DAILY DIARY
Thank you
Thanks for reading my Diary today and yesterday - I hope it helped you in your trading and investment decisions.
Enjoy the weekend.
Artificially Speaking
* Central bank liquidity and stock buying buoys financial asset prices
* As the gap between equity prices and real economies widen
The absence of price discovery remains a prevailing market theme.
Tweet of the Day (Part Deux)
What Has Not Changed
"I never knew that the game of baseball was so easy until I entered the broadcasting booth."
- Mickey Mantle"Investment vision (and wisdom) is always 20/20 when seen through the rear view mirror."
- Warren Buffett
Being away from my office for about a week was invigorating - not only from the standpoint of the stimulation from Tobias's great Bull Bear debate but also from lecturing at The Yale School of Management (more on that Monday morning).
Nevertheless, some things have not changed:
* The mostly silly and superficial analysis of business, the economy and the markets in the business media continues apace.
* Questionable policy decisions emanating from the White House.
* An unrelenting advance in stock prices.
* The number of investors and traders who worship at the altar of price momentum build further.
* The continued bull market in complacency and, generally, the lack of skepticism on the part of market participants.
* More evidence of slowing domestic economic growth.
* An expansion of possible economic, political and market outcomes (many of them adverse).
Back Shortly
Very quiet morning - headed out for a quick haircut.
More Poor Policy Paths
Even worse than the two new Fed Reserve Governor appointees (Cain and Moore) is the President's call for quantatitve easing.
To say this policy would be idiotic - is an understatement.
As Grandma Koufax used to tell me, "Dougie, meshuganah is Trump!" (Craziness is three-fold in Yiddish and now a funny double entandre).
Reducing CBS to Small-Sized
On March 21 I reestablished my CBS long at $46.
It is now trading above $50 and I am moving back to small-sized from medium-sized.
Subscriber Comment of the Day (and My Answer!)
Doug, Did Tobias have anything to say?
Reply
Tobias Levkovich expressed a cautiously optimistic economic and market view.
Anyone that is a client of Citigroup (C) should try to secure his handout: Exploiting the Gap Between Fundamental Reality and Market Perception: A Short-Horned Bull: Buying the Brutal Selloff
The handout is an excellent summation - in tables and charts - of his overall views.
SDS Again
I am back in (SDS) at $32.11 - but only for a day or two (win, lose or draw) .
The Data
* Slightly better # but looking inside the headline
* Manufacturing sheds jobs
* A larger than expected government increase helped the jobs number
* Wage growth disappoints (slowest since September, 2018)
Peter Boockvar on the data:
March payrolls grew by 196k, 19k more than expected while the two prior months were revised up by 14k. The private sector component though had less of an upside print as jobs here rose by 182k, 5k more than expected. Similar to what ADP said and in contrast to ISM, manufacturing shed 6k jobs instead of hiring a net 10k as forecasted. February was revised to a manufacturing job gain of just 1k from 4k initially.
The household survey saw a loss of 201k jobs after a gain of 255k in the month prior and a drop of 251k in the month before that. Thus, is very volatile but all age categories saw declines. Because the labor force shrunk by 224k, the unemployment rate held at 3.8% (thus, not for the right reasons).
Further within the establishment survey, a big contributor to the job gain (outside of the government increase) was health/education which added 70k. Temp help jobs fell which some consider a early precursor to cuts in full time. Retail, trade and transport sectors shed jobs. Leisure/hospitality hired again of a small decline in February. Construction added 16k jobs after losing 25k last month.
Wages disappointed with a .1% m/o/m increase, two tenths less than expected and which brings the y/o/y increase to 3.2% from 3.4%. That matches the slowest since September. As hours worked ticked up to 34.5 as expected, average weekly earnings grew by 3.2% which is around the recent trend but also showing no signs of further acceleration that I've been looking for.
Both the participation rate and employment to population ratio fell m/o/m but the U6 unemployment rate held at 7.3%. The percentage of job leavers (usually a sign of confidence in the labor market) fell to 12.5% from 13.5% last month and back to where it was in the month prior.
Bottom line, as stated, most of the modest upside surprise came from more government hiring. Private sector hiring was a touch better than forecasted and wage growth is not accelerating. Smoothing out the headline figure brings the 3 month average to 180k vs the 6 month average of 207k, the 12 month average of 211k. The average in 2018 was 223k. Thus, at least in 2019, the pace of job growth is slowing. US Treasuries are lower with yields higher in response to the headline beat but again, we need to watch the trend.
Monday's Lunch With Citigroup's Tobias Levkovich
* Following summaries of our investment views, Tobias Levkovich asked several hard- hitting questions of UBS's Suni Hartford and myself
Four days ago, at the invitation of Citigroup's head of investment strategy, Tobias Levkovich, I was invited to participate in a Bull/Bear debate with Suni Hartford, UBS Asset Management's head of investments.
Suni and I were asked to summarize our market views for about 10 minutes each. Suni was succinct, analytical and bullish. Following her optimistic investment commentary, I related some bullet points that formed the basis of my ursine market view:
* The consensus strongly believes that an easy Fed is market-friendly
* The Fed's recent move to pause is a sign of weakness, not strength; remember, Fed moves occur with a lagging impact on the real economy
* I disagree with the bullish consensus as the core factor in determining share prices are profit and economic growth, both of which likely will miss in the one to two years ahead
* A more dovish Fed underscores the deepening risks to the downside for the global economy; a slowdown is the 800-pound gorilla in the room!
* Every cycle is different, rarely are excesses repeated
* Artificially low interest rates and a changing market structure are disguising problems in the credit markets
* There remains a large disconnect between computer-driven markets and fundamentals
I expressed the notion that we are in an abnormal world today with many possible market and economic outcomes, many of them adverse.
I feel that we are in an extraordinarily abnormal investment world today. One such example is that there is $11 trillion of sovereign debt that has negative rates. The idea of paying interest to own a 10-year German bund is absurd.
What is normal? A 0.5% annual gain in population in the U.S., productivity improving 1.5% per year, translating into 2% real growth, and inflation at 2% -- so nominal GDP trends at 4%. That's a subpar and below-trend forecast.
Under these circumstances the U.S. 10-year should gravitate toward a 4% yield and fed funds should be more than 3%.
Given the circumstances a 16.5x price-earnings multiple seems justified.
So, 16.5x the consensus of 2019 S&P earnings per share of $165 translates into a 2720 fair market value for the S&P.
My $160 estimate for S&P earnings results in fair market value of 2640 -- below 2880 today -- but there is much downside to my assumptions and to my intrinsic value calculation for the S&P.
Another big risk, little discussed, is political.
The Democrats have a progressive agenda, and some may argue what AOC and the progressive left have done to New York City (I am referencing Amazon's departure) is retrogressive!
While I am a Democrat, I see the Mueller report helping Trump and the odds may slightly favor Trump for re-election, but it is still early.
More of our country is centrist than left and the risks facing Democrats is that the party might be going to the Left. While the Dems may not have a credible candidate to defeat Trump now, it is not out of the question that a progressive candidate can arise and win. If that occurs it will not be market-friendly.
I went on...
Since late December Pavlov's market dogs have grown feisty and the market's immediate reaction has been to rejoice over a more dovish Federal Reserve that anticipates keeping interest rates lower for longer. I believe, after this strong advance (some of which I anticipated), that the markets will begin to focus on unsupportable levels of debt and slowing growth relative to expectations:
- Weakening Global Economic Growth
2. The Dangers of Low Interest Rates
3. Fewer Tools Left in the Policy Shed
4. Debt is a Governor to Growth
5. Deficit and Demographic Trends are Not Growth-Friendly
6. No Country is an Economic Island
7. The Misallocation of Resources Causes Bubbles
***
The meat of our discussion (and the value-added to all of you) came from a series of pithy questions asked by Tobias to Suni and myself.
Here is a summary of his questions. followed by my answers to some of the questions raised:
1.) Does the recent yield curve inversion change your view?
The bulls say there has been an inconsequential amount of time in inversion and that the inversion, to date, is modest.
With $11 trillion of sovereign debt in negative territory, the inversion is importantly influenced by overseas interest rates.
What sane person would lend to Germany for 10 years with a negative return?
I showed this chart to make my point:
To me the inversion currently provides a clear signal about diminished economic growth and maybe a recession.
The last nine recessions in the U.S. were preceded by an inverted curve (between the relationship of 1-year/10/year Treasury notes).
If history repeats itself, we could see a recession begin as early as eight months from now, which was precisely one of my 15 Surprises for 2019:
My recession call, made five months ago, was outside the consensus and my policy expectations (in response) have also been an outlier, as seen below in my Surprise #2 of my 15 Surprises for 2019. I never expected the Fed to raise rates this year. Indeed, since last November I anticipated that the Fed would pause (after December) and ultimately lower rates in the second half of 2019. I still believe this will be the case.
2)Can renewed China growth following a series of stimuli be the "magic bullet" that removes the path of slowing global economic trends? Do you consider the prospect as realistic? Why or why not?
My view is that China is burdened by monumental debt loads and the current trade hostility could make vulnerable the region's growth opportunities and progress. We have seen this already in China's imports and exports, which are deteriorating badly.
This has significant implications on world trade as China, though representing only about 13% of global trade, is responsible for more than one-third of the delta of growth.
The trade dispute with the U.S. is icing for slower growth. China thinks in decades and centuries and the Supreme Tweeter, our president, has a time frame of tweets.
3) Will we see inflation accelerate or are we doomed structurally to low rates with the possibility of so-called Japanification?
Markets for some time have ignored the secular pressure for lower rates and inflation, which come with slower population growth and a slower rate of improvement in productivity when combined with technological changes. As well, the wage and wealth gap is contributing to lower rates and inflation and I see little chance that the gap will improve over the next few years unless a progressive to the left of the Democratic Party is elected, which currently appears unlikely.
On the other hand, I anticipate that the labor markets over the near term will tighten and that inflation will accelerate.
We must continue to monitor energy prices, productivity and wages.
One thing I am certain of is that we, as a country, don't have the patience of the Japanese!
4) Where do you believe the greatest risks lay? Geopolitics? Protectionism/populism? Wealth and income inequality? Others?
I am concerned with all those issues.
My familiar refrain: The world is growing more flat, networked and interconnected; non-coordination and lack of cooperation among the largest countries in the world represent a profound and new risk. I continue to ask these three questions every day, as the answers might serve to raise uncertainties but also may be viewed as valuation busters in the fullness of time:
- In a paperless and cloudy world, are investors and citizens as safe as the markets assume we are?
- In a flat, networked and interconnected world, is it even possible for America to be an "oasis of prosperity" and a driver or engine of global economic growth?
- With the G-8's geopolitical coordination at an all-time low, how slow and inept will the reaction be if the wheels do come off?
5)Technology is seen as generating growth, but often at the expense of some group, such as online sales versus brick-and-mortar stores; is there a new area that you envision as being prone to major disruption?
It is hard to predict areas that may be the next sector subject to disruption because almost every area is subject disruptive change.
More and more money is going to passive products and strategies. Those products are by definition not active compared to active managers. This is occurring at a time in which transaction costs and investment management fees are being disrupted.
So investment managers may be the next group to feel the disruption.
6)Some believe that debt accumulation via government deficits, share buybacks, M&A and student loans eventually will lead to a major reckoning; how do you see that playing out?
It is infrequent for the last crisis to reoccur. So, we have to look elsewhere from history.
I believe the next crisis is in public sector debt. The problem is timing.
My old boss Lee Cooperman tells a story that decades ago his former Goldman Sachs partner Henry Fowler and Pete Peterson published newspaper advertisements alerting Congress and the public to the evils of a growing deficit.
Years later and with a $22 trillion U.S. debt load, the only consequence has been lower interest rates. So you can see it's all about timing.
To me, the abundance of debt in the private and public sectors is the primary governor to reduced long-term growth around the world.
It plays out and leads to a deep recession when the bond vigilantes come out of their caves.
7) Do you think a breakup of Big Tech is likely?
What Elizabeth Warren and the Democratic progressives are missing is that break-ups weaken companies in a global setting. Amazon (AMZN) and others compete against Alibaba (BABA) and Tencent (TCEHY) , etc.
So, such an initiative (breakup) really depends upon the political backdrop.
8) EM vs. DM? Why?
Given global trade disputes, the historic lack of cooperation of G8 members and China's importance on global GDP, I think emerging markets (EM) continue to face headwinds to growth that explain the lower relative valuations compared to developed markets (DM).
9) Are profit margins too high? What changes are plausible?
Profit margins remain near a cyclical high. And the series is among the most mean- reverting.
In the third quarter of 2018, S&P profit margins hit an all-time high of 12.1%.
Today, margins stand at the lowest level since the first quarter of 2017, at 10.1%.
Factors that could hurt margins from here are:
* Higher corporate tax rates -- a possibility in a Democratic presidential win.
* Higher interest rates. Seems inevitable. But we don't know when.
* Higher materials costs. This, too, seems inevitable, but we probably (like interest rates) have to go through the current downturn first.
* Higher wages and salaries, which will likely come sooner than higher tax rates, interest rates or input costs.
The Celebrity Fed
"Ever since 'The Apprentice,' my life has gotten so much busier."
--Donald Trump
With apparent nominations to the Federal Reserve of Stephen Moore and Herman Cain, the Administration is continuing to govern by "Celebrity Apprentice."
Recently (and in the past) President Trump has been critical of Fed Chairman Powell.
Now the President has apparently decided to nominate two candidates to the Fed Board that neither have the requisite experience nor are they, in any way, independent.
I am just surprised that there has been so little comment and opposition to these foolishly contrived appointments. Then, again, I remain surprised by the many developments in the markets, in policy-making, the belief in debt monetization and elsewhere, these days!
We are in a forgiving market... for now.
Tweet of the Day
Chart of the Day
About two thirds of the stocks in the S&P Index are now above their 200-day moving average -- that's the most since September 2018:
