in October, but it was a negligible gain and too many cities continued to show no durable recovery in prices is yet upon us. The latest consumer confidence reading showed a nice improvement in households’ expectation of the future, but even that reading remains quite depressed and if jobs growth fails to get rolling in substantial fashion a few months down the road, even expectations may get smacked down again. The present conditions index of the report made a new cycle low.

Really the only excitement yesterday was the ubiquitous internet photos of the “Great Balls of Fire” underwear, the clandestine means for the failed explosive device via al Qaeda’s latest human mule.

Seven of the 10 major S&P 500 industry groups closed lower on the session, led by energy and financial shares. The three sectors that gained ground were led by consumer discretionary and industrial shares – consumer-staples being the third of those sectors ending in the black.

The $42 billion five-year Treasury auction went well as the yield was 1.4 basis points lower than the when-issued were trading prior to the auction. The bid-to-cover (gauge of demand) was 2.59, lower than the previous two auctions, but in line with the four-auction average. The indirect bid (gauge of foreign buying) was the worst aspect of the auction, coming in at 44%, down from 60.9% in November and below the 54.2% of the past four auctions. Today’s seven-year auction will be the test for the week.

Market Activity for December 29, 2009
S&P CaseShiller Home Price Index

The CaseShiller HPI (which tracks home prices for the 20-largest metro areas) extended its streak to five months as the measure showed October prices advance 0.37% from the prior month. From a year-over-year perspective, the improvement extended for a seventh month – relative to October 2008 prices were off by 7.28%, which follows a 9.27% decline in September (from the year-ago period).

Nine of the 20 cities tracked registered price declines for October, the same number as last month. Tampa led the declines, where prices were down 1.19% for the month, followed by Chicago (down 0.98%), Miami (down 0.48%), Cleveland (down 0.40%), Las Vegas (off by 0.28% and has never shown an increase since the market collapsed); Boston, NY, Atlanta and Dallas also registered price declines.

For the 11 cities that gained ground, San Francisco led the way (up 1.73%), followed by Detroit (up 1.23%), San Diego (up 1.11%), LA (up 0.69%). Seattle, Portland, Denver, Minneapolis and Washington DC and Charlotte rounded out the positive contributors.

Since hitting its cycle low in May, the CaseShiller HPI has rebounded 3.4%. The current level was first hit in September 2003. Peak-to-date, CaseShiller has home prices down 29.55% -- April 2006 was when prices peaked, according to this index.


Consumer Confidence

The Conference Board’s consumer confidence reading for December improved to 52.9 from an upwardly revised 50.6 (previously reported at 49.5) for November – basically in line with the expectation of 53.0. For perspective, the long-term average is 94.1. The reading averaged 103.4 in 2007 and 60.5 in 2008.

The increase was driven by a nice move within the expectations index (consumer’s view of things six months out), which rose to 75.6 from 70.3. That’s the highest since the recession officially began in December 2007. The cycle low, which is also the all-time low, of 27.3 was touched in February.

The present situation index weighed on the headline reading, slipping to 18.8 (a new cycle low, the all-time low of 15.8 was hit in December 1982) from 21.2 in November. With the present number falling, we’ll have to see a marked pick up in economic activity, and thus job growth, or that expectations number is going to get hammered again.

As we explain each month, the most important reading is the jobs “plentiful” less jobs “hard to get” reading. This is the confidence index’s best indication of future consumer activity trends. The measure made a new cycle low of -46.6 in November, but improved ever-so-slightly in December to -45.7. The all-time low is -58.7, hit in December 1982.

The share of respondents stating jobs are “plentiful” fell to 2.9 from 3.1 in the previous month, but those stating jobs are “hard to get” improved to 48.5 from 49.2, more than offsetting the decline in the plentiful reading.

The readings on plans to buy a car or a home six months out continued to decline. Plans to buy a car fell to 3.8 from 4.5 and the plans to buy a home hit a new 27-year low, falling to 1.9 from 2.1.

Subsidize It

The Treasury Department will throw another $3.5 billion GMAC’s way so that the financial-services firm can keep their mortgage arm, ResCap, out of bankruptcy as loan losses continue to mount. This is on top of the $12.5 billion Treasury has already thrown down this rat hole. We likely haven’t seen the extent of this bailout story as GMAC’s loan portfolio will record additional losses down the road – what’s going to happen when home prices slip just another 5% over the next 6-12 months? With the way that banks have delayed the foreclosure process, there’s little doubt these distressed properties will add significantly to home supply.

The government will hand the 90-year old lender all the money they need to cover losses as the auto market can’t afford GMAC going down, or even slow their financing activity.


Have a great day!


Brent Vondera, Senior Analyst

Daily Insight

U.S. stocks bounced around the flat line for most of the session, ending in positive territory thanks to a tick higher in the final minutes. The gain extended the broad-market’s winning steak to six sessions. We didn’t have a major economic release to trade on, and with most traders out until next week it was overall a quite session.

This time of year is almost always subdued, although things can get interesting on occasion due to the lack of volume; the market can become especially news-driven when there is an event with which to trade on. Thankfully, the failed act of terrorism, the targeting of civilians by an enemy combatant, didn’t offer such a scenario. (But I’ve got to say, and long-time readers know that I’ve been very concerned about our security efforts for a long time, when you have someone go from Nigeria to Amsterdam to the U.S. without luggage -- and on top of that our unwillingness of inability to revoke the visa even after his own father warned that his son may have been radicalized -- we don’t seem terribly serious about this problem; a problem that will grow over time if not properly checked. When one thinks about risk-management within the investment world, this issue has been and must remain a serious element of that risk assessment.)

Telecom shares, the worst-performing sector for the year, led the advance. In fact, all seven of the 10 major industry groups that rose on the session outperformed the broad market. The three that failed to close in positive territory were consumer discretionary, financials and industrials – ranked 3, 4 and 5 in terms of 2009 performance

The $44 billion Treasury auction went fine, not as well as previous auctions but ok. The rate was pushed higher, 1.089% (what a wonderful yield for two years) compared with the 1.077% at which the when-issued was trading just ahead of the auction. The bid-to-cover ratio (measure of demand) came in at 2.91, the previous auction had a bid-to-cover of 3.16 and the four-auction average is 3.07. The indirect bidding (foreign buyers, including central banks) came in at 35%; it had averaged 43% over the past four auctions. In general though, no big deal. Tomorrow’s $32 billion seven-year auction should be the tougher test, but we shouldn’t run into too much trouble, not yet at least. If inflation concerns arise, or the bond market begins to believe that this expansion is for real, that’s when the market will fully shun these levels of interest rates and trouble in financings this deficit spending may begin.

Market Activity for December 28, 2009
Holiday Sales

MasterCard Advisors’ SpendingPulse has holiday sales up 3.6% from the year-ago period – their definition of the shopping season is the timeline Thanksgiving-Christmas, others extend it out to year end. This look by MasterCard does include food and health-care expenditures, which means there is some H1N1 vaccine in the number. There was also an extra shopping day this year (28 days between Thanksgiving and Christmas vs. last year’s 27), adjust for that and sales rose 1%. Severe winter weather across most of the country also helped to boost sales – while many concentrated on how this event hurt in-store traffic, it surely boosted online sales of winter apparel enough to offset the physical-store weakness.

According to SpendingPulse, E-Commerce sales are up 15.5% since Black Friday (day after Thanksgiving), relative to the year-ago period; electronics sales are up 5.9%; jewelry sales higher by 5.6%; footwear up 5.0%; luxury (ex. jewelry) is up 0.8%; apparel down 0.4% and department stores down 2.3% -- again, clearly this is a function of online activity stealing some sales due to the weather. Last year’s holiday shopping season was the worst since 1970, according to the International Council of Shopping Centers.

The final week of the year is also an important one as it accounts for roughly 15% of total holiday sales, according to Dana Telsey of Telsey Advisory Group.

China Watches Inflation, But It’s Just Talk for Now

Chinese Premier Wen Jiabao, in a rare interview, discussed inflation risks over the weekend – pointing to a surge in real estate prices and credit expansion (doubling over the past year as virtually every other economy shows credit is contracting). Wen stated that the Chinese government will address the issue before it becomes a problem. That’s what everyone always thinks, but it is too late by the time politicians begin to address it, at which point the measures necessary to ultimately tamp harmful levels of inflation are intensely detrimental.

We’ll watch for the Chinese to clamp down on credit by tightening standards. For now, they explicitly state that aggressive stimulus measures will remain in place, which propelled the Shanghai Exchange and other Asian markets over the past two sessions.

The Chinese leader also expressed that they will not cede to foreign pressure and allow their currency to appreciate – meaning they will not remove the peg to the U.S. dollar. So much for Mr. Mandarin himself (Tim Geithner) going over to China last month to smooth over the Chinese – nice try. Maybe they allow the currency to float for other reasons, but by explicitly stating that foreign governments’ calls to do so will have no bearing on their decision-making process Wen makes quite the public political statement.

Government Still Can’t Pull Back, But Will Have to Eventually

The Treasury Department has removed a $200 billion limit on aid to Fannie and Freddie and promised to cover their losses through 2012. So, just as the Federal Reserve plans to end it purchases of mortgage-backed securities by the close of first-quarter 2010, Treasury will be their to pick up the slack. Washington is extremely concerned that higher mortgage rates will result when the Fed exits from their purchase program, and the damage this will do to a housing market that has become conditioned to sub-5.00% rates, as well they should be.

The two government agencies underwrite nine out of every 10 new residential mortgages, twice the level prior to the crisis. The housing market may still be in decline if not for the government backing, but such actions carry their own risks. You can’t attempt to backstop everything, sometimes you just have to let the market find the bottom. Increased government involvement has done more harm within the labor market than may have otherwise been the case. Firms know what follows this level of deficit spending – higher tax rates.

As Lender Processing Services (a major provider of mortgage data) has been explaining for a while now, the mortgage delinquency problem is moving upstream. The level of deteriorating loans with credit scores above 680 are making up a larger percentage of all defaults. It’s no longer about sub-prime, but the traditional drag on housing (high unemployment) is now becoming a larger problem for the market. Of the loans that were current at the end of the prior year but now 60 days-plus delinquent as of September of the following year, > 680 FICO mortgages made up 40% of that number (750,000 of the 1.831 million loans). This is up from 35% in the prior year

It seems that the cost of this government support is going to be very costly. It masks the problems in the short term, but they will become evident over time.

Week’s Data

We were without a major data release Monday, but get back to it this morning with the S&P CaseShiller Home Price Index (October) and the Conference Board’s consumer confidence reading (December). CaseShiller is always a heavily watched release; we’ll see if the index can manage a fifth-straight monthly increase and continued improvement on the y/o/y figure, expected to be down 7.15% after September y/o/y decline of 9.36%. The confidence reading is expected to improve to 53.0 for December from 49.5 in the prior month. The figure needs to break above a reading of 60 in order to move past recessionary levels – the 40-year average is 95.8.

On Wednesday we get the Chicago Purchasing Manager Index, the gauge of factory activity out of the largest manufacturing region. The number is expected to slip from November’s reading, but remain in expansion mode nonetheless. It will need to meet expectations as two of the three regionals we’ve gotten for the month thus far have not been good.

We’ll round it out on Thursday with the weekly jobless claims data. The figure is expected to hover around the 450K level, and it should. The problem for claims at this point is the continuing numbers, which continue to rise.

Other Notes

Today marks 20 years since the Nikkei 225 (Japan’s main stock exchange) hit its all-time high of 38,915. Currently that bourse resides at 10,638. This is what can happen when an economy, still the world’s second-largest but probably not for long, implements terrible policy for an extended period of time. For sure Japan has structural issues, namely birthrates that are close to non-existent – not even close to replacement levels. But strong economic and monetary policy would have sparked economic growth, jobs, and encouraged immigration, thus easing or even completely offsetting the population problem.

GM is offering Saturn and Pontiac dealers $7,000 to clear these closed-out models from inventory. This will certainly boost December auto sales but is nothing more than another round of front-loading sales. Just as the clunker-cash program stole sales from the future, this program – although necessary to get discontinued models out the door – will do the same.


Have a great day!


Brent Vondera, Senior Analyst

Stock performance following a bad decade

The new year is approaching and soon investors will be scouring over year-end performance reports. Sadly, one of the most common mistakes investors will make is using past performance as the basis for their investment decisions.

Those that harp on past performance may find it difficult to invest in equities following a decade that was plagued by two brutal bear markets. But shunning equities may be a mistake.

Consider the table below.

Each time the average ten-year return of the S&P 500 was below 6%, the following ten-year period has been very good to investors, with an average return of 13.14%. The following 20-year period is even more impressive, averaging 14.82% per year.

There are no guarantees this trend will continue going forward. After all, it’s impossible to consistently predict the direction of the market (see my June 30, 2009 post: Are you chasing performance?).

Still, the table above should at least make you rethink shunning equities for emotional reasons.

--

Peter J. Lazaroff, Investment Analyst

Daily Insight

U.S. stocks added to a nice holiday-shortened week (S&P 500 gained 2%) as traders were determined to push the indices higher. Thursday’s economic releases were certainly a help as initial jobless claims fell more than expected and durable goods orders, excluding transportation, also came in much better than was anticipated.

Information technology shares led the broad market higher, with financials and basic material shares also posting market-beating gains.

Volume was about as flat as it gets with just 300 million shares traded. It was a half-day session and thus expected for activity to be light, but this Christmas Eve was about 50% lighter than what we’ve seen over the previous four years.

Interest rates continued their march higher on Thursday, particularly on the long-end as the 10-year Treasury is now yielding 3.80% (spiking from 3.20% as of November 30) – up another 4 bps to 3.84% this morning. We’ll get another $118 billion in government debt auctions this week ($1.4 trillion for all of 2009) so we’ll see how they go, and the direction that rates take.

Market Activity for December 24, 2009
Jobless Claims

The Labor Department showed that initial jobless claims fell 28,000 (a 10,000 claim decline was expected) to 452,000 in the week ended December 19 – nice to see initials back to the 450K level after bouncing back to 480K over the previous two readings. Initial claims are now back to the level of September 2008. The four-week average (chart below) of initial claims fell 2,750 to 465,250.

Continuing claims also fell, down a meaningful 127,000 to 5.08 million -- that is for the standard 26 weeks of benefits. However, claims for EUC (Emergency Unemployment Compensation), which kicks in to provide up to another 73 weeks of benefits, added another 142,000. So, again, this suggests that the decline in standard continuing claims is more a function of those benefits running out rather than a resurgence in job growth. (That said, as I’ve been mentioning since the October jobs report was released, we should begin to see some job growth arise over the next couple of months, it’s just that the increase is likely to be quite mild.)


Until we see EUC begin to trend lower, or at least halt it’s consecutive-week increase, the evidence is just not there that statistically significant job growth will take place anytime soon. And frankly it is unreasonable to expect this to occur just yet. These things take time to materialize even during a normal expansion, which this is not. This time we must contend with very low capacity/resource utilization rates. Therefore, those resources have a longer distance with which to be stretched, if you will, before firms begin to aggressively add to payrolls – average hours worked per week continues to hover near the all-time low and until these hours pick up for existing workers, should one expect much by way of new hires?

Durable Goods Orders

The Commerce Department reported that durable goods orders rose just 0.2% in November (+0.5% was expected), but this seemingly weak headline reading off of a 0.6% decline for October was affected by a large drop in commercial aircraft orders. The report was actually well-balanced and quite strong.

Excluding transportation orders, and thus removing the 32.6% decline in the commercial aircraft segment, durable goods orders jumped 2.0% (nicely outpacing the expectation for a 1.1% increase), which follows a 0.7% decline in October. Total orders are down 6.0% on a year-over-year basis and ex-trans are down 4.9%.

Overall transportation orders fell 5.5% -- vehicle and parts orders declined 0.2% and, again, nondefense aircraft plunged 32.6% after a 39.3% jump in October. The rest of the report looked really good though. Computers, electronics orders rose 3.7%; electrical equipment orders increased 3.2%; machinery orders rose 3.5% (following a large decline of 7% in October).

Those components of the report pushed non-defense capital goods ex-aircraft higher by 2.9% after a 2.0% drop in October. This is the reading we like to watch most closely as it is the proxy for business-equipment spending. This segment is down 8.9% y/o/y, but the last three months have been positive, up 5.5% at an annualized rate.

We need to see this segment, as I’ve been saying for a while now, trend higher; this economy desperately needs help from the business side. One hopes for this to occur, but U.S. corporations appear to be managing capital expenditures to maintenance levels as they manage around lower sales. This will help profits in the short term but will not be helpful for overall economic activity if this process extends for a while – it will keep final demand depressed; business-equipment spending is a huge job creator.

The inventories segment of the report showed that firms continue to reduce stockpiles, which is quite strange based upon the record pace of liquidation of the previous few quarters. The largest inventory liquidation on record occurred in the second quarter, and the third-quarter liquidation only looked good compared to that historic reduction – firms remain abnormally cautious. Durable goods inventories fell 0.2% in November, but the three-month annualized change is half that of the prior month – and that is all it takes to boost GDP. We are still waiting for actual re-stocking to begin, but firms continue to hold off.

Expectations for the fourth-quarter GDP reading are definitely going to be boosted by this report. Shipments of durable goods, which gets plugged into GDP, rose 0.3% following a 0.7% rise in October. That’s a great start to the quarter and will help to offset what may be a drag from the housing component. Housing construction was up in November, but on a quarter-over-quarter basis is down. If the December housing starts reading (which we’ll get in three weeks) falls, this segment won’t contribute to GDP.

Reminded, Yet Again

Everyone probably expected the health-care debate to dominate the Washington storyline for a while, but a little event on Christmas reminded (or re-reminded) us that something else looms larger – no matter how badly we’d like to ignore it, there are people, organizations and regimes that want to do us grave harm. Thankfully, the terrorist’s device failed, buy they’ll keep coming; their desires are surely not contained to taking down airplanes, but much more. As I have written for the last eight years, security is key. Obviously now, we have major economically endogenous issues to also deal with but if we don’t get security right, and the overall policies that greatly diminish the chance of major attack, it makes it that much harder for a normal business cycle expansion to take hold.

Futures are higher this morning. Quite the opposite would be the case if it were that explosive device, rather than the terrorist’s leg, that had ignited.


Have a great day!


Brent Vondera, Senior Analyst