G3 Recap 1-27-11

Main Items:

  • US Initial Jobless Claims jumped to 454k last week vs 405k expected and 404k previously. A government rep said that there are some seasonal issues as well as weather impacts on the print.
  • Headline DGO dropped -2.5% YoY vs +1.5% expected due to volatile prints. Non-defense, ex-aircraft capital goods orders rose 1.4% YoY vs 1.3% expected and 2.6% previously.
  • Chicago Fed national Activity Index improved to 0.03 in Dec vs 0.11 expected and -0.46 previously.
  • S&P downgrades Japan to AA-.
  • China hiked the minimum down payment for second home purchases to 60% from 50%. Property prices rose for the 19th consecutive month in Dec despite recent government efforts. – BBG
  • Various government and private studies have found that the average corporation generally pays about 25 percent of its income, compared to a legislated rate of 35 percent. NYT.

Overseas Data:

  • EU Industrial Confidence improved to 6 in Jan vs 5 expected and 4 previously. Services Confidence declined to 9.2 vs 10 expected, however, while consumer and economic confidence was unchanged.
  • German CPI rose 2.0% YoY in Jan vs 2.2% expected vs 1.9% previously.
  • UK CBI Reported Sales dropped to 37 in Jan vs 38 expected and 56 previously.

Commentary:

  • The JGB downgrade is probably a non event. This idea is supported by the fact that Japanese interest rates barely moved on the news, suggesting that the USDJPY jump is a fade. If there is an impact, it is more likely to be Yen positive over the intermediate term, as the effect on monetary conditions will offset the impact from capital flows.
    The other take away is since Japan hasn’t gotten downgraded until now, a US downgrade is probably still a decade off, given the differences in projected debt/GDP.
  • As we know, appreciation from the S&P can come from either an earnings increase, or an expansion of P/E. I put out a piece on the 19th showing that macro data suggests that S&P earnings growth is likely to print inline with consensus expectations of +20% YoY. What out P/E levels?
    My research suggests that P/E’s are a function of several variables, including CPI volatility, long term Credit yields, P/E momentum, and the yield curve. A linear regression of historical S&P P/E has an R-squared of 80%+, with all the signs on the coefficient signs in the right direction. This model suggests that current P/E’s are fair, but could increase to 19 by year end if inflation remains stable. (The chart below graphs the inverse of P/E, the earnings yield)

    Furthermore, the model has done a decent job historically of highlighting periods of excessive P/E’s. Periods where P/E’s were lower than model outputs (in yellow) returned 1.5% a year less, on average, than periods where P/E’s were below. (standard disclaimers about extrapolating backtest data apply)

    Note that this strategy didn’t work well in the early and late 90’s because EPS growth was so high, which offset the effects of a high starting P/E:

  • It’s raining pot!

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6 thoughts on “G3 Recap 1-27-11

  1. maybe credit outlook to change within the next 2 years rather than decade according to moody’s.

    http://www.bloomberg.com/news/2011-01-28/moody-s-says-time-shortens-for-u-s-rating-outlook-as-s-p-downgrades-japan.html

    i presume the coefficients for your multiple regression are + for earnings/pe momentum, credit spreads narrowing and a steeper curve? and -‘ve for inflation vol?

    i would expected pe contraction in an inflationary environment even as earnings improving as what matters is real earnings/rates rather than nominal. been reading minsky and i think government deficits or overall debt levels may also add significant variable to your multiple linear regression.

    overall i guess blue chip stocks better than bonds … maybe rotation into healthcare or more defensive laggard sectors out of growth areas like technology makes sense later this year as firms using tax/depreciation window to replenish capital stock at present.

    1. + for momenum, positive for BBB yields, but negative for the curve. I.e. steeper curve = lower EY & higher P/E. Maybe because of people extrapolating higher Financial earnings.

      You’re right about p/e contraction and inflation. Good point about govt deficits, I will have take a look.

      Blue chip stocks definitely look good, even though they’ve performed like dogs…

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