A singer in a smokey room
The smell of wine and cheap perfume
For a smile they can share the night
It goes on and on and on and on
The past few weeks have been quite important on the central bank/central planning circuit. On March 16th, China’s National People’s Congress passed its 13th Five Year Plan. It is more a set of goals and policies than a specific plan – individual bureaucracies will come up with precise implementation steps later. But it lays out what is important to the top of the Communist Party and in particular to Xi Jinping (this is the first Five Year Plan created under his watch).
Quoting from the Association of Foreign Press, here are some of the main targets of the plan:
1. To grow China's economy, the world's second-largest, by an average of at least 6.5 percent a year over the period. Gross domestic product (GDP) to go from 67.7 trillion yuan (R162.3 trillion) last year to more than 92.7 trillion yuan in 2020.
2. The service sector to account for 56 percent of GDP by 2020, up from 50.5 percent in 2015.
3. To cap total energy consumption under five billion tonnes equivalent of coal by 2020, compared with 4.3 billion tonnes equivalent of coal last year.
4. To cut energy consumption and carbon dioxide emissions per unit of GDP by 15 percent and 18 percent respectively from 2015 levels by 2020.
5. City air quality to be rated "good" or better at least 80 percent of the time by 2020, up from 76.7 percent in 2015.
6. To raise installed nuclear power capacity to 58 gigawatts by 2020, when another 30 gigawatts are scheduled to be under construction. Currently, 28.3 gigawatts are installed, with 26.7 under construction.
7. To expand the high-speed railway network to 30,000 kilometres (around 18,600 miles) by 2020, from 19,000 kilometres last year, and build at least 50 new civilian airports.
8. To boost per capita disposable income by 6.5 percent or higher every year. The figure grew by 7.4 percent in 2015.
9. To create a total of 50 million jobs in urban areas over the five years.
10. Permanent urban residents to make up 60 percent of China's total population by 2020, up from 56.1 percent last year. The proportion of people with urban "hukou", or household registration, is to reach 45 percent of the total population.
Can they do it? Beats me. But they will probably get close – at the end of the day, the Chinese Government dictates who gets capital and for what. That goes a long way towards making things happen. The one that stuck out to me was number 7 – increase their already large high-speed rail network by over 50% and add 50 airports. That’s a lot of infrastructure, and will definitely help with the GDP goals, even if the airports are sparsely used.. But I’m not sure where the urban service jobs are going to come from – that is a big shift in just 5 years in a massive economy. Saying it should happen is one thing, but making it happen, in an economy with significant amounts of graft and regulation, is going to be tough. Good luck…I see lots of smokey back room deals over wine.
Workin' hard to get my fill
Everybody wants a thrill
Payin' anything to roll the dice
Just one more time
Some will win
Some will lose
Some were born to sing the blues
Oh, the movie never ends
It goes on and on and on and on
A headline from US News and World Report on March 10th exclaimed:
"The European Central Bank has cut all its main interest rates, expanded its bond-buying stimulus program, and offered new cheap loans to banks, an unexpectedly aggressive move to boost inflation and economic growth in the 19 countries that share the euro…
ECB President Mario Draghi said the bank's decisions at the meeting of its 25-member governing council were the best answer to recent questions about whether central banks were reaching the limits of what they can do.
'We don't give up in our fight to bring inflation back to our objective,' Draghi said. He added that the steps to increase bank lending would 'reinforce the momentum of the euro area's economic recovery and accelerate the return of inflation to levels below, but close to, 2 percent.' "
What I find funny is that at the same time these steps he’s taking will “reinforce the momentum of the euro area’s economic recovery,” he finds it necessary to further cut interest rates and increase stimulus. I guess he meant to reinforce the downward direction of the recovery – he just forgot to mention that part. Because his prior actions haven’t done anything to boost the economy of Europe, which is on the brink of disaster due to the ECB’s ruinous policies. The ECB keeps wrecking the profitability of banks with low and negative rates, with crazy regulations, and with odd asset risk-weightings, and yet, they wonder why the banks won’t lend more. Gee, I don’t know, because the banks don’t get paid to do it and even if they did get paid to do it, the economy is so tenuous there that their credit costs are likely to be so high that any profits would be quickly erased. So they sit on their funds, try to manage their capital ratios, and hope that things will eventually get better. Hoping isn’t a strategy, which is why Italian banks are sitting on 20% non-performing loan ratios. Worries are that, absent a significant turnaround in their economies, other countries in the Eurozone aren’t far behind, if not to quite that extent. Things are still bad. Don’t let the “momentum of the recovery” fool you…Some will win, and some will lose. I’m guessing the winners are going to be those who stay far away from European credits.
ISIS struck Belgium last week, and unfortunately it doesn’t appear like this will be the last time Europe will be victimized by these barbarians. At some point the political leadership in Europe (and America) needs to stop being apologists and accommodators for radical Islam and realize that they are playing a zero-sum game – us or them. They want to rid the world of western values and return it to a barbaric Middle Ages-like existence. The West is at war, only we don’t want to admit it. Peggy Noonan wrote a great article in the Weekend Wall Street Journal – I have linked it here via a different site so you can read it free. It’s worth the time. We need to attack ISIS and eradicate it, not try to appease or contain it. Evil isn’t appeasable. In the meantime, this is also a terrible blow to the tourist economy of Europe – first Paris, now Belgium, with terrorists freely operating under the nose of Belgian intelligence services. I traveled to Africa 2 weeks after 9/11, but I’d have to think long and hard about a trip to Paris or Belgium or Berlin right now. I don’t think I’m alone in that.
Against this lovely backdrop of global banking problems, central planning, and terrorism worries, I’m actually bullish on a quite a few stocks here in the U.S. I’m trying hard not to let the macro worries scare me out of the good solid companies I like. As I’ve mentioned in the past few Musings, I am bullish on community banks. A few weeks ago I attended a sell-side conference for regional and community banks, and came away with the following observations:
Just a small town girl
Livin' in a lonely world
She took the midnight train
Janet Yellen is in a lonely world, as the only central banker talking sensibly about the fact that rates should be higher. If you want lending to drive GDP growth, maybe let the banks make a little money on the loans? Just a thought. Some at the Fed even seem to be beginning to understand that low rates may be creating low inflation due to the lack of income being earned by savers. After not moving at their March meeting, Fed governors have recently made it clear that moving at the April meeting is a possibility, and that two hikes are definitely on the table for 2016. Given that in February the Street was thinking one or none, two sounds pretty good. They’re slow, but eventually they might get there…
So where do we go from here? I think the S&P 500 is range-bound for now between 1950 and 2100, with a tighter range between 2000 and 2050. As we approach the end the quarter, we could see stocks drift down into earnings, as investors take a wait and see attitude towards new investments. Bond replacement stocks (staples, utilities) are incredibly expensive, while stocks with some issues (energy, financials, international stocks) look attractive. Terrorism and geopolitics continue to be the overhang. China worries cast a shadow as well – can the bureaucrats monetize their debts and assume their banking system’s bad loans without triggering a run on the Yuan? We’ll find out. European financials continue to be in a lose-lose situation, with capital and credit problems in a no-growth economy run by clueless technocrats. As a result, we’re sticking with the US market, but keeping ourselves very well hedged.
This week’s Trading Rules:
Markets in the U.S. have moved on higher oil, a weaker dollar, and a trade into the higher end of the trading range. Nothing has really changed, and now we head into the quiet period ahead of earnings. Expect lower volume and watch for exogenous shocks, which can have an outsized influence during these times. Right-size positions and get ready to play a little defense if needed.
SPY Trading Levels: Last Musings’ levels worked out really well. The market is coloring within the lines. The SPY stopped right at the 205 resistance we mentioned before backing off a bit.
Support: 201/202, 200, 195, 191/192, then 183/185.
Resistance: 204.5/205, then a lot at 209/210.
Positions: Long and short U.S. stocks, ETFs and options. Short XLP, XLU.
Miller’s Market Musings is a free bi-weekly market commentary written by Jeffrey Miller, who has been managing money through various market environments for over 20 years. You can subscribe here. If you no longer wish to receive this letter, simply hit reply and put “Remove” in the subject line. Prior posts can be found at www.millersmusings.com.
Fly me to the moon
Let me play among the stars
Let me see what spring is like
On a-Jupiter and Mars
In other words, hold my hand
In the last Miller’s Market Musings written 2 weeks ago, I closed with the following:
Markets have bounced very nicely in the past week and a half. Will it continue? I think the S&P 500 could easily move up to 1950 or even 2000. After that, I expect it to bounce between 1850 and 1930 for a while, i.e., until China comes apart. Then it will be time to play defense and wait for the next down leg to occur. But in the meantime, I’m going to repeat what I said at the end of the last letter: what’s really interesting is what is happening beneath the surface. I think a wave of M&A is coming to community banks, and that companies that have been crushed on the back of oil’s decline and aren’t actual oil drillers are, for the most part, interesting investments down here. Leadership in the markets will shift from growth to value and large-cap to small.
Blatant self-congratulations alert: that’s basically what happened. The SPX closed at 1999.99 (I’ll call that 2000) on Friday, while in the past two weeks the SPX is up 4.3%, the small-cap Russell 2000 is up 7%, and the KRE (regional bank ETF) is up 9.2%. This game is easy.
So what drove this big move? I think it was a combination of oil prices going up lessening the need for Sovereign Wealth Funds to sell stocks to meet funding needs, selling pressure easing by macro funds, Chinese economic officials making noise about not devaluing the Yuan “for competitive reasons,” and high-yield bond spreads tightening (although they are still fairly wide). There are a number of other, less important factors, but I think those are the main ones.
So where do we go from here? I think the overall market will probably churn around 2000 for a little while, but the sub-sectors will have fairly divergent performance. Banks probably have another 3-5% upside, while high-quality energy stocks could also continue to move higher. The sectors that have been the “safe” havens for stock investors will probably become less safe. Consumer Staples companies like Campbells Soup (CPB), Clorox (CLX) and Kelloggs (K) are trading for incredibly high valuation multiples, mainly because they were being used as a hiding place. Similarly, investors that have been searching for yield anywhere it can be found have driven yields on Utilities to about 3.5% overall, which, to me, is a too low to make a safe investment, especially given the massive changes occurring in how we generate and distribute energy. With the XLU utility ETF trading right at its highs for the past year, I’d be a seller of safety and a buyer of the beaten down sectors.
What’s keeping me from being more bullish? A number of things. In no particular order:
We’ve had a big move from very oversold levels. The fear trade has worked. From here, there will be a bit more covering and performance chasing, especially in sectors where credit issues were feared to be fatal, but the easy money has been made.
China is still a mess. The powers that be are going to be setting some 5 year plans this weekend, so there may be some soothing headlines coming out soon, but overall, their growth is slowing, their debt is growing, and the combination will eventually end badly for them. Now, given that it’s a closed economy and the government can just print Yuan to recap its banks, I don’t expect to see bank failures like you would see here – they will just infuse equity where it’s needed. Some will argue that all this money printing will cause the Yuan to depreciate, but since the Yuan doesn’t really free float, this isn’t guaranteed. Besides, all the other major economies except the U.S. are also printing massively, so on a relative basis to the Euro or Yen they aren’t doing anything that different. That said, the crackdown on dissent, and fear of a more oppressive regime to come, has driven up capital flight, and I only expect that to continue. Eventually, they will have to either let the Yuan depreciate or institute stronger capital controls. When will this happen? Probably further in the future than the China bears think possible, but a lot depends on how fearful the rich in China become about their ability to get money out at all.
Europe is still a mess. Draghi thinks that the Euro economies are so bad that he keeps pledging to “do whatever it takes” to stem the decline every time he speaks. He’s giving a big speech this week, so we’ll get to hear more about his easing plans, but at the end of the day, massive QE isn’t working, hasn’t worked, and won’t work. So Europe will continue to muddle along with economic growth right around zero.
Japan is still a mess. While we’re speaking of massive QE that hasn’t worked, Japan is still unable to produce any real economic growth despite 20 years of near zero rates and now, negative rates. I’m always amazed at the stupidity of the central bankers who think that they can “create” demand by raising and lowering rates that no one borrows at anyway. As I’ve said in prior posts, if you want to get lending up and spending up, let rates be higher. Savers will have more money to spend and banks will be incented to lend because they will actually get paid to do it. With rates where they are, savers are being crushed since they have no current income, and banks aren’t willing to lend long-term at really low rates because frankly, it doesn’t make any sense to do so. But in the la-la land of central bankers, their models all show that lower rates mean more economic growth. The fact that the evidence from economies around the world shows just the opposite seems to not matter.
The U.S. stock market, as represented by the S&P 500, isn’t really cheap. Consensus estimates range from 115 to 125 in earnings for it for this year, so it’s trading at around 16-17 times earnings. Not crazy expensive, but not super-cheap. So we muddle along.
Fill my heart with song
And let me sing for ever more
You are all I long for
All I worship and adore
In other words, please be true
In other words, I love you
I do think some individual stocks look really attractive, and we are long a number of solid community banks as well as some of the largest banks, which look very cheap here. Bill Gross put out his monthly letter on March 2nd and said to get out of the banks, but I think he’s wrong. Mike Mayo, who was bearish on the big U.S. banks for 20 years, is out pounding the table to buy the big 4 at these levels, and I agree with him (full disclosure: I used to share a cab to work with Mike most days about 20 years ago, and I think he’s a good guy). We’re also long some energy stocks, a few solid healthcare companies, and a few retailers trading at 4-5x EV/EBITDA with no debt.
Some have recently been knocking the long-term prospects for banks, saying that they are never going to trade at a decent multiple of book or earnings, because they will be unable to earn a decent ROE. This argument usually says that the banks are now like utilities, over-regulated, over-capitalized, and unable to generate much above a 10% or so ROE. My thought is that if banks are like utilities, that’s not necessarily a bad thing. The average utility in the U.S. is yielding just 3.5% with very high payout ratios and sky-high P/E ratios. Once upon a time, banks actually were traded like utilities (this was back in the 1950s and 1960s), where their dividend yields were what mattered. Over time, the metric shifted to P/E ratios and earnings growth. But if we go back to the way things were, and banks are viewed as a stable source of dividend income again, I’d argue that their valuations would go up about 50%. I’ll take that.
This week’s Trading Rules:
Markets have ripped as the fear and panic that gripped markets in mid-February diminishes. I think this rally is about done. We probably just muddle along here around 2000 as market leadership continues to shift, but I think S&P 500 could fall back to 1950 fairly easily. If it breaks 1940, I’d expect it to retest the recent support around 1850, then to bounce between 1850 and 1930 until some exogenous, macro situation causes another round of selling. Then it will be time to play defense again.
SPY Trading Levels:
Support: 195, 191/192, then 183/185.
Resistance: 200, 204.5/205, then a lot at 209/210.
Positions: Long and short U.S. stocks and options. Short stock or long puts on CPB, CLX and K.
Miller’s Market Musings is a free bi-weekly market commentary written by Jeffrey Miller, who has been managing money through various market environments for over 20 years. You can subscribe here.