Week Ending 2/26/2016

It was a winning week as four of the main indexes we follow advanced. The overall US market as measured by the VTI was up 1.86%, the SPY was up 1.61%, overseas x-US (VXUS) was up 0.12% and the aggregate bond index (AGG) was up 0.15%.



Warren Buffet, in his much anticipated annual letter for Berkshire Hathaway, set the record straight (at least in his opinion) on the US economy and the constant negative attacks by our political candidates.

Buffet writes, “It’s an election year, and candidates can’t stop speaking about our country’s problems (which, of course, only they can solve). As a result of this negative drumbeat, many Americans now believe that their children will not live as well as they themselves do.

That view is dead wrong: The babies being born in American today are the luckiest crop in history.”

Buffet writes that American GDP/capita has increased in real terms by a factor of six since 1930.

“Some commentators bemoan our current 2% per year growth in real GDP – and, yes, we would all like to see a higher rate. But let’s do some simple math using the much-lamented 2% figure. That rate, we will see, delivers astounding gains.

America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net migration). Thus 2% overall growth produces about 1.2% per capita growth. That may not sound impressive. But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita.”

“For 240 years it’s been a terrible mistake to bet against America, and now is no time to start. America’s golden goose of commerce and innovation will continue to lay more and larger eggs.”


Reports this week show that the much feared threat of recession did not gain traction in January, at least in the United States. Personal income rose 0.5% in January, the biggest increase in eight months. Personal consumption expenditures also rose 0.5%, the most in seven months. This is a good signal for Q1 GDP growth as the consumer spending accounts for 70% of overall growth. Inflation also is picking up, core prices rose 1.7% year over year, close to the Fed’s 2% inflation target. This data suggests the economy is not slipping into recession at this time and would give the Fed more ammunition to increase rates once or twice this year.

The 2015 Q4 GDP estimate was raised up from 0.7% to 1.0%, matching the GDPNow number for Q4. The GDPNow latest forecast for Q1 growth came in at 2.1% on Thursday, down from 2.5% but still an improvement on the Q4 number.


Energy related losses are now beginning to pile up at the banks. Wells Fargo (WFC) has allocated $1.2b in reserves for potential losses. “If oil remains low for a prolonged period of time, there could be additional performance deterioration in our oil and gas portfolio resulting in higher criticized assets, nonperforming loans, allowance levels and ultimately credit losses,” according to a securities filing on Wednesday. About 2% of Wells $917b loan portfolio is related to oil and gas. JP Morgan (JPM) is adding $500m in reserves bringing the total to $1.32b. The Company said that if oil is priced at about $25 per barrel for 18 months that bank might need to increase reserves by another $1.5b. But JPMs CEO Jamie Dimon says the bank can absorb the losses. “I put [that] in the drop-in-the-bucket category” relative to the strength of the balance sheet.

Banks also have billions in untapped lines of credit that energy companies can draw upon. JP Morgan has $44b in exposure including $30b that is still unfunded. Dimon says a good portion of that is in loans to investment-grade companies and may not be drawn upon. Bank of America (BAC) has $22.6b and Wells $24.6b in unfunded loans.

Regional banks also have exposure. Regions has about $2.9b in unfunded loans roughly matching the amount already outstanding. SunTrust has $3.1b outstanding and $6.2b unfunded.


Venezuela’s economy is spiraling out of control. Since Chavez took power, and continuing with President Nicolas Maduro, the country has made just about every single economic mistake that a country could make. Nevertheless, the country managed to cover the $1.5b debt payment on Friday and says they are committed to meeting their international obligations. At least give them credit for that. Senior economic official Miguel Perez Abad said on Tuesday that “the state will honor its debt.” The reason, a default would open up claims to the assets of the state run oil company, including Texas based Citgo, which is owned by the Company and processes hundreds of thousands of Venezuelan oil every day. Venezuela has about $120b of foreign debt including the oil company. The majority of emerging market debt funds hold some Venezuelan debt. The country also has $30b in other debt to private companies like airlines, pharmaceutical companies, etc.  They made the payment this week, but unless oil rebounds future payments are in serious doubt.


The difference between “pro-forma” reported earnings and earnings based on generally accepted accounting principles (GAAP) reached 25% for the 2015 year. That is the biggest gap since 2008. GAAP are the official earnings although companies will tell you that their pro-forma earnings present a more realistic picture of the earnings. A large difference is not a good signal as they tend to occur at times when the economy is having difficulty. The SP500 trades at 17x pro-forma earnings and 21 times GAAP earnings. For 2015, pro-forma earnings were up by 0.4% but down by 12.7% per GAAP. Most of that difference was due to the energy sector. They reported $45b in income on a pro-forma basis but had a GAAP loss of $48b. Other sectors were guilty also but not to the same extent. Materials had a difference of $27b, health-care $53b and tech $42b. Overall, GAAP SP500 earnings were $787b compared to pro-forma numbers of $1.04t.

Week Ending 2/19/2016

The market picked up where it left off on Friday and put together back to back +1% gains on Monday and Tuesday. For the week, the overall US stock market was up 3.12% (VTI), the SP500 (SPY) was up 2.87% and the aggregate bond index (AGG) was even. The market was led by up by stocks with heavy short interest.

This downturn has been marked by a series of lower highs and lower lows. The SPY, which closed at 192.00, will have to get north of 194.60 to set a higher high to possibly signal a change in trend.

spy 2 19 2016


Gene Epstein writes in this week’s Barron’s about the threat of a recession. In each of the six previous recessions, there was a spike in crude prices before the onset of a recession. There is no case of a recession when crude prices were falling as they are currently.

oil shocks barrons 2 19 2016

Of course, the threat in this case is that falling crude prices will lead to a wave of defaults impacting banks and high yield bonds. According to Carsen Valgreen of Applied Global Macro Research, these types of loans amount to less than 4% of the banks’ total loan book. So even if half of these loans go bad, it should not be enough to set off a banking crisis.

The US economy continues on its slow growth path, while economic conditions might be on a more slippery footing overseas. According to Michael Lewis, economics chief at Free Market, “in the modern era, there is not a single recession that can be traced to foreign economic woes.”

Epstein concludes that we should be able to avoid a recession, albeit with subpar growth.

barrons gdp forecast 2 19 2016


The market was helped by some talk that OPEC members were in discussion to limit production to get the price of oil under control.


Home builder sentiment fell to its lowest level since May.  Time will tell if we have seen the peak in sentiment. In the past, peaks in home builder sentiment often preceded a downturn in the overall business cycle by at least two years.


The Leading Economic Index fell 0.2% in January, marking the second straight decline. Four of ten LEI components declined. But the six-month smoothed LEI number increased. An alternate leading index, made up of the difference between the Coincident Index and the Lagging Index, increased by 0.2%.


Jobless claims fell again, to 262,000. This is the lowest level in three months.


Industrial production was up 0.9% in January. This was the first gain in four months and the most since November 2014. Manufacturing output was up 0.5% and the capacity utilization rate increased to 77.1% from 76.4%. These increases show signs that the industrial and manufacturing sector are beginning to stabilize, thereby reducing the near term risk of recession.


Housing starts dropped 3.8% in January. Snowstorms in the northeast might have impacted the number.

Week Ending 2/12/2016

It was another tough week in the equity markets. The US market (VTI) was off 0.94%, the SP500 (SPY) -0.70% and the international markets (VXUS) -3.05%. The aggregate bond index (AGG) was up 0.41%. The market did rally on Friday, as the SPY advanced 2.06% on higher energy prices, better retail sales, and insider buying at JP Morgan.

For the year, the SPY is down 8.45% and it is off 12.58% from its high on May 21, 2015. The market is in a tug of war over the probability of a recession. On one hand, declining equity markets point to higher probabilities of recession, while hard economic numbers point toward continued slow growth. The most recent GDPNow forecast, released by the Atlanta Fed on February 12th, shows Q1 growth at 2.7%. The estimate has increased three weeks in a row and it is up from the 2015 Q4 estimate of 1% growth. Employment numbers are also solid and we had a good retail sales report (see below).

GDP Now 2 14 2016

Whether or not the US enters a recession is important in determining possible implications for the market. According to Ned Davis Research, the average loss on the MSCI ACWI international index when the US and the global economy is in recession is 45.2%. But when the global economy is in recession but the US isn’t, the loss has been 16.8%. At the low on January 20th, the SPY was down 15.22%. The ACWI was down 17% from its high on that date. So if there is a recession overseas that the US escapes, a lot of the downside might already be in. As it is, growth around the world seems to also be advancing slowly.

Looking at the SP500, the median drop in a bear market during a recession has been 29.7%. But the median drop in a bear market during an expansion and within a long-term market uptrend has been much less, 19.3%.


Through February 11, the SP500 was down 10.96% year to date. That makes it the worst start ever since the index began in 1928. The previous low was in 1948 when the SP500 was down 9.22%. The market finished 1948 up 9.43% from that point.


The January retail sales report came in with good numbers. Excluding autos and gas, sales were up 0.4% and they were up 3.4% year over year. December numbers were also revised higher. Consumers might be finally starting to spend their gas savings “dividend.”

going shopping wsj 2 13 2016









According to Factset, 76% of SP500 companies have now reported earnings. 69% have beat the mean estimate and 49% have topped the sales mean estimate. The blended earnings decline is 3.7% for Q4. 68 companies have reported negative EPS guidance and 17 guided to the upside. The 12-month forward p/e is an even 15 based on the Friday close (1864.78/124.25).


Fed Chief Janet Yellen was in front of Congress this week. She said a US economic contraction is not imminent. She also said that due to economic uncertainty around the world, the Fed would slow, but not halt, planned interest rate increases. When asked about a negative interest rate scenario, Yellen said that would be a remote possibility. NY Fed President William Dudley said that the debate about negative rates is “extremely premature….the US economy is in quite good shape.”


Banks have been hit hard this year. The Financial Select Sector ETF (XLF) is down 14%. Financials are down due to worries about China, lower interest rates, lower energy prices and the spillover from problems in European banks. Credit default swap spreads are increasing in price on all of the major money center banks, but they are not close to the peaks seen in the last crisis. Mike Mayo, a research analyst at CLSA Americas, a long-time bear on the sector, has turned positive on the banks due to their strong balance sheets. In response to the low prices, Jamie Dimon, CEO of JP Morgan, bought about $25m of shares in his Company this week.


The SP500 dividend yield now (2.33%) has a 59 basis point advantage on the 10-year treasury (1.74%). This is the widest spread since 2012. Prior to 2009, we went about 50 years when the SP500 yield was less than the 10-year treasury. According to Bespoke Investment Group, since 1929, there have been five periods where  the differential was 50 basis points or more. If an investor bought the index the next day and held for one-year, the returns would have been -19%. +31%, +45%, +32% and +24%. The only negative return was in 1929.


Initial jobless claims came in at 269,000. That was down from last week’s reading of 285,000 and lower than the 280,000 estimate. Continuing claims also declined. This is another signal that fears of a recession, at least for now, are overstated. The JOLTS report shows that layoffs are at lows and employees are feeling comfortable enough to leave their jobs, both signals of a strong job market. This should translate into continued wage gains.

Hard data claims 2 14 2016


The US budget came in at a +$55b for January, which was the best January performance in 10 years. The number is also a positive in confirming that the economy is hanging in there. In the last quarter of 2007 and the first quarter of 2008, the balance went negative, indicating economic trouble ahead.


Barron’s cover story this week was titled “Trump, Sanders – Are they killing the market.” We spoke about this in our 2015/2016 Market Review. But as we get closer to the election, and if the possibility of either Trump or Sanders becomes realistic, it could have negative consequences for the market. Of course, either candidate would have to get their radical policies through Congress, something that would be unlikely. Still, some of their proposals would simply be terrible for the United States and the world.


The NFIB Small Business Optimism survey fell to its lowest level since March of 2013.


Gold has been off to the races in a safe haven trade. The GLD was down 46% from its September 2011 high to its December 2015 low but has since rallied 18%.


Week Ending 2/5/2017

The US markets continued their decline falling 3.12% (VTI) for the week. Overseas markets dropped 2.32% (VXUS).

Randall Forsyth writes in Barron’s that foreign countries in need of cash, due to the decline in the price of oil, or domestic economic problems (like China), might be tapping into their investments to free up cash for use at home. That might be impacting equity markets around the globe.

High p/e stocks led the retreat during the big 2%+ sell-off on Friday. LinkedIn (LNKD) dropped about 50%. According to Bespoke, stocks with the lowest p/e’s had average drops from -0.7% to -1.1% while those stocks with the highest p/e’s dropped an average of 1.2% to 3.1%. This analysis was based on splitting the market into deciles and calculating the average declines of the 5 lower deciles and then calculating the five higher deciles. The market has favored growth stocks over value the last couple of years but Friday may mark a change in that sentiment.



So far 63% of SP500 companies have reported earnings for Q4. According to Factset, 70% have beaten the earnings mean estimate and 48% have topped the sales mean estimate. The blended earnings decline is -3.8%. Assuming earnings end up in the negative, this would be the first time since the first three quarters of 2009 that earnings have declined three quarters in a row. 57 companies have lowered EPS guidance and 14 have raised guidance. 12-month estimated earnings are now $124.29, putting the SP500 at forward p/e of 15.12. Revenue growth has been led by the telecom and healthcare sectors.  Energy had the largest decline in revenue.


Employment numbers released Friday were generally favorable. The unemployment rate fell to 4.9% from 5.0% and a 151,000 new jobs were created in January. The labor force also grew for the third consecutive month. Long-term unemployment hit a new post-recession low. Wages and hours worked improved. On the downside, jobless claims were 285,000 which was higher than expected for the fifth time in six weeks. However, while 285 is greater than some of the low jobless claims numbers we were seeing a few months back, it is less than almost all of the other reports dating back to 2005.


Markit released its Purchasing Manager’s Index for various countries around the world. A PMI reading greater than 50 indicates growth. Of the 20 countries listed, 13 had a PMI greater than 50, two had a PMI equal to 50 and five had a PMI less than 50. Ten of the twenty countries had a month over month improvement. Looking from a global perspective, the PMI improved to 50.9 from 50.7. So growth continues on a global basis at a slow rate.

PMI Feb 7 2016


There was a negative report this week indicating that credit conditions are tightening. The Senior Loan Officer Opinion Survey showed that credit standards for commercial and industrial loans are starting to tighten. There was also a decrease in these types of loans. In the past, that has been a leading indicator of a recession. However, other types of loans are showing positive growth rates.


The Department of Energy announced that inventories continued to increase for oil, gasoline and distillates. At the same time, demand for oil and gasoline increased. That set up a short squeeze rally that moved the WTI up by 10%. That rally turned the market around from a 1.61% loss to a 0.60% gain on Wednesday.


The other big news on Wednesday was a massive drop in the dollar. It was the largest decline in the Bloomberg USD index since March 18, 2015.


Productivity fell at a 3% annualized rate in Q4 according to the Advance release. Employee compensation increased. The economy had higher wages and flat output resulting in the lower productivity. This could be a bad sign for corporate profits.


China has been burning through their foreign-exchange reserves, dropping to a 3-year low in January. The government is in a battle with speculators and hedge funds that are betting on a decline in the yuan. China want to maintain a stable currency. For now, their efforts have kept the yuan stable over the last few weeks, the question is how long they can hold out.

Cash Drain China 2 6 2016 WSJ


There was plenty of news on the negative side this week. But most every respected economist still does not see a US recession in the near term, although the percentage chances are increasing. The market stalled right at its resistance level of about $95 on the VTI. However, valuations are reasonable. The market is selling at about 15 p/e based on forward earnings and the spread between the dividend yield on the SP500 versus the 10 year treasury bill is at its highest since 2012.