DOW @ Record Highs: Why Shouldn’t One Fall In Value Trap?

With the US equities firmly setting themselves up around all time highs, the doomsday predictions have started flowing in. This is typical scare mongering which has been witnessed every time a prominent trend stays in place for a sustainable period of time. Equities have been remarkably resilient this year, factoring in fallout from events like Brexit and the Trump victory. However, “While the S&P 500 is reaching all-time highs on optimism over Donald Trump's economic agenda, some Wall Street strategists are increasingly worried about a widely followed valuation measure that's reached levels that preceded most of the major market crashes of the last 100 years” ,  (http://www.cnbc.com/2016/12/08/market-indicator-hits-levels-last-seen-before-plunges.html )

To be sure, the valuations have been elevated. But is that a good enough reason for the bulls to start offloading their prized possessions? The article says that the Shiller "cyclically adjusted price-to-earnings ratio" (CAPE) is calculated using price divided by the index's average historical 10-year earnings, adjusted for inflation. Yale economics professor Robert Shiller's research found future 10-year stock market returns were negatively correlated to high CAPE ratio readings on a relative basis. He won the Nobel Prize in economics in 2013 for his work on stock market inefficiency and valuations.

Here is the chart being refereed to…

Shiller CAPE PE Ratio 

 

 While the article is right in pointing out that the current levels have been exceeded only thrice in last one century, the difference in absolute values on the chart over last one decade is puzzling. The CAPE strode up to near 45 levels at the height of the 2008 debt fueled rally. The metric currently stands at just about 28 now. One more important point to consider is the alarming spurt in global central bank assets. Major central banks have witnessed a tremendous spike in their balance sheets in the aftermath of the global financial crisis. The aggregate size of major central assets is up from $5.5 Trillion to $18 Trillion over last eight years.

  

Coming back to the CAPE, it is important to note that the value of the metric has been elevated over last two to three years. In fact, in September 2014, when US stocks were rising in a similar manner and looking unusually expensive, Rober Shiller himself stated that 'We saw this before the Wall St crash, the dot-com bubble and the credit crunch". Will the CAPE hold true this time or investors would fall in a value trap? ...only time will tell! Read more: http://www.thisismoney.co.uk/money/investing/article-2742297/PROF-ROBERT-SHILLER-INTERVIEW-How-stocks-crash-2014.html#ixzz4SLTBjsva.
  

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Deere Experience: The Expectations Exuberance

Security prices are ideally supported to follow the underlying financial performance and though markets tend to discount the future developments well in advance, massive price movements tend to become out of sync with the reality at times. This is most visible when the broad indices are in a heavy bull run or even in a massive downtrend.

Take the case of Deere stock. Shares in tractor maker Deere & Company soared, as the company issued a relatively upbeat forecast for the coming financial year, at least compared to expectations. And results for the most recent period also comfortably beat expectations, according to an article on Agrimoney.com. (here is the link http://www.agrimoney.com/news/deere-shares-soar-on-comparatively-upbeat-sales-forecast--10190.html)

The article stated further that Deere saw sales falling only slightly, and said the company was well placed to survive the current downturn thanks to cost saving measures. However, Tractor sales in South America are expected to rally in the coming year, thanks to the recovering economic situation there.  Here comes the clincher. “Deere forecast company equipment sales, and overall net sales and revenues, to fall by about 1% in the year from November 1, where a Reuter's survey of analysts saw revenues dropping by 2.9% for the full year.”

The stock went up a whopping 11% in a single session following the “upbeat” results. The YTD gain so far is about 34%. Now the question is will the stock continue to perform like this in next few months if the financials come in line with the estimates or worse still, if they turn out to be below these current estimates?
Ideally, with falling sales, the prices should be at least be factoring in the possibility of a tepid turn in earnings over coming months. But, as stated in the article “Results for the August to October period also beat expectations.  Net sales over the period were down 4.7% year-on-year, at $5.65bn, but beating analyst expectations of $5.36bn. And although net profits were down 16.7%, at $0.90 a share, this was well ahead of analyst expectations of $0.39 a share. Deere shares were up some 8.3% in morning deals in New York, at $99.35”

How do you justify something as ironic as this? One more article offers some explanation. As quoted in https://www.incomeinvestors.com/urgentdeere-company-de-stock-soaring-today/9035/,  Deere & Company (NYSE:DE) stock is up 11%, due to a fourth-quarter earnings beat. Deere reported earnings per share (EPS) of $0.90, which more than doubled analysts’ estimate of $0.36. The total sales revenue came in at $5.65 billion in the quarter, which was higher than the estimate by analysts of $5.35 billion.

Keeping aside, the “expectations” irrationality for while, the surge in the stock could be easily explained by the fact that the US stocks are on a tear and currently been making a series of all time highs. One more article sums up the underlying business scenario for Deere in a much ordinate manner. “US farmer incomes are projected to fall to the lowest level in seven years as consecutive bumper crops have tempered prices. Tractor inventories are at record highs and credit availability has tightened. North American inventories through October were 5.5% higher than a year ago, data compiled by Bloomberg show”, according to http://farmfutures.com/story-deere-profit-forecast-tops-estimates-amid-cost-cutting-0-149813.

A Twisted Tale Of De(Leveraging)

A Twisted Tale Of De(Leveraging)

Notwithstanding the merits of debt

Given the tepid global growth prospects, it is clear now that most of major central banks will be holding onto their easy money stance in near term. While the US Fed is sole candidate to take a step in the other direction, it is becoming increasingly clear that the rest of the world is still suffering from the great financial crisis. Even for the Fed, it will not be an easy task to undo the QE driven monetary excesses of the last half a decade.

http://www.alternet.org/economy/paul-krugman-how-simple-minded-analogy-has-wreaked-havoc

http://www.mckinsey.com/insights/economic_studies/debt_and_not_much_deleveraging

Quantitative Easing: Strange To See US Warning Against Competitive Devaluation Of Currencies!

Interesting to see the US warn the rest of the world that it will "push back very hard" against countries that target weaker exchange rates to gain an unfair trade advantage, Treasury Secretary Jack Lew said on Thursday, driving home concerns he expressed to the Group of 20 this week. In an interview with NDTV Profit, Lew drew a distinction between policies of quantitative easing, which seek to stimulate credit and growth, and those targeting the exchange rate to gain an "unfair trade advantage".

"We have been clear, that kind of unfair policy is something that we will oppose and we will push back very hard on," Lew told the financial news channel.

Here's what he said in detail...http://in.reuters.com/article/2015/02/12/india-usa-economy-idINKBN0LG0BT20150212


The comments from Lew are coming out on an interesting day… 

The Swedish central bank as introduced negative repo rates today. the bank stated that there are signs that underlying inflation has bottomed out, but the situation abroad is now more uncertain and this increases the risk that inflation will not rise sufficiently fast. The Executive Board of the Riksbank has therefore decided to cut the repo rate by 0.10 percentage points, to -0.10 per cent, and to adjust the repo-rate path down somewhat.

The Bank Of England has noted today that it sees UK headed for a deflation in coming times. Bank of England has warned UK inflation rate will slip into negative territory soon even as it upgraded the economy's growth forecasts on strong underlying dynamics. The bank noted that it more likely than not that headline inflation would turn negative this year. In such a scenario, it would consider cutting interest rates and doing more quantitative easing.

Earlier in the day, the People's Bank of China officials reported that China is facing the risk of deflation as weak domestic demand continues to hinder economic growth. "In the medium term, the biggest uncertainty is from the risk of deflation as well as expectations of deflation," Lu Lei, director of the PBOC's research bureau, said in an article published recently on a private think tank's website.

While it is indeed ironic that the US wants the rest of the world not to follow the QE path, the stressed economies have no other option left given the tumultuous economic scenario. Commodities are in a persistent downward swoon and the US dollar is near its highest levels in 11 years. This is making the race for a secular and synchronized devaluation in global currencies even more intensifying.  The US central bank expanded its Balance Sheet by five times in last six years and nine times since the dotcom bust. The US, it seems wants the rest of the world to do as it says rather than doing what it does! 

Global Economy And Bernanke’s Dollars

In a fabulous piece in the Times, Michael Schuman argues that the global economy has become heavily addicted to the ultra cheap money polcies of the US Fed. However, he states that since the Fed will inevitably scale back, sooner or later the world is going to have to think about quitting the habit..

The proof can be found in the tumult in world stock and currency markets in recent days. Last week, global investors expected Federal Reserve Chairman Ben Bernanke to announce that he would begin to “taper” his program of quantitative easing, or QE, in which the Fed buys $85 billion of bonds a month to support growth. Yet in a surprise move, he didn’t, citing uncertainty about the strength of the U.S. economic recovery.

“We want to make sure that the economy has adequate support,” Bernanke said in a press conference, “until we can be comfortable that the economy is, in fact, growing the way we want it to be growing.”

You’d think such a statement would scare investors. After all, the U.S. is the world’s largest economy, and any indication its recovery may be sputtering (again) should be a negative for markets. Not so this time. Stock markets around the world soared. Even the stocks and currencies of emerging markets like India and Indonesia, which had gotten battered in anticipation of the taper, rebounded strongly, notes the writer. .

Schuman hits the nail on the head as he concludes that the (positive) reaction is a sign that investors have become more worried about liquidity than fundamentals. Like a smoker gladly unwrapping a fresh pack, they let themselves be cheered by the promise of further Fed cash rather than be dismayed by what it might mean. This is understandable. Ever since the collapse of Lehman Brothers in 2008, bankers, corporate executives and investors have become accustomed to operating in a global economy where money is cheap and easy to obtain. Central banks in the developed world have kept interest rates extremely low, even near zero in the U.S. and Japan, to support sagging economies.

http://business.time.com/2013/09/23/the-global-economy-has-become-heavily-addicted-to-bernankes-dollars/