Good Evening: U.S. stocks rose once again on Tuesday, halting its latest losing streak at one. What was interesting about today’s rather modest closing gains is that, given the news flow, they could have been quite a bit better. Ben Bernanke was reappointed to his position as Fed Chairman, home prices actually rose a tad last month, and consumer confidence soared well beyond expectations. A very firm tape this morning was greeted with yawns and some selling this afternoon, and though stocks have risen nicely since I departed for a vacation last week, equities are starting to look winded. The other major capital markets aren’t sending the same V-shaped recovery signals that stocks have since March, according to Gluskin Sheff’s David Rosenberg, so it makes sense to examine this dichotomy in search of some directional clues.
Stocks have been seizing upon every piece of better than expected economic data for months now, and today was no different. U.S. stock index futures were relatively unmoved by Chairman Bernanke’s reappointment, which was leaked to the press last night, but the mood brightened when the S&P Case-Shiller home price indexes were released prior to this morning’s open. Both the 10 city and 20 city composite indexes rose 1.4% month over month, slightly besting forecasts for fractional gains (see below). The year over year figures are still well in the red (down 15%), but the second quarter marked the first advance in home prices since 2006. This release was welcome news indeed for the 30% or so of mortgage holders sporting negative home equity (as of June), but a true revival in the housing market still looks a long ways off.
The major averages popped 0.5% in the wake of the Case-Shiller data, but they went to post March highs once the Conference Board posted its latest consumer sentiment readings. Leaping from the mid 40’s to the mid 50’s in a single bound (consensus estimates were for an uptick into the upper 40’s), the August reading for consumer confidence was immediately greeted with a further 1% gain in the major averages. Taken in context, however, it’s hard to see why market participants were so enthusiastic about this report. A reading of 54.1 is less than half the peak levels over 110 seen in 2007, and the August numbers are still below May’s 54.9. For reference, the S&P 500 is up more than 15% during this timeframe.
Whether or not this statistical disparity finally dawned on equity investors after this morning’s high water mark was reached is not knowable, but stocks spent the rest of the session on the defensive. Though they never did hit negative territory, the indexes did nose over and approach the unchanged mark in the early afternoon. They went mostly sideways for the rest of the day, finishing with gains ranging from 0.25% for the S&P to 0.7% for the Dow Transports. The retreat from new highs may be nothing more than simple profit taking, but on a day when the wizard of quantitative easing was granted four more years in which to work his magic, the bulls might have expected more upside. I was asked by a reader just what Bernanke’s extended stay in the Eccles building might mean, but I will table the matter for a future commentary. Besides, the true measure of the impact of Bernanke’s policies can’t be taken until more time passes. Let’s see if he can exit all the emergency easing programs with the same haste with which he launched them.
With equities rising, the Depression fighting Bernanke getting another term, and more supply at hand, Treasurys had every reason to decline today — but didn’t. They have even ignored an assertion by PIMCO’s Paul McCulley that the bond bull market is over (see below). Just what message bonds might be sending these days will be examined in more detail below, but today yields managed to decline 3 to 4 basis points. The dollar index was virtually unchanged, but commodities struggled. Led by a 3% drop in crude oil, the CRB index fell 1.5% on Tuesday.
David Rosenberg, who used to toil as the Chief North American Economist at Merrill Lynch and is now in charge of all things macro for Toronto’s Gluskin Sheff, posed some interesting questions for those who assume the equity rally is proof positive a global economic recovery is now under way. In Monday’s “Afternoon Tea with Dave”, Mr. Rosenberg asks investors to “be mindful of some non-corroborating variables”. Quoting directly from his piece, Mr. Rosenberg lists the following disparities:
1. The Treasury market should be selling off if we are in the midst of a reflationary or a major asset allocation shift. Instead, the yield on the U.S. 10 year Treasury note is some 50 bps below its recent highs.
2. The “real” yield, as measured by the TIPS market, has fallen 20 bps since July 9, to sub 1.7% (a proxy for “real growth expectations”) — during which the S&P 500 has rallied 16%.
3. The Baltic Dry Index slid 10% last week and down 26% in August and is now at a three month low. Combined with the news of the sharp 25% falloff in Chinese copper imports in July, this could be a sign that the global inventory cycle has proven to be a one quarter affair.
4. Corporate spreads have begun to widen out (by 24 bps from the recent low in the investment-grade U.S. market and by nearly 80 bps for the high-yield sector) — these spreads, in the past, have proved to be reliable leading indicators (in both directions).
5. Finally, not only do we currently have a puny sub 4.0% earnings yield on the S&P 500, but look at the dividend yield — all the way down to 2.3%. At the March lows in the market, the dividend yield was sitting at 3.6%, which compared very favourably at the time to a 1.8% yield on the 5 year Treasury note and a 2.8% yield on the 10 year note. Now, the 5 year note is 2.5% and the 10 year at 3.6% — both back at a premium to the dividend yield. The most appealing yield, however, may be Baa corporate bonds, which is now at 6.5% or a juicy 8.6% in “real” inflation-adjusted terms.
Mr. Rosenberg is essentially saying that if the post WWII playbook for a V-shaped rebound in stock prices preceding a V-shaped recovery in economic growth is the right model for what we’ve all witnessed since March, then some key markets (Treasurys, TIPS, corporates, high yield bonds, commodity volumes, and dividend yields) are not reading from the same script. To Mr. Rosenberg’s fine list of “non-corroborating variables”, I would add the U.S. dollar. The U.S. dollar index is hovering near all time lows, but it is supposed to be rising at this point in the economic cycle. Our trade deficit was averaging more than $60 billion per month only a year ago and is now averaging less than half that amount. Due to trade alone, global dollar emissions have been cut in percentage terms that used to strongly correlate with rising greenback values. Not this time; some other factor must be at work.
That something is money printing and quantitative easing by the Bernanke Fed. Stocks love it, but the rest of the capital markets have been grudging in their embrace. Perhaps the other markets will some day reach what seems like such an obvious conclusion to the momentum crowd chasing equities at these levels, but I’m not so sure. Credit spreads have led equities and the Baltic Dry Index has led commodity prices since the Great Recession began. Though just as prone to short term noise as the markets they tend to lead, they have both been flashing warning signals for weeks now.
The bullish retort, of course, would likely be one of welcome — “just some more bricks in the ‘wall of worry’ stocks love to climb!”. A wall constructed of inventory re-stocking, ersatz demand (“cash for clunkers”), and funny money (quantitative easing) will remain high and sturdy-looking only as long as the mortar holding it together (sentiment) remains strong (btw, the State Street Investor Confidence hit its highest level since May 2004 just today — see below). Let’s see how this edifice withstands the changing weather come autumn. How it fares will in part determine Chairman Bernanke’s legacy, just as will any outbreak of inflation should he forget to take away the punchbowl equities have been dipping into these last few months.
— Jack McHugh
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