SandPointe_September Market Perspective 2014
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Transcript of SandPointe_September Market Perspective 2014
1 SANDPOINTE
SandPointe Investment Perspective
Roger E. Brinner, PhD Chief Market Strategist and Co-founding Partner September 2014
2 SANDPOINTE
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist
The Fundamental Investment Strategy View from Our “One-Armed” Economist
President Harry Truman famously asked for a one-armed economist so that he could get an unequivocal, fact-driven assessment, rather than hearing “on the one hand…., but on the other hand…” In this, SandPointe’s first Investment Perspective, you’ll get this treatment.
3 SANDPOINTE
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist and Bryce Quillin, Chief Economist
• US equities will benefit from another year of profit growth and P-E ratio expansion - Real GDP growth in the US is shifting from 2% to 3+% real growth rates) unlike others who have prematurely predicted
acceleration, I have waited until the fiscal policy corrections were digested and wealth had been rebuilt to make this call - Confounding pundits who have repeatedly, mistakenly projected an imminent peak in profit margins for years (just
because the profit/GDP ratio was higher than “normal”), profits will rise more rapidly than GDP based on rising capacity utilization rates, price inflation still exceeding unit labor cost growth, and diminishing interest burdens
- Even if, as we believe, the competing 10-year Treasury yield is headed toward 3.5% or more within three years, this would still easily align with a trailing PE ratio of 23-plus versus 19 currently. 23.5, for example, implies an earnings yield (the inverse of the PE) of 4 ¼% that would still exceed T-bonds, and then the equity investor also gets earnings growth and the bond investor gets nada
- Another way of stating this is that the equity risk premium is still exceptionally, unjustifiably large and is taking its sweet time shrinking, even though the risk premia in bond markets are now at relatively low levels (e.g. the corporate Baa is 2.2% above the 10-yeaar Treasury versus 5.6% in 2008); Putin has scared the equity markets but they can rally strongly after his threats to Europe have been sized up and stabilized
• Long-term Treasuries are “dead men walking” for the next 3 years: everyone should know the real after-tax return will likely be negative yet such bonds still sit prominently in portfolios - A year from now, the 10-year Treasury yield will be near 3% versus less than 2 ½% today, producing a 1 ½% total return
with a capital loss of 1% offsetting the meagre coupon - Subtract 3% cost inflation and you’re underwater if you’re an endowment - Subtract 40% income taxes and 2% price inflation if you’re a consumer, so welcome to the investor scuba-diving team - Three years from now the federal funds rate will be at least 3% (2% inflation target plus 1-2% real return at cyclical peaks)
and I judge the 10-year Treasury will be closer to 4%, thus more capital losses to offset historically abysmal coupons - Why would a prudent investor accept such returns when the implied bond-equivalent long-term equity return is at least
11%: the 5 ¼% current earning yield (i.e. 19 PE) plus sustainable earnings growth of 6%?
4 SANDPOINTE
Equity Prices Respond to Four Fundamentals
Absolute and relative performance of US and global regional
equities
Earnings (Primarily Past 2 Years)
Competing Yield On “Risk-free” Sovereign Fixed Income
Perceived Risk/ Uncertainty of Earnings Due to Stage of
Business Cycle
Additional Risks Due to Abrupt Changes in Regulations or
Global Shocks
5 SANDPOINTE
Profit Growth, Plus a “Super-Rotation” from Risky Treasury Bonds to Equities, Continues to Bode Well for US Share Prices
-5
0
5
10
15
1981
1986
1991
1996
2001
2006
2011
2016
Bond Yield - Earning Yield
10-Year Treasury Yield
S&P 500 Earnings Yield (E/P Ratio)
History Forecast
INCREASING RISK AVERSION REVERSION
TOWARD NORMAL RISK AVERSION
SPREAD WITH NORMAL RISK AVERSION
April 2013 Forecast for S&P 500 price increase to Q2 2014:
+26.2% Actual gain:
+25.5%
6 SANDPOINTE
Central Banks Dominate Short-and Long-term Interest Rate Behavior, Responding to their Legislated Mandates to Control Inflation and Growth
Short-term interest rates
Job Growth
Core and Overall Inflation
Exchange Rate
“Quantitative Easing”
The Fed, the ECB, the Banks of England and Japan, and their Global Peers All React to National Conditions, with
identifiable national sensitivities and timing/patience
Additional Forces Critical to Sovereign Bond Yields
Government Deficits
Potential Election Impacts
Special Crisis Situations
Long-term treasury rates
7 SANDPOINTE
-6-4-202468
101214161820
-6-4-202468101214161820
1960
Q1
1962
Q1
1964
Q1
1966
Q1
1968
Q1
1970
Q1
1972
Q1
1974
Q1
1976
Q1
1978
Q1
1980
Q1
1982
Q1
1984
Q1
1986
Q1
1988
Q1
1990
Q1
1992
Q1
1994
Q1
1996
Q1
1998
Q1
2000
Q1
2002
Q1
2004
Q1
2006
Q1
2008
Q1
2010
Q1
2012
Q1
2014
Q1
2016
Q1
2018
Q1
Fed. Funds Rate10-Year Treasury Note Yield
Policy Indicator: Job Growth+Inflation
The Economic Indicators Watched by The Fed Are Calling for Rate Increases and Bond Markets Began Responding Last Year
Bond Yield and Fed Funds Rate vs. Policy Indicator (Sum of Inflation and Employment Growth (1960-2018)
Extraordinarily Low Funds Rate 2009-2014
8 SANDPOINTE
The Fundamental Investment Strategy View from Our “One-Armed” Economists (continued)
• In dollar terms, commodities also shouldn’t offer any momentum plays to the investor • With the European Central Bank dropping euro interest rates as US rates rise, the dollar strengthens: it logically and
empirically gains about 8% for each additional point of the US-Euro bond spread • Restrictive Japanese fiscal policy and Chinese growth targets also require easy monetary policy • Other things equal, within 6-12 months, each percentage point rise in the dollar against a currency basket cuts dollar-
denominated commodity prices for industrial metals, farm products, chemicals, and energy by 7-9% • Gold and precious metals will be hard pressed to hold their value in a strong dollar, rising interest rate environment
• Looking beyond mid-2015, there are reasons for concern • Know these two facts of postwar economics: 1) the US has never had a recession that wasn’t preceded by significant Fed
tightening; and 2) the Fed has never raised the funds rate by 3% without causing a recession (classic declining real GDP recession or moderate “growth recession” with rising unemployment due to too-tepid GDP growth)
• The Fed has announced it will raise rates beginning next year and continue until normal rates are established • The normal peak would be 4 ½% in that the inflation is targeted at 2% and the average funds rate when unemployment is
under 6% (cyclical peak periods) is 2.6% above inflation; I expect a slightly lower 2018 peak in the 3 ½% to 4% range • As a result of this moderation, and the absence of a preceding overheated boom, I expect only a growth recession with
2% real GDP growth, slightly rising unemployment, and a brief profit retreat • In other words, 2016-2018 will be an extended balancing act by the Fed as it seeks to temper growth without reversing it;
the mid-1990s are the best example of a successful maneuver of this type by the Fed • Both equity and bond returns are likely to be low and volatile in this future stretch until the Fed’s degree of success is
learned
SandPointe Investment Perspective By Roger E. Brinner, Chief Market Strategist and Bryce Quillin, Chief Economist
9 SANDPOINTE
Global Economic Factors Drive All Commodity Prices, and Unique Supply Forces Impact Oil Prices in Particular
All Commodities: Farm, Metals,
Plastics, Energy, Chemicals
Oil Prices
Global Growth
General Inflation (GDP Deflator)
Dollar Exchange Rate
OPEC Oil Production
Non-OPEC Oil and Gas Production
Common Demand Forces Affecting All Commodity Prices
Additional Supply Forces Affecting Oil Prices
New Technology for Oil and Gas
The “noise” of severe weather, strikes, catastrophes, and other crises is dominated by these discrete fundamentals when the investor prudently
steps back from daily and weekly data
10 SANDPOINTE
Commodity Prices Have Cycled Massively, Consistent with Historical Patterns
• All commodities are driven by three shared fundamentals: − Exchange rate of dollar
vs. other currencies − Global economic activity − Trends in global GDP
price
− Note that in the graph, the simple sum of these 3 factors very closely matches the behavior of the average materials price index
− Our econometric model creates a weighted sum that matches even better
Source: Global Insight, BLS, IMF
0.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.5
1988
Q1
1989
Q1
1990
Q1
1991
Q1
1992
Q1
1993
Q1
1994
Q1
1995
Q1
1996
Q1
1997
Q1
1998
Q1
1999
Q1
2000
Q1
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
All
Pric
es R
elat
ive
to 1
990
Ave
rage
s In
dexe
d to
199
0=1
GDP Deflator
Exchange Rate
Average Materials (Farm, Metals, Chemicals) excluding Oil
Industrial Capacity Utilization
Simple Sum of 3 Factors
Drivers of Wholesale Materials Prices, 1988-2013
11 SANDPOINTE
Commodity Prices Move in Parallel, with the Exchange Rate Acting as a Dominant Common Force
Source: Global Insight, BLS, IMF
Historic U.S. Wholesale Prices of Key Crude Commodity Groups, 2001-2015
-30
-20
-10
0
10
20
30
40%
-90
-60
-30
0
30
60
90
120120%
2001
Q1
2002
Q1
2003
Q1
2004
Q1
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
Infla
tion
vs. Y
ear A
go
Farm ProductsChemicals
Oil Prices (Right Scale)
Exchange RateMetals
12 SANDPOINTE
Looking Beyond Mid-2015, There Are Reasons For Investor Concern Because The Economy Responds Predictably, Logically Strongly To Policy Shifts
National Output, Employment,
Interest Rates, Exchange Rates
and
Differentials versus Other
Nations/Regions
“Business Cycles” with predictable
sequences of strength and
weakness for each asset class
Monetary Policy
Fiscal Policy
Trade and Capital Policy
Regulatory Policy
If the wise investor looks beyond the noise of weekly data releases, trustworthy signals --patterns based on good logic and theory-- are apparent and thoroughly investable
Technology and Entrepreneurial Zeal
13 SANDPOINTE
Monetary Policy is Particularly Important: In the Postwar Era, Recessions Are Nearly Perfectly Paired with Preceding Federal Funds Rate Increases
Source: Global Insight, BLS, IMF
Federal Reserve Rate Increases Always Precede Every Recession
0
5
10
15
20
0
5
10
15
20
1959
Q1
1962
Q1
1965
Q1
1968
Q1
1971
Q1
1974
Q1
1977
Q1
1980
Q1
1983
Q1
1986
Q1
1989
Q1
1992
Q1
1995
Q1
1998
Q1
2001
Q1
2004
Q1
2007
Q1
2010
Q1
2013
Q1
2016
Q1
Unemployment RateFederal Funds Rate
The only rate increase not followed by a classic recession occurred in the mid-1990s
14 SANDPOINTE
The Case for the Long-Awaited Acceleration of US Growth Improvement From 2013 to 2014 -2015 Reflects Clear Major Forces
The range of bad events has been greatly reduced, encouraging employment, consumer spending and investment
Global growth struggled in 2013 o The Euro-zone was in recession due to ultraconservative and late policy changes o The emerging nations felt the burden of higher bond rates and slow G-7 Growth
Fiscal policy was very restrictive in 2013, an adverse force equal to 2% of US GDP then but greatly moderated to only 0.5% now
2014 and beyond will see far higher growth o The extremely harsh winter grossly distorted Q1 in the US, but the loss is temporary, and
the official Q1 data probably overstated the weakness o Rising asset and property values leading to substantially improved consumer spending and
business investment & acquisitions o US housing legitimately, sustainably rising 10%+ per year o Europe is on the mend: positive growth soon to be aided by monetary policy stimulus o Asian growth will be fuelled by consumers as well as exports
15 SANDPOINTE
Fear/Uncertainty Greatly Reduced, First In North America And Then In Europe
Euro Will
Collapse US
Fiscal Cliff
War with Iran
2nd Great Depression
0
1
2
3
4
5
6
7
8
9
10
2005
Q1
2006
Q1
2007
Q1
2008
Q1
2009
Q1
2010
Q1
2011
Q1
2012
Q1
2013
Q1
2014
Q1
2015
Q1
2016
Q1
Euro Periphery (PIIGS) Bond minus German Bond
Corp. BAA Bond minus 10-Year Treasury
Sum of Key SpreadsHistory Forecast
Bond Spreads, Reflecting Fears of Truly Bad Events, Now Markedly Lower
Stronger Hiring, Consumer & Capital Spending
16 SANDPOINTE
US Growth Strengthens as Fiscal Restraint Is Diminished and the Harsh Winter Effect Lapses
-4
-2
0
2
4%
-4
-2
0
2
4%
2007
1.8
2008
-0.3
2009
-2.8
2010
2.5
2011
1.6
2012
2.2
2013
2.2
2014
2.2
2015
2.9
2016
2.3
Perc
enta
ge P
oint
Con
trib
utio
n to
Rea
l GD
P G
row
th
Real GDP
Total Fiscal Stimulus or Restraint
Changes in Real GDP and Fiscal Changes as % of Prior Year Real GDP
17 SANDPOINTE
-200
-100
0
100
200
2014 Winter
1989
1994
1999
2004
2009
2014
This Was The Coldest Winter In 25 Years, And Cut The Q1 Real GDP Growth Rate By ~1.5%
1st Quarter Deviation From 1985-2013 Average Temperature (“ Heating Degree Days” with Reverse Sign)
Unusually Mild Winter
Unusually Cold Winter
18 SANDPOINTE
The Q1 GDP Figures Show Huge Drags on Final Demand from the Harsh Winter, Plus Strangely Weak Initial Estimates of Inventory Accumulation and Net Exports
Contributions to GDP growth, percentage point annualized rates
-4
-2
0
2
4
6
-4
-2
0
2
4
6
12Q
1
12Q
2
12Q
3
12Q
4
13Q
1
13Q
2
13Q
3
13Q
4
14Q
1
14Q
2
14Q
3
14Q
4
15Q
1
15Q
2
15Q
3
15Q
4
Real GDPInventoriesNet Exports
Final sales to domestic purchasers
Discretionary Consumer Spending
Source: Commerce Department
history forecast
19 SANDPOINTE
70
75
80
85
90
95
100
105
110
115
120%
Jan-
13
Feb-
13
Mar
-13
Apr-1
3
May
-13
Jun-
13
Jul-1
3
Aug-
13
Sep-
13
Oct
-13
Nov
-13
Dec
-13
Jan-
14
Feb-
14
Mar
-14
14-A
pr
14-M
ay
Cons
umer
Spen
ding
,Inf
latio
n-A
djus
ted
(Per
cent
of20
12Av
erag
eM
onth
)
Bicycles
Garments
Health Care
Furniture/furnishings
All Durable Goods
Restaurants
Major householdappliances
New Autos
New Light Trucks
Almost All Discretionary Markets Were Hurt By The Cold Weather Last Winter, But Rebounded To Recovery Trend In March
20 SANDPOINTE
-30
-20
-10
0
10
20
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Industrial production,manufacturing
Real GDP, Goods Sector
The Officially Estimated Q1 GDP Drop Is Likely Exaggerated The Commerce Department’s Estimate Of Goods GDP Plunged In Q1, But The Federal Reserve’s Estimate Of Manufacturing Production Did Not
Real GDP in the goods sector and industrial production in manufacturing, annualized real rate of growth, Q/Q, percent
Source: Commerce Department, Federal Reserve
21 SANDPOINTE
-6-5-4-3-2-10123456
7%
-30-25-20-15-10-505101520253035%
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Real Consumer Spending
Consumer Sentiment (right scale: 5x)Household Net Worth (right scale: 5x)Disposable Income
Income, Consumer Finances, and Psychology Drive Spending in Systematic Patterns That Held True to Form Even Through the Great Recession
Source: Parthenon analysis; Bureau of Economic Analysis
Growth in Real Consumer Spending and Key Drivers, 2002-2016
Consumer Spending
Income Net Worth Psychology
Improving Wealth and Sentiment Offset the 2013 Tax Burden on Consumers, Setting the Stage for Strong Growth in Coming Years
Note that consumer spending growth is quite different from
income growth when wealth is moving in the opposite direction
22 SANDPOINTE
0
50
100
150
200
250
300
350
$400K
1965
Q1
1967
Q1
1969
Q1
1971
Q1
1973
Q1
1975
Q1
1977
Q1
1979
Q1
1981
Q1
1983
Q1
1985
Q1
1987
Q1
1989
Q1
1991
Q1
1993
Q1
1995
Q1
1997
Q1
1999
Q1
2001
Q1
2003
Q1
2005
Q1
2007
Q1
2009
Q1
2011
Q1
2013
Q1
2015
Q1
2017
Q1
2019
Q1
Infla
tion-
Adju
sted
Net
Wor
thpe
rAdu
lt(T
hous
ands
of$U
S)
Real Net Worth per Adult (2012 prices)2.2% Real Growth Trend from '72-'00 Peaks2.0% Real Growth Trend from '74-'91 Troughs
99% Of The Maximum 2007-2009 Real Wealth Destruction Has Already Been Reversed with More Growth to Come
Source: Parthenon analysis; Federal Reserve
History Forecast
The Peak-to-Trough Loss Was an Exceptional 23% (’07Q1 to ’09Q1)
23 SANDPOINTE
0
5
10
15
20
25
30
35
40
45
50%
RecordLow Prices
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
Sha
reof
Typi
calH
ouse
hold
Inco
me
Existing Housing
New Housing
Strong Home Demand Will Help GDP Directly and by Bolstering Furniture, Appliance and Vehicle Sales Though Home Prices Are Rising, Housing Remains At Historically Attractive Levels Of Affordability
0
20
40
60
80
100
120
140
160
180
200
220
240
$260K
Q4
2005
Q4
2006
Q4
2007
Q4
2008
Q4
2009
Q4
2010
Q4
2011
Q4
2012
Q4
2013
Median New Home Sale Price
Median Existing Home Sale Price
Source: U.S. Census Bureau; National Association of Realtors; BEA; Federal Reserve; Parthenon Analysis
New Home and Existing Home Sale Prices ($K), 2005–2013
New and Existing Home Prices as Share of Typical Household Income, 1996-2013
Carrying cost assumes 80% loan-to-value mortgage, at
prevailing income levels and mortgage rates
24 SANDPOINTE
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
Ann
ualC
hang
e(M
illio
ns)
Net New DwellingsAdded
Housing Starts+Manuf. HomesAdult Population Growth/1.8Household Growth
U.S. Housing Remains Weak, But Demographic Demand Necessitates A Long, Major Recovery
• Almost 300,000 units are demolished per year (0.3%) and our household growth is 1.3 million, implying annual long-term demand for 1.6 million new units constructed
Source: Parthenon Analysis; Global Insight
Excess construction versus household
formation Inadequate
construction versus household formation
History Forecast
25 SANDPOINTE
Monetary Policy is Particularly Important: In the Postwar Era, Recessions Are Nearly Perfectly Paired with Preceding Federal Funds Rate Increases
Source: Global Insight, BLS, IMF
Federal Reserve Rate Increases Always Precede Every Recession
-5
0
5
10
15
20
-5
0
5
10
15
20
1959
Q1
1962
Q1
1965
Q1
1968
Q1
1971
Q1
1974
Q1
1977
Q1
1980
Q1
1983
Q1
1986
Q1
1989
Q1
1992
Q1
1995
Q1
1998
Q1
2001
Q1
2004
Q1
2007
Q1
2010
Q1
2013
Q1
2016
Q1
Unemployment RateFederal Funds Rate
The only rate increase not followed by a classic recession occurred in the mid-1990s