From Markit Economics, released February 3rd, 2014:
The strong upturn in manufacturing production was maintained in January, as companies scaled up output in response to stronger inflows of new orders. There were reports of improved demand from the domestic market and rising levels of new business from overseas…..
Read more at Markit/CIPS UK Manufacturing PMI: Strong UK manufacturing rebound continues.
Fierce debate has been raging as to whether rising US corporate profits are sustainable or likely to shrink, leaving the market overvalued. Consideration of some of the key contributing factors will enable us to assess if and when this is likely to occur.
Low interest rates are clearly boosting corporate profits. The inverse relationship is evident from the strong profits recorded in the 1950s, when corporate bond rates were lower than at present, and also the big hole in profits in the 1980s, when interest rates spiked dramatically during Paul Volcker’s reign at the Fed.
The outlook for inflation is muted and the rise in interest rates is likely to be gradual and over several years, rather than a sharp spike, if the Fed has its way.
Employee Compensation as a percentage of Net Value Added (by Corporate Business) has fallen sharply since the GFC, boosting corporate profits. Again we can observe an inverse relationship, with corporate profits spiking when compensation rates fall, and vice versa.
A sharp fall in unemployment would send wage rates soaring, as employers bid for scarce labor. But that is not yet on the horizon and we are likely to experience soft wage rates in the medium-term (one to two years).
The third element is the effective corporate tax rate which has fallen to an historic low, post GFC. Part of this can be attributed to tax losses incurred during the GFC, used to shield current income. The effect is likely to be short-lived, causing effective tax rates to drift upwards, towards pre-GFC rates around 24%.
The sharp rise in corporate profits is unsustainable in the long-term, but adjustments in the medium-term are likely to be modest. Higher wages and interest rates will have a more significant impact in the long-term, but are only likely to occur when sound economic growth is restored — which in turn would have a compensatory effect on corporate profits.
The quality of a person’s life is in direct proportion to their commitment to excellence, regardless of their chosen field of endeavor.
~ Vince Lombardi
The US Dollar is testing support at ¥102 to ¥103 against the Yen. Breach of the rising trendline would strengthen the warning from a bearish divergence on 13-week Twiggs Momentum. Reversal of Momentum below zero would suggest a primary down-trend. Recovery above ¥104 is less likely, but would offer a target of ¥110*.
* Target calculation: 106 + ( 106 – 102 ) = 110
A rising Dollar/Yen exchange rate would assist Japanese stocks. The Nikkei 225 is testing support at 15000 after penetrating its rising trendline. Bearish divergence on 13-week Twiggs Money Flow warns of selling pressure. Reversal below 15000 would indicate a strong correction, while a Twiggs Money Flow cross below zero would warn of a primary down-trend.
US employment is topical after two months of poor jobs figures. Employers added 113,000 new jobs, against an expected 185,000, last month and a low 75,000 in December. Rather than focus on monthly data, let’s take a long-term view.
The number of full-time employed as a percentage of total population [red line below] fell dramatically during the GFC, with about 1 in 10 employees losing their jobs. Since then, roughly 1 out of 4 full-time jobs lost has been restored, while the other 3 are still missing (population growth fell from 1.0% to around 0.7% post-GFC, limiting the distortion).
Comparing employment levels to the 1980s is little consolation because this is skewed by the rising participation rate of women in the work-force. The pink line below shows how the number of women employed grew from under 14% of total population in the late 1960s to more than 22% prior to the GFC. The effect on total employment [green line] was dramatic, while employment of men [blue line] oscillated between 24% and 26%.
Part-time employment — the difference between total employment [green] and full-time employed [red] below — has leveled off since 2000 at roughly 6% of the total population. So loss of full-time positions has not been compensated by a rise in casual work. Both have been affected.
The “good news” is that a soft labor market will lead to low wages growth for a considerable period, boosting corporate profits.
The bad news is that low employment levels will depress sales growth [green line]….
And discourage new investment…..
Which would harm future growth.
Nymex Light Crude found support at $92/barrel. Penetration of the descending trendline would suggest trend weakness, while respect would signal another test of primary support at $92/barrel. Breach of primary support would offer a target of $84/barrel*. Recovery above $100 is unlikely and another 13-week Twiggs Momentum peak below zero would indicate a strong down-trend. Brent crude continues to drift sideways, reflecting global supply constraints; breach of $104 would warn of a down-trend.
* Target calculation: 92 – ( 100 – 92 ) = 84
The Gold Bugs Index, representing un-hedged gold stocks, is often a leading indicator of spot prices. Bullish divergence on 13-week Twiggs Momentum and breach of the descending trendline suggest that a bottom is forming. Only recovery above 280 would signal a primary reversal at present, but another retracement that respects support at 190 would change that.
Spot gold broke resistance at $1250/ounce and we should expect retracement to test the new support level. Bullish divergence on 13-week Twiggs Momentum and breach of the descending trendline suggest that a bottom is forming. We may face an extended consolidation if falling interest rates boost gold while a stronger dollar exerts downward pressure. Failure of $1200 is now unlikely, but would warn of a decline to 1000*.
* Target calculation: 1200 – ( 1400 – 1200 ) = 1000
The yield on ten-year Treasury Notes broke support at 2.75 percent after penetrating the rising trendline. Both warn of trend weakness. Bearish divergence on 13-week Twiggs Momentum strengthens the signal and reversal below zero would warn of a primary down-trend. Breach of support at 2.50 still seems unlikely, but would offer a target of 2.00 percent*.
* Target calculation: 2.50 – ( 3.00 – 2.50 ) = 2.00
The Dollar Index, on the other hand, appears headed for another test of resistance at 81.50. Breakout would signal a primary advance to 83.00*, while recovery of 13-week Twiggs Momentum above zero would strengthen the signal. Reversal below 79.80 cannot be ruled out, with long-term rates falling, and would warn of another test of primary support at 79.00.
* Target calculation: 81.5 + ( 81.5 – 80 ) = 83
Great article from Kiran Pande:
Since the 1960s, we’ve been dependent on a model called CAPM (capital asset pricing model) to understand the relationship between risk and return, despite the fact that its measure of risk only explains about 70% of return. This measure, beta, makes the assumption that the entirety of every stock’s return is due to its exposure to the market. Put simply, every stock’s returns will equal a factor of the S&P 500’s returns. Thus, if a stock’s beta is 2.0, it will double the S&P 500’s returns on a bull day and double its losses on a bear day. Obviously, this assumption is wrong almost every day, but the idea is that this factor is explaining most of a stock’s returns.
All returns not explained by beta in the CAPM model are called alpha. This is traditionally accepted as the level of skill and value added by a portfolio’s manager……
There is a whole laundry list of reasons not to use CAPM, beta, and alpha but here are some highlights…
- 70% is not 100%, not even close
- Beta is symmetrical, risk is not… downside risk is rarely the same as upside risk.
- Since the market index used to calculate beta (usually the S&P 500) contains stocks whose returns are supposedly dependent upon beta, these stocks’ returns are somewhat dependent upon themselves.
These counterpoints do not render beta, alpha, and CAPM useless, but we can do much better. The Fama-French Three Factor model is the answer. Rather than a single factor (market performance), the model throws a size factor and a value factor into the mix, replacing much of the nebulous alpha term. With the addition of these factors, Fama and French boast that their model explains as much as 96% of returns with quantifiable measures.
Read more at How I Can Explain 96% Of Your Portfolio's Returns | Seeking Alpha.
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Watch Stanislas Wawrinka break Novak Djokovic at 3/3 of the second set [56:00] in the Australian Open quarter-final.
http://youtu.be/9eyx3uk4pEs
