Positive Economic News Overwhelms the Latest “Bubble” Fears
By Louis Navellier
The stock market fell the first four days of last week, despite some very positive economic news. The big fear was that the Fed might “taper” in December or soon after Janet Yellen assumes control. Investors weren’t mollified when San Francisco Fed President John Williams reiterated on Tuesday that the Fed will not taper until the board members are “completely confident” that the economy is on the right track.
Just like kids who fear the candy store will soon close, investors acted like spoiled children. But Friday’s positive jobs report lifted the Dow nearly 200 points to close above 16,000 for the third straight week.
One of this year’s Nobel Prize-winning economists – Yale professor Robert Shiller, who is also in the money management business – has started warning investors about a stock market bubble. Since Shiller called the 2000 market top and the 2005 housing bubble in his book, “Irrational Exuberance,” that gives him credibility with the financial media. In this week’s MarketMail, my senior writer, Gary Alexander, will analyze Shiller’s predictions, as well as the views of the other two Nobel Prize-winning economists receiving their awards today. Their widely different views on how to value stocks show that economics isn’t rocket science – it’s a lot harder than that. It involves predicting the unpredictable: Human behavior.
In our first article, below, Ivan Martchev offers his third installment in a series about stock dividends for income investors. With interest rates and dividends still trading near their long-term historic lows, I’m sure that you can use Ivan’s insights to increase your investment income without adding any undue risk.
All of us at Navellier wish you Happy Holidays and successful investing!
In This Issue
Dividends are Still Low by Historical Standards
by Ivan Martchev
Is QE Working, or is it Merely Delaying the Inevitable
Why Sustainable Dividends Matter So Much Right Now
Investing Isn’t Rocket Science – It’s Harder than That!
by Gary Alexander
Introducing this year’s Nobel Prize-Winning Economists
Successful Investing Differs from Econometric Modelling
Stat of the Week:
203,000 (or More) New Payroll Jobs Added in November
by Louis Navellier
The Worldwide Manufacturing Recovery Accelerates
U.S. GDP Growth Rises to a Healthy 3.6% Rate
Dividends: Still Rather Low by Historical Standards
By Ivan Martchev
Inspired by the inflation chart going back to 1872, which I showed in last week’s MarketMail, I searched for a longer-term perspective on the stock market’s dividend yield, as represented by the S&P 500 or its equivalent. As luck would have it, Global Financial Data posted a chart of the 10-year constant maturity Treasury yield going back to 1870 vs. a chart of the S&P 500 dividend yield over the same time period.
Since the S&P 500 has only existed in its current form since 1957, I am sure the folks at Global Financial Data are using a NYSE average of sorts (the first stock index was the Dow Jones Industrial Average, dating back to 1896, with a predecessor developed by Charles Dow in 1884). Global Financial Data had previously done some interesting comminglings of various sources to get the longest possible history on record, so I will give them the benefit of the doubt that this stock market/10-year yield is close to par.
The blue line is the 10-year bond constant maturity yield, and the red line is the S&P 500 dividend yield.
Source: Global Financial Data
Note that the above chart was posted on GFD’s website in February of 2013. There has been quite a bit of drama in the bond market since last February, but even with the 2013 QE tapering drama, the back-up in yields is still within the long-term downtrend that started in 1981.
Is QE “Working,” or is it Merely Delaying the Inevitable “Deleveraging” Process?
I will not be convinced that this bull market in bonds is over until the Fed delivers successful tapering and a successful unwinding of QE. This is because the tapering itself may cause the bond market to overshoot, which may cause all sorts of issues in a slowly de-leveraging – but still highly-leveraged – economy.
If you want to zoom in on a shorter 30-year time frame, the 10-year yield had what technicians call a “false breakout” in 2007, due to an inflation scare which turned into a horrific deflation scare in 2008.*
So, in the short term, the 10-year note chart is shooting up. This suggests, from a tactical perspective, that it would be difficult to fight the bearish trend in government bonds. Still, if you look at the situation more strategically, I think we are due for another deflation scare in 2014 that may extend into 2015 due to the inability of departing Fed chairman Ben Bernanke to get the U.S. economy to re-leverage with QE.
What I mean by that is that the total leverage in the economy is falling again. Falling total leverage and sharply rising interest rates do not go hand in hand. A QE tapering mistake can slow down the economy so much that we may see 10-year Treasury note yields revisiting their 1.39% low from 2012.
I have publicly stated – and will repeat here – that if the 10-year Treasury note falls below 1.39%, it would mean the complete failure of QE policy, as the move would most likely be driven by deflation, which is exactly what QE has tried to prevent. For the time being, therefore, QE is neither a success nor a failure, but an elaborate maneuver to buy time for something else, which has yet to become apparent.
Why Sustainable Dividends Matter So Much Right Now
Dow Chemical (DOW) and LyondellBasell Industries (LYO), discussed previously here, are examples of highly cyclical businesses paying high dividends. In this environment, where we might get a whiff of deflation, you might want to be invested in less cyclical dividend payers, as deflation tends to weaken corporate revenues and ultimately endangers the payment of high dividends.
Over the past five years, the highest annualized dividend growth belongs to CMS Energy(36.9%, CMS), Lorillard (27.8%, LO), and L Brands (27.2%, LTD). In fact, L Brands is in the top three spots in the three-, five- and ten-year annualized dividend growth rate tables due to the payment of large semi-annual special dividends (skipped in 2013 because of the larger amounts paid in 2012 due to better tax treatment).
While I have discussed L Brands before, CMS Energy puzzled me as utilities are supposed to be steady high-dividend payers. CMS has a very respectable but not exorbitantly high dividend yield of 3.9%. So how come the 36.2% growth? In 2002 and 2003, CMS saw its quarterly dividend yield cut from 36.5 cents to 5-cents in two swift moves. The fascinating saga of energy trading companies – culminating with Enron’s collapse – had extensive repercussions with CMS Energy, described in more detail here. CMS is a different company now. It has stood by its word to restore its dividend, as business conditions allow.
This leaves us with Lorillard (LO), the third largest U.S. cigarette maker. Discussing Lorillard would be incomplete without including Altria Group (MO) and Reynolds American (RAI), the top three enablers of the ever-shrinking U.S. cigarette market. This chart shows the decline in cigarette smoking rates, but the data is incomplete, since the percentage of cigarette smokers has declined from 20% to 18% in 2013.
All three cigarette stocks have either spun off or divested their international operations—which are very vibrant and rapidly growing at the moment—and all three are leveraged towards the shrinking U.S. cigarette market. The question becomes: How does one invest against a headwind of fewer U.S. smokers?
The dividend growth of all three—LO, MO, and RAI—is impressive in the present environment. They are determined to give out every last penny as dividends and adapt to the new market conditions as they develop. A decline to a zero-percent smoker rate within 10 years sounds like a chimera, but constant price hikes and continual cost-cutting have made the three top tobacco processors some of the best dividend dynamos on Wall Street. I do not believe that there is any reason to fear dividend cuts for some time as tobacco dividends fill the sustainability bill to a “T,” even as the number of U.S. smokers declines.
*If you want to know my opinion on technical analysis, I use charts to study the major trends, but I have never been comfortable enough with technical analysis to make an investment decision based solely on a chart. I have to know what is behind the chart and how to interpret the numbers that the chart reflects about the asset in question.
Investing Isn’t Rocket Science – No, It’s Harder than That!
By Gary Alexander
On December 10, 1896, Alfred Nobel died. He left a lot of money for scientific prizes named after him. In honor of his death date, the Nobel Prize ceremony is usually held on this day, December 10. The first ceremony was in 1901, when the first Nobel Peace Prize was awarded to the Swiss founder of the Red Cross, Jean Henri Durant. The 1901 Physics prize went to Wilhelm Roentgen for the “remarkable rays” named after him. The 1903 Physics prize went to Pierre Curie and Marie Curie – the first female winner.
Three “hard” sciences have been awarded Nobel Prizes since 1901, namely physics, chemistry, and physiology or medicine. The softer, more subjective awards are for Literature and Peace. Since 1968, the Nobel commission has added the “Nobel Memorial Prize in Economic Sciences,” but the question facing us today is whether economics is more of a hard science, like Physics, or a creative art, like Literature.
Since the days of John Maynard Keynes, economists have tried to turn their profession into a science, using calculus to create complex mathematical models, which they call “econometrics.” Alas, in the end, as Alan Greenspan unburdened himself in his recent tome, “The Map and the Territory,” economics is more about our “animal spirits” – greed, fear, and mob behavior – than bloodless mathematical models.
That brings us to the three winners of the 2012 Nobel Prize for Economics. Each won the big Prize for his work in how to apply mathematical models to asset values – like stock prices. The problem is – all three came to strikingly different conclusions. In Physics, this would be like Albert Einstein and Neils Bohr (the 1921 and 1922 winners) having divergent opinions about how gravity works, or the speed of light.
Meet the 2013 Nobel Prize Winners – Eugene Fama, Robert Shiller, and Lars Hansen
If you want to watch the Nobel Prize award ceremony, you can see the streaming video (starting at 10:20 am EST today) at www.Nobelprize.org. In the meantime, here are the winners and their divergent views.
Eugene Francis Fama, age 74, is Professor of Finance at the University of Chicago. He is often called the father of the “efficient market” hypothesis, which stemmed from his doctoral thesis. He is best known for using exhaustive market databases to formulate theoretical and empirical (real life) portfolio decisions.
Robert James Shiller, 67, often appears on CNBC in connection with his famous housing index, as well as his market predictions. He is currently Professor of Economics at Yale, after holding key positions in the National Bureau of Economic Research and the American Economic Association. He is also co-founder and chief economist for an investment management firm, MacroMarkets LLC. Unlike Fama, Shiller is noted for pointing out market inefficiencies and price anomalies within the major markets.
Lars Peter Hansen, 61, is perhaps lesser known to investors than the other two. Like Fama, he teaches at the University of Chicago as the David Rockefeller Distinguished Service Professor of Economics. He is best known for his studies on the interface between the financial and the “real” sectors of the economy.
All three plow the same field – asset valuation – but they emerge with different answers. Fama says that most markets are “informationally efficient,” since most investors revalue prices almost instantaneously to reflect any new information. In shorthand, the news is rapidly reflected, or baked into, the market price.
Shiller doesn’t think investors are that smart or rational. Investors are subject to animal spirits, prisoners of their human nature and subject to mob psychology. Shiller proved in the 1980s that stock prices move in much wider swings than their underlying dividends, which are far more predictable than stock prices.
A famous case in point is Shiller’s book, “Irrational Exuberance,” which was first published in March of 2000, the exact month of the peak in NASDAQ and S&P 500. In his 2005 update to that book, Shiller added a section on how overvalued the U.S. housing market had become. He showed that housing was a case of greed fueled by unrealistic previous price increases. His predictions were once again right on the money, as real estate prices soon peaked and began to fall precipitously over the next few years, as reflected in the housing index that Shiller pioneered – now called the S&P Case-Shiller home price index.
The tie-breaker in this argument comes from Lars Hansen, who studies the causes of market volatility. He seems to lean more toward Shiller’s view, that the wide variations in asset prices within a short time cannot be caused by slight changes in valuation measures. Such swings are not explainable by normal valuation models, so Hansen focuses on those “moments” of change, when investors vacillate from manic to depressive. This seems to be the origin of the recent fixation with the terms “risk on” and “risk off.”
While Shiller and Hansen seem to dispute Fama’s conclusions, Fama has won the allegiance of armies of index fund managers, who deny the value of individual stock selection in favor of exchange-traded funds (ETFs) and various index funds, which try to reflect the movement of indexes by constantly rejiggering the fund’s contents to reflect the market capitalization of each stock in the index, thereby exacerbating the size of the market’s swings, as index fund managers are forced to chase the “hottest” stocks in the index.
At Navellier, we tend to agree with Shiller and Hansen – that there are clear price anomalies available to alert investors. However, we don’t agree with Shiller that the current market is nearing a “bubble” state.
Successful Investing Differs from Econometric Modelling
My father was a rocket scientist, of sorts. During my college years (1963-67), he was a Boeing engineer and project manager in Huntsville, Alabama, and New Orleans, helping build the Saturn booster rockets. In retirement, dad applied his scientific skills to the stock market. He kept elaborate graphs of each stock he followed – by price, dividend, P/E, and other ratios. It was all very mathematical, but his track record was unsatisfactory, so he asked for my advice. Looking at all his charts, I said, “Dad, investing isn’t like rocket science. It’s harder than that.” He wasn't sure if I had lost my marbles, so I explained: “Investing involves real people making emotional decisions, usually bad decisions. In rocket science, you can project a missile into space with known variables, with almost exact precision. With investing, you have to work with human beings. The numbers have some limited value, but they won't be able to predict stock prices.”
Justin Fox’s 2009 book, “The Myth of the Rational Market” covered how physicists from the Los Alamos National Laboratory launched the Santa Fe Institute, which attempted to apply chaos theory to markets. Fox wrote: “Physicists struggled with the reality that sentient beings are harder to work with than, say, subatomic particles.” One physicist, J. Doyne Farmer, said economics is “a harder field than physics."
In my 30+ years of working with financial newsletter editors, I’ve run into many former engineers who became investment advisors, lured by the fascination of seeking scientific formulas for profits. These advisors became successful, but only by accounting for investor sentiment and other emotional elements.
Prices will always swing in wide arcs - due to human excesses, not just logic. That fact will always give investors a chance to beat the markets. After all, it’s almost un-American to strive to be just “average.”
Stat of the Week:
203,000 (or More) New Jobs Were Added in November
By Louis Navellier
There was an avalanche of good economic news released last week, capped by Friday’s jobs report. The Labor Department said that 203,000 payroll jobs were created in November, better than the economists’ consensus estimate of 180,000. Also, the September and October payrolls were revised up by a total of 8,000 jobs, and the unemployment rate fell to a five-year low of 7%, down from 7.3% in October.
A much more bullish jobs number came from the broader household survey, which counted 818,000 new jobs in November, after reporting 735,000 fewer jobs in October. Another piece of good news is that the labor force participation rate rose to 63% in November, up from 62.8% in October – a welcome trend.
The other positive news on the payroll front was that ADP reported on Wednesday that 215,000 private payroll jobs were created in November, much better than the economists’ consensus estimate of 178,000. Also, ADP’s October payroll report was revised up to 184,000 from its original estimate of 130,000.
Clearly, payroll job growth is perking up, averaging 195,000 per month in the past three months, up from an average of 176,000 in the same period a year ago. According to ADP, private payrolls are now growing at the fastest pace in over a year. Thursday’s news that weekly jobless claims fell by 23,000 to 298,000 was also good news. This is the first time since 2009 that weekly claims fell below 300,000.
The Worldwide Manufacturing Recovery Continues to Accelerate
The Institute for Supply Management (ISM) reported last week that its manufacturing index rose to 57.3 in November, up from 56.4 in October and well above economists’ consensus estimate of 55. The ISM new orders component rose three points to 63.6, while the production component rose two points to 62.8. The ISM manufacturing index is now at its highest level since April of 2011. A big part of the latest manufacturing boom is the fact that November vehicle sales rose 7.2% to an annual rate of 16.4 million, up from 15.3 million in the same month a year ago – the fastest annualized vehicle sales rate since 2007.
The manufacturing boom is a worldwide phenomenon, due to strong demand from Asia, Europe, the Middle East, and U.S. Markit reported that Germany’s manufacturing index rose to 51.6 in November, up from 50.8 in October, the fifth straight month above 50 – the level that signals an expansion. Britain’s manufacturing index surged to 58.4 in November, its highest level since February of 2011. Even Italy’s manufacturing rose to 51.7 in November, up from 50.7 in October, the sixth straight increase in Italy.
Thanks to booming domestic energy production, the U.S. trade deficit continues to decline. Last week, the Commerce Department reported that October’s trade deficit dropped to $40.6 billion as exports rose 1.8% to $192.7 billion while imports rose just 0.4%, to $233.3 billion. Soybean exports rose the fastest, up 22% (vs. a year ago), followed by a boom in refined petroleum exports, rising 16% in the last year.
Speaking of oil exports, Texas’ crude oil production rose to 2.7 million barrels per day in September, more than double its production three years ago. Thanks to booming crude oil production in Texas’ Eagle Ford Shale and West Texas’ Permian Basin, Texas’ crude oil output is now at the highest level in 25 years. The energy boom in both North Dakota and Texas is clearly helping to reduce the U.S. trade deficit, as well as boosting the exports of refined products, such as diesel, gasoline, jet fuel, and fuel oil.
U.S. GDP Growth Rises to a Healthy 3.6% Rate
The other big economic news this week was that the Commerce Department revised their third-quarter GDP estimate up to a 3.6% annual pace last Thursday, up from a previous 2.8% estimate. The primary reason was a surge in inventories, to $116.5 billion, up from initial estimates of $86 billion. The bad news is that any inventory surge this large typically causes GDP growth to slip in the next quarter.
Clearly, a lot of inventory has been built up in anticipation of record holiday sales, so please go out and spend up a storm in December. Let’s deplete all those huge inventories! So far, there is some hope. Even though analysts were disappointed by slow Black Friday retail sales, Cyber Monday’s sales surged 19% vs. a year ago, hitting an all-time record. The fact that Amazon is testing drones to deliver goods near their fulfillment centers is exciting. I can’t wait to see how my dog Coco reacts to a drone delivery!
Finally, we learned that new homes sales surged 25.4% in October to an annual rate of 444,000, up from a 354,000 pace in September and well above economists’ estimate of 419,000. The inventory of new homes fell to just 4.9 months, down from 6.4 months in September. Tightening inventories usually help home prices to firm up. This surge in new home sales is very encouraging, since home sales tend to drive the sales of appliances, furniture, and other household items, which is good for overall GDP growth.