PRAGMATIC CAPITALISM

GOLDMAN SACHS: THE S&P WILL END 2012 -4.2% LOWER THAN TODAY

Cullen Roche — Fri, 25 May 2012 04:40:55 +0000

David Kostin, chief U.S. equity strategist at Goldman Sachs has bucked the bullish trend in the first few months of the year after having been bullish for a long time. Kostin vocally called for S&P 1,250 despite the persistent rally in the first 4 month of the year (see here). Kostin now says the S&P is likely to end the year down slightly at 1250 (4.2% lower than today). He broke his reasoning down based on three big trends:

1. Stagnating US economy.

2. Multiples are likely to stagnate

3. Earnings growth is slowing.

Kostin says the S&P is likely to earn $100 this year and that margins are likely to contract. I think his positioning is totally rational given my own outlook for earnings and the very low upside potential and substantial downside risks heading into the latter portion of the year (see here for more on that).

Kostin also outlined Goldman’s hedge fund monitor and the stocks most aggressively accumulated and most owned by hedge funds. Goldman’s hedge fund VIP basket recently added the following names:

Barrick Gold (ABX)

Berkshire (BRK)

Calpine (CPN)

Devon (DVN)

AIG (AIG)

Capital One (COF)

Salesforce (CRM)

Ebay (EBAY)

EMC (EMC)

Ford (F)

Hertz (HTZ)

Rock Tenn (RKT)

Equinix (EQX)

Hess (HES)

Illumina (ILMN)

WellPoint (WLP)

The names most DROPPED by hedge funds are:

IBM (IBM)

J&J (JNJ)

McDonalds (MCD)

Amazon (AMZN)

WalMart (WMT)

Exxon (XOM)

The 5 names most owned by hedge funds are:

Apple (AAPL)

Express Scripts (ESRX)

Google (GOOG)

Microsoft (MSFT)

Qualcomm (QCOM)

You can see the full Kostin interview at CNBC.

EUROZONE PMI’S POINT TO DECLINING GDP DATA

Sober Look — Fri, 25 May 2012 04:01:11 +0000

By Walter Kurtz, Sober Look

European officials keep insisting that the euro area as a whole is not yet in a recession. That’s wishful thinking because the latest PMI numbers say otherwise. PMI tends to be a leading indicator for GDP growth. PMI of 50 means no change.

Eurozone PMI (source: Markit)

This is not just driven by the periphery. While Germany has stalled…

Source: Markit

France is undergoing a contraction.

Source: Markit

It’s just a matter of time before the recession becomes visible in the GDP numbers.

Capital Economics: – The fall in the euro-zone composite PMI, from 46.7 to 45.9, was sharper than the consensus forecast of a decline to 46.5 and left it consistent with quarterly falls in GDP of about 0.5%. After narrowly escaping a return to recession in Q1, it now appears very likely that the economy will experience a renewed contraction in the second quarter.

May’s fall was due to declines in both the services and manufacturing indices. And worryingly, the limited available breakdown by country revealed that the downturn is affecting the core as well as the periphery, with both the German and French composite PMIs falling further below the “no-change” level of 50.

What’s more, the previously resilient German Ifo measure of business confidence dropped much more sharply than expected. The fall from 109.9 to 106.9 reversed the gains of the previous five months and reflected weakening current conditions and business expectations across a range of sectors. Most notably, the drop in the retail index will have dampened hopes of a strong consumer recovery.

RAIL TRENDS: STEADY AS SHE GOES….

Cullen Roche — Thu, 24 May 2012 16:00:53 +0000

The recent mixed rail data continued today with a weekly decline in carloads and a rise in intermodal volumes. Carloads were off 5% year over year while intermodal was up 3.1%. The 10 week moving average fell to 3.3% down just slightly from last week. All in all, the trend has become one that points to a weak, but modestly expanding economy. The AAR has more details on this week’s data:

“The Association of American Railroads (AAR) today reported mixed weekly rail traffic for the week ending May 19, 2012, with U.S. railroads originating 280,565 carloads, down 5 percent compared with the same week last year. Intermodal volume for the week totaled 241,664 trailers and containers, up 3.1 percent compared with the same week last year.

Twelve of the 20 carload commodity groups posted increases compared with the same week in 2011, with petroleum products, up 49.4 percent; motor vehicles and equipment, up 23.3 percent, and lumber and wood products, up 17.9 percent. The groups showing a decrease in weekly traffic included nonmetallic minerals, down 16.3 percent; coal, down 16.1 percent, and coke, down 8.6 percent.

Weekly carload volume on Eastern railroads was down 4.5 percent compared with the same week last year. In the West, weekly carload volume was down 5.3 percent compared with the same week in 2011.

For the first 20 weeks of 2012, U.S. railroads reported cumulative volume of 5,627,959 carloads, down 3.4 percent from the same point last year, and 4,595,071 trailers and containers, up 2.8 percent from last year.”

BULLISH SENTIMENT REBOUNDS

Charles Rotblut — Thu, 24 May 2012 14:59:32 +0000

By Charles Rotblut, CFA, AAII

Bullish sentiment rebounded as bearish sentiment pulled back from unusually high levels in the latest AAII Sentiment Survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, rose 6.9 percentage points to 30.5%. This is the eighth consecutive week that bullish sentiment has been below its historical average of 39%.

Neutral sentiment, expectations that stock prices will stay essentially flat over the next six months, edged up 0.4 percentage points to 30.9%. The historical average is 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 7.3 percentage points to 38.7%. Even with the drop, bearish sentiment is above its historical average of 30% for the sixth time in seven weeks.

The level of pessimism declined from the unusually high readings registered during the last two weeks as the market’s downside volatility paused. Nonetheless, individual investors remain concerned about the short-term direction of stock prices. Europe and the pace of U.S. economic growthremain key concerns.

This week’s special question asked AAII members which sectors or industries they like right now. Energy was named by the largest number of respondents, followed by technology, health care, and consumer staples. When the same question was asked last February, members said they liked energy, technology and real estate [real estate investment trusts (REITs) and home building stocks].

This week’s AAII Sentiment Survey results:

Bullish: 30.5%, up 6.9 percentage points
Neutral: 30.9%, up 0.4 percentage points
Bearish: 38.7%, down 7.3 percentage points

Historical averages:

Bullish: 39%
Neutral: 31%
Bearish: 30%

(chart provided by pragcap.com)

The AAII Sentiment Survey has been conducted weekly since July 1987 and asks AAII members whether they think stock prices will rise, remain essentially flat, or fall over the next six months. The survey period runs from Thursday (12:01 a.m.) to Wednesday (11:59 p.m.). The survey and its results are available online at: http://www.aaii.com/sentimentsurvey.

IT’S TIME TO KICK GERMANY OUT OF THE EMU

Cullen Roche — Thu, 24 May 2012 04:51:05 +0000

Okay, that headline is a little extreme (I actually laughed out loud as I wrote it), but I am trying to think like a European politician here. Let me explain. I’ve already said what I’d do if I was a member of the peripheral countries. I’d go right up to Angela Merkel and tell her that if Germany doesn’t start giving in to some of our demands that I’d take my country, leave the Euro and default on the German bankers. Really, they should all do this in unison although Alexis Tsipras appears to be the only one actually willing to make this threat. It’s time to turn the tables on Germany and start pushing them around. That’s what this has come to.

It’s now abundantly clear that austerity is failing. And it will continue to fail until a true resolution is brought to the table. That either involves a full dissolution of the Euro (resulting in full sovereignty with the former currencies) or a push towards fiscal union. These half hearted moves that we keep seeing just aren’t going to fix the root cause of the currency crisis. The single currency system is broken. Just like the gold standard was broken. There is no reviving it in its current form. It either needs major changes like the USA did when it created a full fiscal union or it needs to be busted up so these nations can regain monetary sovereignty and floating FX.

The sad thing is, Germany likes the way things have been. As long as they can avoid having their banks defaulted on then they continue to enjoy being the trade surplus nation within the single currency and the primary beneficiary of the EMU. They have meager growth, but record low unemployment. Things are pretty good on a relative basis! So they’re holding on for dear life just hoping that something turns around and the music continues to play on. But the music is coming to an end and Germany needs to start making decisions. They either need to leave the Euro and stop holding everyone in the EMU hostage to their demands or they need to start making some concessions and moving towards fiscal union. And since it’s becoming clear that they won’t make decisions then someone has to start making decisions for them.

There’s no provision in the EU for kicking a country out (as far as I know), but that doesn’t mean they can’t create one. The peripheral nations could all unify and I am certain they’d find support from France at this point since Hollande is pushing for fiscal unity as well. Together, these countries can all start pushing Germany around. In fact, they could threaten to kick Germany out of the EMU (though they clearly don’t need to go that far!!). It sounds crazy, but that’s the last thing Germany wants. If they were kicked out of the EMU they’d not only default on trillions in Euros, but they’d have to bring back the D-mark which would be a total disaster for their economy as the D-mark would soar versus the Euro and crush their export driven economy. Ironically, it would likely result in higher debt levels for Germany as automatic stabilizers would result in more government spending as recession occurred. So they’d not only lose their trade position, but they’d end up printing more money anyhow!

Now, part of this is a bit facetious. I really don’t think they should try to kick Germany out of the EMU. But they should certainly unify more tightly and begin pushing back very aggressively. There’s much more to the EMU than Germany, but for some reason everyone is taking orders from Angela Merkel. Europe needs leaders to start walking into meetings and making very serious threats. There are millions of people held hostage in a depression due to this inaction. Someone needs to start standing up for them and recognizing that the currency union needs very serious changes and it needs them YESTERDAY.

TRENDS IN HEDGE FUND EQUITY HOLDINGS

Sober Look — Thu, 24 May 2012 04:05:42 +0000

By Walter Kurtz, Sober Look

Hedge funds have been known to move stock prices, sometimes dramatically raising volatility of specific shares. Here are two latest trends on hedge funds’ equity holdings that may have some impact on equity volatility going forward.

1. Investment allocation in small-, mid-, and large-cap stocks for an average fund is about a third for each of these categories. So one would think that by taking the full hedge fund universe, it would be equally weighted across the three capitalization groups. But that is far from reality. Small hedge funds like small-cap stocks and large ones prefer large-cap stocks. It means that as the large funds become even bigger, the overall percentage of large cap stocks within the hedge fund universe should rise (simply because large hedge funds control a bigger portion of the total hedge fund assets). That has indeed been the case, with small caps representing only 17% of the overall hedge fund equity AUM.

Source: GS

2. Hedge funds run highly concentrated portfolios. The latest numbers from Goldman indicate that top 10 positions make up some 64% of hedge fund equity portfolios. That compares to 34% for large-cap mutual funds. Such concentrations indicate that hedge fund overall performance is driven by just a few stocks.

Source: GS

Combining 1 and 2 above tells us that certain large-cap stocks could experience dramatic moves, as hedge funds change positions in these names. Large concentrations and significant holdings could result in some outsize volatility.

CHINA’S FLASH PMI SOFTENS MAY

Cullen Roche — Thu, 24 May 2012 04:01:25 +0000

The latest HSBC Flash PMI on China points to a still soft economy in China. The latest reading came in at 48.7, down from 49.3 in April. The Manufacturing Output Index came in at 50.5, up from 49.3. Here’s more via Markit:

“Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & CoHead of Asian Economic Research at HSBC said:

“Manufacturing activities softened again in May, reflecting the deteriorating export situation. This calls for
more aggressive policy easing, as inflation continues to slow. Beijing policy makers have been and will step up
easing efforts to stabilize growth, as indicated by a slew of measures to boost liquidity, public housing and
infrastructure investment and consumption. As long as the easing measures filter through, China will secure a soft landing in the coming quarters.’”

THINK LIKE A CHESS PLAYER

Cullen Roche — Wed, 23 May 2012 20:23:48 +0000

Great chess players think many moves ahead of their opponent. The only way to get an edge in chess is to break down the many possible future scenarios and always remain one step ahead of where your opponent is planning to move next. The market is no different, but most people don’t think like a chess player. They think like a Twitter user (what have you done for me lately). But the market isn’t a 140 character snippet of the here and now. The market is a chess board whose players are always thinking dozens of moves ahead of you. To succeed in the markets (regardless of your approach, long-term or short-term) you have to be able to think like a chess player.

A good example of this is the current market. Greece seems to be the only headline out there. All anyone can think of is how Greece is going to be the next Lehman Brothers. And the market has positioned for this event with a 8% decline in recent weeks. But the key to winning this game is in understanding the potential future outcomes of a worst case scenario like Greece. Most investors are just assuming it will be a disaster. Which it will be if there is no policy response. But if there’s one thing we can rely on from politicians who hate seeing their net worth decline it’s that they’ll respond. So the key to this market is gauging the political response in case of a Greek default. What will European leaders do? As I said on Twitter earlier today, the thing to fear is not a Greek default, but the response. Will politicians respond with a bazooka like Eurobonds? Or will they respond with nothing? Obviously, nothing would be a total disaster. But my guess is they’re assessing precisely how this sort of event will unfold and spread and they’re looking to ring fence and contain the effects. Will they succeed? Who knows.

What I do know is that over the last 4 years the investors who didn’t understand the next big policy and its effects were the players who got steamrolled by the Fed, ECB and other entities parading down Wall Street firing their various tools into the hearts of traders. This environment is no different. Personally, I’d be shocked if they let Greece default and defect without unveiling a bazooka. So to me, the key isn’t obsessing over the Greek default. The key is obsessing over the response. Thinking beyond today’s headlines to what the NEXT headline will be. Will it be:

“European leaders let Greece default, no policy response leads to market collapse”?

Or will it be:

“Greece defaults, European leaders unveil deposit guarantee, ECB credit facility, Eurobonds as markets soar in response”?

I guess you need to place your bet. If you’re on the wrong side of that headline it’ll be checkmate for you.

SO GOES THE STOCK MARKET, SO GOES OBAMA?

Cullen Roche — Wed, 23 May 2012 19:19:47 +0000

Anyone who remembers the 2008 election remembers how important the economy and the stock market were in deciding the outcome. It looks like a similar trend is developing in the 2012 election.

Personally, I am shocked that Obama even has a prayer in this election given the unemployment rate. I said back in 2009 that the unemployment rate was likely to be over 8% when he was running for re-election and that that would bury his chances. But boy was I wrong about that. According to Intrade the President is still the odds on favorite to win the upcoming election at 58%.

But the stock market could change all of that in a heart beat. I was struck by the chart below showing the Intrade odds of an Obama win versus the S&P 500. In this “what have you done for me lately world” it seems that the latest stock quote is one of the primary drivers of the well-being of the country and a real-time reflection of the President’s efficacy. Obviously, this isn’t an entirely rational view of the world and stock prices don’t always reflect our reality, but the data doesn’t lie….

THE RELATIONSHIP BETWEEN GOLD LEASE RATES AND GOLD PRICES

Sober Look — Wed, 23 May 2012 17:56:33 +0000

By Walter Kurtz, Sober Look

Since the post on gold lease rates back in December, a number of Sober Look readers have asked whether there is a long-term relationship between gold lease rates and gold price. Based on the weekly data available, there is none. The scatter plot below shows weekly moves in gold futures price vs. weekly moves in 3-month gold lease rates since 6/29/2007.

Source: Bloomberg

The R-squared, which shows the proportion of variance in gold price explained by moves in lease rates is 0.008. Daily data shows no significant relationship between the two either.

One would think that higher lease rates should provide support to gold price because a commodity that could be leased at a higher rate should be worth more. But that assumption is not supported by the data. In fact the recent moves demonstrate somewhat of an inverse relationship.

Recent data (source: Bloomberg)

The rationale for this inverse relationship is fairly simple. As more investors put short positions on, there is higher demand to borrow the metal (one needs to borrow an asset in order to short it), driving up lease rates. Many gold investors have been shorting gold using forward or futures markets to hedge their holdings. But dealers who buy forwards from these investors end up shorting physical gold to become neutral. The end effect is the same – large volumes of gold shorting should translate into higher lease rates. The recent weekly data shows a correlation of -0.6 (R-squared of 0.4).

Recent data (source: Bloomberg)

Whether this recent relationship holds going forward remains unclear. But based on historical data, the correlation should revert back to zero over the long run.