More on PEs and earnings

Monday largely went according to plan.   The dollar softened a bit, gold broke its losing streak, and equities evidently decided that with Fed tightening looking like a high probability, it was time to eject a few toys from the pram.  The obvious (and sad) question is how far would equities have to fall over the next month to get the Fed to turnabout yet again?

If we were talking about the Bank of England, the answer would be "one basis point", but the Fed is made of sterner stuff.  Macro Man reckons a 5% dip would still be manageable, given the starting point: even Evans and Rosengren are currently onside with a December lift-off, it would appear.  However, if Spooz were to drop below 1900 over the next few weeks, that price action- and more importantly, the faux narrative that would accompany it- could well be enough to dissuade the Fed from going.  It's absurd that the SPX is even a consideration for monetary policy, let alone a reason not to lift off, but there you go:  your author's best guess is that a 7.5%-10% decline in equities over the next five weeks would probably be enough to get the Fed to "wait for more data."

Interestingly, high yield is already singing from a different hymn sheet than either stocks or investment grade credit.  Thanks largely to the impact of an energy sector wracked by lower oil prices, the rolling one year returns of the high yield index have been negative for most of the second half of 2015.  It's quite a contrast from last year, when even a blind monkey could make money owning dodgy credit.  Curiously, Macro Man's caveat emptor warning last June coincided with the top.  (He's not sure why last year's chart looks so different from the current one.   Was the index re-formulated or something?)


It's interesting to note that both of the previous post-crisis downdrafts in high yield rolling performance lasted approximately 11 months before the bull market reasserted itself.   The current performance dip is now.....11 months old.  While history need not repeat, of course, if high yield does not bounce soon it will appear as if the nature of the market has changed.

The obvious hypothesis is that thanks to the oil debacle, high yield has fallen off of the wagon of "credit-worthy borrowers", for whom there is apparently no limit on borrowing capacity, and acquired the taint of the "have nots" for whom credit will not flow.   If so, high yield would hardly be the first to fall off that wagon; over the last year and a half, for example, the [Edit: the price} total return index of leveraged loans has fallen back to levels last seen in late 2011.  Unfortunately, monetary policy has no easy answers when it comes to directing the flow of credit to where it is most acutely needed.


Indeed, Macro Man would argue that maintaining a super-easy monetary policy in the hopes that credit might eventually flow to sectors currently denied credit is counterproductive, insofar as it is rarely the price of money that's an impediment to the transmission mechanism, and overly-easy policy can lead to distortions in other areas (including important public policy touchstones such as income inequality.)

Macro Man included a chart in yesterday's post of NDX earnings versus the PE, but in many ways it was unsatisfying.  Not only did Bloomberg not have the data history before 2001, but it is generally inappropriate to compare a trending series (earnings) with a mean-reverting/stationary series (P/E ratios.)

He recomputed the data, this time for the SPX, going back to 1971...and using y/y changes in both the P/E and earnings to create an apples-to-apples comparison.  As you can see, there has been a generally strong negative correlation:  when earnings go up, P/Es go down, and vice versa.  (This chart was linked in yesterday's comments section.)


The full sample correlation is -0.64, but it was actually quite a bit stronger before the Fed became a serial blower of financial bubbles; from 1971 until the timing of Alan Greenspan's "irrational exuberance" speech, the correlation has -0.83; since then, it's been -0.34.  The increased volatility of PEs relative to earnings during the Internet bubble and its aftermath is particularly notable; thanks Fed!


It is interesting to note that in contrast to the Nasdaq, SPX PEs have actually not expanded as much as one might expect given the rollover in earnings.  This certainly supports the notion of a two-speed equity market, with Buzz Lightyear winning "forecaster of the year" for tech stocks and the rest just kind of treading water.  We've seen this sort of thing before, albeit to a greater degree than presently observed.

What's the implication?  From Macro Man's perch, if you're trying to call a top you want to sell the laggards; once the broad market turns, however, it will be time to short the high-fliers.  From where he sits, we're not there yet.
Previous
Next Post »

22 comments

Click here for comments
Anonymous
admin
November 10, 2015 at 9:11 AM ×

MM the lev loan chart is price rather than total return
Would be quite something if lev loans were underwater on a TR basis since 2011!
Can you answer my final Q on the Boom Shaka thread? (why not just short the long end)
Many thanks!

Reply
avatar
Martin T.
admin
November 10, 2015 at 9:33 AM ×

" While history need not repeat, of course, if high yield does not bounce soon it will appear as if the nature of the market has changed."

Simple, the credit cycle is turning, that's what the Q3 release of the Fed Senior Loan Officer Survey is telling you. The most predictive variable for default rates remains credit availability. In terms of predictive value, the SLO survey and Non-financial leverage are the best indicators. For the US there is a clear sign of tightening financial conditions: a net 7.4% of banks also worsened terms for C&I loans to large borrowers, vs. -7% in Q2 and the worst since Q4’09. Today’s spreads are merely fair-value for what is a late cycle environment, so regardless of the very heavy flows back in US HY in recent weeks, there is limited upside. You can clearly see this in terms of performance given that this time around BB paper was the top corporate segment last week, adding 3.25% meanwhile B’s were up 2.39% and CCC’s gained 1.32%. For the CCC segment is the "Credit Canary".

Best,

Martin

Reply
avatar
Anonymous
admin
November 10, 2015 at 10:14 AM ×

Italy bank loans to private sector fell 0.5% YoY in Sept. Go QE go!

Reply
avatar
Booger
admin
November 10, 2015 at 10:19 AM ×

I think the Fed will pike out again. If they do actually hike, long usd.cnh could be a very interesting asymmetric risk. A fed hike with or without an ECB easing will put enormous pressure on the Chinese with their peg. Also the cost of carry reduces with this position with Chinese easing or US hikes and yet the price remains the same, which is value.

Reply
avatar
Nico G
admin
November 10, 2015 at 10:51 AM ×

it is obvious Fed will hike again and again for the following reason:

commodities collapsed prices were NOT transmitted to consumers. There was no deflation whatsoever in the food you paid and limited mark down on gas. Companies and distributors just milked record, tremendous (dare i say, unpatriotic) margins out of that.

what happens when commodities pick up next year? expect THAT to be transmitted to consumers. Hence you can expect inflation to pick up dramatically as soon as commos bounce like i am betting they will.

The Fed knows that and has already announced their hawkish campaign for December AND beyond, throughout 2016

Reply
avatar
Macro Man
admin
November 10, 2015 at 12:22 PM ×

@Anon 1: Doh! I though I had downloaded the TR index but now see I was wrong. Thanks for pointing that out, and it's been edited in the post.

Reply
avatar
November 10, 2015 at 12:45 PM ×

Divergent central bank policy within the G10, and divergent meaning "polar divergent" will destabilize markets adding markets and friction. A reflexive aspect to the USD strength will ensure this trend cannot continue unabated...

Divergent Central Bank Trends

Reply
avatar
washedup
admin
November 10, 2015 at 1:28 PM ×

MM - interesting observation on that credit downturn lasting 11 months - HYG and JNK are both in the process of putting in a reverse head and shoulders pattern, so conventional wisdom would suggest credit could rally from here - the problem is that I am really not seeing any catalysts for it, and would also hazard a guess that given its overall pear shaped behaviors over the last few quarters that its still over-owned.
If credit does start making new lows, I've been thinking the next step in the Fed's 'unconventional' box may be to buy corporate credit and not necessarily negative interest rates as some have alluded to. Obv ECB seriously mulled it late last year as well - questions of moral hazard aside, I think that has the best chance of keeping the asset ponzi going.
Agree with the spoo reaction function on what would put off the next hike as well - I must say its a bit sad to see you cynical like the rest of us!

Reply
avatar
abee crombie
admin
November 10, 2015 at 2:21 PM ×

Credit will be interesting to watch as there are lots of deals to get done into year end (SAB, and now CP) However if we are in a lower rate environment, these spreads are attractive, given that you do your homework on the issuer. lots of babies being thrown out here, but I do agree its not the asset class to be in anymore. And aside from energy, the market has a problem with EM $USD bonds and also roll ups, like Valent and Altice

Reply
avatar
DownWithTheBeanCounters
admin
November 10, 2015 at 2:24 PM ×

If leverage loans are not bubbly and credit is not bubbly then where are the bubbles that argue for tightening financial conditions in the face of deflation and a global economic slowdown? Are we so worried that the young googlers won't be able to find affordable housing in the posher parts of San Francisco or is it the $170m that was dropped on a naked lady picture that has us all wound up?

Reply
avatar
Anonymous
admin
November 10, 2015 at 2:26 PM ×

Can you say debt? This so insane, a new word may be in order...

via BBG:

Debt in developing markets is estimated to have reached $58.6 trillion at the start of 2015, with credit in China, Hong Kong, India, Indonesia, Malaysia, Singapore, South Korea and Thailand exceeding that of Latin America, emerging Europe and the Middle East

Emerging-market debt has grown $28 trillion since 2009

Global debt has soared $50 trillion during the period to surpass a total of $240 trillion

Anyone know what the end game is?

Reply
avatar
Leftback
admin
November 10, 2015 at 2:40 PM ×

Bubbles are local this time around. That's exactly right. There are no bubbles in the Midwestern Rust Belt, or Pennsylvania, no bubbles in Mississippi or Arkansas. The bubble is mainly localized in Silicon Valley and its NYC cousin Silicon Alley, now that the Shale Oil bubble has more or less burst.

High Yield looks like being another one for the Bargain Basement shopper into EoY. Every year, investors and advisors decide to dump "stuff that isn't working" in so-called "tax sales", even though the tax benefits of so doing are often a mirage. The selling begins after Thanksgiving and into mid-December, and results in some interesting distortions. A few years ago it was REITs selling down to the point where the preferreds offered 9-10% yield, or muni CEFs trading at a 10% discount to NAV. That was some real value for Yield Hogs and Income Whores such as the team at Hammock Capital. This year we are likely to see the following get marked down for clearance: gold miner CEFs (!!), emerging market equity and debt CEFs, and possibly US high yield CEFs as well. So, as always, it's never too early to do one's homework!!

Bucky making another Run for the Roses this morning. Another commodity washout is not exactly out of the question. I can't help agreeing with Nico's proposal that US inflation can make a swift and sharp (if transient, say 6-12 months) comeback, to 2-3% CPI and maybe 4% PPI, on the heels of a weakening greenback and a firmer crude oil price in 2016. To our way of thinking that makes the entire universe of reflation trades quite interesting, especially things that are absolutely hated and detested right now like emerging market energy, debt and FX, gold mining etc... just my 2c.

Reply
avatar
Nico G
admin
November 10, 2015 at 3:51 PM ×

you spend $170m on a Modigliani well it's almost all right by today's absurd standard. But the same Chinese collector spent $30 million on a cup of tea. Sorry i meant a minuscule porcelain soup bowl. This is how much wealthy Chinese are willing to overpay to park their cash somewhere else which should give the right measure of their confidence in their economy/government/future to come.

China is being depleted. It will crash big.

Reply
avatar
Nico G
admin
November 10, 2015 at 4:35 PM ×



[Top brass of] “Companies in the United States have taken advantage of low interest rates to issue record levels of debt over the past few years to fund buybacks and M&A,” Goldman analysts led by Robert Boroujerdi wrote in a note. “This has driven the total amount of debt on balance sheets to more than double pre-crisis levels.”

in other words, top managers have used ZIRP to make themselves real real rich. No lesson learned from 2008 'aprés moi le déluge'. This wealth extraction is the hold up of the Century. Now you watch what happens when IR go back up again

Reply
avatar
Anonymous
admin
November 10, 2015 at 5:17 PM ×

@LB,
I like you year-end plan, except for the EM part.

I won't be as extreme as Nico, but I do expect that China's economy will experience another bad turn pretty soon: this week's online retail discount events pull lots of future comsumer demand forward, export continues trending downward, government spending is limited due to anti-corruption and declining tax revenue, and industrial investment is still declining. Then you have the December Fed event. There is a real possibility that there will be another shock EOY during the holiday season (my 2 cents: PBOC will do it to offset the USD's strength when most traders are away from offices.)

So maybe EM is a steal by the end of Q1 2016, I do not want to stand in front the train right now. HY looks to be a better choice. Any vehicle to play this theme? HYG?

Reply
avatar
abee crombie
admin
November 10, 2015 at 6:41 PM ×

LB, have you looked at mREITs.. most are trading at about 80% of book and now starting to buy back shares.

They are being hit hard as Swap rate spread turned negative. There was an aticle in the FT aobut this http://www.ft.com/intl/cms/s/0/e86a211e-847f-11e5-8e80-1574112844fd.html#axzz3r7DYQSho

I'm still trying to understand the implications for the broader market. Any thoughts from the crowd are appreciated

Reply
avatar
washedup
admin
November 10, 2015 at 9:21 PM ×

abee - are mREITs really being hit because of the recent swap spread issues? I think they have traded worse than dogs@3t since q414 when the markets started worrying about the phantom rate hike - the odd thing is prepayment risk actually heads down with any rate rally and you can't really argue credit risk for agency mortgage borrowers has increased with this jobs picture - I see their NIM potential as the same that it has been since the financial repression era began - I think they are just getting swept up in the overall hatred for anything yield-y.
All from the fear of a (most likely) 25 bps one and done rate hike - go figure.

Reply
avatar
Anonymous
admin
November 10, 2015 at 9:43 PM ×

Good news, we could soon be seeing the end of the fascist state known as the EU:

http://www.politico.eu/article/asselborn-eu-end-break-up-schengen-migrants-refugee-crisis/

Reply
avatar
Anonymous
admin
November 10, 2015 at 10:19 PM ×

Cleveland Fed Inflation Nowcasting... as cool as the Atlanta Fed GDP Nowcast

https://www.clevelandfed.org/our-research/indicators-and-data/inflation-nowcasting.aspx


They also has a paper that explains a simple model of core PCE that backs up the "disinflationary forces from energy and USD are temporary and inflation will trend back to 2%" comments from Feds.

https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-trends/2015-economic-trends/et-20151110-explaining-low-inflation-model-based-decomposition.aspx

Reply
avatar
Nico G
admin
November 10, 2015 at 10:27 PM ×

re. EU what happened in Portugal is absolutely horrible

am moving out of EU where unelected officials in Brussels - whose average personality resembles a Monday pub urinal - are shitting on democracy next door

2015 annus horribilis

Reply
avatar
abee crombie
admin
November 10, 2015 at 10:34 PM ×

Interesting to see the HYG and JNK arent destroying shares even as the drop lower every day. The number of shares outstanding is increasing. Someone is buying

http://imgur.com/IASgobw

Reply
avatar
JohnL
admin
November 11, 2015 at 12:50 AM ×

Washed: Q3/4 14 were QE3 tapper and end ( http://goo.gl/9tA1Es ) , no interest rate hike even whispered. About the same time $usd launched, commodities rolled over and inventories stated to ramp.....and apparently mREIT's turned to dog s&!t. ;-)

Reply
avatar