Friday, January 20, 2012
James Paulsen: Investment Outlook (January 17, 2012)
For Domestic Investors, is the Euro Crisis Really About Europe?
by James Paulsen, Chief Investment Strategist, Wells Capital Management (Wells Fargo)
The ratings downgrade of France last Friday reminds investors how sensitive the U.S. stock market has been to the daily news flow emanating from the euro zone. Recently however, U.S. economic momentum has increasingly delinked with euro-zone economic performance and, as it has, the U.S. stock market has been much less vulnerable to European news.
Actually, the sensitivity of the U.S. stock market to the European crisis has varied widely since it first arrived on the global scene in January 2010. While crisis news surrounding the euro zone has produced dramatic stock market volatility whenever U.S. economic growth has been sluggish, the stock market has also exhibited remarkable resiliency and indifference towards euro-zone news whenever U.S. economic reports were strengthening. Consequently, what should domestic stock investors be most focused on when accessing the potential impact of the European crisis? Should the primary focus be the euro zone or is the performance of the U.S. economy (not developments in Europe) more important in determining the riskreward outcome of the U.S. stock market?
How Sensitive is the U.S. Stock Market to the Euro Crisis?
The solid line in the accompanying exhibit illustrates how closely and significantly the ebb and flow of European crisis news has impacted the daily volatility and performance of the U.S. stock market. It displays a rolling 41-day trailing correlation coefficient of daily percent changes in the S&P 500 Stock Price Index with the daily percent changes in the euro-dollar currency rate. Relating movements in the U.S. stock market to changes in the euro currency is a proxy for the sensitivity of the U.S. stock market to European crisis events. A coefficient about zero indicates no relationship whereas the more positive (negative) the coefficient, the stronger is the direct (inverse) relationship exhibited by the two variables.
When the European crisis first broke on the world scene in January 2010, the correlation between the U.S. stock market and the euro currency was around 0.5. This positive relationship did not change much (even though events in the euro zone became recognized as a “crisis” in early 2010) until the summer of 2010 when it rose substantially reaching a level above 0.7 by fall 2010. Then, the correlation steadily declined during the next seven months reaching about 0.15 (a reading suggesting virtually no relationship between the euro zone and the U.S. stock market) by the early spring of 2011. However, from April 2011 until October 2011, the impact of the euro zone on the U.S. stock market strengthened considerably—the correlation coefficient rose steadily reaching a peak near 0.9 in October (a coefficient suggesting a near perfect and strong daily relationship). Finally, since last October, the correlation has persistently diminished and most recently the speed of its collapse is similar to its drop in early 2011.
Obviously, the sensitivity of the U.S. stock market to problems in the euro zone has oscillated widely during the last two years. However, as the accompanying exhibit insinuates, U.S. stock market sensitivity may depend more on the performance of the U.S. economy than on problems in the euro zone. The dotted line shows the Citigroup U.S. Economic Surprise Index. It is shown on an inverse scale so when the dotted line rises (falls) U.S. economic reports are disappointing (surpassing) expectations.
Although not perfect, the relationship between the U.S. stock market and the euro currency seems highly connected to “U.S. economic momentum.” While the euro-zone crisis emerged in January 2010, events in this region did not materially impact the U.S. stock market until the U.S. economy began to disappoint in the spring. Thereafter, European crisis news increasingly dominated U.S. stock market performance until the U.S. economy began reaccelerating again in the last part of 2010. As the U.S. economy continued to outpace expectation into early 2011, the relationship between the U.S. stock market and the eurozone crisis noticeably calmed (even though the European crisis never went away). However, euro-zone news again became “the only news” which seemed to matter for the U.S. stock market during the late summer/early fall of 2011. Why? Because U.S. economic reports weakened considerably and persistently between April and October 2011 culminating in a widespread outbreak of imminent U.S. recession fears in September. As U.S. recession fears intensified, the correlation between the euro and the U.S. stock market surged to about 0.9! Finally, as U.S. economic reports have again improved substantially in recent months, the correlation between the U.S. stock market and euro-zone news has weakened considerably.
Should Investors Fixate on Euro Zone News or Remain Focused on the U.S. Economy?
For domestic investors, is the daily news flow emanating from the euro zone really of paramount importance? Or, is the momentum of the U.S. economic recovery much more crucial in determining the performance of the stock market? Undoubtedly, the euro-zone crisis is important and will certainly impact the future of both the global and U.S. economic recoveries. However, as the accompanying chart illustrates, the euro-zone crisis seems to dominate the U.S. stock market “only when and only because” U.S. economic momentum proves disappointing.
It seems European fears will likely be part of the global fabric for years, but should not be overly significant for U.S. stock investors as long as the U.S. economic recovery remains healthy. Currently, in our view, the U.S. economic outlook appears reasonably favorable. Job creation is now strong enough to produce a slow but steady decline in the U.S. unemployment rate which should boost confidence throughout the economy this year. Moreover, plenty of economic stimulus has been added to the U.S. economy in the last year. The 30-year mortgage rate was above 5 percent a year ago and is now below 4 percent. The annual growth in the M2 money supply was only about 5 percent last summer and is now about 11 percent. The U.S. dollar is still about 10 percent below where it peaked in 2010 boosting U.S. export competitiveness. Finally, because commodity prices declined last year, particularly food and energy costs, the rate of consumer price inflation is set to decelerate this year potentially providing a large boost to “real” household income growth during 2012.
It’s been two years since the European crisis first arrived on the global scene and along the way, many investors have been scared out of the stock market. The S&P 500 has risen by about 200 points during this time (from about 1100 in January 2010 to about 1300 today) and with dividends included, has provided investors with about a 10 percent annualized return! Although the euro-zone crisis has certainly been associated with “high drama,” it has also provided ongoing solid stock returns. So, worry about Europe, but stay invested while you worry!
While funds like the Vanguard Value ETF (NYS:VTV) have allowed everyone to be "value" investors, going against the grain is the hallmark of many premier investors in the style. Often waiting years, if not decades, for their ideas to pan out, true value investors see the long-term picture for what it is. Generally, the stock market overreacts to both good and bad news, resulting in stock price movements that do not correspond with the company's or sector's long-term fundamentals. This results in an opportunity for value investors to profit when prices are depressed. Warren Buffet's famous "be greedy, when others are fearful," quote highlights this fact. For those looking for extreme, left for dead values, the following ETFs and sectors may be up your alley.
Downhill Since Fukushima
In the wake of Japan's Fukushima disaster, a variety of nations have begun plans to wind down their nuclear operations and stall new reactor projects. However, as the developed world begins its nuclear phase-out, the emerging world is under-going a massive building binge. Overall, The International Atomic Energy Agency predicts that by 2030, the world will have up to 803 GW worth of generation capacity. If the upper range is met, it would mean an 113% increase versus 2010s generation numbers.
However, despite nuclear's long-term potential, stocks within the sector have fallen hard since Japan's woes. The Global X Uranium ETF (ARCA:URA), which tracks a basket of uranium mining stocks, fell more than 60% during 2011, but still represents a great long-term play on the emerging world's love affair with atomic power. Similarly, the iShares S&P Global Nuclear Energy Index (ARCA:NUCL) is a good broad choice to play the sector.
The Arab Spring
Given the riots, social upheaval and political problems facing Egypt, it's no wonder why investors have shunned the battered nation. However, the nation is one of the largest economies in the Middle East and many analysts predict that Egypt will be one of the replacement nations for the BRICs. While the short-term road is bumpy, the elimination of the Mubarak regime is expected to be a long-term positive for the country. The Market Vectors Egypt Index ETF (ARCA:EGPT) fell around 50% during 2011 and tracks 28 different firms including Orascom Construction (OTCBB:ORSCY).
Slowing raw material demand from the emerging world, coupled with decreasing economic activity in the developed, has hurt the global shippers. Acting as a leveraged play on global growth, a variety of shipping firms like Navios Maritime (NYSE:NM) saw their fortunes sink along with the global economy. However, many firms within the sector are trading for less than their book values, and the Baltic dry index has been steadily increasing since the start of 2011. The Guggenheim Shipping ETF (ARCA:SEA) tracks a basket of 25 global shippers across both the dry bulk and liquids categories. Top holdings include Teekay LNG Partners (NYSE:TGP) and Nippon Yusen. The fund dropped about 46% during 2011, but now yields a delicious 6.65%.
A Platinum Play
As global uncertainty remains high, investors have stuffed their portfolios with gold. In doing so, an ounce of gold now trades for more than platinum. Historically, platinum has been the "money" metal, usually trading for a wide premium over gold; since 1997 platinum has often cost 50 to 100% more than gold, due to its scarcity of supply and sheer expense in mining it. However, as platinum prices have dipped, so have shares in its miners. The First Trust ISE Global Platinum Index (ARCA:PLTM) sunk about 50% in 2011, but should be great long-term bet. Platinum is seeing increased demand from both industrial and investment purposes. Analysts estimate that long-term platinum demand will grow, outstripping supply.
Value can be had in some pretty nasty places. The previous ideas are some of the most beaten down and unloved sectors currently on the market. However, each offers great long-term fundamentals and potential. For patient portfolios and investors, going against the herd can mean long-term profits.
One typically doesn’t look to government bureaucracies for hard-nosed, objective discussions on the economy. Far too often official reports are skewed to paint a much rosier picture than what is unfolding in reality. Case in point, the repeated denials from Ben Bernanke and the Federal Reserve, Fannie Mae and various oversight committees circa 2006 that the US housing market was anything but an excellent place to invest your money.
So, imagine my surprise when the December 2011 Financial System Review, published quarterly by the Bank of Canada (BoC), landed in my inbox and I discovered that it contained a very sobering look at Canada’s economy and the many systemic risks we are facing! It’s not surprising that this report was not picked up by the main stream news, because if they did the popular opinion of Canada’s invincible, recession-proof economy, may begin to crumble.Read More @ DollarVigilante.com
When reporting on the unfolding of the credit crisis I often referred to the Barron’s Confidence Index. This Index is calculated by dividing the average yield on high-grade bonds by the average yield on intermediate-grade bonds.
The difference between the yields is indicative of investor confidence. A rising ratio indicates bond investors are growing more confident, in other words preferring more speculative bonds over high-grade bonds. On the other hand, a declining ratio indicates investors are demanding a lower premium in yield for increased risk. That shows a waning confidence in the economy.
Since hitting an all-time low in December 2008, the Index was almost back to pre-crisis levels in January this year as investors grew increasingly confident. But that was when investors started focusing on sovereigns that were starting to get into trouble.
Since the start of 2011 the Index has given up more than 40% of its gains. This puts us back at levels experienced during mid-2008 – just prior to confidence falling off a cliff. Based purely on this chart, one has to conclude that confidence remains fragile.
from King World News:
With gold remaining firm above $1,650, today King World News interviewed legendary Jim Sinclair, to get his take on where things are headed. Sinclair surprised KWN by telling us there would be a run, by European countries, on the gold they have stored at the New York Fed. Here is what Sinclair had to say when we asked him if the IMF would be selling any gold: “No. The role of gold has changed and gold is moving more toward the central bank then away from it. On top of that you have seen a significant amount of media attention towards, ‘Where is our gold?’ This is taking place in the European press.”
Jim Sinclair continues: Read More @ KingWorldNews.com
Owens Corning (NYSE:OC) — This producer of glass-fiber reinforcements and building materials, including roofing materials, has predicted that roofing demand could reach the highest levels in 15 years.
Wall-board shipments rose 4% in Q3, the first year-to-year increase since 2006. And a 35% increase in wall-board prices will take effect this year, according to Fitch.
The results of an increase in home construction would directly benefit OC with a dramatic increase in earnings from the estimate of $2.30 in 2011.
This was on our list of Top Stocks to Buy for January, when we said, “Technically the stock has formed a ‘V’ bottom and a break through the resistance band at $30 to $32 should result in a quick run to $36-$38.”
That breakout occurred yesterday. Longer term expect much higher prices that should track an economic recovery.