Strong vehicle sales

Sales of light vehicles in May exceeded expectations (16.7 mil. vs. 16.1 mil.) and rose by 8.4% from their year-ago level. Vehicle sales are now up over 85% from their recession low—recording 12.5% annualized gains in the past five years—and are very close to regaining their pre-recession level (sales averaged about 17 mil. units a year from 2000-2006). This is quite impressive.

The importance of real yields

The introduction of TIPS (Treasury Inflation Protected Securities) in 1997 was an important milestone for financial markets. For the first time ever, TIPS gave us the ability to see real interest rates in real time. Before, we had to infer real yields after the fact. Real yields are a significant contribution to analysts' arsenal of data, since they can be used to discover what the market is expecting about the future of economic growth and inflation. Currently, TIPS are telling us that the market is quite pessimistic about the prospects for real growth, but not concerned at all about the outlook for inflation.

Before, when nominal yields rose we didn't know how much of that was due to rising inflation expectations or rising real growth expectations. Now, if real and nominal yields rise by the same amount, then we know it's because the market's real growth expectations are rising. If nominal yields rise by more than real yields, then we know it's because inflation expectations are rising. 

The chart above compares the nominal yield on 5-yr Treasuries to the real yield on 5-yr TIPS. If you subtract the real yield on TIPS from the nominal yield on Treasuries you get the market's expected inflation rate over the next 5 years (more commonly referred in the bond market as the "break-even" inflation rate, since that is the inflation rate that would cause holders of TIPS and Treasuries of similar maturities to have similar total returns). The main message of this chart is that inflation expectations haven't changed much over the past 17 years: the average expected inflation rate since 1997 is 1.94%, and the current expected inflation rate, by this measure, is 1.98%. The actual annualized CPI inflation rate over the past 17 years was 2.3%. So TIPS have underestimated inflation by a little. But in any event, this chart tells us that the market is not very concerned about rising or falling inflation, and that, in turn, suggests that the Fed is doing a good job.

In theory, real yields on financial instruments should tend to track real economic growth, because you need economic growth to deliver positive real returns to investors. Not surprisingly, we can observe this thanks to TIPS. Real yields on TIPS have tended to track the real growth rate of the economy, as the chart above shows. I've used 5-yr real yields on TIPS as a proxy for the market's expectation for future growth, and I've used a 2-yr annualized measure of real GDP growth as a proxy for the current level of growth. When real economic growth was in the 4-5% range in the late 1990s, TIPS' real yields were 3-4%. Since then, economic growth has been trending lower, and so have the real yields on TIPS. The current level of real TIPS yields, according to this chart, suggests that the market is priced to the expectation that real growth in coming years will be 1% at best. That's pretty pessimistic.

Real yields on short- and intermediate-maturity TIPS can also serve as proxies for the market's desire for safe assets. TIPS are unique in that they are default-free, inflation-protected, and they are the only security in the world with a government-guaranteed real yield that you know in advance. Gold is a classic "safe asset," being historically a refuge from inflation and geopolitical risk. As the above chart shows, the price of TIPS (shown here using the inverse of their real yield as a proxy for their price) has tracked the price of gold in recent years quite closely since 2007. Both have acted as safe havens for all the concerns that arose in the wake of the 2008 financial and economic collapse that affected nearly everyone around the globe. One of the more important developments of the past year or so is the decline in both TIPS and gold prices. That tells us that the world's demand for safe assets has declined meaningfully, even though it remains elevated. I've been watching these two assets very closely for over a year, looking for signs of a further decline in the demand for safe assets. Should it occur, I think that would go hand in hand with a return of optimism, a decline in the demand for money, and, eventually, an acceleration in nominal GDP and inflation. And that, in turn, would show up as higher interest rates and probably a somewhat stronger economy.

Apple disappoints on hardware, but beats on software

At today's developer conference, Apple once again disappointed the world by not introducing any new hardware products. But the company did unveil a stunning display of new software features and device integration that will make give new life to existing products, from phones to tablets to laptops and desktops. When OS X 10.10 and iOS 8 are released in a few months, the Apple ecosystem will become an even more compelling platform than it already is, one that could be very tough—if not impossible—for anyone to beat.

Apple did announce a greatly expanded cloud product/service today: iCloud Drive. This is a central storage service that syncs all data and photos across all devices. This sort of functionality had been sorely missing for some time and should be a welcome addition to everyone who uses an Apple device.

Apple's legion of developers were surprised and excited by all the new features discussed today. Swift, a new and more powerful programming language, coupled with Metal, which greatly speeds up graphics processing, plus 4,000 new APIs and the ability to have integrate apps, could all but revolutionize the future of apps for Apple devices in coming years.

Today Apple showed that it remains firmly on the cutting edge of technology and software, and, to judge by the breadth and depth of today's announcements, it should hold a commanding lead against would-be competitors for many years to come.

I've been an Apple user and fan since 1986 and an AAPL investor for over a decade (full disclosure: I am long AAPL as of this writing). I'm very excited by what I saw today. Software advances of the sort unveiled today are arguably worth more than a new hardware product. But in any event, it seems very likely that Apple in the second half of the year will come out with a larger iPhone and at least one new class of device. The future looks very bright.

Apple's current PE ratio is 15. But if you back out the overseas cash and assume they pay taxes to repatriate it, then the PE ratio drops to less than 12. This is not an expensive stock.

Apple's earnings have been in a two-year hiatus, but new products and greatly expanded software capabilities should be enough to drive earnings higher in coming years. With a current earnings yield of 6.6%, the market seems priced to the likelihood of stagnant or declining earnings for the foreseeable future. That's a very pessimistic take on today's announcements.