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The Correction in the US Equities Markets Nobody Wants to Talk About
Edgar Perez, Author, The Speed Traders, and Knightmare on Wall Street
Stocks in the US markets slipped on Friday, ending the Dow Jones Industrial Average’s (DJIA) longest winning streak since 1996, just after snapping a 10-day run. Data from Thomson Reuters’ Lipper service showed that investors in U.S.-based funds had poured $11.26 billion of new cash into stock funds this last week, the most since late January. The DJIA slipped 25.03 points, or 0.17 percent, to 14,514.11 at the close. Meanwhile, it was announced that the fewest workers on record were fired in January and job openings rebounded, showing employers were gaining confidence the U.S. expansion would be sustained.
According to some pundits, recent market activity is essentially driven by positive corporate earnings. The S&P500 Price/Earnings (PE) ratio is currently slightly high at 16.5, if we compare with past indicators. The median S&P500 Trailing Twelve Months (TTM) PE ratio has been about 14.5 over the last 100 years; average is around 16. It was during much of 2009 when the disconnect between price and TTM earnings was so extreme that the P/E ratio was in triple digits, as high as the 120s. Going back to the 1870’s, the average P/E ratio has been about 15; therefore, the US equity markets are not excessively valued, leaving some room for further growth.
Other pundits point to the Federal Reserve’s determination to continue stimulating the economy with increased liquidity. Mohammed Apabhai, head of Asia trading at Citigroup Global Markets, favors this train of thought. He has noted that there is a 70 percent correlation between stock market performance and liquidity, “whether it’s through the promise of lower rates, QE (Quantitative Easing) or promise of more QE.” The Federal Reserve has launched three rounds of Quantitative Easing since the financial crisis hit in 2008.
More likely, both factors are in play, very good corporate earnings and monetary policy that pushes investors to take risks in equities. So is the earnings momentum sustainable? Unfortunately, savings from the smaller share of the pie from labor, government spending and earnings coming from emerging markets (EM) outside the US are all factors that will be curtailed at some moment. Is the Fed eager to continue being the huge player in this equation? Some of its members are increasingly worried about the effectiveness of the continued QE; if the labor market recovers, as the January numbers showed, the Fed most probably might be ending its bond purchases soon.
As pointed out by James Saft, wages in the US have taken a smaller and smaller piece of the pie; now below 44pc of GDP and dropping, down several percentage points since 1999. That is in part the consequence of globalization and the offshoring of jobs. However, the labor which can be offshored largely has already been and the likely trend is for new manufacturing technologies to start pushing jobs back into the US. As has been of national knowledge as well, there is a real danger of declining government spending. A dollar spent by the government is a dollar that supports household income, and consumption, and of course corporate profits; there will be less dollars starting this month thank to the sequester, a series of spending cuts and tax increases aimed at reducing the budget deficit.
Emerging markets are looking overstretched heading into the second quarter, Barclays Capital said in a report dated March 15, pointing out that the cyclical recoveries in EM have slowed down. Consensus growth forecasts (according to Bloomberg) have been revised down by 0.75 percentage points on average since mid-2012. EM equities have been slow to react to these developments due partly to the continued inflows into the asset class from retail clients. The correction has started recently and the performance by country year to date has been mixed, but the most pronounced selloffs have been associated with the largest revisions to GDP growth forecasts. Adding to this dire situation, the economies of emerging markets grew at a slower pace in February than the month before, according to HSBC’s monthly purchasing managers’ index. The PMI recorded a level of 52.3, down from 53.8 in January, its lowest since August. The index covers 16 leading emerging markets, including India, Brazil and China, which all saw their rate of growth fall. Investors had been questioning whether emerging markets, whose growth depends in part on exports to mature markets, could continue to expand at fast rates of almost 10% in some cases.
What the equity markets want indeed is stable and/or predictably increasing US profits and the Fed to stay in the bond markets. Saft ironically suggested that markets’ best hope might be a cut in government spending deep enough to kill job growth and indefinitely extend QE, something that nobody else would agree with. Instead, markets would be happy with a bit of positive news today followed by another bit of negative news tomorrow. Unfortunately for the markets, profits will start showing stagnation starting with first quarter results. Federal Reserve said in September 2012, when QE3 was announced, that it would start pumping $40 billion a month to purchase agency mortgage-backed securities (MBS) until the labor market improves substantially. When will the Fed determine that the job market has made enough progress to reduce stimulus? The numbers for February will prove paramount in this regard. As these two important factors converge in a nightmarish scenario, equities markets should beware of the ensuing correction, coming as early as in the second quarter.
Read Full Post | Make a Comment ( None so far )Yuri Milner’s Wishful Thinking? Facebook, Google and Wikipedia Will Stay Dominant For Only 10 Years
Yuri Milner, co-founder and chief executive officer of DST (Photo: Forbes)
In an interview at the South by Southwest Interactive conference in Austin, Texas, Yuri Milner, the Russian investor whose early bet on Mark Zuckerberg’s firm made him a billionaire, said companies like Facebook, Google and Wikipedia will still exist a century from now because their services gain momentum the more people use them. “All three have amazing network effects,” said Milner, the co-founder and chief executive officer of DST. “Chances are that those are long survivors.”
Milner has long believed that the internet would develop into a “global brain”, which is often described as an intelligent network of individuals and machines, functioning as a nervous system for the planet Earth. He also has envisaged that the advent of the Internet of things and ever increasing use of social media and participatory systems such as Twitter, Facebook, and Wikipedia would increase our collective intelligence.
Richard Foster, the Creative Destruction author referred by Forbes as The Wizard of Innovation and speaker at China Leaders Forum, was in the 80s in a search for “the excellent company”, the all-seeing, all-knowing, all-wise company that made all the right moves in advance, and that made more money for its shareholders than any of its competitors. This was the permanent outperformer stock, the really good deal, he said. Foster looked at 4,000 companies over 40 years; he concluded there was no such company, and there never had been such a company! No company had been able to outperform the market for any substantial length of time. (GE once came as close as any, but didn’t do any better than the overall market index, Foster reflects). Somehow the market, managed by nobody in particular, was performing better than all the brains on the planet.
Why is it that no company can outperform the markets for a long time? Foster thinks there are several reasons, but the most important is something called legacy cost. All companies have legacy costs, which are created the moment a company makes a commitment of time or resources to a particular course of action. And when a company is challenged to do something new, to take a new course of action, it has a hard time abandoning its legacy costs. Companies argue that the incremental cost of making a slight improvement to an existing product or service is much better than the full cost of developing something new from scratch. In doing so, the company attempts to optimize between the old and the new. This takes the decision making power away from the customer, and it’s a bad direction to go in. Markets, however, just charge on ahead with the new, because new entrants don’t have any legacy costs to deal with.
Just last week, Facebook’s new News Feed made some welcome cosmetic changes. But it didn’t go very far in addressing the social network’s deeper issues. Fortune’s Kevin Kelleher talks about the vulnerabilities Facebook is facing since it went public. Facebook is facing more powerful competitors and two important yet sometimes contradictory mandates, to create a service that will engage its users, and to make money that will satisfy investors; Facebook’s presentation played down those facts. How intrusive these ads strike users will depends on the algorithms Facebook designs to insert them in feeds.
So while Facebook’s new news feed makes some cosmetic fixes that users are likely to welcome in time, they don’t go very far in addressing rising competition from newer social networks and the uneasy balancing act between users and advertisers. Those are the legacy costs Foster refers too, which new entrants that will grow into becoming new leaders never face. Legacy costs never stopped Wikipedia and Google from dethroning leading institutions called Britannic Encyclopedia and Yahoo!
To think that new companies will take a century to remove Facebook, Wikipedia or Google from their leadership positions is no more than wishful thinking; these firms have at most 10 years to milk their cows and make the big decision: change or die. While Milner appears not to have a vested interest in Wikipedia or Google, he might as well start cashing in on his already wildly profitable Facebook bet. Somebody in some garage is already building a better mousetrap.
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