Monthly Archives: August 2017

More Good News for the Economy, and Some Banal Puns

Thurs, AUG 31st, 2017

All real estate is local. It’s the industry’s version of Tip O’Neill’s famous adage regarding success in politics. And while there is certainly some truth to this phrase, the housing market at the macro level provides important information on the condition of the national economy. Admittedly, it’s a notoriously noisy (1, 2, 3, 4 etc.) data series month-to-month, quarter-to-quarter. It can confuse even the most seasoned market watchers.

For me, I prefer to smooth out the variations by 1) looking at annual year-over-year trajectories, and 2) focusing my attention on what I consider to be higher quality housing data points: supply / demand = inventory, builder confidence, consumer confidence (i.e., window into the appetite for big ticket purchases), employment & income levels, affordability, household formation trends, borrower profiles, access to credit, and, of course, a household’s ability to service a mortgage (I don’t know … this one feels kind of important!). Taken together I consider these the foundation underlying the housing market, most of which currently signal that housing continues to be on the mend. Meanwhile, enter fresh data on mortgage debt servicing:

(More on this from Bill McBride over at Calculated Risk.)

Wait, what? The lowest level of serious delinquencies in 10 years!? *But-but … what about last month’s housing starts? Can’t we blow out of proportion that particular monthly statistical noise? I need a headline! Something to trade off of! Or at least complain about!* Jason here: You can if you’d like, but I prefer the abovementioned sturdier analytical framework.

The housing market is an important piece of the macroeconomic story. It impacts jobs, wages, downstream consumption (think – furniture, artwork, towels, spoons, Windex, etc.), materials pricing, profits, taxes, bank credit, and ultimately virtuous net asset formation on household balance sheets. It’s about shaping communities and other vital collective factors, security & well-being, and underpins the much lauded “American dream.” In a nut-shell, housing matters … a lot. Just remember, understanding the housing market at any point in time is akin to constructing a home: it’s much more imperative to keep your eye on foundation and framing than other less crucial elements – like roof color, or style of drapes.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
jware@albionfinancial.com
(801) 487-3700

Relative Returns, Bulls and Bears – Oh My!

Thurs, AUG 24th, 2017

I appreciate high quality simple data points and explanations on complex topics. In our industry the reverse is often the case. *Pay attention to everything you possibly can, no matter how esoteric. “Rework” it. Over-complicate it. Draw irrelevant conclusions from it. Hopefully sound smart in the process. Rinse. Repeat.* This, in part, explains why the contemporary discussion of valuation and stock market returns is so convoluted. And yet it could be so simple.

First, we know that markets don’t just die of old age nor because price levels are perceived as elevated. And second, time-tested measures of valuation are more relevant than … well … made up ones. OppenheimerFunds CIO Krishna Memani – a man I’ve met personally and respect immensely – recently authored a paper outlining several reasons the bull market should continue. Many of these I have blogged about in the past and openly discussed in the financial press. Nevertheless, I decided to share Krishna’s piece and the Bloomberg article both for the quality of the data and because I felt that it nicely distilled much of the valuation and returns noise down into a simple to view and understand logic. From Bloomberg:

Simple. Elegant. Relevant. Nice hat trick, Krishna.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
jware@albionfinancial.com
(801) 487-3700

Ignore the Bears, the Economy and Markets Appear Fine

Thurs, AUG 10th, 2017

Aggregate data in the second quarter remained broadly supportive of both economic expansion and a healthy stock market. The job market continues to thrive, balance sheets are strong, confidence is buoyant, inflation and interest rates remain muted, and monetary policy is still loose – albeit decisively on the path toward normalizing. And while the daily fixation with U.S. politics has not gone away in the 24-hour news cycle, financial market sensitivity to such noise has dampened. Not that we mind; a market more focused on the fundamentals – i.e., real economic data and corporate results – is a more attractive and rational market. Global economic growth continues to trend up. As we mentioned in our last quarterly missive, a synchronized global economic bounce appears to be taking place. In fact, it’s the first time in the contemporary recovery where we’ve experienced the majority of the world’s largest economic horses all pulling in the same direction.

Europe’s economic footing has improved, so much so that the European Central Bank is finally beginning to entertain gradually removing extraordinary monetary stimulus; Japanese manufacturing
is perking up and its economy seems to be in a moderate recovery; and China is … well … China, growing output around +6% with a government ready to turn the economic dials in either direction if required. Save for an unanticipated exogenous shock, the world economy looks as if it’s in decent shape. S&P 500 profit growth accelerated further in the first quarter (the most recent data available), and is expected to continue to rise throughout 2017. The +13.7% earnings growth rate logged in the first quarter was the best pace since 2011. It also marks the third straight quarter of accelerating profit growth. Despite all the bullish conversation around the potential for fiscal stimulus, it’s this profit growth in our view that has been the real driver of stock returns this year. Indeed, we remain dogged in our position that corporate profits do the heavy lifting with regards to stock prices. That said we do not anticipate earnings growth to continue its current energetic stride. Rather we believe that while the upward trajectory should stay intact, it will likely be closer to a normalized mid-single digit speed.

Equity valuations remain neither cheap nor expensive, in our view. Nevertheless it seems rare to find anyone who doesn’t think that stocks are too high or richly priced. This is likely a good contrarian indicator, and tells us a lot about the current state of the market. We both recognize and are attuned to the metrics that the bears point to suggesting an overvalued market. But there are many other metrics that show no such excess. When viewed comprehensively we continue to assert that valuations are sensible, particularly considering low interest rates, tepid inflation, and improved earnings growth.

Despite another rate hike of 0.25% in June monetary policy remains rather loose. And for the third time since December financial markets took the hike in stride as the collective belief has been that the Fed is raising rates for the “right reason” – that is, the general economy is fit and warrants such action. Under our baseline assumption that the U.S. economic expansion perseveres we think that the Fed is likely on the path towards further policy normalization, although perhaps at this point focusing more on reducing the size of their large balance sheet versus raising the Fed Funds rate. If correct, this policy shift could ultimately have a more direct impact (upward pressure) on longer-term interest rates.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
jware@albionfinancial.com
(801) 487-3700

Valuation is an Art – But that Doesn’t Mean it’s Always Pretty

Fri, AUG 4th, 2017

Monet was brilliant with color and stroke. Picasso used interesting shapes and had an uncanny ability to impart mood. Renoir celebrated sensuality. Each had critics, but all share a common trait: artists widely regarded as great in their field. We can squabble about taste, but there’s little debate around their influence. Ansel Adams once said “there is nothing worse than a sharp image of a fuzzy concept.” Indeed. Whether it’s art, engineering, or investing, eminent concepts and high quality work are timeless.

On traditional time-honored metrics like P/E, earnings yield, “Fed model” and equity risk premium – i.e., the Monets, Picassos, and Renoirs of equity valuation – current stock price levels and fundamentals look reasonable. This market is not overvalued. Nevertheless the preponderance of pundits, pros, and portfolio provocateurs find themselves somewhere along the scale between outright gloomy and resistive participation. This has been an enduring feature for much of this contemporary bull market. Outside of small pockets here and there (existing in any environment) exuberance remains extinct. Despite this there are those who seem to make a living off trying to scare investors out of their skulls. Over the past week I have noticed a new chart and narrative getting some traction. Similar to the “scary” parallels between now and 1929 and other unavailing bearish correlations this chart from the equity strategy team at BAML seems to make intuitive sense with a cursory glance. It may even generate churn in brokerage accounts from clients who digest its contents. (I am sure the Thundering Herd’s brokers won’t mind). They call it a “classic euphoria signal.” Hardly.

This view is typically presented to imply some sort of direct relationship between Fed asset levels and stock prices. I don’t deny that Quantitative Easing had some indirect impact on equities, primarily by way of driving down longer-term bond yields. But this chart isn’t helpful in forecasting where stocks are headed. As with anything in markets, the right context matters. So, I did some digging. Below you can see what this relationship looks like when you zoom out some 33 years (max data set for FRED). The chart, which in full disclosure isn’t exactly the same data set BAML uses – they use Federal Reserve assets while I use monetary reserve base, but it’s effectively the same thing – shows the Fed’s balance sheet relative to the broader Wilshire 5000 index. Through this lens the purported correlation breaks down and it’s clear that stocks can and have rallied even when central bankers are not playing Pac-Man in the bond markets.

fredgraph

It’s earnings, not central bank liquidity that’s driving stocks. Charts like BAML’s can get wide dissemination among trading desks and the investing public. They are often both cherry-picked and misleading; the staple recipe for cooking up clicks on spooky market headlines. Take them with a pinch of salt, and stay the course with your investment plan. If the macro economy and corporate earnings continue to expand and stock prices don’t aggressively outrun that pace, high quality valuation metrics will tell the correct story. Just keep that in mind the next time someone tries to tell you that their Dogs Playing Cards is just as good as Houses of Parliament.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
jware@albionfinancial.com
(801) 487-3700