The Big Picture

Inflation and Stocks
Succinct Summations of Week’s Events (May 24 2013)
Nikkei Downtrend (1982-Present)
Romancing Alpha, Forsaking Beta
10 Friday AM Reads
Random Thoughts: Comebacks, Intraday Reversals and the like
Paul Tudor Jones: Why There Are So Few Women Traders
It Takes a Regime Shift: Japanese Monetary Policy Through the Lens of the Great Depression
Star Formation in Orion Nebula

Posted: 25 May 2013 02:00 AM PDT

Inflation and Stocks
David R. Kotok
May 24, 2013

Inflation is not on the radar anymore. We do hear occasional comments from central bankers who warn about future inflation arising from QE. We also recall a few statements in the media along the lines of, “They’re printing all this money, we’re going to have huge inflation, and interest rates are going to shoot up.”

We have been on the low-inflation side of that debate for years. We have supported the argument that there is a huge overhang of surplus capacity in the global labor force and that inflation is not a problem when labor income is flat, falling, or not rising robustly. This coincides with a wounded credit multiplier and a damaged financial credit system, conditions that have existed for the last five years. They are gradually improving, but only gradually. They are conditions that cause deflationary pressures.

Will we have deflation? We are not certain. The forces at work globally that could bring on deflation are being blunted by the huge quantitative easing (QE) being undertaken by most major central banks.

Let’s take a quick look at the US. All important measures of inflation in the US are on downward trends. Many thanks to Credit Suisse’s Neal Soss and Jay Feldman for a recap of the data in their research note of May 17. They report Core CPI, Cleveland Fed Median CPI, Cleveland Fed Trimmed Mean CPI, Core PCE, and Dallas Fed Trimmed Mean PCE. All are trending downward, as measured on a year-over-year basis, and those trends are accelerating. Commodities are also on downward price trends. So are the more esoteric inflation measures like market-based indices and chained indices.

In the case of the Core PCE, which is believed to be the Federal Reserve’s preferred measure, the rate of inflation measured year-over-year is approaching one percent. Remember that the Fed’s threshold for any change in monetary policy is two percent. And Fed communications have suggested that a rate of 2.5 percent would be the threshold for any action taken to alter QE for the purpose of improving the employment statistics. So we are a full point and half away from that threshold, and the trend is in the opposite direction.

The Fed’s stated unemployment threshold is 6.5 percent on the traditional headline unemployment rate (U-3). The Fed has also talked about other elements in the employment statistics, suggesting that the U-3 unemployment rate is not the only target measure for restoring the US to a more robust recovery. The charts and graphs that we have posted on our website and released in speeches present the employment statistics in a variety of ways that may be useful.

Other measures, such as the U-6 broad-based unemployment rate, Beveridge Curve analysis, and the disaggregation of employment data, all point to a very large underutilized labor force in the US. The same seems to be true for most of the rest of the world.

Our conclusion is that inflation is not a problem now and is not likely to become a problem soon. In fact, if certain indicators of inflation continue to head downward, they could trigger a reaction by the Fed because the risk of deflation will be perceived to be rising.

Is deflation a threat today? The answer seems to be no. More likely, we are in a period in which the rate of inflation will be too low to be a problem and will gradually turn higher over several years as additional stimulative policies unfold worldwide.

Meanwhile, low inflation is a very healthy environment for the stock market. It means that inflation distortions in reports of earnings are nearly nonexistent. That implies that the quality of earnings reports is very high, since they do not contain the distortions that occur in accounting systems when inflation is high.

Higher-quality earnings justify higher price/earnings multiples and higher stock prices. There is a consistent linkage between very low inflation and very strong asset pricing. This is particularly so when interest rates are very low and likely to stay low for a very long time.

We remain bullish. Inflation statistics support that outlook. They also support a gradual change in the outlook for bonds. Eventually, bond yields will be higher, maybe much higher, but the process is a gradual one. That means some tactical hedging in bond portfolios is appropriate. Panic selling of bonds is not.

~~~

David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors

Succinct Summations of Week’s Events (May 24 2013)

Posted: 24 May 2013 01:00 PM PDT

Succinct Summations for the week ending May 24. Very light data week despite all the noise.

Positives:

1. U.S. jobless claims fell 23k to 340k v expectations of 345k.
2. Housing remains a significant tailwind in the U.S. as existing home sales increase 0.6% m/o/m in April to 4.94M units, the highest reading since November 2009.
3. U.S. new home sales rose 2.3% m/o/m in April to 454k versus expectations of 425k.
4. U.S. April Durable goods orders shows a nice beat, showing a rise of 3.3% v expectations of +1.5%.
5. Durable good ex-trans rose 1.3% v expectations of +0.5%
6. Dow Jones had gone a record 100 days without a 3 day losing streak, that was snapped this week (market could use a breather).
7. Despite a very noisy week, the S&P 500 is up >15% YTD, through May!

Negatives:

1. The Nikkei had a violent selloff Wednesday night, selling off 12.5% peak to trough.
2. The 7% overnight down move is the equivalent of 1,117 Dow points. Only the 10th time in the last 50 years the Nikkei declined more than 7% in a single day.
3. Wednesday saw a nasty reversal in the market with the Dow dropping nearly 300 points from the highs of the day to the lows.
4. The S&P 500 had not been up 1%only to finish down 1% since August 2011 (market came off the lows at the end of day to avoid this).
5. China’s May flash PMI comes in at 49.6 v expectations of 50.4, a 7 month low for the worlds second biggest economy, signaling contraction.
6. Japan’s April exports rose 3.8% y/o/y v expectations of 5.4%. C’mon Abe.
7. Secular decline in the PC market is reaffirmed by HP, whose PC sales fell (Wow!) 20% from a year ago.
8. Bernanke had a difficult time communicating the Fed’s intentions. Mr. Market had a difficult time digesting the fact that tapering can begin as early as this summer.
9. U.S. core capital shipments came in light than expected, declining 1.5% m/o/m v expectations or a 0.5% drop.

Thanks, Mike!

Nikkei Downtrend (1982-Present)

Posted: 24 May 2013 09:30 AM PDT

click for ginormous chart

Source: Kimble Charting

Awesome chart from Chris Kimble showing the Nikkei going back to 1982 — in particular, the downtrend that began in 1989 and still persists to this day.

Chris notes that Declines of 32% to 60% taken place at this level for the past 20 years!

One would normally expect a pullback and consolidation after a long move up to a major trendline, and under pre-Abenomics stimulus, that would be my highest probability outcome (pre-stimulus, I have no idea!).

The key here is if and when the Nikkei breaks through that trendline, it is likely the beginning of a longer term multi-year breakout. This is why we put on Japan exposure for clients much earlier this year.

~~~

Disclosure: Clients are long GAL, DXJ, which have substantial exposure to Japan.

Romancing Alpha, Forsaking Beta

Posted: 24 May 2013 07:30 AM PDT

This is the presentation I gave at the IPI yesterday:

10 Friday AM Reads

Posted: 24 May 2013 06:45 AM PDT

It does not look like the best weather this weekend, so I expect to be around to keep you entertained:

• The Smart Money Is Still Bullish (Barron’s)
• Notes from the PIMCO Investment Summit with Mohamed El-Erian (The Reformed Broker) Is this the dumb money?
• With 'Abenomics,' Japan catches a sense of revival (WaPo) see also Japan the Model: We are in economic terms, all Japanese (NYT)
• Gold Traders Most Bullish in a Month After Bernanke (Bloomberg)
• The Rules, Part XXXVIII (The Aleph Blog)
• Why pension funds are eating your 401(k)’s lunch (Reuters)
• Tax Two-fer:
…..-In Tax Overhaul Debate, Large vs. Small Companies (NYT)
…..-The Corrosive Effect of Apple's Tax Avoidance (NYT)
• Four Reasons Housing Recovery Isn't Yet Boosting Economy (Real Time Economics)
• Android's Market Share Is Literally A Joke (Tech.pinions)
• Photos: Tornadoes wreak havoc in US (Boston.com’s Big Picture)

What are you reading?

World Shakes Off Nikkei’s 7.3% Plunge

Source: WSJ

Random Thoughts: Comebacks, Intraday Reversals and the like

Posted: 24 May 2013 05:25 AM PDT

Since it is a Friday before a 3 day holiday weekend, it is a good time to kick back, and think about what the recent market action might (or might not) mean.

• Most Day-to-day market action is noise, There is very little signal involved, with the vast majority of commentary simply after-the-fact rationalizations of what just occurred.

• Over the years, one of the few exceptions that I have found is the IntraDay reversal. After a long move in either direction, followed by a big flip can be worrisome. (it is not, however, conclusive).

• I do pay attention to days like Wednesday that start out strong and end weak. The caveat: All bets are off on FOMC minute days, as we seem to have a big spike in volatility (someone must have done a study on this).

• Never confuse a forecast with an analysis.

• Consider a day that starts out 150 Dow points up (or down) and ending the day down (or up) 150. That 300 point swing is more significant than a down (up) 300 point day. We sometimes see it at major tops and bottoms, as it reflects an exhaustion of one side in the battle of supply and demand. (Candlestick technicians have the data on shooting stars and dojis; if this interestS you see Steve Nison’s book Japanese Candlestick Charting Techniques).

• Of course, all of this can reflects your biases, holdings, fears and worries. That is why I try to think about issues such as these in the abstract, rather than referencing current positions.

• The alternative is allowing markets to serve as Rorschach tests, reflecting peoples pre-existing investment postures — not what they truly think. This an ongoing pundit problem.

• Be aware of your own timeline — are you a trader or an investor? (Then act like it).

• Bears see the intraday reversal (like Wednesday’s) as a very significant change in tone; Bulls see a comeback (like Thursday’s) as proof of a Japanese overreaction to weak China economic news, that was not applicable to the US.

• Lately, it seems that markets close the day much stronger than the early morning futures would imply. I’d love to see the actual data on that (Closes vs AM Futures). It is similar to what used to be called the Smart Money Index, something created by Don Hays. (I have no clue if SMI has any insight).• My key takeaway is that the cognitive bias is immense. Most of the attempts we see to interpret short or even intermediate term market action are often overwhelmingly filled with rationalizations of existing positions.

• Be aware of the tendency to let Narratives obscure the data.

• Raymond James’ Jeff Saut is fond of saying “Where you stand is a function of where you sit.” Meaning, your book often reflects how and what you think.

• So much of what we have learned from the data is counter-intuitive. The most challenging thing confronting the vast majority of investors is their inability to make objective, emotion-free decisions based on empirical data. Instincts, hunches and emotions are killers when it comes to the markets.

Identifying the cognitive errors we make is only the first step; Developing a way to respond to them, preventing this aspect of our personalities from affecting investing decisions is an ongoing, indeed, never-ending process.

What are you doing to prevent your biases and emotions from getting in your own way?

Paul Tudor Jones: Why There Are So Few Women Traders

Posted: 24 May 2013 04:00 AM PDT

Ouch! There is a valid point to be made about emotions in Trading, but it gets lost in the sauce here:

At a University of Virginia symposium in late April, Paul Tudor Jones responded to a question about why the panel only featured "rich, white, middle-aged men."

Tudor responded by saying that trading requires intense focus, which he believes many women lose when they have children. The panel featured (from left to right) U-Va. professor David Mick, Paul Tudor Jones of Tudor Investment Corporation, Julian Robertson of Tiger Management, John Griffin of Blue Ridge Capital and moderator Jeff Walker, chairman of the U-Va. Council of Foundations

Paul Tudor Jones comments on the lack of female traders

It Takes a Regime Shift: Japanese Monetary Policy Through the Lens of the Great Depression

Posted: 24 May 2013 03:00 AM PDT

Star Formation in Orion Nebula

Posted: 24 May 2013 02:00 AM PDT

Click to enlarge

Source: Sci-News