A Full Circle for the S&P500

The S&P500 has made a full circle since its April 2, 2012 peak. The index closed at 1,419 on that day, but then steadily lost steam as Q1 earnings poured in. Disappointing earnings pressured the index, and by the end of the earnings season, the S&P500 had lost ~10%. The standout performers during downtrun were Telecom Services, Utilities, and Food and Staples Retailing. Not a surprise there.

The S&P500 troughed on June 1, 2012 at 1,278. It was the day May non-farm payroll surprised to the downside by a big chunk (+69K vs +150K consensus and downward revision for the prior months). The S&P500 traded lower the next day but snapped back above the 200-day moving average the day after. Thereafter it grinded higher on combination of favorable comments from the Fed and the ECB members, and on better than expected US macro data. The start of the Q2 earnings season on July 9th meant that investor focus shifted to corporate news from macro headlines. From June 1 to August 21, when the S&P500 touched 4-year high on the intra-day basis (1,426), it gained ~10%. Energy and Tech led the rallies but their outperformance was relatively muted. Telecom Services and Pharma lagged but only slightly.

The bottom line is that the defensive sectors (Telecom Services, Pharma, Food & Staples Retailing and Software and Services) have acted much better both in the downturn as well as the upturn. Cyclical sectors (Autos, Semis and Consumer Durables and Apparel) have fared the worst.

The S&P500 is hitting against important resistance levels. If it were to make a next leg up, I would bet that the cyclicals will have to do the heavy lifting. That means, if you are bullish, buy Semis, Materials, Diversified Financials and Tech Hardware.

Fun Stuff - Shhhhh

Earl Long, the colorful late former Governor of Louisiana once offered this advice on Louisiana politics: "Don't write anything you can phone. Don't phone anything you can talk. Don't talk anything you can whisper. Don't whisper anything you can smile. Don't smile anything you can nod. Don't nod anything you can wink."
That advice is equally applicable to Wall Street but with a caveat "Don't e-mail anything, you can write on paper. Don't write anything on paper, you can phone....."  

Source: hereisthecity.com

1. 'You f.cking Americans. Who are you to tell us, the rest of the world, that we’re not going to deal with Iranians'.
In October 2006, the head of the Standard Chartered’s American operations allegedly sent a panicked message to a Group Executive Director in London, saying that the bank’s handling of Iranian clients could cause 'catastrophic reputational damage'. The above is said to be the reply the American got for his troubles.

2. 'Dude. I owe you big time! Come over one day after work and I'm opening a bottle of Bollinger'.
External trader to a Barclays trader who allegedly asked for a low LIBOR submission.

3. 'Just made it to the country of your favourite clients (Belgians)!!! I have managed to sell a few Abacus bonds to widows and orphans that I ran into at the airport, apparently these Belgians love synthetic ABS CDO2!!!!'.
Fabrice Tourre, an Executive Director in Goldman's Structured Products, Group Trading unit, messaging a girlfriend.

4. Many of the 'e-mails they'd like you to forget' were sent by equity analysts. Here are some other gems which appeared in the press a few years back:

'If I so much as hear one more f.....g peep out of them, we will put the proper rating...on the stock'. (Citigroup)

'If you can't say something positive, don't say anything at all'. (CSFB)

'Question 'What's so interesting about GoTo except investment banking fees ?' Answer - 'Nothin'' (Merrill Lynch)

'Triangle is a very important client. We could not go out with a big research call trashing their lead product'. (UBS)

'For the record, I have attempted to downgrade RSL THREE times over the last year but have been held off for banking reasons each time'. (Lehman)

'I can't believe what a POS that thing is. Shame on me/us for giving them any benefit of the doubt'. (Merrill)

While on the subject of stock analysts, it would be remiss not to mention former Citigroup man Jack Grubman. Former New York State Attorney General Eliot Spitzer released 'report cards' on Grubman. These were compiled by some of Citigroup's own brokers and investment bankers.
Here's a selection of what Grubman's colleagues allegedly said about him:

'Not all four letter words are bad ones. Perhaps some of the analysts, like Grubman, should consider this one: SELL'.

'A monkey could pick better stocks than he could'.

'Please do not fire Jack. He is my No.1 indicator - I do exactly what he says not to'.

5. 'Ratings agencies continue to create an even bigger monster - the CDO market. Let's hope we are all retired by the time this house of cards falters'.

'Screwing with criteria to 'get the deal' is putting the entire S&P franchise at risk - it's a bad idea'.

6. Bear hedge fund manager Matthew Tannin sent the e-mail below to his boss, Ralph Cioffi, in April 2007- months before two Bear hedge funds collapsed. Prosecutors used it to bolster their case that the two men had committed fraud.

'The supbrime market looks pretty damn ugly ... If we believe the (report) is ANYWHERE CLOSE to accurate I think we should close the funds now....the reason for this is that if (the report) is correct then the entire subprime market is toast'.

The matter ended up in court, and all over the front pages. In the end, and after a lot of aggro, both fund managers were found not guilty by a New York jury.

Bond King versus Stock Guru

In his monthly Investment Outlook, Mr. Bill Gross, the Bond King had not so nice things to say about Mr. Jeremy Siegel, the Stock Guru. Basically, Gross said Siegel's argument that "Stocks are for the Long Run" does not make economic sense. Both are clearly the leaders in their respective fields and their fiesty debate on CNBC is an interesting side-show.

Cult Figures

Pimco, August 2012

By Bill Gross

• ​The long-term history of inflation adjusted returns from stocks shows a persistent but recently fading 6.6% real return since 1912. 
• The legitimate question that market analysts, government forecasters and pension consultants should answer is how that return can be duplicated in the future.
• Unfair though it may be, an investor should continue to expect an attempted inflationary solution in almost all developed economies over the next few years and even decades.

​The cult of equity is dying. Like a once bright green aspen turning to subtle shades of yellow then red in the Colorado fall, investors’ impressions of “stocks for the long run” or any run have mellowed as well. I “tweeted” last month that the souring attitude might be a generational thing: “Boomers can’t take risk. Gen X and Y believe in Facebook but not its stock. Gen Z has no money.” True enough, but my tweetering 95-character message still didn’t answer the question as to where the love or the aspen-like green went, and why it seemed to disappear so quickly. Several generations were weaned and in fact grew wealthier believing that pieces of paper representing “shares” of future profits were something more than a conditional IOU that came with risk. Hadn’t history confirmed it? Jeremy Siegel’s rather ill-timed book affirming the equity cult, published in the late 1990s, allowed for brief cyclical bear markets, but showered scorn on any heretic willing to question the inevitability of a decade-long period of upside stock market performance compared to the alternatives. Now in 2012, however, an investor can periodically compare the return of stocks for the past 10, 20 and 30 years, and find that long-term Treasury bonds have been the higher returning and obviously “safer” investment than a diversified portfolio of equities. In turn it would show that higher risk is usually, but not always, rewarded with excess return >>>

The Story from July Employment Report

Last Friday's July employment report surprised to the upside. The upside came from a robust growth in private payroll. There was some hint of such outcome earlier in the week in the form of the ADP report. But be as it may, markets rallied on the back of this report.

While the report was better than what could have been, some economists raised the issue of"seasonality". July is a tough month for calculating seasonal factor because teachers are off for the summer break and auto workers stay home as plants stay idle. Even ignoring this issue, the report was not great.

Private payroll peaked in January 2008 at 138 million and troughed in February 2010 at 129 million. The latest release showed 133 million workers suggesting 130K a month job growth since the bottom. At this growth rate, job level will not reach January 2008 peak until early 2015.

We calculate monthly job growth required to get unemployment rate back to 6% by January 2015 on different population growth and participation rate assumptions. The bottom-line is that 160K is the minimum required.

From January 2008 to February 2010, 8.7 million jobs were lost. Since February 2010, 4 million jobs have been re-gained, meaning there are still 4.7 million jobs missing. Those 4.7 million jobs still missing are in manufacturing, construction and retail trade. Other interesting facts from the report, (1) since February 2010, 230K teachers have lost their jobs (2) manufacturing renaissance is a myth. Only 500K jobs have been re-gained since February 2010, while job loss between January 2008 and February 2010 was 2.2 million, meaning a net loss of 1.7 million jobs since the recession.

A Picture's Worth Thousand Words

Mario Draghi "Overpromised on July 26 and under-delivered on August 2". Markets reacted accordingly. With the earnings season in the US tapering off, macro factors, more specifically around euro survivability, will start to dominate again. Expect volatility to trend higher.

On July 26, Draghi said, "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough". Investors were caught off-guard by such unexpected comments. That caused an instant rally in the euro, the Spanish 10-year, Dax and the S&P500 future.

On August 2, Draghi could not even deliver a rate cut (benchmark rate stayed at 0.75%) let alone convince policymakers at the ECB and the wider Europe to pursue aggressive policies like Securities Market Purchase, ECM banking license etc. Not surprisingly, all the asset classes fell in unison as soon as Draghi opened his mouth at the bi-weekly post-ECB meeting press conference.

The charts on the left (click on it to enlarge) show the schizophrenic reaction of different asset classes to Draghi's comments.

Forget the Fed, Focus on ISM

Stock markets were pretty sanguine today despite being hit by trifecta of major economic data, the ADP employment pre-market, the ISM during the early morning trade and the FOMC decision before the close. The most significant and the most waited of all was the 2:15PM EST Fed announcement. Investors were anxiously waiting for Bernanke’s team to give hints of QE3. Surprisingly, they didn’t although there was a slight change in the language. Equity investors shrugged off the “bad” news. May be they are expecting “Super Mario to Save the Market” tomorrow.

From the economic standpoint, the more relevant data was July ISM. It missed economists’ estimates and was the second consecutive month of sub-50 reading. More ominously, the gap between New Orders and Inventory indices was negative for the first time since September last year. A negative reading is usually a precursor for a downturn in ISM. Last year’s negative readings (July and August) were exception mainly because the Fed embarked on QE2. Everyone is expecting the Fed to do again (QE3) in September. Bernanke may prep the market in his Jackson Hole speech like last year. If the Fed does not do QE3, for whatever reason, or even if it does but is ineffective, then the downward momentum in ISM may be unstoppable.