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So Close.

Brouwer & JanachowskiJune 3, 2016

So close. U.S. stocks hit an intra-day high of 2120 on Wednesday, less than 0.5% short of last May’s record. We have seen the S&P 500 hover around 1800-2100 for 20 months. Why so dull? Well, it’s down to a slow economy, slow global growth, bad messaging from the Fed and a dollar rally. Throw in the energy collapse and we’re lucky we didn't see a bigger correction. Next week the Fed meets. Don't expect much except the normal guff of “data dependency” and talking the economy up. Chair Yellen said it all again this week. Elsewhere, this caught our eye. 

  1. GAAP Earnings: we’re keeping a watch on the widening gap between GAAP (which companies must report) and non-GAAP earnings (which they like to report). Guess which is higher? Normally it’s not a big deal. But a few things are going on: i) more companies are reporting non-GAAP earnings, ii) the spread between the two is at 25%, and iii) non-GAAP earnings are higher 87% of the time.

What's it all about? Mostly, non-GAAP will not amortize as quickly as required, add impairments and restructuring back in and account for stock options differently. Some of the worst are tech and mining companies. One 140 character-limiting company will have you think they earned $316m in the last three years. GAAP says they lost $1,750m. In a worse case, the market may overvalue companies by up to 25%. We’d like to see this trend reverse.

  1. Treasuries: everybody’s favorite asset class. But few will admit. The Treasury rally continued with the Ten-Year reaching 1.64% by week’s end. The year to date return for long Treasuries is around 13% compared to 2.5% for the S&P 500 and 4% for the broad bond market. Why? Well as we’ve noted before:
  • Lower supply. Here’s the latest Treasury Statement , which shows the deficit down. Again.
  • Overseas bonds yields are negative. You have to go out to 2027 to earn a positive yield on Bunds. Even there it’s a paltry 0.01%.
  • Throw in a weak job report, Brexit and associated fears and we don't see this trend changing

In the search for yield, you can extend duration or head down the credit ladder. We’ll stick to the former.

  1. Energy: BP published it’s 65th giant annual report. Here it is. There are lots of nice charts and takeaways. But we like this one: Blog june 10 16bp-statistical-review-of-world-energy-2016-spencer-dale-presentation.pdf copy

Those bars pointing down show the decline in energy intensity or the amount of energy to produce GDP. It’s falling fast. Some of this is through efficiency. Some through the fuel mix (like ethanol). Some through substitution (gas for coal). Our takeaway? This is going to be an intensely competitive industry.

Bottom Line: the debate is whether the rally in stocks is down to better prospects or lower rates. Low risk free rates push valuations up. We’ll punt and say it’s both. Either way, stocks look set to stay around current levels. Unless we get a weird election cycle. Stay tuned.



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--Christian Thwaites, Brouwer & Janachowski, LLC


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