Last weekend, I said that risk assets were getting frothy, and showed that speculation was rampant in several financial sectors. I also pointed out that essentially the entirety of the total return to investors for several years, and perhaps for several decades, might be able to be explained by the appreciation in price (decline in yield) of the Treasury bond complex. I noted how surprising it was that especially in recent years, the ongoing bull market in Treasury bond prices has been a virtual secret, with media attention going to stocks, gold, etc., even though Treasuries have been the top performing major asset since 1980 on most time frames.
This past week, Treasurys rose in price a bit (declined in yield) all across the yield spectrum from two years through the long bond (30 year duration). In the past month, the difference in yield between the 2-year T-note and the 10-year T-note has shrunk by 24 basis points to a recessionary level of about 133 basis points (1.33%). The fact that the Fed is selling short-term Treasurys, including the 2-year note to buy the long bond suggests that natural as well as Fed-induced forces are bringing rates down. One can look more or less in vain for headlines about how much money investors in TLT and EDV are making (Treasury bond funds that trade in the stock market).
Also last week, stocks took a hit. Normally, the financial media makes sure to promote whatever is hot, because people like to jump aboard appreciating assets. Don’t hold your breath, though, about the media pumping the T-bond the way it pumps assets that make more money for the financial industry. It hasn’t happened recently, and it’s not happening yet.
As an example, the latest Barron’s front page features the “sexy” smartphone battle between Samsung and that great attention-getter, Apple. Great company though Apple is (and I own a smallish position in it), it is a risk asset. Barron’s is pumping the upside to the stock, even though analysts have steadily been lowering earnings estimates both for FY 2013 and FY 2014, which is typically a danger sign. Almost every analyst is publicly bullish on AAPL, there is only a minimal amount of skepticism on the stock as judged by short interest, and put-call options measures of the stock reflect relatively large optimism. Meanwhile, the stock is considered a bargain because it is way off its high– but it’s still up about 30% this calendar year and more than that over the past 12 months. A bull on AAPL might be better off not seeing a bullish article but instead seeing a picture of a bruised, fallen rotting apple. That would be capitulation! Yet the article teases the reader that AAPL, last trading around $527, may go to… $800. As if Wall Street, which is scrambling to earn little bits of interest income, is going to leave an obvious bargain with 50% upside plus a 2% dividend yield just lying around for the public to get rich on simply by reading a Barron’s article!
Despite economic data suggesting recessionary forces at work regardless of precisely what policies Washington comes up with, stock traders continue to be upbeat.
The NASDAQ is down about 2% in the past week and 8% in the past month. A measure of optimism-pessimism is the volatility skew, and for both the ‘NAZ’ and the S&P 500, these measures have stayed steadfastly on the optimistic side. In contrast, during the sell-off this spring, these indices reflected fear. Investor’s Intelligence still shows 53% bulls amongst newsletter writers, about 10% higher than during the spring sell-off and up from 20% bulls during the important stock market bottom in the late summer and early fall of 2011.
The Federal Reserve reported on October’s industrial production (I.P.) this past Friday. This report also provides long-term charts on industrial production, linked to HERE. Those on pages 5 and 7 are interesting. Those on page 5 show a picture of declining vigor over the decades, and shows the downtrend in I.P. that began several months ago. On page 7, one can see that the year-on-year growth of industrial output has been decreasing down to the same level, about 2%, where the recent ‘Great Recession’ began. It is a few points below the level at which the Great Recession of its time, the 1973-5 monster, began. The period in which a recession begins is a dangerous one for stock market investors, because they have now experienced several years of strong stock markets, and the economy has survived recession scares year after year.
While Barron’s draws the public’s attention to the great bull market star of AAPL, it does not give a lot of attention to the NYSE Composite Index, which has hardly moved up from its post-crash early 2010 peak in the past 2 1/2 years. Meanwhile, the massive bull market in the fixed income category has gone largely unnoticed, and it is that bull market which has made the paltry 2% yield on the S&P 500 look enticing.
Regional Federal Reserve Banks find persistent optimism for a better future six months forward than companies see currently. This has been the case for over a decade. One of the latest examples comes from this past week’s Empire State Manufacturing Survey. Respondents indicated that more companies are firing personnel than hiring, and that of those ongoing employees, work weeks are beginning to be shortened. Fewer workers working shorter hours. Plus, the trend for new orders has been flat-to-down for six straight months, and the general assessment of business conditions has been negative for four straight months (so it’s not Sandy’s fault). Yet the CEOs surveyed are resolutely upbeat about the future.
This phenomenon may be relevant to the under-performance of stocks and the general economy since then. Perhaps aggressive Fed “stimulus” has led to over-optimism, thus leading to misjudging the future pace of economic action? Perhaps media cheerleading has played an effect? In the Clinton years, the limited data available from the same surveys does not show much difference between the assessment of current conditions versus outlook six month’s hence.
In any case, there is now a distinct complacency about the economy despite obvious downtrends in growth (or actual declines) in industrial production, real retail sales, real disposable income, and exports. This is reflected (one more indicator) in the ‘fear index’ VIX, which bullishly moved sharply down on the week to the lowest level in one month. (Note: lower VIX correlates with less anxiety about the future; usually the VIX index rises when stock prices drop.
To long-term investors, what happens to securities prices in the short term is of almost no interest. The basic fact is that if one buys “the market” as in the SPY ETF which tracks the S&P 500 index, then one year from now, one will have received about $2 back in dividends for every $100 invested. If a recession turns out to be ongoing now or begins relatively soon, one is investing despite the fact that the average post-WW II recession has been associated with a 30% drop in stock prices from peak to trough. Similar reasoning applies if a recession strikes within a 2-year time frame, unless stock prices soar in the interim or the recession is associated with an atypically mild stock market downturn.
In the entire history of the United States and also in the post-WW II period, a recession has begun about every five years. It is now almost five years since the onset of the ‘Great Recession’.
Thus it is unclear why faith should prevail over precedent.
Anything could happen, and more than usual in this world of central bank intervention in markets I mean anything, so my main point once again is to argue for a cautious strategy, as I have been advocating for some time.
Addendum: Much of this post has to do with volatility, and the markets’ tendency to bet on low volatility (to be bullish) for stocks even as they act bearishly. After completing the above, I came across this article on volatility by the redoubtable Nassim Nicholas Taleb from Saturday’s WSJ. Enjoy.