Saturday, September 6, 2014
Only 37% of Companies Are Seeing Rising Sales Estimates
Yesterday we noted here the fact that EPS estimates have fallen versus 3 months ago for most stocks in the developed world. In a similar vein, today we note that top line estimates are rising for only 37% of stocks in the MSCI developed world index, meaning they are falling for 63% of stocks. The only region in which more than half of stocks are seeing rising sales estimates is North America, where 62% of companies have seen top line estimates rise versus three months ago. In Europe only 8% of companies are seeing rising sales estimates and in the Pacific the number is 24%. A quick look at the data at the country level reveals that in France, Germany and Japan a single digit percent of companies have rising estimates while in the US 60% of companies do.
Friday, September 5, 2014
Mr. Market Thinks Industrials and Consumer Staples Companies Have the Same Amount of Risk!
One way to view the risk profile of a group of companies is to measure the average standard deviation of price changes for that group. We do this for all the sectors and countries comprising the MSCI World Index. This idea is to see how the market is pricing risk across various constituent groups. High average standard deviation levels for a group of companies usually prevail during times of stress in the markets, and vice versa. However, we also notice varying risk profiles between groups of companies. For instance, the average standard deviation of companies in non-cyclical sectors tends to be much less than the average standard deviation of companies in cyclical sectors, which makes sense since earnings of companies in cyclical sectors are inherently more volatile.
While we have noticed the average standard deviation of price changes drop for all the sectors and countries we look at, we have also noticed that the average standard deviation for companies in cyclical sectors has fallen even more than the average for non-cyclical sectors. To us this implies that the market is pricing cyclicals as if the earnings carry the same volatility characteristics as non-cyclicals, which makes little sense to us. But, that is where we are right now.
In the first chart below we show the spread between the average 65-day standard deviation for companies in the Industrials sector and the Consumer Staples sector. We can see that the spread is at an all-time low as far back as we have data and is basically zero. The last two charts show the absolute level of the average standard deviations for the two sectors.
While we have noticed the average standard deviation of price changes drop for all the sectors and countries we look at, we have also noticed that the average standard deviation for companies in cyclical sectors has fallen even more than the average for non-cyclical sectors. To us this implies that the market is pricing cyclicals as if the earnings carry the same volatility characteristics as non-cyclicals, which makes little sense to us. But, that is where we are right now.
In the first chart below we show the spread between the average 65-day standard deviation for companies in the Industrials sector and the Consumer Staples sector. We can see that the spread is at an all-time low as far back as we have data and is basically zero. The last two charts show the absolute level of the average standard deviations for the two sectors.
A Euro On the Move
Following the ECB's June meeting, we noted (here) a curious disparity in the relationship between the EUR/USD exchange rate and the spread between interest rates in Europe versus the U.S. While the euro had failed to move lower then (as it has in the past), the relationship appears to have reasserted itself more recently.
Meanwhile, any rise in German CDS--which have risen in the past, as the euro has declined-- has remained subdued (thus far):
Meanwhile, any rise in German CDS--which have risen in the past, as the euro has declined-- has remained subdued (thus far):
EPS Estimates are Falling for Most Stocks in the World, Driven by Europe
Earnings estimates have been coming down for most companies across the developed markets, and the decline is almost entirely driven by Europe. In the charts below we show the percent of companies that have seen their EPS estimates rise vs three months ago.
For the World Index, only 46% have seen rising estimates, meaning that 54% have seen falling estimates. A closer look at the regional breakdown shows that Europe is to blame. Indeed, in North America 57% of companies have seen rising estiamtes vs three months ago and in Asia 55% of companies have experienced rising estimates (though the trend is down in both regions). In Europe, however, only 18% of companies have experienced rising estimates. When we break down the EPS estimate revisions for Europe by sector (last three charts below) we observe that the decline has been driven heavily by the most cyclical sectors of the economy (industrials, tech, and materials).
For the World Index, only 46% have seen rising estimates, meaning that 54% have seen falling estimates. A closer look at the regional breakdown shows that Europe is to blame. Indeed, in North America 57% of companies have seen rising estiamtes vs three months ago and in Asia 55% of companies have experienced rising estimates (though the trend is down in both regions). In Europe, however, only 18% of companies have experienced rising estimates. When we break down the EPS estimate revisions for Europe by sector (last three charts below) we observe that the decline has been driven heavily by the most cyclical sectors of the economy (industrials, tech, and materials).
US Dollar Breakout & Growth Counter-Cyclical Outperformance
The trade weighted US Dollar broke out of a four year range in the last couple days, eclipsing the June 2010 highs. Alongside this breakout in the USD, North American growth counter-cyclicals have made a new high in relative performance compared to the MSCI World Index. Growth counter-cyclicals are stocks in the consumer staple and health care sectors.
North America health care stocks are the strongest driver of this trend in growth counter-cyclical outperformance. Our equal-weighted basket of 66 North American health care companies are up 15.61% on average year-to-date, outperforming the MSCI World index by some 10%. Our equal-weighted basket of 50 North American consumer staple companies are up 9.4% year-to-date and has outperformed the MSCI World index by 4% year-to-date.
North America health care stocks are the strongest driver of this trend in growth counter-cyclical outperformance. Our equal-weighted basket of 66 North American health care companies are up 15.61% on average year-to-date, outperforming the MSCI World index by some 10%. Our equal-weighted basket of 50 North American consumer staple companies are up 9.4% year-to-date and has outperformed the MSCI World index by 4% year-to-date.
5 Consequences Of A Stronger Dollar
The real trade-weighted USD index (major countries) quietly made a 64-month high at the end of August.
If this marks the beginning of a structural strengthening trend for the dollar than it is plausible that the following consequences could follow:
1 - Cyclical stocks should continue to underperform
2 - The long end of the yield curve should flatten further
3 - Inflation expectations should fall further
4 - And actual inflation should drop
5 - Commodity prices should feel a deflationary drag
If this marks the beginning of a structural strengthening trend for the dollar than it is plausible that the following consequences could follow:
1 - Cyclical stocks should continue to underperform
2 - The long end of the yield curve should flatten further
3 - Inflation expectations should fall further
4 - And actual inflation should drop
5 - Commodity prices should feel a deflationary drag
Thursday, September 4, 2014
Cyclicals: Early or Late
For the first part of the year, early cyclicals (consummer discretionary sector) in North America underperformed late cyclicals (energy, material and industrial sectors), which made perfect sense given the appearance of a strengthening economy and the tapering of FRB asset purchases. Recently, however, early cyclicals have come back to lead late cyclicals. Since June 23, early cyclicals have outperformed late cyclicals by 7%. In the chart below, we compare an equal weighted basket of early cyclical companies in North America against late cyclicals.
When we compare the relative performance of these two cyclical baskets versus the Fed's tapering, we come away thinking the recent relative performance of early cyclicals is a bit out of step. In the chart below, we overlay the relative performance of early vs. late cyclicals against the three month increase in Fed assets. As the Fed was accumulating assets at an accelerating rate, early cyclicals outperformed late cyclicals, and as the Fed has been decelerating its asset purchases, early cyclicals have underperformed. We think that, despite a small recent detour, late cyclicals will probably outperform early cyclicals over the course of this year.
Are Stocks Really "Fairly Valued"?
No matter how many times we hear "stocks are trading right around their average valuation levels of the past 15 years" and this chart is trotted out as evidence that stocks are "fairly valued", we cringe a little bit.
By every measure that we look at stocks have flown by fairly valued and have entered into richly valued territory. We hinted at this fact yesterday as well when we showed that most stocks around the world are trading at a premium to book value.
Today, we are going to try and dispel the idea that stocks in North America, at least, are fairly valued. We are going to use the MSCI North America Index as this is the data we subscribe to instead of the S&P 500 for our analysis. Now, before we are accused of comparing apples to oranges we contend that we are comparing Red Delicious apples to Golden Delicious apples. Or put another way, the MSCI North America Index and the S&P 500 are very similar, especially for the largest weightings in both indices, which is important since the largest 20 names in MSCI North America account for 23.84% of the index and the largest 20 name in S&P 500 account for 27.42% of the index. To give the reader an idea of how close these indices are, let's look at the largest 20 stocks in each index. Out of the top 20 names in each index, they are exactly the same except for two names (figure 1). The 20th largest company in the MSCI North America Index is Coca-Cola (which is the 22nd largest in the S&P 500) and the 6th largest company in S&P 500 is Berkshire Hathaway (which is the 22nd largest in the MSCI North American Index).
Figure 1
If we look at the next 20 largest, which account for another 12.56% in the MSCI North America and account for another 14.14% in the S&P 500, 18 out of the 20 names are the same. The two that are different are Royal Bank of Canada (53 basis points of the MSCI North America Index) and Toronto-Dominion Bank (48 basis points of the MSCI North America index). So yes, the comparison isn't perfect but we think it is close enough.
Back to valuation levels. Let's begin by looking at the differences between average and median valuation levels. Average valuation levels are well below median valuation levels which implies that there are more companies trading at higher valuation levels at first blush. As the charts below show, this tends to be true most of the time. Currently, the median price to cash flow ratio is at levels seen from 2005-2007 and the median price to sales ratio is above 2000 and 2007 highs.
We also like to look at valuation breadth. We analyze breadth in a few ways. We look at the percentage of stocks trading above 3-year, 5-year, 7-year averages as well as the percentage of stocks trading with 25% of their 3-year, 5-year, 7-year max valuations. We also like to look at the percentage stocks trading at important absolute levels such as 1x book value or 10x cash flow. When we analyze our breadth data points, we find that breadth is at or above levels seen in 2000 and 2007. For example 67% of stocks are trading above their 3-year average price to book ratio. This is below highs hit in 2006 (86%) but well above the average (44%) over the past 15 years. From a price to earnings perspective, the percent of stocks trading above their 3-year average is right at the same level as it was in 2006 and 2007. When we look at 5-year and 7-year averages, we find that all valuation ratios have more stocks trading above their averages than in 2007.
Currently, 65% of all stocks are trading with 25% of their max P/S valuation level which is higher than it was in 2007. Also higher now than it was in 2007, is the percentage of stocks trading within 25% of their 7-year max P/E ratio. As the charts below show, similar trends emerge when looking at shorter time periods as well.
Finally lets look at the percentage of stocks that are trading above (or below) various absolute levels and compare the current situation to how it was in the 2007-2009 period. Currently, 64% of all stocks are trading above 10x cash flow which is slightly higher than in 2007. Perhaps more telling is the fact that only 7% of stocks are trading below 5x cash flow compared to 45% at the bear market low. Currently, 89% of all stocks are trading above 10x earnings while only 6% are trading below 5x earnings. And lastly, just over half (53%) of stocks are trading above 2x sales while only 16% of stocks are trading below 1x sales.
By every measure that we look at stocks have flown by fairly valued and have entered into richly valued territory. We hinted at this fact yesterday as well when we showed that most stocks around the world are trading at a premium to book value.
Today, we are going to try and dispel the idea that stocks in North America, at least, are fairly valued. We are going to use the MSCI North America Index as this is the data we subscribe to instead of the S&P 500 for our analysis. Now, before we are accused of comparing apples to oranges we contend that we are comparing Red Delicious apples to Golden Delicious apples. Or put another way, the MSCI North America Index and the S&P 500 are very similar, especially for the largest weightings in both indices, which is important since the largest 20 names in MSCI North America account for 23.84% of the index and the largest 20 name in S&P 500 account for 27.42% of the index. To give the reader an idea of how close these indices are, let's look at the largest 20 stocks in each index. Out of the top 20 names in each index, they are exactly the same except for two names (figure 1). The 20th largest company in the MSCI North America Index is Coca-Cola (which is the 22nd largest in the S&P 500) and the 6th largest company in S&P 500 is Berkshire Hathaway (which is the 22nd largest in the MSCI North American Index).
Figure 1
If we look at the next 20 largest, which account for another 12.56% in the MSCI North America and account for another 14.14% in the S&P 500, 18 out of the 20 names are the same. The two that are different are Royal Bank of Canada (53 basis points of the MSCI North America Index) and Toronto-Dominion Bank (48 basis points of the MSCI North America index). So yes, the comparison isn't perfect but we think it is close enough.
Back to valuation levels. Let's begin by looking at the differences between average and median valuation levels. Average valuation levels are well below median valuation levels which implies that there are more companies trading at higher valuation levels at first blush. As the charts below show, this tends to be true most of the time. Currently, the median price to cash flow ratio is at levels seen from 2005-2007 and the median price to sales ratio is above 2000 and 2007 highs.
We also like to look at valuation breadth. We analyze breadth in a few ways. We look at the percentage of stocks trading above 3-year, 5-year, 7-year averages as well as the percentage of stocks trading with 25% of their 3-year, 5-year, 7-year max valuations. We also like to look at the percentage stocks trading at important absolute levels such as 1x book value or 10x cash flow. When we analyze our breadth data points, we find that breadth is at or above levels seen in 2000 and 2007. For example 67% of stocks are trading above their 3-year average price to book ratio. This is below highs hit in 2006 (86%) but well above the average (44%) over the past 15 years. From a price to earnings perspective, the percent of stocks trading above their 3-year average is right at the same level as it was in 2006 and 2007. When we look at 5-year and 7-year averages, we find that all valuation ratios have more stocks trading above their averages than in 2007.
Currently, 65% of all stocks are trading with 25% of their max P/S valuation level which is higher than it was in 2007. Also higher now than it was in 2007, is the percentage of stocks trading within 25% of their 7-year max P/E ratio. As the charts below show, similar trends emerge when looking at shorter time periods as well.
Finally lets look at the percentage of stocks that are trading above (or below) various absolute levels and compare the current situation to how it was in the 2007-2009 period. Currently, 64% of all stocks are trading above 10x cash flow which is slightly higher than in 2007. Perhaps more telling is the fact that only 7% of stocks are trading below 5x cash flow compared to 45% at the bear market low. Currently, 89% of all stocks are trading above 10x earnings while only 6% are trading below 5x earnings. And lastly, just over half (53%) of stocks are trading above 2x sales while only 16% of stocks are trading below 1x sales.