Archive for month: September, 2014
Is This As Good As It Gets for the S&P 500?
Is This As Good As It Gets for the S&P 500?
The outlook for U.S. stocks remains positive, as the “Four Pillars” of the rally remain intact: Global central bank accommodation (this was mildly solidified last week by the ECB and the soft jobs report), a clear macro-economic horizon (also further solidified by the Ukraine/Russia cease-fire), global economic recovery and reasonable valuations.
But, one characteristic of last week’s market that I didn’t like is there was no real desire for buyers to push stocks higher. The two failed rallies at 2,010 in the SPX are representative of the sentiment that this may be as good as it gets in the U.S: Economic growth (according to most metrics) is accelerating, but any material improvements will be met with a “hawkish” Fed. Washington is coming back into focus via the mid-term elections (the absence of any tomfoolery from Washington has been an underappreciated tailwind for the market). And from a valuation standpoint, even if the economic data stay “Goldilocks,” you’re buying an SPX that is trading at 15.4X 2015 earnings—again not prohibitively expensive, but not cheap, either.
Now, to be clear, I’m not saying there’s anything wrong with the market and/or to de-risk. But unless we get some additional multiple expansion by an uptick in earnings, I’m not sure what else out there is going to carry stocks higher in the near term. So, I think a consolidation/chop sideways is in order.
Adding to this is the growing attractiveness of Europe (and to a lesser extent Asia). European stocks, while mired in slow growth at the moment, are about to see the implementation of growth-stimulating programs. Meanwhile in Japan and China, both the respective governments and central banks are intent on helping their economies. And, the above regions trade at a significant discount on a valuation basis compared to the U.S.
So, point being, while I wouldn’t materially decrease U.S. equity allocations, I would point any new or tactical capital toward some other regions (especially Europe) as there is just a lot more room for improvement over there than there is in the U.S. at this moment.
Bond Bulls Not Done Yet
The Bond bulls aren’t giving up just yet – trying to re-take the 2014 uptrend. From today’s Report:
“The 30 year Treasury is now below the 2014 uptrend, but before getting outright bearish short term, I’ll want to see it close a few more times below that support level—as this 2014 rally deserves the benefit of the doubt. “
In Focus: ECB Decision
ECB Decision
The ECB shocked/surprised markets last week by announcing a targeted, private-market QE program that will begin in October. This decision, combined with the start of the TLTRO, represents a significant bullish tailwind on the euro zone that should not be ignored.
What Happened:
The important event you need to be aware of from the ECB today was the announcement that it would begin purchasing “Asset-Backed Securities” and “Covered Bonds” starting in October. This amounts to a “private-market QE” program, which was not expected by the market (and is very dovish).
Why It Is Important:
The ECB can’t do the type of QE we have here in the U.S. because there is no European equivalent to Treasuries. Instead, there are individual countries’ bonds. So, if the ECB were to try and do traditional QE on the scale of the Fed or Bank of England, it could very well end up owning all of smaller European countries’ debt (like Portugal, Ireland, etc.). So, public QE isn’t an option.
Instead, the ECB needs to do a more-targeted, private QE program, and that was what today’s announcement was about.
By buying ABSes and covered bonds (which are basically higher-rate ABSes), the ECB is directly funneling money into the real EU economy, which should help spur economic growth and, eventually, inflation.
This is how it works: A European bank will now be able to bundle and sell performing loans on its books to the ECB. It would get cash in return, which it can then turn around and lend to businesses, thereby creating inflation (eventually) and economic growth.
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Why You Need to Care More About the ECB Than You Probably Do.
Why You Need to Care More About the ECB Than You Probably Do.
I realize not everyone will have read this by the time the ECB makes its policy announcement (in 45 minutes) or when Draghi holds his press conference (in 90 minutes), but I want to include this analysis because simply put, Europe is really important right now.
Europe is by far the weakest major developed economy in the world, and it’s teetering on the brink of a triple-dip recession, if not worse. And, seeing as a “global recovery” is one of my 4 pillars of the stock market rally, if the EU slips back into recession, that will be a headwind globally.
So, understanding what’s happening with the EU economy and what the ECB is doing is very important. It is equally important as understanding what Fed policy was during the past three years here in the U.S. – because like the US economy with the Fed back then, the EU economy is now totally dependent on the ECB to provide stimulus. This is all about the ECB.
Before going into what’s expected from the ECB today and the implications on policy, it’s important to make sure we correctly understand the setup …
First, the major threat to the EU is deflation. That threat has resulted in European bonds surging to record levels, and a rise in the expectation that the ECB will eventually do QE—just as the BOE and Fed did when faced with a deflation threat in ‘11/’12.
Second, think of EU (especially German) interest rates as an inverse indicator of deflation. So, the lower the yields go, the higher the market expectation the EU will actually find itself in deflation (and German yields are just off record lows).
Third, unlike the Fed when it did QE, the ECB’s goal isn’t to lower interest rates. Interest rates in the EU are already too low. For the ECB to start winning this economic fight, interest rates need to start rising. That will reflect increasing inflation expectations and an uptick in the demand for money (which means increased economic activity).
Fourth, if the ECB does not ease policy materially this morning (i.e. is hawkish), you will see EU interest rates go down, as the expectation of a deflationary crisis in the EU grows and investors rush for cover. Conversely, if the EU shocks the world and actually announces QE, rates likely won’t decline by all that much in Europe, as that will ultimately be inflationary. Those two reactions are the opposite of what should happen normally, but again this is about deflation expectations, not about the level of interest rates.
With that in mind, let’s turn to ECB expectations:
Consensus: No changes to policy. Draghi talks “dovish,” threatens QE, but basically plans to wait and see if the plans announced in June (TLTROs/ABS purchases) can help jumpstart the economy. Market Reaction: European bonds and the euro will rally (which is bad) and European stocks will likely fall.
“Slightly Dovish”: Draghi announces some tweaks to the existing TLTRO program by reducing the fee to use it, increasing the size, releases more specific plans on the Asset Backed Lending program or makes further small cuts to interest rates. Market Reaction: The market wants QE; this won’t satisfy it. Look for a mild decline in European bond yields and EU stocks.
“The Total Surprise”: ECB announces QE. Market Reaction: This would be a total shock – but if so, European (and U.S.) stocks would scream higher. EU bond yields would decline but only modestly – and may even rally. Treasury reaction would be tough to gauge, but I think we’d see a Treasury sell-off after an initial spike higher.
I know we don’t normally think of Europe as a key influence on stock prices – but it’s a different world nowadays. The bottom line is what’s happening with the EU economy (and specifically its influence on Treasuries) is critical to monitor – and we’ll continue to stay on top of it.