The Bull Flattening Continues: The Long End of the Yield Curve is The Flattest It's Been Since 2009

The long end of the yield curve has continued to flatten over the last several days. At 77 basis points, the spread between 30 year and 10 year treasury bonds is the narrowest it's been since 2009 (1st chart below). The flattening, which began when Ben Bernanke first uttered the word, "taper" in May of 2013, has been driven primarily by a contraction of 30 year bond yields and is thus termed a "bull flattener". In How Bullish is a Bull Flattener we explored the mostly deflationary implications of a bull flattening. In that post we also noted how stocks had basically disconnected from the yield curve since the middle of 2012 around when the Fed began its unlimited QE policy (2nd chart below). That disconnect has grown wider in recent days, but we don't think the relationship between stocks and the yield curve has broken completely, it's just become more tenuous. In the third chart below we attempt to show in a different way how stocks and the yield curve are connected to each other by measuring the six month changes in each and then putting a five month lead on the yield curve. We show a decently tight correlation between changes in the yield curve and changes in stock prices. We also note that the flattening of the yield curve over the last six months, at 32 basis points, is one of the most rapid flattenings we've seen over the last five years and at the very least suggests that stocks will have a tough time making a strong advance (a la 2013) in 2014.

(More) Internal Incongruity

The number of cumulative new highs in members of MSCI Europe has fallen pretty steadily since March, all while the index itself continues on a steady path upward:



Given the high degree of correlation in the past, we have to ask ourselves: will the number of new highs rebound or will the index retreat?
For more on disturbing divergences we have noticed in our work, please refer to this summary of our quarterly conference call, held yesterday.

Update on Lack of New Cycle Highs in Individual Stocks

At the risk of sounding like a broken record, below we provide an update on our count of new 100-day highs. The trend that has been in place since the end of last year (a lower number of new individual stock 100-day highs with each passing new cycle high in the index) remains in place even as stock indices yesterday closed within points of new cycle highs.

The Rate at Which Foreigners are Dumping Japanese Stocks is Slowing

Foreigners have been net sellers of Japanese stocks in 2014 but that trend may have seen its climax. Data released today showed that foreigners were actually net buyers of stocks for the week ending April 18th, which marks the second week of net buying out of the last three. Importantly, when we calculate the 12-week moving average of net foreign purchases of Japanese stocks (second chart), we see that the selling trend seems to have reversed such that foreigners are at least not selling as quickly as a few weeks ago. As we can see from the chart below, the changes in the direction of the trend often (but not always) coincide with peaks and troughs in 1-quarter performance of the Nikkei Index.

Copper is Breaking Out to the Upside

On a relatively quiet day on the markets there is one asset that is exhibiting some serious thrust. That "asset" is copper, which has now decisively broken through an important line of overhead resistance. We've written extensively about how copper is seen as a barometer of global growth (because it's an input in so much manufacturing and construction output), so a decisive and lasting breaking could be seen as good news for global growth.

Apple: Can't Buy My Love

Yesterday Apple announced a whopping $90 billion stock buyback, to be completed by the end of 2015. This means they will be buying roughly $45 billion in stock this year and next.  By way of comparison, this is $5-7 billion more than earnings that are expected this year or next.  So, Apple will be using over 100% of its earnings to finance stock repurchases.

Analyst Earnings Estimates


What would we rather see Apple do with the money than buyback stock?  The short answer is that we would prefer to see them accumulate more long-term (productive) assets.  Of the technology hardware companies, Apple has smallest proportion of its assets represented by intellectual property and long-term assets.

Balance Sheet Ratios


The stock has been in a relative strength downtrend since the middle of 2012 and has recently popped back up to the downtrend line.  We will be watching how this chart evolves in the months to come.



For now, investors seem to be indicating that Apple can't buy their love and they want to see new products drive earnings, taking Apple's expected earnings growth up compared to its peers.

Analyst Earnings Estimates

Unprecedented QE is Not Lifting Stocks in Japan

Despite introducing by far the largest QE program of any central bank, the BOJ's unlimited quantitative and qualitative easing program is failing to have the desired effect on stocks. Indeed, the popular price-weighted Nikkei index is about 11% from it's recent high last December. More concerning, however, is the fact that the average stock is 19% from its 1 year high. This means that the average Japanese stock is just a stone's throw away from being in bear market territory.

In the below chart we show how far the average MSCI Pacific stock is from its 252-day high. In the table below that we show just the MSCI Japan and the sector breakdown.



MSCI Japan:

Most Economies Are Missing The Mark in 2014

The Citi Economic Surprise Index is a useful data point in determining whether or not a country or a region are meeting economic expectations. Throughout 2014 actual data has come in below expectations for most of the developed market economies as well as for China and other emerging countries. Below are some of the more interesting charts highlighting this theme:

Simple Explanation For Counter-Cyliclal Outperformance

For the last few years, the relative performance of counter-cyclicals compared to cyclicals has turned on the movement of 30-year TIPS yields.  In our counter-cyclical basket are the consumer staple, health care, telecom and utility sectors.  In our cyclical basket are the consumer discretionary, financial, industrial, material, energy and technology sectors.  When the taper talk began in the spring of 2013, real yields (TIPS yields) began a steep increase.  In this backdrop, cyclicals outperformed.  But, that upward trend in real rates has reversed itself somewhat this year, and with it stock market leadership has reverted to counter-cyclicals. As 30-year TIPS yields have fallen by 45bps, counter-cyclicals have outperformed by some 4%.

New Home Sales Plunge In March

New home sales dropped by 14.5% in March and are now down over 13% year-over-year. All four regions are now negative on a year-over-year basis. Meanwhile, median price rose over 11% to a all-time new high of $290K as months' supply spiked to its highest level since October 2011.

What's the Deal with Japanese Stocks? Only 18% are Outperforming the World Index!

We've been looking a lot recently at all the market divergences that are present today ranging from lack of new highs, to weakness in copper and lumber, to the average stock being more than 10% from it's recent high. So in the spirit of divergences we thought we'd point out one more, that being the fact that the number of companies outperforming the World Index over the last 200 days has fallen from 57% in May of 2013 to as low as 45% recently. This behavior is another indicator signaling deteriorating participation of individual stocks even though indices are near their all-time highs.



When we dig into the details on a regional level we notice that only 24% of MSCI Pacific stocks have outperformed over the last 200 days, while 70% of MSCI Europe stocks have outperformed over the period.







Digging even deeper into the underperformance of MSCI Pacific stocks, we point out that only 18% of Japanese stocks have outperformed over the last 200 days and no individual sector has seen outperformance by more than 50% of its constituents.

MSCI Japan:


But in Europe only the Consumer Staples sector has seen less than 50% of its members outperform.

MSCI Europe:

A Pharmaceutical Frenzy

Over the last few months, the MSCI World Health Care sector has struggled to maintain its position at the top of the leaderboard:

 

As companies swap cancer drugs for flu vaccines, or endeavor into the realm of animal health, we are reminded of just how impactful these investments in R&D (and other intangibles) can be when looking at the overall health of an industry over time.  Biotech companies spend more than 30% of sales on research and development efforts, while their Pharmaceutical cousins spend nearly 15%:

Compare these R&D investments as a percent of sales to a Health Care sector average of ~10% and the MSCI World average of 2.4% and it highlights just how much importance companies like Novartis, Glaxo, and Lilly place on the value of intangibles.

These investments can be linked to attributes such as higher than average margins and strong cash flow positions-- all achieved with very low leverage:

And, while the Health Care sector as a whole may have reached higher than desirable valuations, a group like Pharmaceuticals appears to be more moderately valued at this point:

First Stock Market Crash on NYSE Reminds Us What Can Happen At A 25x CAPE

The panic of 1901 was the first crash on the New York Stock Exchange, brought on by a battle for control of the Northern Pacific Railway.  June 1901 marked the peak in valuations for 27 years, only to be eclipsed in the months preceding the September 1929 peak in stock prices.  Between June 1901 and December 1920, the 10 year real P/E (Shiller CAPE) fell from 25x to 5x.



In real terms, the S&P index (and its predecessor prior to 1923) fell some 69% during this time.



In April 1899, the consumer price index turned positive on a year over year change basis for the first time in 16 years.



Why do we recall this history?  The basic point is that bad things can happen when valuations get rich, and as of March 2014, CAPE based valuations are back above 25x.  Absent the decade between 1996-2007, the S&P has sold at a CAPE above 25x for only very brief periods of time.  June 1901 was the only month valuations peaked above 25x until 1929 when valuations were above 25x from November 1928 through April 1930.  So, if we exclude the biggest stock market bubble in history (NASDAQ 5,000...a huge outlier!), current valuations have only been seen for 18 months out of the last 123 years.

US Existing Home Sales Are Now Down -7.5% Year-Over-Year

Existing home sales actually slightly beat consensus estimates for March (4.59 million vs 4.56 million), however, they still declined for 7th time in 8 months. The good news is the decline in March was minimal. Average and median home prices also both increased in March. Median home prices are at their highest levels since August. Months supply of homes ticked up to 5.2 months which is the highest level in 11 months. This should continue to hold home prices back somewhat during the next quarter.

In other housing news, the FHFA Home Price Index gained again for the 24th time in 25 months, The year-over-year price gain did slow to 6.9%, however.