Musing on the Markets : us economy

Beyond the Sound Bite: An Interview with Michael J. Mauboussin

Vinny Catalano, CFA — Tue, 03 Nov 2009 20:51:00 GMT

In my latest interview with the Chief Investment Strategist for Legg Mason Capital Management, we discussed a bottom-up view of the markets, the sustainability of the US economic recovery, and key segments of his new book: "Think Twice: Harnessing the Power of Counterintuition", including concepts such as decision making danger zones.

The length of the interview is 14 minutes 10 seconds.

(Please visit the site to view this media)

Vinny Catalano, CFA, Global Investment Strategist with Blue Marble Research publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

Beyond the Sound Bite: An Interview with Donald Rissmiller

Vinny Catalano, CFA — Tue, 20 Oct 2009 23:50:00 GMT

My third interview with the Chief Economist at Strategas Research Partners focused on my bifurcated earnings outcome, the US employment situation, the political dynamics of 2010, the dual exit strategies of monetary and fiscal policy, and the inevitability that the deficit bill will come due, among other topics.

The length of the interview is 17 minutes 16 seconds.

(Please visit the site to view this media)

Beyond the Sound Bite: An Interview with David Rosenberg

Vinny Catalano, CFA — Wed, 07 Oct 2009 14:39:00 GMT

"Hope always seems to spring eternal in liquidity-driven financial markets. That is very much the case today in the aftermath of the biggest liquidity injection in modern history." So wrote Stephen Roach, Chairman, Morgan Stanley Asia in today's FT. And liquidity is where my interview with David Rosenberg, Chief Economist and Strategist with Gluskin Sheff & Associates (formerly chief north american economist with Merrill Lynch) begins. We go on to discuss the state of the global consumer and new frugality, the continuing process of deleveraging, the probabilities of top line growth, and asset valuations, among other timely topics.

The length of the interview is 14 minutes 55 seconds.

(Please visit the site to view this media)

V Shaped Rally ≠ V Shaped Recovery

Vinny Catalano, CFA — Wed, 23 Sep 2009 16:56:00 GMT

Yesterday’s posted interview with David Malpass brings into sharp focus a key aspect of the US economic recovery that far too few investors are tuned into. Specifically, the underappreciated dynamic that second, third, and lower tier companies (the backbone of employment growth in the US) may not deliver the much anticipated above consensus earnings results this and future quarters ahead. Moreover, as the backbone of employment growth, weakness in second, third, and lower tier companies act as a depressant on wages, hours worked, and consumer sentiment. Therefore, how the US (and global economy) will reach a sustainable recovery without the US consumer is a riddle wrapped in an enigma.

Lacking a large exposure to global markets (where the growth is and where the weak US dollar helps deliver strong short term results), the SMIDS (small and mid cap companies) on down are vulnerable to disappointing investors with at or below consensus earnings results next month. In this regard, David points out in the interview that above consensus earnings results this coming 3Q09 for large and mega cap multi nationals may come to pass via pricing power pressures on all companies offset by volume growth courtesy a cannibalization of the units growth to lower tier companies.

(As a reminder, 2Q09 bottom line results surprised to the upside thanks to cost cutting, as top line growth was largely in line with expectations. In the current quarter ending next week, expectations are for above consensus earnings results produced by top line growth that surprises to the upside (with cost cutting is largely done). With the US economy still on its knees, it is hard to see how US domestic top line growth (revenues = price x units sold) can surprise to the upside. How this happens for companies that will not benefit from global markets (and a weak dollar) is a mystery soon to be revealed.)

Investment Strategy Implications

In a liquidity driven stock market, all logic goes out the window – for a while. Justifications for over valued markets abound. And buy high to sell higher becomes the music that all performance based investors must dance to. Phrases like “melt up”, thanks to expectations that the $3.5 trillion sitting in near zero percent money market funds will be forced into equities, is the support rendered for P/E ratios that warrant above average (i.e. 15 times) levels. Sound familiar?

In such times, a prudent investor is a contrarian investor. Momentum driven/fast money “investors” awaiting sideline money to sell to on the basis of melt ups and a sustainable global economic recovery rooted in a deleveraging US consumer may turn out to be a fantasy bubble about to burst.

Vinny Catalano, CFA, is President and Global Investment Strategist with Blue Marble Research (BMR). BMR publishes the "Sectors and Styles Strategy Report" newsletter, which contains the market beating Model Growth Portfolio. To learn about subscribing as well as other benefits, click here.

Beyond the Sound Bite: An Interview with Susanne Trimbath, Ph. D.

Vinny Catalano, CFA — Wed, 09 Sep 2009 15:26:00 GMT

My interview with the CEO and Chief Economist of STP Advisory Services includes her libertarian perspectives on the virtuous circle, the risks in the Fed's exit strategy, key consequences of financial innovation, and the next global financial crisis: public debt. Dr. Trimbath is also the author of "Beyond Junk Bonds: Expanding High Yield Markets".

The length of the interview is 18 minutes 28 seconds.

(Please visit the site to view this media)

The 3 Phases of this Bull Market

Vinny Catalano, CFA — Tue, 25 Aug 2009 13:41:00 GMT

The stock market rally since early March appears to have three distinct phases to it.

The first phase was the backing off from the economic abyss. The second phase was a bounce to fair value normalcy. The third phase (the one we are in now) is what I would call the return to business as usual phase (or “Recession. What recession?).

From where I sit, the first two phases were justified on many levels. Both phases featured massive amounts of government intervention combined with strong technicals to produce a rally to fair value. The elimination of the tail risk of the Great Depression II was followed by the above consensus macro economic readings (my MERI indicator), which was reinforced by the above consensus earnings results of 2Q09. Stocks rose to a reasonable fair value. So far, so good.

Unfortunately, at this point the seeds of questionable earlier decisions began to bear fruit. (Now, this going to sound very libertarian, so here goes.) Instead of pursuing the necessary cleansing process that all excesses produce, the Obama administration (which includes the US Treasury and the “independent” Federal Reserve) opted for a massive debt transference from the private to the public sector with the hope that time will heal all wounds. Along with this decision to socialize the bad behavior of the private sector most responsible for the crisis, the financial services industry, the Obama administration supported its core structure built on the laissez-faire era of the past two decades, accepting the largely unsubstantiated argument that financial innovation is a vital and necessary good for the economy.

With the government’s tacit support of the status quo, the investment mood shifted from fear and concern to hope and then enthusiasm.

The evidence of this mood shift back to the animal spirits days of yore came from a logical source – the financial services industry, the very sector of the global economy that provided the financial innovation grease to the out of control freight train of credit. And what better symbolic locomotive than Goldman Sachs, whose earnings report of July 14th whistled the bad old days were back in action. At this point, the Obama administration swung into action – with silence.

With its absence of outrage, the increasingly politically tone deaf Obama administration sent the public policy signal that its okay to bring the world economy to its knees, its okay to get bailed out with taxpayer money, its okay to shrink the competitive landscape (via Bear and Lehman’s demise), and its okay to return to the way things were – big profits and in your face fat bonuses.

The product of this wink and nod to Wall Street was the backlash at town hall meetings, which were as much about fairness as they were about healthcare reform concerns, a paranoid view of government, and a reactionary view of what constitutes being an American. It also produced an enthusiasm for stocks and an implied return to the bad old days.

Investment Strategy Implications

When you combine all these factors with the massive amount of investment capital ($3.5 trillion) still sitting in the near zero interest rate money market sidelines, the rising belief among many institutional investors that P/Es above their historical average are justified in the current low inflation environment, and the fledgling confidence that the global economy is on the mend* (along with the blind faith that the economic data from China is real), it is understandable how valuation levels could get to where they are today – stretched.

The investment question then becomes, “Is this a solid enough foundation upon which sustainable bull markets are built?” I have my doubts.

*I suggest reading Nouriel Roubini's comments in yesterday's FT.

The End User Dilemma

Vinny Catalano, CFA — Wed, 19 Aug 2009 03:02:00 GMT

Back on August 3rd subscribers to my weekly newsletter - Sectors and Styles Strategy Report - read the following:

"China may become the bigger fly in the bullish ointment. Unlike the US, China has spent all of its stimulus package money not on consumer demand related areas (where it is most needed) but on more infrastructure projects. Since the US consumer is and will remain in balance sheet repair mode for a while and developed economy consumers (Europe and Japan) reluctant and/or unable to pick up the slack, end user (consumer) demand must materialize from emerging economies. With savings rates very high in China and other developing economies, expectations of V-shaped global economy recovery of a sustainable nature (meaning balanced and asset bubble free) seem fairly unlikely.

Therefore, a close eye should be kept on China and the very real prospect that a bubble burst may occur in that country. Should such an event occur, the global growth story becomes highly suspect, and equity values based on a global V-shaped recovery and expansion very problematic."

At the end of the day, somebody has got to buy something from someone else. The government may be the lender of last resort but it is not the buyer of last resort. That title belongs you and me - the consumer. And, despite its best Keynesian wishes, the prospect of demand being a guaranteed result of fiscal stimuli remains an unresolved mystery. Therefore, as helpful as next year's conveniently politically-timed US stimulus package will be, it cannot be, nor should be, counted on as lifting the world economy out of its end user dilemma. Moreover, government schemes like "cash for clunkers" get you only so far. They're like a life preserver keeping one's economic head just above the water, and nothing more.

Investment Strategy Implications

When stocks moved away from the abyss a certain sense of relief was taken to a modestly enthusiastic extreme. The more optimistic drank the valuation kool-aid of born again bullish investment strategists. "The more things change, the more they remain the same" became the mantra as business as usual replaced the panic-driven mindset - business most unusual.

With the past few days of market decline, perhaps reality will begin to sink into the valuation equation. Hopefully (but not likely), the vital focus on what is necessary for a sustainable global economic recovery will take center stage. And with it a concentrated effort to appreciate the end user dilemma.

When Goldman Talks, Investors Listen

Vinny Catalano, CFA — Tue, 21 Jul 2009 14:46:00 GMT

For the past two months, I have made the argument that above consensus macro economic data would lead to above consensus earnings results and that investors would see the evidence of this as 2Q09 earnings season got underway. Based on the reports issued thus far, this argument has won the day as above consensus earnings results have matched the above consensus macro economic reports preceding them. Accordingly, stocks responded.

The second part of my argument was that such positive data would eventually encourage bottom up analysts (along with many investment strategists and top down economists) to reassess their more cautionary views and begin to raise their full year earnings expectations for this and next year. This, too, has begun to occur – none more significantly than from the investment strategy folks over at Goldman.

In a research report published yesterday, the Goldman strategists raised their estimates of S&P 500 operating earnings for this and next year - from $40 to $52 and from $63 to $75, for 2009 and 2010, respectively. In the process, the group estimated the target fair value for the S&P 500 at 1060 – ten points above my best guesstimate for the year (as reported in the Wall Street Journal on December 30, 2008) and my more evolved view of the same number based on the simple math of the historical average P/E of 15 times a mid 2010 estimate of $70 = 1050. As John McLane (“Die Hard”) might say, “Welcome to the party, pal”.

With Goldman in tow and many fence-sitting traditional money managers and individual investors being forced to reconsider the wisdom of leaving $3.5 trillion in money market funds earning 0.1%, the more meaningful investment strategy question is “Where are we in the stock market cycle?”

Investment Strategy Implications

As expressed in this week’s research report to subscribers, stocks are clearly in extreme overbought territory at the top end of the range. A completed bottom has not occurred. Therefore, stagnation (at best) or a pullback (most likely) appears to be in the very short-term offing for stocks.

That said, each week provides more evidence that the global economy has moved further away from the economic abyss of early March. Now that monetary stimulus and creative governmental action has done its work, the bulk of the fiscal stimulus package (conveniently timed for the 2010 election cycle) will provide the needed power to move the economic needle from stabilization to growth.

Aided by the global growth story (from emerging economies) as well as the likely positive forces of the wealth effect (from higher financial asset values), corporations, having demonstrated their ability to manage solid results in times deep economic distress, should be able to generate very satisfactory earnings results in an overall improving global economic climate - including a modest contribution from the US consumer.

So, where are we in the stock market cycle?

Stocks appear to be well into a transitional phase – one in which sector (style, country, and regional) rotation will (must?) produce the new leadership necessary for a new bull market to sustain itself to 1050 and beyond. The rotation to new leadership coupled with a completed bottom are the stock market signs most worthy of investor attention.

Beyond the Sound Bite: An Interview Dr. Neal Soss

Vinny Catalano, CFA — Thu, 02 Jul 2009 21:36:00 GMT

My interview with the Managing Director and Chief Economist with Credit Suisse (recorded Monday, June 29) includes the 2Q09 end to the US recession, expectations of a sub par recovery of 3 1/2%, a sustained level of relatively high unemployment, and a potential compositional shift in the US economy. The length of the interview is 16 minutes 58 seconds.

(Please visit the site to view this media)

To learn about "Sectors and Styles Strategy Report" newsletter and other subscriber benefits, including the market beating Model Growth Portfolio - click here.

Four Steps to 1050

Vinny Catalano, CFA — Wed, 01 Jul 2009 13:01:00 GMT

The Fourth of July is just a few days away. So, how about a four step process to investment fireworks for this summer?

The media is attributing yesterday’s stock market swoon as being driven by the disappointing report on US consumer sentiment. No doubt it is a contributing factor, however, a single data point does make a trend, for when one expands their time horizon beyond the day a decidedly bullish trend has emerged over the past 8 weeks as the above table clearly shows.

Investment Strategy Implications

The investment implications for the above consensus results rests in the likely upward adjustments economists will make to their forecasts, which will in turn produce increased earnings expectations from bottom up analysts. As noted previously, this would occur for the following reason:

Earnings (cash flows) are one of the key fundamental-analysis inputs upon which valuation (and therefore investment) decisions are made. The fundamental premise is that, in the aggregate, current earnings expectations incorporate the consensus view. Therefore, whenever macro economic reports come in above or below consensus expectations, economists change their outlook, which in turn cause individual company analysts to adjust that macro economic component of their industry and company forecasts. However, since this process occurs with a meaningful lag, investors can gain a competitive advantage by anticipating changes to earnings forecasts as the above or below consensus reports are filtered into the forecasts.

In regards to current earnings expectations, consider the following statistic from contrarian value investor and behavioral finance expert, David Dreman (from last week’s NYSSA conference): from 1973 through 2008, the average analyst forecast error is 39%. That means that 2Q09 operating earnings for the S&P 500, currently estimated by bottom up analysts at approximately $14, may actually come in as high as $19.50 or as low as $8.50.

In light of the above consensus data noted above, the lag component of the forecasting process, along with an increasing number of economists estimating that the trough of the recession was reached this quarter, it would not surprise me if the 2Q09 earnings reports tilt more toward the higher number. Should that occur, then all the angst heard over the past few weeks re low volume would dissipate rather quickly as some of the $3.5 trillion still sitting in money market funds moves off the near zero percent interest rate sidelines.

And if that were to occur and stocks made a strong move to the upside, then old school market technicians will ring the bullish bell as completed bottoms and moving average signals will abound.

So, here is how a major bull market begins in earnest:

1 - Above consensus macro economic readings produce
2 - Above consensus earnings reports which
3 - Moves funds moving out of money market funds which produce
4 - Bullish readings by old school market technicians which results in

1050 or higher in the S&P 500.

Let the fireworks begin!