Thursday, July 20, 2017

Global green shoots

If you want bad news and arguments for why the market is due to collapse any day now, just spend a few hours reading Zero Hedge or browsing the media and punditry. Very few observers these days are willing to pound the table for stocks, considering they have been rising for more than 8 years and are hitting new highs almost every day. Is there anyone who isn't dismayed that Trump and the Repubs haven't been able to repeal and replace Obamacare after years of trying? Is there anyone who is confident that Trump and the Repubs will succeed in massively lowering tax rates? I don't see any evidence that the market is pricing in a stronger economy: 5-yr real yields on TIPS are a mere 0.15%, a level that suggests the market is priced to sluggish growth for as far as the eye can see. And then there are the geopolitical risks. The chances of North Korea dropping a nuclear bomb somewhere are frighteningly high, and China seems bent on expanding its ocean domain. And of course, the Fed is in tightening mode, and tight monetary policy has been the precursor of every recession in modern times.

Yet amazingly, despite the obvious problems out there, complacency reigns: the Vix Index and the MOVE index (the bond market's version of the Vix) are both down to all-time lows. Isn't it scary that the market is moving higher at a time when there are so many troubling things going on and complacency is rampant? Anyone in his right mind would be concerned, no?

Investors are on the horns of a dilemma: it's tough to be bullish, but it's also expensive to be bearish. The earnings yield on stocks is still quite high relative to the yield on cash and bond market alternatives; so hiding out in cash means giving up a lot of precious yield. But almost $9 trillion in bank savings deposits paying almost nothing says that there are lots of people who are reluctant to take on market risk. Indeed, when I look at the market, I see more evidence of caution than I do of exuberance. Bill Miller, a long-time friend and former colleague, maintains that the market is still in a "safety bubble" after the shock of 2008. I've long observed that real yields on TIPS are miserably low, and for that matter nominal yields on sovereign bond markets nearly everywhere are very low. So it's not at all obvious that the market is running on fumes.

Amidst all the worries, however, there are actually some encouraging developments. Call them global green shoots. The U.S. may be stuck in slow-growth mode, but the rest of the world is looking better on the margin. Some charts follow which help flesh out the story:

China is pulling back from the abyss, after scaring the bejesus out of nearly everyone two years ago (check out the "Walls of Worry" chart below), when it looked like their stock market and economy were tanking. As the chart above shows, real GDP growth now looks to have stabilized in a 6-7% range.

As the chart above shows, China's forex reserves have been stable for most of this year, after having plunged from $4 trillion to $3 trillion over the previous two years. The fact that the yuan has stopped falling suggests that the central bank has managed to maneuver the yuan to a level that is balancing capital flows. This further suggests that the fundamentals in China has improved significantly in the past two years. Capital inflows and outflows are about equal these days. (The level of forex reserves is a direct result of net capital flows; reserves decline when outflows exceed inflows, and vice versa.)

Due to the yuan's strength and relative stability against the dollar, inflation in China is virtually identical  to inflation in the US, and it has been for a number of years. This further suggests that the Chinese currency could remain relatively stable against the dollar going forward. What's good for China is good for the world.

As the chart above shows, the Chinese stock market has been trending higher for the past 18 months after the bursting, beginning in mid-2015, of what in hindsight looks like a huge speculative bubble. Now that the dust of that bursting has settled, we see that the Shanghai Composite has actually kept pace with the S&P 500 over the past four years. This is a problem? On the contrary.

The Eurozone has been struggling for many years and continues to struggle. Since the beginnings of our bull market in March, 2009, Eurozone stocks have underperformed their US counterparts by over 30%, as the chart above shows.

But as the chart above shows, Eurozone industrial production now is outpacing US industrial production.

Eurozone ISM manufacturing surveys confirm that the industrial side of the Eurozone economy is regaining its health. And the Euro is strengthening on the margin of late, another sign that the outlook for Europe is not as gloomy as it used to be.

Industrial metals prices are up strongly in nearly every currency over the past 18 months. This is an excellent sign that global economic activity is picking up.

Emerging market stocks have been doing exceedingly well in the past 18 months, as the charts above show. In dollar terms, the Brazilian stock market has more than doubled and the MSCI emerging market equity index (second chart) is up some 50% since early last year. It's not that emerging economies are booming; rather, it's that the outlook has improved from dismal to maybe Ok. Emerging economies are also being bolstered by stronger commodity prices: the CRB Spot Commodity index is up 20% in the past 18 months.

The current PE ratio (using 12-month trailing earnings from continuing operations) of the S&P 500 is just under 22. That's well above its long-term average, but is that a sign of unwarranted exuberance?

Not necessarily. Earnings are growing, as the chart above shows. 12-month trailing earnings are up more than 7% in the past year, and we see positive earnings surprises almost daily.

The current earnings yields on stocks (the inverse of the PE ratio) is 4.6%. That means that if earnings held steady at current levels and if companies paid out all their earnings, the dividend yield on stocks would be 4.6%. The chart above compares the earnings yield on stocks to the yield available on risk-free 10-yr Treasuries. It's unusual for stocks to yield a lot more than risk-free bonds, as they do today. By this measure stocks look cheap. About as cheap, in fact, as they were in the late 1970s, when the world was terrified of stocks. When the stock market is fueled by optimism, as it was in the 1980s and 1990s, the yield on stocks is typically less than the yield on bonds. People are willing to accept a lower yield on stocks because they expect that stock prices and dividends (and earnings) will rise in the future.

The chart above shows yields on a variety of different investments, from Treasuries to mortgage-backed securities to corporate bonds, REITs and emerging market debt. The yield on stocks stacks up quite favorably to the alternatives, and that again is unusual. If the market were optimistic, the yield on stocks would be much lower than the yield on less risky alternatives. Put another way, when the yield on stocks is relatively high, thus the price of stocks is by inference relatively low.

Shown above is an update of one of my favorite charts. The equity market rally which began last November has been driven in no small part by a decline in fear and uncertainty, coupled with a belief that the economy is likely to continue to be relatively sluggish but also relatively stable (which is reflected in a modest rise in 10-yr Treasury yields since November).

The chart above shows the implied volatility of stocks and bonds. Both are now at new lows: that means the stock and bond markets have never been so unconcerned about the future. In a sense, the capital markets appear to be pretty sure that nothing much is going to happen to the economy for the foreseeable future: growth is going to remain modest, inflation is going to remain relatively low, and the Fed is not likely to upset the applecart. In addition, the market seems pretty sure that earnings are not going to increase, and are more likely to be flat or to decline.

To sum it up, although the market is priced to mediocrity (sluggish growth, flat to lower earnings), the global green shoots are hinting that the future may be a bit more exciting. If Trump and the Repubs manage to pull off a successful tax reform, then things could get really exciting.


Buy Low then Sell High said...

I do occasionally read the doom and gloom posts. However, after 30 years of investing, I've learned to bet on America. Keep up the well-reasoned analysis. We only had Joe Granville in the 1970s and 1980s to provide great buying opportunities.

steve said...

You can look at the world and see a glass half full OR empty. Simply depends on your disposition and propensity. Being bearish is usually expensive as it means cash or God forbid, short! I agree with Scott 95% of the time and this is no exception.

AmericanFool said...

Scott, I really need to frequent your blog more often. Your comments display inordinate common sense, now and every time i drop in. I'm with you... I'm not betting on late 1990's growth, but I think we're poised for several more years of reasonable growth, with a lot of help from the Global Economy (finally.) I won't opine on market corrections, that's just part of the scenery in my world. The world has always been nuts, yet growth just keeps happening. Check your risk, play the probabilities, and let it ride... and hope no black swans appear on the horizon!

The Cliff Claven of Finance said...

I believe the always negative ZeroHedge is the antidote for this always positive blog.
I read both and many others.
I'm interested in data and charts -- there are many good charts here.

It's never been smart in the history of American stock markets
to be bullish when valuations are very high,
as they are now,
and never been smart to be bearish
when valuations are very low,
as they were on March 9, 2009.

Zero Hedge would be a better source, in my opinion,
when stock valuations are very high and you want to seek bad news.

High stock prices tend to give investors confirmation bias ( and vice versa )

This blog would be a better source, in my opinion,
when stock valuations are very low and you want to seek good news.

The total annual return on the S&P 500 since the 2000 peak
was only 4.7% if you held with no commissions or fees,
and held on during two 50% declines without flinching.

Please remember that things looked great before the 2000 and 2007 bear markets started.

Please remember that the 2000 peak was preceded by the greatest bull market in American history,
from 1982 to 2000 -- and be aware that median stock price to sales ratio TODAY is 50% higher
than at the 2000 peak.

That's something to consider.

Also consider that betting on America now is betting on much lower rates of economic growth
than in the past -- just 1.5% average growth under Obama, and about 2.1% average growth since 2000
-- much slower than in the past.

The purpose of buying stocks is capital gains in your pocket -- not "betting on America".

I was as bullish as anyone in early 2009.

My March 9, 2009 financial / economics newsletter switched from bearish to bullish
-- just a coincidence I'll never repeat in my life.
I just happened to publish my bi-monthly newsletter on that day.

I turned neutral in Spring 2016 after no bull market progress in a year
and the sickening thought of Hillary as President. I'll turn bearish when the
economic data justify that. Of course I'd be bullish now if I expected a large
decline of corporate tax rates soon, but I don't.

I know ultra high stock valuations when I see them.

From my latest newsletter:
- The 26x S&P 500 Price/Earnings Ratio was only higher just before the 2000 and 2007 bear markets.
- The Median S&P 500 Price/Sales Ratio is at a record high, 50% above the 2000 extreme.
- The Stock Market Capitalization to GDP Ratio is highest since just before the 2000 bear market.
- From current valuation levels, the expected rate of return over the next decade is low. The cycles of the market and the economy have not been repealed. This time is not different. The price you pay for any investment today determines the return you will receive in the next decade or two.

My personal investments are now 66% cash, 10% gold stock, and 24% common stock & MLP.
The best investors do not buy and hold.

Expect 90% of stocks to go down in the next bear market.
I have no idea how to identify the 10% that don't go down.

marcusbalbus said...
This comment has been removed by a blog administrator.
Benjamin Cole said...

Great blogging from Scott Grannis, per usual.

Perhaps China and Japan are the new engines of global growth. Together, their economies are larger than that of the US, and they consume far more commodities and raw materials.

China and Japan are now both growing, and both have growth-oriented central banks. That is a positive.

Europe is a cipher, what with socialism.

I hate to say it, as the nicest people in the world live in Latin America, but you can get rich betting against Latin America in terms of investing. I hope for the best, but inevitably…

steve said...

the problem with trying to "time" the market is you have to be repeatedly correct TWICE. once on the buy side and once on the sell side. having been in the business for 30+ years I have NEVER witnessed anyone consistently do this. it's "cool" to be bearish but the best investors in the world do NOT time stocks, they choose them.

honestcreditguy said...

Whats interesting is how companies will use their available money when stock buybacks are not cheap due to Fed policies. Buybacks was an easy decision and easy money as the PPS rose higher. With the Balance sheet unwinding and 1 more rate hike we will finally get to see if companies decide to turn up inflation by using their money to ignite it...

Johnny Bee Dawg said...

After the 4.7% return since the 2000 peak, and Cliff's prediction of low returns from here out...I realize he is predicting the lowest long term returns on stocks in US history.

Our worst 30 year stock market period started at the market peak of August of 1929, and delivered only 7.5% per year, total return. We need double digit returns over the next 13 years to tie that number. The low returns Cliff is looking for from here out would give us the worst 30 year period ever. Worse than the Great Depression.

Steady earnings with upside surprises, pent up consumer demand, high earnings yields, looming tax reform, regulatory rollback, and record cash on the sidelines all look like opportunities to me.
Sure stocks will pull back along the way, but America is tired of malaise. Americans are ready for optimism and tired of nanny state scolding. America is ready for things to work, and tired of the PUB controlled Congress and PUB created "Special Prosecutor" leading endless investigations of non-existent collusion with Russia, while failing to deliver any legislation to sign. They are all excited about fighting Opioids. Good lord.

I think America is ready for some double digit returns, and PUBs should be more respectful of the voters who put them in power. Trump gave PUBs the most seats nation-wide since 1920 in this landslide election. DEMs were kicked to the curb. People want PUBs to stop blocking the POTUS, and get busy doing what they promised. That whole Party's power base needs a good flush. They need to be replaced with energetic, optimistic free-market Constitutionalists, and get DC out of the way.

Repeal the dumbass ObamaCare debacle, slash taxes and regs, and lets get on with prosperity.
If the PUBs succeed in stopping the Trump agenda, I'd probably agree with Cliff about our worst ever performance.

steve said...

Hey Johnny, weren't you the "drain the swamp" guy? How's that working out? DT is a complete embarrassment. Reminds me of a recalcitrant 12 yr old. He has been LUCKY as a RE tycoon in NYC, struck a nerve as a presidential candidate (although for the life of me I have no idea why) and has been a 100% abysmal failure as the country's top executive. What a role model. Good grief.

Johnny Bee Dawg said...

So far its working out great!

S&P is up 17% since election. NASDAQ up 23%. Consumer Confidence at highest level in 17 years.
Gasoline prices at multi-year lows.
Interest rates low, jobless numbers low, US companies announcing countless earnings upside surprises, US and International firms announcing new plans for plant and hiring all over the country.
Wages rising for the poorest. Illegal immigration plummeting.
Got us out of the dumbass Paris Climate con.
Got increased funding from other NATO members.
Got wild applause and standing ovations from hundreds of thousands for his Pro-America speeches overseas.

And I have the best July year-to-date return for my portfolio in my 25 year career.
And that is all without the PUB Congress delivering a single piece of major economic legislation for him to sign, yet.

If Trump keeps up this "100% abysmal failure" stuff you describe, he will win a second term in a bigger landslide than he won his first.
Good to see he still pisses off all the right people.

The Cliff Claven of Finance said...

Johnny B.

I have merely said that investing when valuations are unusually high
has always resulted in low returns.

I did not specify a 30 year holding period.

In fact I was thinking of 10 years.

Many people can not invest for 30 years without ever touching their money.

The current S&P 500 Price to Sales ratio is higher than it has ever been
except for one week in early 2000 when that bull market peaked.

The median Price to Sales Ratio is 50% higher than its ever been.

It seems that mentioning those facts here, which adds another point of view
to what appears to be an always bullish blog, upsets some people.

The 4.7% total return from the 2000 peak to today
is a reminder of what would happen
if you invested at a peak and sold at a peak
(I consider this year to be a peak year)
4.7% is not very good if you have to hold for 17 years and
suffer through two 50% declines while remaining fully invested.

Never in history have investments made at these very high valuations
led to good returns in the next ten years.

It's fine with me if you want to believe this time is different.

And if you invested at the peak in 1929, you would have had to hold on through a 90% decline
without ever selling ... and hold for the next 30 years.

I have not checked your claim of a 7.5%
annual return in the 30 years after the 1929 peak.

But I don't know what 1929 has to do
with 2017, when our economy
has struggled to grow 2% a year since 2000.

Congratulations on your best portfolio return in the past year.
Sometimes that's a warning to take some money off the table.
For myself, when my portfolio is doing great,
and I feel like a financial genius, it's always been a good time
for some selling.

Scott Grannis said...

JBD: Indeed. If Trump's record to date (SCOTUS pick, cabinet picks, de-regulating, Paris Accord exit, military strengthening, respect for business, global leadership, tax reform, etc) is a failure because of his chaotic character and White House turmoil, I love to see what might happen if his presidency turned out to be a success.

A cynic and/or a smart Trump watcher might conclude that Trump, like a magician, succeeds by distracting his enemies from his real agenda.

But I do wish he would stop tweeting!

The Cliff Claven of Finance said...

Given his success in the private sector, his success on TV, his success picking a wife ... on the third try, the success of his children, and his success as a novice politician ... who are we to criticize Trump's style?

Maybe the tweeting is entertainment for Trump, who obviously gets little sleep, and there's nothing better to do in the morning?

I feel it is the equivalent of walking past the monkey cage at the zoo and rattling your steel cup against the bars.

The monkeys in his case are the Democrats, who get all riled up, jump up and down, shout, throw verbal rocks, and generally get distracted from most of the things Trump has been doing with executive orders?

I recently finished a six page report on Trump's first six months for my economic newsletter.
Here is the beginning of the article below (the summary)

-- but I don't think the next three and one-half years will be as good,
because too many Republicans in Congress oppose too many of his campaign promises.

I have to research what can be accomplished with reconciliation in Congress before I can
figure out how well the Democrats in the Senate will block legislation.

Can you believe we live in a country where the Senate minority can block so much legislation?

And I think they'll block everything they can just like they're doing with political appointments.

"PRESIDENT TRUMP: The Results, Not the insults
Based on the results, not the insults:
From my libertarian 'smaller government is better' point of view:
-- President Trump had the BEST first six months of any president in my lifetime.

From a traditional conservative point of view:
-- President Trump was better than President Reagan in his first six months,
and probably the best since the 1920s.

From a 'bigger government is better' Democrat point of view:
-- President Trump was the WORST President since the 1920s!

I was pleasantly surprised by the elimination of many Obama-era regulations,
and an unprecedented decline in new regulations.
That was an indirect Trump campaign promise.

Just as important was appointing a new conservative Supreme Court Justice
who respects our Constitution ... a document designed to prevent the powerful
Executive branch of government that we now have ... until it was undermined
by liberal justices who specialize in misinterpretation, or just ignoring the document,
in their constant effort to expand government powers.

This report is not about pre-election promises, tweets, or speeches.
Trump grossly over-promised what he could deliver.
Trump's tweets are usually okay, but usually okay is not good enough.
Trump's speeches from TelePrompTers are mediocre --
of course he follows an expert TelePrompTer reader named Barack Obama.

Alex in Montana said...

For those that are bullish and I usually am, I would suggest reading one the great investors Bob Rodriguez. I am not bullish now because I believe we could go up a little, but we could go down a lot, so my cash level is very high as it was in 1999 and 2007. In both cases I bought 2 year Puts or shorted the S&P 500 and I just bought some protection last week for the first time in 10 years. I will be wrong for some months but if I read things correctly as I did the last two times I will not be wrong within the next two years.


or here:

Good luck to everyone regardless of position

Johnny Bee Dawg said...

You are predicting the worst 30 year stock market in US history, whether you know it nor not.

If we've done 4.7% for the last 17 years, then we have to make double digit returns for the next 13 period to avoid it. You said you are looking for bad returns from here.
I was just pointing out the unprecedented call you are making.

Johnny Bee Dawg said...


I LOVE the Tweeting! Trump has succeeded so far by going straight to the people and bypassing the gatekeepers.
The Main Stream Media is completely corrupt, and dealing with them is futile. Just watch their idiocy at a press conference.
Russia! Russia! Russia! Mouthpieces of the Deep State, trying to end MAGA.

Gimme the Tweets! Trump has communicated to voters more often, directly, and effectively thru his Tweets than any POTUS in history. I love the message, and the results. MAGA!!
Trump is my crowbar, and lord knows we need one!

marcusbalbus said...

depressing the same blather for 8 years. go QE

Scott Grannis said...

I guess you haven't been reading too carefully over the years. It's never been about QE.

The Cliff Claven of Finance said...

Johnny the Dawg

You are committing a psychological error of getting mad at someone
who thinks the stock market is overvalued -- that seems like confirmation bias.

You are also committing several logical errors:

The worst of them is creating a red herring --
claiming I predicted the stock market for the next 30 years
and then attacking a prediction I never made.
I made NO PREDICTION of anything.

I said stock investing when valuations are very high
has historically led to low returns, and I had the data
to prove it, but not the time to find it and post it then.

You decided to commit another logical error.

You cherry-picked the dates August 1929 to August 1959 to "prove"
how smart it was to invest at a market high.

You forgot to mention the return from the Dow alone was 2%
a year from 1929 to 1959,
and ONLY reached 7.4% a year if all dividends
were reinvested in the 30 Dow stocks immediately upon receipt
-- that would be a logistics nightmare in the pre-ETF era,
and commissions would have been high.

You might have considered a 20 year return from August 1929 to August 1949:
Return form Dow alone = -3.4% loss per year
Return including reinvested dividends = +1.5% gain a year

You might have considered a 10 year return from August 1929 to August 1939:
Return form Dow alone = -9.2% loss per year
Return including reinvested dividends = -4.7% loss per year

It seems that the 10 year and 20 year returns are pretty bad for investments made
in August 1929 ... but your data mining overlooked those important facts!

Data source:

The Cliff Claven of Finance said...

Alex in Montana
You are a smart man.
People are most bullish at the peak.
RV sales are hot right now.
That's a great indicator too!
And people get made when you point out
that stock prices have very high valuations.

Johnny Bee Dawg said...


I was in no way "mad" at you at all, or at your prediction of a correction. Not sure where you got that. Surprised at that reaction.

The reason I picked the peak of August 1929 is because it began the worst 30 year return in US history, so far.
The worst periods always begin at market peaks.

That worst 30 year period for the S&P 500 was about 7.5% per year. That's not "cherry picking" This is just a fact. You can look it up. Of course dividends are included in total returns. Dividends come with the investment.

You pointed out that we have done only 4.7% per year for the past 17+ years since the 2000 peak.
If you didn't predict, you certainly warned that we are about to have another major market correction.
(Why else praise the Zero Hedge articles, and point out perceived similarities to the last major peaks?)

The FACT remains that we need to average double digit returns from here to beat the worst 30 year return in US history.
We are over halfway thru a 30 year period since that 2000 peak. That isn't "cherry picking" either. Its just a math fact.

If you are looking for bad returns from here, then you are predicting the worst market in US history whether you know it or not.

If we don't have the worst 30 year period in US history, then an investor will make double digit, above average returns for the next 13 years. Thats just a math fact. Nobody knows what the market will do.

I was putting the recent weak returns you quoted in context. Use the information if you find it useful.