Even excluding auto sales and gas the numbers were soft (although the March figures were revised higher). Looking at the year-over-year growth in retail sales there appears to be a pretty solid downtrend at this point which is disappointing considering the fall in gasoline prices were supposed to provide a shot in the arm for retailers. Now gas prices are on the rise with AAA saying, “The national average price of gas has increased for 26 of the previous 27 days to $2.66 per gallon, which is the highest average of the year.” That doesn’t seem like a positive trend.
According to the preliminary University of Michigan Consumer
Confidence figure, the U.S. consumer – the backbone to this country’s economic
growth prospects - is losing confidence in the economy. In light of the
expected “rebound” from the abysmal 1Q15 weather related softness, consumer
confidence registered 88.6 in May, way off from the expectations of around
95.9.
Richard Curtin, the chief economist for the Michigan survey
stated (via
Business Insider), “Confidence fell in early May as consumers became
increasingly convinced that there would be no quick and robust rebound
following the dismal first quarter (even if the underperformance was
exaggerated by inadequate seasonal adjustments)."
So are we headed for a severe economic slowdown or quite
possibly a recession?
The Atlanta Fed had quite a bit of press last
quarter after accurately predicting soft 1Q GDP when the rest of consensus were
clinging to overly optimistic expectations. Impressive work and something worth
watching. That said, they are at it again calling for just 0.7% economic
growth while consensus is still sitting around 3.0% expected growth. 
When tracking the economy, I like to aggregate several leading indicators into a single easy to read economic gauge. The variables that I input into the model are U.S. Average Weekly Manufacturing Hours, U.S. Manufacturers New Orders Consumer Goods, the Conference Board U.S. Leading Index Vendor Performance, the Conference Board U.S. Manufacturers New Orders Non-Defense Capital Goods, M2 Money Supply and University of Michigan Consumer Expectations. The chart below places this model against the S&P 500. The trend for the economic model is trending lower and yet the S&P 500 remains unfazed by the seeming economic slowdown. The stock market is the ultimate leading indicator and I always default to the market knows best discipline but this divergence is worrisome (the last time such a divergence occurred was the 2011 market correction).
The Citigroup Economic Surprise Index is also showing how
far the general economic consensus is off from reality. This index isn’t
exactly a pure reading on economic growth but more of a reading of economist
forecasts versus the actual economic releases. It is telling us that the
forecasts that are published are probably too optimistic and need to be
trimmed.
Climbing the Wall of Worry
April 30, 2015 CNBC
– “Marc Faber: Stocks are about to fall
40%—at least! “The market is in a position where it's not just going to be a 10
percent correction. Maybe it first goes up a bit further, but when it comes, it
will be 30 percent or 40 percent minimum!" Faber asserted. Faber says low
yields and stimulative central bank policies around the world have led to a
condition in which "all assets are grossly overvalued … and eventually
this will unwind and cause some problems."”
April 30, 2015 CNBC
– “It's going to get ugly, says Dennis
Gartman. "It's not going to get ugly bad; it's not going to get ugly for a
long period of time. I think it's going to get ugly swiftly and I think it's
going to make a lot of people very nervous," the editor and publisher of
The Gartman Letter said in an interview with CNBC's "Closing Bell" on
Thursday. He expects the downturn to last two to three weeks, and said then
it'll be time to buy again.”
May 1, 2015 CNBC
– “Mario Gabelli: There's no margin of
safety in stocks. “As we look into 2016 ... I'm [also] looking at the economy
in Europe picking up. The American companies will do a lot better because of
earnings in Europe coming into the U.S.," he predicted in a CNBC
"Squawk Box" interview. "The [U.S. stock] market is a function
of earnings, and we're comfortable with that." He warned, however, that
"on balance there's no margin of safety. If something goes wrong, you'll
have the volatility that you had [Thursday]." The Dow Jones Industrial
Average, the S&P 500, and the Nasdaq Composite Index closed lower in a
choppy session on the final trading day of April, which did finish positive,
but just barely.”
May 4, 2015 Business
Insider – “We haven't heard Carl
Icahn this bearish in a long time. He told hosts Anthony Scaramucci and Gary
Kaminsky that his portfolio was hedged for a correction. "I'm very
concerned about the market," he said. "I think that you have a
situation where this market keeps going up ... and yet a lot of the economic
news isn't all that good, and also more importantly, earnings aren't
good." The bottom line, to Icahn, is that some stocks are trading at 17
and 18 times the S&P. Those same stocks are going to whiff earnings. What
rational person would buy that?”
May 4, 2015 Business
Insider – “BUFFETT: Stocks won't look
cheap if interest rates rise. Stocks are definitely on the "high side of
valuation," Berkshire Hathaway CEO Warren Buffett says.”
May 4, 2015 Monthly Investment
Outlook from Bill Gross – “Policymakers
and asset market bulls, on the other hand speak to the possibility of
normalization – a return to 2% growth and 2% inflation in developed countries
which may not initially be bond market friendly, but certainly fortuitous for
jobs, profits, and stock markets worldwide. Their “New Normal” as I reaffirmed
most recently at a Grant’s Interest Rate Observer quarterly conference in NYC,
depends on the less than commonsensical notion that a global debt crisis can be
cured with more and more debt. At that conference I equated such a notion with
a similar real life example of pouring lighter fluid onto a barbeque of warm
but not red hot charcoal briquettes in order to cook the spareribs a little bit
faster. Disaster in the form of burnt ribs was my historical experience. It
will likely be the same for monetary policy, with its QE’s and now negative
interest rates that bubble all asset markets.
But for the global
economy, which continues to lever as opposed to delever, the path to normalcy
seems blocked. Structural elements – the New Normal and secular stagnation,
which are the result of aging demographics, high debt/GDP, and technological
displacement of labor, are phenomena which appear to have stunted real growth
over the past five years and will continue to do so. Even the three strongest
developed economies – the U.S., Germany, and the U.K. – have experienced real
growth of 2% or less since Lehman. If trillions of dollars of monetary lighter
fluid have not succeeded there (and in Japan) these past 5 years, why should we
expect Draghi, his ECB, and the Eurozone to fare much differently?”
May 6, 2015 Bloomberg
Business – “Yellen Says Stock
Valuations ‘Quite High,’ Bond Yields Low. Federal Reserve Chair Janet Yellen,
surveying the financial landscape for signs of bubbles after more than six
years of near-zero rates, warned that both stocks and bonds are richly valued.”
“I would highlight that equity-market valuations at this point generally are
quite high,” Yellen said in Washington on Wednesday in response to a question
at a forum on finance. “Now, they’re not so high when you compare the returns
on equities to the returns on safe assets like bonds, which are also very low,
but there are potential dangers there.””
May. 8, 2015 Seeking
Alpha – ”Signs Of A Stock Market
Correction Developing - My view is that price action in the stock market is
hinting at some possible "changing winds" in the days, weeks and
months ahead. If the break of the ascending triangle in the short-term chart is
confirmed, and if the market subsequently breaks and confirms a break of the
lower channel trend line in the longer-term chart (the break has not happened
yet), I think the market may be set up to enter into a corrective phase.”
- James A. Kostohryz.
May 12, 2015 Business
Insider – “HARRY DENT: 'The curtains
are falling for the greatest bull market and bubble in history' - We’ve been in
an unprecedented period since late 2008 wherein central banks around the world
have stepped in and printed whatever amount of money they deemed necessary.
They’re desperately trying to stop the depression and deflation meltdown that
started in the second half of that year.
But there is a limit
to how much you can stimulate an economy pointing down… especially one already
up to debt levels twice that of the last great bubble boom that peaked in 1929
— 4 times if you include unfunded entitlements. Just how much more can you get
people and companies to spend and borrow when they already way overdid that? The
answer is, you can’t.”
Risk Management
There is always the treat of a correction or bear market on
the horizon but it is truly impossible to forecast when it will happen. In the
cases of market “bubbles”, market sentiment has much more influence on asset
prices than intrinsic values. Attempting to time market tops and bottoms is a
futile and unprofitable strategy in my opinion. Understanding the fallacy of
the Efficient Market Hypothesis and the Efficient Frontier and embracing the influence
investor behavior can have on market valuations is one of the hardest parts of
investing.
We have written in the past about our concerns about the market
valuation but have an equally sound concern about missing potential market
gains by ignoring the power of investor sentiment. The proper use of portfolio
risk management while maintaining equity exposure is the most prudent option
right now, in our opinion. Building cash from dividends and interest and the
use of options is reasonable. We acknowledge providing liquidity using call
options on our positions in the near-term and taking liquidity using put option
on our positions on a longer term prospective will create a collared strategy
that will minimize the damage should a sudden shift occur. This strategy also
keeps the portfolio insurance costs under control.
With the proper risk management in place, we are not only
prepared for a correction but actually encourage it. When following a concave
constant mix portfolio structure, it allows us to reposition the holdings in
the portfolio to take advantage of new opportunities. Most of the alpha
generated within the portfolio comes from such events in our experience.
Joseph S. Kalinowski, CFA
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