Download Ed Yardeni - EuroCapital

Ed Yardeni
O Ed Yardeni είναι διεθνούς φήμης αναλυτής και σύμβουλος επενδύσεων
11 Μαρτίου 2010
MAJOR TOPICS: LSD and Deficit Spending.
BULLET POINTS: (1) What does Congress have in common with Tiger Woods? (2)
Everything. (3) What do Paul Krugman and Timothy Leary have in common? (4) Can
governments go cold turkey? (5) Krugman’s hallucination. (6) A shocking CBO
report shows Obama budget will boost debt to 90% of GDP. (7) Meet Andy Stern, the
Joker in the White House debt pack. (8) Has China been discounted? (9) What’s good
for Financials is good for the country, and vice-a-versa.
NOTICE: Our Morning Briefings are now available on FactSet.
I) PUBLIUS: Overcoming addiction is tough. Of course, addicts rarely choose the
path to recovery until they realize that their addiction is destroying their lives and the
lives of their loved ones. Such enlightenment usually occurs as a result of a near-fatal
experience attributable to the addiction. This includes fleeing for your life from your
wife who is chasing you with a golf club in the middle of the night.
Governments around the world are addicted to deficit-financed spending. Their drug
dealers are Keynesian economists who believe that such spending is the only way to
avoid getting into recessions, and that more of it will get an economy out of a
recession faster. The problem is that governments are now hooked on running longterm structural deficits to finance rapidly expanding social welfare spending and to
provide government workers with outrageously generous pay and benefits. The
deficits are no longer just cyclical; they are forever.
Paul Krugman is today’s Timothy Leary of Keynesian economics. Leary pushed LSD.
Krugman gets his kicks from more government spending. For the past year, he has
argued that the federal government should have been providing much more deficitfinanced stimulus. In his February 4 NYT column, he states, “The point is that
running big deficits in the face of the worst economic slump since the 1930s is
actually the right thing to do. If anything, deficits should be bigger than they are
because the government should be doing more than it is to create jobs.”
According to Krugman, “more than half of the deficit was caused by the ongoing
economic crisis.” That’s probably true. As Krugman notes, the bond yield remains
subdued. That’s true too. So who cares about deficits? I do. As recommended by
Rahm Emanuel early last year, the crisis has been used as a great opportunity to
ratchet up the structural deficit to finance the ever expanding social welfare state. In
our “Social Welfare in America” chart book (linked below), Figure 10 shows that
over the past 12 months through February, the federal government spent a near record
$29,410 per senior citizen for Social Security and Medicare. That’s up three-fold from
about $10,000 during 1990. Since then, the CPI is up only 70.0%, and wages and
salaries in personal income are up only 136.6%.
In my latest Topical Study titled “A Dozen Reasons To Be Bullish,” my list included
the assertion that “governments are starting to recognize that there are limits to
deficit-financed spending, particularly on social welfare. A backlash against
excessively generous pay and benefits for public employees is also underway in many
countries.” I was asked by one of our accounts if that’s wishful thinking or supported
by any evidence. Here is some evidence:
(1) Yesterday’s WSJ reported, “Irish teachers and police have had their gross salaries
slashed by as much as 15%, with new across-the-board taxes taking an additional
cut.”
(2) The Kansas City, Missouri School Board voted Wednesday night to close nearly
half of its schools to avoid going broke. As a result, 28 of 58 schools will be shut and
about 700 of the district's 3,300 jobs will be cut, including 285 teachers.
(3) In Denmark, for the first time in 50 years, raises in the public sector exceeded
those of the private, meaning employees must pay the extra money back! Hundreds of
thousands of public employees who were given pay hikes two years ago are now
being told they will have to pay the money back to their employers. Salary increases
from their 2008 bargaining agreement and the accompanying cost of living
adjustment resulted in many employees' receiving wages that were too high,
according to the language of an original pay adjustment settlement from 1960.
(4) Yesterday, Portugal’s Finance Minister announced that his country's austerity plan
will also limit wage increases for public workers to less than inflation until the end of
2013.
(5) Under pressure from markets and European Union partners, the Greek government
unveiled a new austerity package last week. It included cuts in civil service incomes
and a pension freeze.
In his March 4 column, Krugman declares, “What Democrats believe is what textbook
economics says: that when the economy is deeply depressed, extending
unemployment benefits not only helps those in need, it also reduces unemployment.”
He rejects the notion that the benefits are actually increasing both the duration and
level of unemployment.
I recall learning in my microeconomics textbook that if the government subsidizes
farmers not to plant corn, there will be less corn. I think it follows that if Congress
subsidizes unemployment, there will be more unemployed. The Blogosphere is all
atwitter with the following excerpt from Krugman’s “Macroeconomics” textbook:
“Public policy designed to help workers who lose their jobs can lead to structural
unemployment as an unintended side effect. . . . In other countries, particularly in
Europe, benefits are more generous and last longer. The drawback to this generosity is
that it reduces a worker’s incentive to quickly find a new job. Generous
unemployment benefits in some European countries are widely believed to be one of
the main causes of ‘Eurosclerosis,’ the persistent high unemployment that affects a
number of European countries.” (See link below.) Was Krugman hallucinating back
in 2005, when his textbook was published, or is he doing so now? In 2008, this wild
and crazy guy won the Nobel Memorial Prize in Economics.
* Government Employment: Government employment has steadily increased since
the 1960s, while goods-producing payrolls, primarily manufacturing, have shrunk.
Government employees surpassed manufacturing workers in the fall of 1989, and total
goods-producing workers in the fall of 2007. Government workers currently exceed
the former by 10.9mn and the latter by 4.7mn. State & local governments accounted
for most of the job growth in the public sector since the 1960s, with education-related
jobs accounting for more than half the S&L gain. Unions have played a role in the
growth and stability of government jobs. Last year, 37.4% of public workers were
union members while only 7.2% of private workers were unionized, with the latter’s
percentage falling.
II) CREDIT: Usually addicts try to hide their addiction. This is not the case with
Washington’s addicts. They aren’t hiding their addiction to deficit-financed spending.
They just deny that it’s an addiction. The extent of the problem was updated on
Friday, March 5 by the Congressional Budget Office. In a letter to the Chairman of
the Senate’s Committee on Appropriations (linked below), the director of the CBO
provided a preliminary assessment of the Obama administration’s proposed budget
and compared it to the current “baseline” projection based on current legislation:
(1) From 2011-2020, the baseline deficit is projected to be $6.0tn. The President’s
budget would increase that by $3.8tn to $9.8tn.
(2) Relative to the baseline projections, the President’s budget would decrease
revenues by $1.4tn and increase spending by $2.3tn on a cumulative basis over the
next 10 years.
(3) From 2010 through 2020, the President is proposing a 56.7% increase in federal
outlays.
(4) If the President’s proposals were enacted, the federal government would record
deficits of $1.5 trillion in 2010 and $1.3 trillion in 2011.
I’ve saved the worst for last: According to the CBO’s latest assessment, "Under the
President’s budget, debt held by the public would grow from $7.5 trillion (53 percent
of GDP) at the end of 2009 to $20.3 trillion (90 percent of GDP) at the end of 2020.
As a result, net interest would more than quadruple between 2010 and 2020 in
nominal dollars (without an adjustment for inflation); it would expand from 1.4
percent of GDP in 2010 to 4.1 percent in 2020.”
Yes, but what about the recently appointed National Commission on Fiscal
Responsibility and Reform? It was established by a Presidential executive order on
February 18. The group’s mission is as follows: “The Commission is charged with
identifying policies to improve the fiscal situation in the medium term and to achieve
fiscal sustainability over the long run. Specifically, the Commission shall propose
recommendations designed to balance the budget, excluding interest payments on the
debt, by 2015. This result is projected to stabilize the debt-to-GDP ratio at an
acceptable level once the economy recovers. The magnitude and timing of the policy
measures necessary to achieve this goal are subject to considerable uncertainty and
will depend on the evolution of the economy. In addition, the Commission shall
propose recommendations that meaningfully improve the long-run fiscal outlook,
including changes to address the growth of entitlement spending and the gap between
the projected revenues and expenditures of the Federal Government.” The
Commission’s report is due no later than December 1, 2010, after November’s
Congressional elections.
It is a joke. Indeed, the Commission's deck is stacked with a Joker. His name is Andy
Stern, who happens to be the corruption-tainted head of the Service Employees
International Union, the fastest-growing union in the Americas. SEIU is the second
largest union in the United States and Canada after the National Education
Association. The SEIU raised $60mn for Barack Obama’s presidential campaign.
Stern is viewed by some analysts as one of the chief strategists behind the push to
nationalize healthcare. He frequently visits the White House. In his 2006 book, “A
Country That Works,” he railed against globalization and called for unions to be the
dominant vehicles for the promotion of social reforms. He also advocated increased
taxation on the wealthy and universal health care. His motto is: “We like to say: We
use the power of persuasion first. If it doesn't work, we try the persuasion of power.”
* Federal Budget: Another record deficit for FY 2010? Maybe not, now that the
economy is picking up. However, it will likely be close to FY 2009’s record $1.4tn
shortfall. During the first five months of the current fiscal year, the deficit was
$651.6bn, 10.5% larger than the $589.8bn gap during the first five months of FY
2009. February’s monthly $220.9bn deficit was the seventeenth straight monthly
shortfall and the largest on record.
* Mortgage Applications (weekly): MBA mortgage applications new purchase index
rose 5.7% during the week ending March 5, after climbing 9.0% the prior week.
Those gains followed a 17.2% drop over the prior three-week period. The 4-wa rose
for the first time in four weeks, edging up 0.7%, after falling 6.9% over the previous
three-week span. The refinancing index slipped 1.5% during the latest week,
following a 17.2% jump the week before, which had more than reversed a two-week
decline of 10.0%. The 4-wa has increased 27.3% the past seven weeks. The rate on
30-year fixed mortgages (FRM) climbed 6bps to 5.01%. The spread between the FRM
and the 10-year Treasury yield is just below its historical average, while FRM remains
high relative to the federal funds rate.
III) STRATEGY: We know that China is booming again. We know that the nation’s
economic policymakers are tapping on the brakes. Today, we’ll find out if all this is
fully discounted in the US stock market. The S&P 500 dropped 8.1% from January 19
through February 8. The major contributor to the selloff was news released on January
12 that the Chinese were tightening their credit policy. A report released on January
20 showed that China’s CPI inflation rate rose to 1.9% y/y in December. The next
report released on February 10 showed that it moderated to 1.5%. This morning, we
learn that it was back up to 2.7% in February. January’s downtick seems to have been
temporary, caused by a base effect from the different timing of the New Lunar Year in
2009 and 2010.
* S&P 500 Sectors Forward Earnings & Valuation (weekly): What’s the latest
direction in weekly forward earnings per share and valuation for the 10 S&P 500
sectors? In the week ended March 4, forward earnings rose for all 10 sectors as
valuation increased for 5/10 sectors. Analysts continue to raise forecasts after betterthan-expected Q4 results. Forward earnings at a record high last week for Consumer
Staples, Health Care, and Tech. Telecom near a five-year low and Utilities stalled
near December’s 11-month high, but Financials back up to December’s 13-month
high. S&P 500 valuation down to 13.6 last week from 13.7 and down from a 27month high of 15.1 in mid-October. Valuation should stay near these levels as
forward earnings continue to rise, but P/E ratios are down now for all 10 sectors from
September’s highs. Industrials’ P/E down to 15.6 from a 30-month high of 16.7, and
Health Care down to 11.7 from a 16-month high of 12.3 seven weeks ago. Financials
P/E down to 14.0 last week from 14.4 and down from an 11-year high of 17.6 in
September. Tech up to 14.2 from an 11-month low of 13.8 four weeks ago, and
Materials up to 15.5 from an 11-month low of 15.0 four weeks ago. Utilities P/E of
11.7 down from a 15-month high of 12.6 in December. Telecom down to 13.7 from a
two-year high of 14.9 in December. Consumer Staples down to 14.0 from a 14-month
high of 14.2 in November. Consumer Discretionary up to 15.1 from a 14-month low
of 14.6 four weeks ago. For detailed charts including squiggles, see Earnings Week on
our website.
* S&P 500 Sectors Quarterly Earnings Growth Trends: Any big changes to
quarterly earnings and revenue growth forecasts lately? Analysts still expect the S&P
500 to record double-digit percentage earnings growth and high single-digit revenue
growth through 2010. They have trimmed the S&P 500’s Q1 earnings growth forecast
in the past month to 42.0%, but the revenue forecast rose to 9.8%. Three sectors are
expected to record both double-digit earnings and revenue growth for nearly all of
2010: Energy, Materials, and Tech. Earnings growth usually tends to outpace revenue
growth, but the reverse is happening during some of 2010’s quarters for the Telecom,
Utilities, and Health Care sectors. Health Care revenue growth is expected to be in the
double digits during Q1-Q3, but earnings growth is expected only to be in the single
digits. On a good note, revenue growth is expected for all sectors except Financials
during 2010.
IV) FOCUS ON FINANCIALS: The S&P 500 Financials are back on a roll.
They’ve been trading in a tight range since July 2009. They’ve rallied toward the top
end of this range over the past five trading days. The following industries in the sector
are now at new bull market highs: Life & Health Insurance, Multi-line Insurance,
Regional Banks, Property & Casualty Insurance, and REITs. The 22.2% ytd increase
in Regional Banks is especially good news since it suggests that credit conditions
should improve for small businesses.
Helping to revive Financials is the improving labor market. The unemployment rate
may have peaked last October. This may partly explain why the news about
foreclosures is also improving. In February, foreclosure filings in the US rose 6% y/y
and fell 2% m/m, according to RealtyTrac. The 6% rise from February 2009 was the
smallest year-over-year increase since January 2006, when RealtyTrac began
calculating this figure.
* Financials Forward Earnings vs. Yield Curve & Credit Spread: What’s
boosting the earnings of money center and regional banks? The sharply ascending
yield curve is a big plus for them. So is the narrowing of credit spreads.
* Consumer Finance: Time to charge back into the Consumer Finance industry? It’s
down 0.6% ytd, and credit quality is still a concern, but earnings and valuation are in
the process of returning to normal. Forward earnings surged 8.9% m/m in February
and was up for a ninth straight month. Analysts expect earnings to soar 94.9% in 2010
and 33.0% in 2011 after falling 34.9% in 2009. Valuation fell to 13.7 in February and
was down to a 1% premium. This industry typically traded at a steep discount to the
market in the past.
* Diversified Banks: Time to bank on Diversified Banks? The industry is up 10.2%
ytd so far in 2010 and isn’t likely to be the target of the government’s cross hairs. This
industry’s forward earnings stayed positive during the recession because they did not
engage in “risky” businesses, but still surged 7.1% m/m in February. Analysts expect
earnings to rise 18.0% in 2010 and 52.5% in 2011 after surging 44.9% in 2009. P/E
down to 13.9, but is trading at an unusually high 2% premium to the market due to
depressed forward earnings.
* Other Diversified Financial Services: Can Other Diversified Financial Services
(BAC, C, JPM) recover its steep losses since 2007? It still has a lot of ground to make
up, but the industry’s price index has doubled since the March 2009 bottom and is
successfully testing its 200-dma. The industry reported a loss in 2008 and 2009 for the
first time since 1989, but is expected to rebound to a profit in 2010 and rise 116.7% in
2011. However, NERI was negative again in February, and annual forecasts for 2010
and 2011 are falling as the industry continues to face the headwinds of government
meddling.
* Regional Banks: Why is Regional Banks the best performer in the sector and fourth
best in the S&P 500 with a gain of 22.2% ytd? Although analysts still expect the
industry to report a slight loss in 2010, forward earnings has been positive since
January for the first time since April 2009. NERI has been negative for 64 straight
months and still holds the title as the longest negative streak in the S&P 500, but is
improving, and all bad things must end eventually. Regional Banks are likely to
benefit if the government is serious about reducing the size of their “too big to fail”
competitors.