The Days Ahead:
U.S. looks tired. Keep eyes on Europe and dollar.
This is a mid-week update due to travel schedules. Hold the applause. We had our first big correction this week. Well, it was 2% over two days which in past years would have been a “hold page 6” story. But because the VIX (volatility) has been moribund, it got more attention than it deserved. The VIX jumped 35%, which, again, sounds like a lot, but we’ve never paid much attention to that index unless it’s in the 20s and moving fast (buy us beer and we’ll tell you why it’s a rotten index.)
So why? Markets are kind of efficient until they aren't. No real new news (fake or other) came down the road. But the realization that infrastructure, tax and regulatory reforms may have to wait while Congress burns momentum on a health care act, is seeping in. Economic data was thin but what there was, disappointed. First up were existing home sales. New housing starts get most of the attention but we watch existing home sales because:
a) that’s where a lot of private wealth is stored (it’s around 30% of household net worth and 50% larger than equities, the second big asset)
b) if you're selling your house it’s usually a sign of confidence
c) it’s a good indicator of where people think interest rates are heading
d) existing home sales are nearly six times larger than housing starts
You would think that with consumer confidence on the rise (well at least among the old folk), people would start to buy houses. But inventories and sales fell. We’ve argued that the economy has little chance of breaking out of its 2% growth range and Q1 is almost certainly going to be well below that. We won't know until April 28th but don't hold your breath.
Anyway, Treasuries rallied to 2.3%. You would have made nearly 5% if you had timed the 30-year bond. (But, you know, that's not investment advice.) Remember the recent high was 2.6% and the charts show that Treasuries have gone nowhere since mid-December. So, yeah, the reflation trade looks a little tired. But nothing to get wound up about.
1. Meanwhile in Europe: We've mentioned that Europe gets the Rodney Dangerfield treatment. Investors have been underweight for years but this year European stocks have rallied strongly up about 4% in local terms and nearly 7% for a U.S. investor. Compare that to the S&P 500 at 4.8%. The Euro has recovered strongly and bonds have remained pretty much unchanged despite the overblown political risk. When we put up some basic valuations on European stocks, this is what we see:
Now there’s a lot more to Europe than a valuation story but those numbers on the right hand side (so 9.3%, 15x, 5.4% and 3.5%) compare well to the U.S. market at 14%, 18x, 5% and 2%. Also, we ran some numbers showing
a) that 622 stocks, or 48%, in Europe are more than 25% below their all-time high. In the U.S. it’s 30%.
b) 612 companies, or again around 48%, yield more than Europe sovereign bonds. In the U.S. it’s also 30% against the 10-Year Treasury.
2. What's with the Dollar? After its post-election rally and talk about pricing multi-nationals out of business, the dollar rally looks well and truly stalled. It’s down around 4%. Here’s one reason why:
This is the spread between U.S. Treasuries and German Bunds. They are at their widest in over 30 years. Why? It’s down to i) Central Bank policy differences (the ECB is easing, the Fed is not) ii) inflation differences (the U.S. is around 2%, Europe is at 1.5%) and iii) early stage growth from a lower level rather than slower growth from a mature level. Anyway, that’s all very supportive of a stronger Euro and probably, although they won't say so, what the U.S. Treasury wants.
3. Corporate America to Bank Lending: “Yeah, we’ll let you know." We looked at the Bank Officers recent tightening/easing survey and advanced actual C&I (Commercial & Industrial) loans by a quarter.
It’s not great. Loan officers report a gradual tightening and three months later, loans drop. This hasn't quite happened yet but we’ve just seen a drop in the upward growth of loans. We'll have to see if this recurs in the Q1 survey due in May. Either way, makes you wonder what all those corporate go-get-‘em surveys are actually going to do.
Bottom Line: Recent market nerves will probably subside. Energy stocks are soft, down 10% since December. But the market is getting used to that. We're looking at Europe hard and are looking to increase our allocation.
--Christian Thwaites, Brouwer & Janachowski, LLC
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All charts from Factset unless otherwise noted.