Risk is On as France Gets Downgraded

We find it interesting that on a day when the French government gets its credit rating downgraded the spread between French OATs and US Treasury Bonds widens to the highest level since April 2010, with OATs now yielding 52bps less than USTs. This spread can be viewed as a measure of investor risk seeking behavior. Perhaps not surprisingly then, the OAT-Bond spread shares a pretty close relationship with the forward PE ratio of the S&P500, which two days ago hit its highest level since October 2009.

For some perspective, US real GDP growth hit 3.9% in 4Q09 with expectations for 3% growth in 2010. Today, the latest GDP print hit 2.8% (thanks to inventory accumulation) with expectations for 1.6% in 2014. In other words, investors are putting the same premium on stocks today as four years ago, but both realized and expected growth are well below the levels seen then.

EPS Estimates Deteriorating Once Again

In what has become a common theme during this cycle of hockey stick estimates being persistently lowered, earnings estimates have once again been dropping for most companies around the world. Over the last one and three months only the Financials and Health Care sectors have seen EPS estimates rise on average, while Telecom and Industrials EPS estimates have been taking it on the chin.

 

Taper Or No Taper?

On the back of the "strong" jobs report the market is sending some pretty mixed signals when it comes the implied policy path. Gold, treasuries and the USD are all saying "taper" while stocks are proclaiming more QE is on the way.

Nonfarm Payrolls Rise 204K as Participation Drops to 35 year Low and Overall Employment Drops by Most Since March 2009

Today's employment report was...interesting. While the headline number of 204K jobs added in October was above expectations of 163K new jobs and has been widely read as welcome sign that the labor market is on the mend, the details were a little messier (to say the least). The household employment survey indicated that overall employment contracted by 735K in October (the largest drop since March of 2009) and in sympathy the participation rate has now fallen to a fresh 35 year low. And while we would't count ourselves as strict believers in the Phillips Curve, we do observe the long standing relationship between the labor force participation rate and CPI inflation and note that the current trajectory of the participation rate would not exactly have the Fed on a tapering path anytime soon.

On the bright side, though, our nominal income proxy (which is payroll employment*average weekly hours worked*average hourly earnings) at least remained flat for the month.

Tesla Down a Cool 29% from Its Peak So Far

In what must win the award for this year's most speculative stock, Tesla finished the day today down 8.6% and is just shy of 30% off its all-time high. And this on a day when the speculators were fairly revved up, as is evidenced by Twitter's mere 73% pop from the IPO price.

Merck's Orderly Liquidation

We received a question today as to why we don't like Merck among the major pharma companies.  In short, the stock shows all the markings of an orderly liquidation.  We measure the daily percent change and standard deviation of those price changes everyday.  The relationship between the daily percent change and the standard deviation of those price changes we have named the "Allen Ratio" in memory of our friend and mentor Clay Allen who pioneered (and taught us) this method.  Merck scores the lowest of all the US pharma companies on this measure with a -.49%



We compile a year's worth of data to look back on the statistical footprint of all companies.  Ideally, one wants to find a company in a persistent uptrend characterized by a negative skew and small kurtosis.  What this means in non-stat speak, is that the stock is notching small gains everyday with a low measure of dispersion around those daily gains.  Underneath the randomness of the market, stocks display strong trend characteristics.  In this case, the trend characteristics are quite negative--at least compared to the other US pharma companies.

Finding Cheap Stocks Isn't Easy These Days

Earlier today we highlighted how overbought the Telecom sector was, so we thought it only fair to mention that by some valuation metrics it is also the cheapest sector, on average. Below we show two tables of valuation breadth metrics. The first table shows the percent of stocks in each sector that are within 20% of their five year max valuation and the second table shows the percent of stocks within 20% of the five year minimum valuation. Each table is sorted from highest to lowest in the Price to Sales column and the constituents are all 1600 companies in the MSCI World Index. The standout in the bottom table is the Telecom sector, where one might find at least a few stocks near their low valuation over the last five years. By no means are most stocks in that sector (or any other sector for that matter) cheap though. If anything, the below two tables just highlight how difficult it is becoming to find good values. This picture looks a lot more like 2007 or 2000 than 2009 or 2002.

Telecom The Most Overbought Sector Over the Last 200 Days

Global stock markets have obviously had a great year in 2013, leaving most sectors rather overbought on an intermediate term basis. In the below tables we present from highest to lowest each sector's average stock price relative to it's own 200 day moving average. What we find is that the most overbought sector by this measure is Telecom, with this sector's stocks on average trading 9% above their 200 day smoothing.

MSCI World:


MSCI Europe:


MSCI Pacific:


MSCI North America:

US Railraod Traffic Remains At Depressed Levels

One of the more striking, and under reported, trend changes in the US economy since the Great Recession has been the decline in railraod carload trafffic. The chart below shows the four-week moving average and one-year moving average total carload traffic. As you can see there has been remarkable slow down in total traffic since 2007. The exception to this, however, is the dramatic increase in petroleum products carloads.

Casinos And Hotels Lead Hong Kong Equities

Over the last month, casino and hotel companies have been the best performer in the MSCI Hong Kong index.



With Macau gaming revenues on the upwswing, the hotel/casino companies are experiencing rising sales expectations, particularly over the last month.

A Quick Look at the European Personal Products Industry

In the wake of management's improved outlook for Beiersdorf and the stock's subsequent one-day gain of 5.3%, we wanted to take a closer look at it's peer group.

After years of languishing in a trading range, European Personal Products companies broke out in 2012:

While companies' relative stock performance became a bit extended on a technical basis, prices have moderated--but, importantly, have not violated support--so far in 2013:

In addition to a strong balance sheet, Beiersdorf also manages to outspend its European rival, L'Oreal, on one of our favorite metrics: intellectual property.

Meanwhile, L'Oreal boasts 70%+ gross margins, the lowest financial leverage among global peers, and impressive growth in spending on intellectual property over the last decade:

ISM Manufacturing and Non-Manufacturing Survey's Estimate About 2% Growth For The US

The US ISM Non-Manufacturing Survey came in today slightly above consensus expectations for October (55.4 vs 54.5) The survey indicated the the non-manufacturing survey accelerated slightly in October and is growing.  Combining the ISM Manufacturing survey that came out on Friday with today's report (using an approximate GDP-weighting to reflect the more service oriented US economy), the surveys point to approximately 2% growth for the near future.

UK Housing Market

As mortgage lending continues to recover from the downturn in 2008...

...the UK Homebuilding sub-industry has outperformed, especially recently:

BMW Stock Price Falls Nearly 3%

But is there a silver lining to the company's lower projected profitability in 3Q? Perhaps.

Management cited a focus on long-term competitiveness versus short-term profit, which we can see in the increased investment in R&D (as a percent of sales) over the last few years:

And, while margins are expected to moderate some in the next quarter, they are the highest of any automaker in the MSCI World Index:

So will one day's stock price weakness dramatically derail BMW's long-term performance?

Or can the last year's positive trends in the overall European Automobile industry persist?

Junk Bond Spreads Hit New Cycle Low

The spread between junk bond yields and the yield on the 10 year treasury bond hit a new cycle low yesterday, confirming the strength we've seen in the equity markets. Historically, junk spreads have been able to go go as low as 250 basis points, but with nominal rates this low we wonder if this pattern will be repeated this time around. Holders of junk bonds are already barely getting paid for their credit risk (the historic default rate on junk bonds is 5% and nominal junk bond yields are 5.67%), unless of course something has changed and junk bond default rates are set to level out at a permanently lower plateau. Remembering that profit margins are 1) cyclical and 2) near an all-time high (thus pushing down corporate defaults) we doubt this is the case, however.

Commodities Chart Review

Much has been made in recent days over the broad based weakness in commodity prices so we thought we'd share some Point & Figure charts to help the reader differentiate trend from noise.