Are Profit Margins at Risk?

With all of this talk about the economy improving and potential for rates moving higher, it got me thinking. What if we finally see higher inflation this year?

In order for this to happen, we would need to see economic activity pick up enough to require more hiring by companies. As competition in the labor market would theoretically heat up, wages would likely begin to rise, and this would create the kind of inflation we are looking for to really get our economy going. 

Don’t look now, but it appears these two “needs” for inflation may be coming to fruition:

  • Small Business Survey Upbeat (Dr. Ed)
    • “…the percent of firms expecting to increase employment rose to 6.3% in December. That may not seem like much, but it is the highest reading since October 2008. “
  • Empire State Manufacturing Activity indicates faster expansion (Calculated Risk)
    • “The general business conditions index rose ten points to 12.5, its highest level in more than a year. The new orders index climbed thirteen points to 11.0, a two-year high.”

Both of these signs bode well for the economy, but what about the market? If hiring and wages were both to pick-up, we would almost surely witness a compression of profit margins in the short term. Factor in tapering by the FED, higher yields which would be very attractive if the market loses momentum, and the ominous “warnings” throughout the market, could we actually be on the verge short-term pause or pullback in the market? How will investors respond to this new environment? Would they blindly sell on falling margins or instead turn their eyes to newly revived revenue growth from stronger consumer spending? 

Long-term, I think this is a great problem to have. However, there are a lot of “what-ifs” in the air at the moment in regards to the US equity market. Will we have a “regular” year which is up but witnesses a return of volatility and one or more 10%+ drops, or will we see a flat to down year as investors cope with compressed margins yet strengthening economic fundamentals? I remain very bullish over the long-term as we all should be, but I am becoming more cautiously bullish by the day in regards to the next 6-12 months. 

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How does your zip stack up?

Washington Post has an incredible article and interactive map about the ridiculous number of wealthy and well educated zip codes concentrated around our nation’s capital. You can actually click on every single zip code in the country and view the median income per household and % of residents with a college degree. The map does a great job of illustrating the enormous disparities between communities within our borders… great food for thought. Check it out:

Enjoy your weekend. 

Kendrick Lamar on Yields: “Hol’ Up”

Happy hump day y’all. While I am a firm believer in yields continuing to rise over the “long-run”, especially on the heels of great December private payrolls data, two of the bloggers I follow tend to disagree as far as the near-term. If you are like me you have been positioning for rising rates gradually since 2012… but this kind of analysis may make you second guess completely dumping any government bonds you own before the next taper:

This was a good statement made in the Charts etc article:

 Commercial hedgers, typically the smarter money, are currently very long the UST note, attaining their highest level of long exposure in years. In the past, when their exposure has reached elevated levels (beyond 200K, green horizontal line), the UST note has more often than not responded by rallying. If that were to happen in the near future, I would expect equities to stall or retreat in kind.

Here’s some more supporting data on the potential for a near-term “shakeup” in equity markets based on current sentiment data.

Good stuff to consider if you’re bullish like me… hopefully it keeps us honest.

Happy New Year!

Hopefully you’re all bundled up and avoiding this blistering cold sweeping the nation. The grind of 2014 has started and these are some great articles to get your year and first full work week started off with. Have a look:

Looks like this year’s theme will be: “Invest cautiously, because we have no fucking idea what is coming down the pipe… but we know things are starting to get pricey in the US.”

Trickle Down or Trickle On?

Around Christmas time most Americans are cheerful and giving. They take time to appreciate their friends, family, and fellow citizens. Charities collecting food, clothing, and toys for the needy can be found on every corner as those who are well to do attempt to give back to their community and country. It’s a shame the well-off are only filled with this charitable spirit once a year. To many lower and middle-class Americans, “Tickle-Down” economics is starting to look more like a way for them to merely be “Trickled On” by the upper echelons.

During a year where vast amounts of wealth for the super-rich were created in US equity markets, the warnings of increasing inequality in our nation suddenly became more real. While the outrageously wealthy and “conservative” (i.e. crony capitalists) power brokers consider any mention of inequality or higher taxes socialism, most Americans are waking up to the reality which is this: the American dream has become more like a work induced coma.

While many people cite record after-tax profits as the main driver of inequality due to deterioration of wages (see this chart), our inequality can’t be pinned on any single metric. There are plenty of reasons contributing to this growing problem. Stanford even created a page titled “20 Facts About US Inequality that Everyone Should Know“. Pundits will pick their favorite stat on this page to write about and place a bulk of the blame, but it’s the combination of these issues which have created a cocktail for social unrest in America. 

The fact that it took this long for inequality to make headlines more frequently is probably a result of American’s attitude toward wealth. Most Americans believe they are a few risks away from striking it big… others just simply didn’t believe there was much inequality until more media sources filled them in on just how outrageous the inequality is. Just look at how our nation has become more and more unequal since the late 1970’s. Since the 2008 recession inequality has only become more extreme. Since the recession, 95% of gains in income went to the top 1%.

The 1% is a diverse group and I wouldn’t dare lump them all together in the same category. It may surprise you just how many 1%’ers are extremely hard working individuals who aren’t making millions a year. That doesn’t mean they aren’t making serious money, but once you peel back a few layers of the 1% and see the ridiculous wealth held by the .5% and .1%… that’s when all the calls to lessen inequality by the “mere mortals” in the nation seem less like class war and more like a solid idea.

During the election last year there was plenty of heated discussion about inequality in America, and this discussion led to one of the best video illustrations of wealth in America being created. I highly suggest you watch it to get an idea of how Americans perceive wealth distribution compared to the reality. It may surprise you just how ridiculously wealthy the 1% is. However, once you break it down further it becomes clear that it’s those in the top .5% who are truly rolling in the dough

There is hope for the masses, though. Many of the wealthiest and most influential Americans are catching on to our wealth disparity and believe they should be paying more to help society as a whole. While I’m not sure them paying higher taxes will solve everything, it’s at least a start. I don’t really trust that the government will somehow solve this issue if they were to receive more money… it’s more likely they would squander that. I do believe that by investing more in their employees, corporations can make a considerable improvement in our situation. While wage increases and stronger hiring may cause a drop in profitability, aggregate demand would improve and create more wealth for the entire pie rather than only those at the top. 

As the economy continues to improve, it’s the hope of many that inequality will solve its-self. I don’t think that will be the case, so as investors we must take into consideration what, if any, action(s) will be taken to reduce this dramatic gap in wealth. What is your stance on the issue? It’s a great time of year to reflect on personal views about society, wealth, and equality. 

This will be my final post of 2013, so I hope you all have a Merry Christmas and a Happy New Year! 

PAGING MITT ROMNEY

Oh, Mittens. I assume you’re knee deep in that binder full of women you carry around. You might want to check this out before running for POTUS again, though:

This whole class war narrative has just become a bit more interesting.

Don’t be so sure about CAPE fears

Well look what we have here. A market post-taper announcement that has not completely collapsed. In fact, it appears that maybe more taper had been priced in than we received (if it had been priced in at all). The market jumped significantly higher after Bernanke started the QE-Exit party while keeping forward guidance dovish. Today we have a market that has essentially done nothing in the face of a high reading on initial unemployment claims. Yields on the 10-yr Treasury are up slightly but will likely face some hesitation once testing the 3% level. If we break that level switfly, 3.5% may not be too far away. 

Around the industry the bears keep on pointing to CAPE as their super hero in disguise. However, what happens when a bear’s strongest piece of ammunition (CAPE) is suddenly revealed as not being completely “honest” over the course of history? This is exactly what has covered in their recent article “When a Good Indicator Goes Bad“. Morningstar claims that once CAPE is adjusted for modern goodwill accounting methods, valuations aren’t so ridiculous in the market. This is illustrated here:

Perhaps bears should find another method to prove the sky is about to fall. Until then, their silver bullet has turned to aluminum. 

 

What’s the reason for the Decline in Labor Participation?

Kudos to Mish who gives a stellar breakdown of what is pushing our labor force participation rate down. This has been greatly debated. One side of the coin claims it’s due to retirement, and the other side claims it’s because of discouraged workers. 

According to Mish (and the FED), it’s due to retirement

I highly recommend this article. Take a look around Mish’s Blog, also. I tend to be optimistic about our current market (especially in the long run), and he tends to be skeptical and a tad bit bearish. It’s always good to hear a different take on the same data… you may come away with a more balanced take on where we are today.

Interesting Week for Markets

Happy Monday all! This week will be interesting as we are facing the first potential 3-week losing stretch on the S&P in 82 weeks… and the FED reports Wednesday afternoon with what could be the dagger (taper announcement) to solidify this drop.

I think there are solid narratives on both sides of the aisle for why the FED will or won’t taper. Many seem too confident they will taper due to recent improvements in economic data. This is setting up like a repeat of this summer/fall when everyone was surprised there was no taper even though inflation expectations fell drastically in the run-up to the “no-taper” press-conference. I’m in the boat of 60/40% for No-Taper/Taper. If we do see a taper, I believe it will come with some sort of caveat to keep things super loose and (hopefully) push inflation.