From the Desk of Joe Rollins
I hope you had a wonderful Thanksgiving and that the weather was as beautiful in your neck of the woods as it was here in Atlanta this past weekend. There are many things that I am thankful for – my family and our clients topping the list. We recently celebrated Ava’s six-month birthday, and she gets cuter by the day. She’s up to a whopping 20 pounds and sleeps 10 hours a night uninterrupted. We’re thankful that she’s healthy and happy, and she brings us much joy. She is not spoiled yet – but she will be soon. Life is good!
In economic news, however, there may not seem to be a lot to be thankful for this year. Nevertheless, I’m still optimistic, and in this post I’ll share some of the positives that the media has seemingly swept under the rug. Admittedly, I’m an economic nerd, and while most people probably don’t enjoy researching economic statistics, I find it fascinating. After reading the back page of Barron’s over the weekend, I am more convinced than ever that the economy is doing okay and that the stock market is overreacting to current events.
Over the last two weeks, the broader stock market has gone down approximately 8%, although none of the economic news concerning the United States warranted such a decline. Rather, and as many financial commentators explained, the decline centered on the problems in Europe. After years of a “cradle to grave” mentality, many of the Eurozone countries are now faced with the economic reality that they cannot deliver on their socialist promises. But as I’ve said before, the impact to the U.S. economy and its stock market from Europe’s woes is a mystery to me. I’ll explain why below.
First, the U.S. only exports about $1.5 trillion a year to foreign countries. Of that $1.5 trillion, about 25% -- or $375 billion -- is to European countries. The U.S. GDP is now roughly $15 trillion of which exports are only 10%. How can any reasonable economist think that the $375 billion exported to Europe is going to have any major affect on the U.S. economy?
I don’t understand why anyone would think that just because the European banks are having trouble, European consumers would be any less inclined to buy. It’s perfectly possible that Europe might fall into a mild recession, but even so, it’s likely that consumers throughout Europe will still continue to spend. If that’s the case, exports from the U.S. will continue. However, the real focus for investors should be what the U.S. corporations are doing insofar as the profits they are earning and what prospects there are for the U.S. economy. Those are the facts that affect stock prices.
Noted lifetime bear economist Nouriel Roubini has essentially guaranteed that the U.S. will fall into recession next year due to the European problems. Since Roubini has basically been forecasting a U.S. recession since the turn of the 21st century, however, this proclamation from him should not be a surprise. After all, even a broken clock is correct two times a day.
As I’ve said before, it’s unwise to invest for your future based upon public sentiment and conjecture. The only true catalysts for stock prices are earnings, interest rates, and the economy. These are the hard facts upon which I will bore you with today.
The economic data makes it absolutely clear that the U.S. economy is sound. Except for the residential construction industry, most facets of the U.S. economy continue to operate in a positive fashion. The growth in GDP for the third quarter of 2011 was 2%, and it is a common belief among economists -- and me -- that we should see between 2% and 3% GDP growth for the fourth quarter of 2011 and all of 2012. While this can’t be considered robust growth, it is more than adequate to generate profits.
Let me give you some real numbers. When they announced last week the GDP growth had been revised down from 2.5% to 2%, the market took a major hit. I am positive most of the traders sold on the news without even reading the actual report. I read the report. During the quarter, private business inventories fell by $8.5 billion. This could be for a lot of reasons, but maybe it was due to high sales liquidating inventory.
If inventories had not dropped, the GDP growth would have been 1.55% higher. Therefore, rather than 2% for the third quarter it would’ve been 3.55%, which would have been extraordinarily good. For those that do not find reading the GDP report intellectually stimulating, it is likely that this inventory number will be reversed in the fourth quarter and that gain of 1.55% will then be realized. If so, fourth quarter GDP should be excellent.
For the month of October, the manufacturing capacity utilization has jumped to 77.8%. The full capacity rate is met when capacity utilization is at 80, and so we are just shy of full capacity. Non-residential investment is up year-over-year with close to a 9% jump for the first quarter year-over-year. This is a positive move for any type of building trade other than residential housing.
Automobile production is also up this year. Total automobile product manufacturing (cars and trucks) is up roughly 9.3% year-over-year. Manufacturing of automobiles is a major employment source, yielding a positive sign for new jobs in this industry.
There have been numerous articles in major publications over the last thirty days regarding the increase of oil and natural gas drilling in the U.S. We are seeing an enormous increase of oil production in this country right now – more than anything this country has seen in decades. Natural gas is being located and drilled in many parts of the U.S., forcing the cost of natural gas to all-time lows. This production of new oil in the U.S. has already forced a reduction of our foreign oil imports by 15% in the last two years. This is rarely in the press, however, since environmentalists frown upon drilling for oil and natural gas. However, if we are ever going to be economically independent from our current oil suppliers of oil (many of these are not friendly to the U.S.), we must produce it in the U.S.
Even with the current administration’s attempts to diminish the value of oil produced in this country, drilling is producing jobs unlike any sector of the U.S. economy. While the administration’s “green” job efforts have been a total bust, the traditional jobs created by natural gas and oil productions in the U.S. have been quite lucrative.
U.S. exports are up close to 6% year-over-year while imports are only up less than 2%. We are definitely a long way from balancing our trade budget, but it’s clear that the trend is moving in a positive direction. With further reductions of imported oil, we could get close to balancing the trade budget within this decade. If we did not have an administration in Washington that was against the U.S.’s production of natural resources, we would be closer to accomplishing this goal than we are today. These industries create good, high-paying jobs. The administration’s nearly $90 billion expenditures on green job efforts, in the last three years, has been a complete failure. It has created neither significant energy nor hardly any permanent jobs.
It’s true that unemployment continues to be stubbornly high, but it is trending in a more positive direction. With new unemployment claims falling below 400,000 a week, employment appears to be increasing slowly. Only a year and a half ago, weekly claims for new unemployment were 700,000 per week, and therefore, the current numbers are a significant improvement. In October, the index of leading indicators was up 5.5% year-over-year. This evidence is overwhelming positive for the economy based on economic statistics alone.
The major alternatives to stocks are interest-bearing investments. Of course, interest rates are currently at all-time lows. The Federal Reserve announced that the year-over-year inflation rate is 3.5%. This week, a 30-year Treasury bond was yielding 2.91%. Therefore, by virtue of buying a 30-year Treasury bond, you will have built-in loss of purchasing power over the entire 30-year term. A 10-year bond is yielding roughly 1.9% and a 5-year CD, at its best rate, is yielding only 2.8%. These instruments only assure investors that they will lose purchasing power over their term with inflation at 3.5%.
Earnings this quarter will again set a new record for the highest earnings ever in the history of U.S. finance. Corporate buy-backs and dividend increases have never been higher. It is very easy to purchase utility stocks and other great growth stocks with dividend rates above 3% and many at 5%. As of Friday, the Dow Jones Industrial Average was selling for a price/earnings ratio of 10.6% for the 2012 year. That’s almost a historic low for high quality earnings on large companies. Additionally, the dividend rate for the same group of stocks is greater than 2%, which is higher than the 10-year Treasury bond. This has only occurred a few other times in U.S. financial history.
The FDIC recently announced that bank net earnings during the third quarter were a cool $35.3 billion. U.S. banks are expected to have net profits in excess of $120 billion for the 2011 year. However, bank stocks are selling at a small fraction of their intrinsic value. As of today, Bank of America has a book value of $20.96 per share and has on its balance sheet over $1 trillion in cash. However, the current market value of the stock languishes at $5.50 per share. JP Morgan Chase, one of the great banks of our country, has a book value of $43 per share and the stock sells for $29 per share. Therefore, these two major financial institutions are selling at a discount of nearly 50% of their book value. These types of discounts are rarely seen in the U.S. Furthermore, U.S. banks have never been as financially sound or as financially able to lend as they are today.
It’s easy to be confused by all of this positive economic news when the market was down close 8% in the last two weeks. Like I’ve said before, however, the traders on Wall Street don’t care about economic trends or positive economic results; their only concern is movement (either up or down). Once the market moves, they can adjust either up or down by trading millions of shares for a minuscule gain. Long-term investors like us should not be concerned with day-to-day movements that really mean nothing in the end.
Yes, there are negatives stemming from the crisis in Europe. But in my opinion, even if Europe were to implode, it might actually be good for U.S. companies. How? If the Eurozone countries split up and started creating tariffs among themselves, it would likely benefit American companies. Moreover, the reestablishing of central governments in each of these European countries would be a positive economic benefit for the U.S. because we would have a competitive advantage on currency and corporate strength. To me, the biggest concern is the uncertainty of it all. At the speed they are moving at in Europe, it doesn’t appear that we will see a complete resolution for months, if not years.
I believe that the major negative facing our country is Washington’s complete ineptitude. The Congressional super committee’s failure to come up with a compromise on a financial plan is a classic example. The U.S. is facing $44 trillion in deficits over the next decade and this group of twelve could not agree on a mere $1.2 trillion in reductions. While the issues in Europe are wreaking havoc on the financial markets, at least they are dealing with their problems; U.S. leaders have yet to step up to the plate to deal with ours. In spite of Washington’s incompetence, however, the extraordinarily high levels of corporate profits, rock bottom interest rates, and a stable banking environment provide for a favorable appreciation in the stock market. If we want “real change” in Washington, we need to make a change.
As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
I hope you had a wonderful Thanksgiving and that the weather was as beautiful in your neck of the woods as it was here in Atlanta this past weekend. There are many things that I am thankful for – my family and our clients topping the list. We recently celebrated Ava’s six-month birthday, and she gets cuter by the day. She’s up to a whopping 20 pounds and sleeps 10 hours a night uninterrupted. We’re thankful that she’s healthy and happy, and she brings us much joy. She is not spoiled yet – but she will be soon. Life is good!
In economic news, however, there may not seem to be a lot to be thankful for this year. Nevertheless, I’m still optimistic, and in this post I’ll share some of the positives that the media has seemingly swept under the rug. Admittedly, I’m an economic nerd, and while most people probably don’t enjoy researching economic statistics, I find it fascinating. After reading the back page of Barron’s over the weekend, I am more convinced than ever that the economy is doing okay and that the stock market is overreacting to current events.
Over the last two weeks, the broader stock market has gone down approximately 8%, although none of the economic news concerning the United States warranted such a decline. Rather, and as many financial commentators explained, the decline centered on the problems in Europe. After years of a “cradle to grave” mentality, many of the Eurozone countries are now faced with the economic reality that they cannot deliver on their socialist promises. But as I’ve said before, the impact to the U.S. economy and its stock market from Europe’s woes is a mystery to me. I’ll explain why below.
First, the U.S. only exports about $1.5 trillion a year to foreign countries. Of that $1.5 trillion, about 25% -- or $375 billion -- is to European countries. The U.S. GDP is now roughly $15 trillion of which exports are only 10%. How can any reasonable economist think that the $375 billion exported to Europe is going to have any major affect on the U.S. economy?
I don’t understand why anyone would think that just because the European banks are having trouble, European consumers would be any less inclined to buy. It’s perfectly possible that Europe might fall into a mild recession, but even so, it’s likely that consumers throughout Europe will still continue to spend. If that’s the case, exports from the U.S. will continue. However, the real focus for investors should be what the U.S. corporations are doing insofar as the profits they are earning and what prospects there are for the U.S. economy. Those are the facts that affect stock prices.
Noted lifetime bear economist Nouriel Roubini has essentially guaranteed that the U.S. will fall into recession next year due to the European problems. Since Roubini has basically been forecasting a U.S. recession since the turn of the 21st century, however, this proclamation from him should not be a surprise. After all, even a broken clock is correct two times a day.
As I’ve said before, it’s unwise to invest for your future based upon public sentiment and conjecture. The only true catalysts for stock prices are earnings, interest rates, and the economy. These are the hard facts upon which I will bore you with today.
The economic data makes it absolutely clear that the U.S. economy is sound. Except for the residential construction industry, most facets of the U.S. economy continue to operate in a positive fashion. The growth in GDP for the third quarter of 2011 was 2%, and it is a common belief among economists -- and me -- that we should see between 2% and 3% GDP growth for the fourth quarter of 2011 and all of 2012. While this can’t be considered robust growth, it is more than adequate to generate profits.
Let me give you some real numbers. When they announced last week the GDP growth had been revised down from 2.5% to 2%, the market took a major hit. I am positive most of the traders sold on the news without even reading the actual report. I read the report. During the quarter, private business inventories fell by $8.5 billion. This could be for a lot of reasons, but maybe it was due to high sales liquidating inventory.
If inventories had not dropped, the GDP growth would have been 1.55% higher. Therefore, rather than 2% for the third quarter it would’ve been 3.55%, which would have been extraordinarily good. For those that do not find reading the GDP report intellectually stimulating, it is likely that this inventory number will be reversed in the fourth quarter and that gain of 1.55% will then be realized. If so, fourth quarter GDP should be excellent.
For the month of October, the manufacturing capacity utilization has jumped to 77.8%. The full capacity rate is met when capacity utilization is at 80, and so we are just shy of full capacity. Non-residential investment is up year-over-year with close to a 9% jump for the first quarter year-over-year. This is a positive move for any type of building trade other than residential housing.
Automobile production is also up this year. Total automobile product manufacturing (cars and trucks) is up roughly 9.3% year-over-year. Manufacturing of automobiles is a major employment source, yielding a positive sign for new jobs in this industry.
There have been numerous articles in major publications over the last thirty days regarding the increase of oil and natural gas drilling in the U.S. We are seeing an enormous increase of oil production in this country right now – more than anything this country has seen in decades. Natural gas is being located and drilled in many parts of the U.S., forcing the cost of natural gas to all-time lows. This production of new oil in the U.S. has already forced a reduction of our foreign oil imports by 15% in the last two years. This is rarely in the press, however, since environmentalists frown upon drilling for oil and natural gas. However, if we are ever going to be economically independent from our current oil suppliers of oil (many of these are not friendly to the U.S.), we must produce it in the U.S.
Even with the current administration’s attempts to diminish the value of oil produced in this country, drilling is producing jobs unlike any sector of the U.S. economy. While the administration’s “green” job efforts have been a total bust, the traditional jobs created by natural gas and oil productions in the U.S. have been quite lucrative.
U.S. exports are up close to 6% year-over-year while imports are only up less than 2%. We are definitely a long way from balancing our trade budget, but it’s clear that the trend is moving in a positive direction. With further reductions of imported oil, we could get close to balancing the trade budget within this decade. If we did not have an administration in Washington that was against the U.S.’s production of natural resources, we would be closer to accomplishing this goal than we are today. These industries create good, high-paying jobs. The administration’s nearly $90 billion expenditures on green job efforts, in the last three years, has been a complete failure. It has created neither significant energy nor hardly any permanent jobs.
It’s true that unemployment continues to be stubbornly high, but it is trending in a more positive direction. With new unemployment claims falling below 400,000 a week, employment appears to be increasing slowly. Only a year and a half ago, weekly claims for new unemployment were 700,000 per week, and therefore, the current numbers are a significant improvement. In October, the index of leading indicators was up 5.5% year-over-year. This evidence is overwhelming positive for the economy based on economic statistics alone.
The major alternatives to stocks are interest-bearing investments. Of course, interest rates are currently at all-time lows. The Federal Reserve announced that the year-over-year inflation rate is 3.5%. This week, a 30-year Treasury bond was yielding 2.91%. Therefore, by virtue of buying a 30-year Treasury bond, you will have built-in loss of purchasing power over the entire 30-year term. A 10-year bond is yielding roughly 1.9% and a 5-year CD, at its best rate, is yielding only 2.8%. These instruments only assure investors that they will lose purchasing power over their term with inflation at 3.5%.
Earnings this quarter will again set a new record for the highest earnings ever in the history of U.S. finance. Corporate buy-backs and dividend increases have never been higher. It is very easy to purchase utility stocks and other great growth stocks with dividend rates above 3% and many at 5%. As of Friday, the Dow Jones Industrial Average was selling for a price/earnings ratio of 10.6% for the 2012 year. That’s almost a historic low for high quality earnings on large companies. Additionally, the dividend rate for the same group of stocks is greater than 2%, which is higher than the 10-year Treasury bond. This has only occurred a few other times in U.S. financial history.
The FDIC recently announced that bank net earnings during the third quarter were a cool $35.3 billion. U.S. banks are expected to have net profits in excess of $120 billion for the 2011 year. However, bank stocks are selling at a small fraction of their intrinsic value. As of today, Bank of America has a book value of $20.96 per share and has on its balance sheet over $1 trillion in cash. However, the current market value of the stock languishes at $5.50 per share. JP Morgan Chase, one of the great banks of our country, has a book value of $43 per share and the stock sells for $29 per share. Therefore, these two major financial institutions are selling at a discount of nearly 50% of their book value. These types of discounts are rarely seen in the U.S. Furthermore, U.S. banks have never been as financially sound or as financially able to lend as they are today.
It’s easy to be confused by all of this positive economic news when the market was down close 8% in the last two weeks. Like I’ve said before, however, the traders on Wall Street don’t care about economic trends or positive economic results; their only concern is movement (either up or down). Once the market moves, they can adjust either up or down by trading millions of shares for a minuscule gain. Long-term investors like us should not be concerned with day-to-day movements that really mean nothing in the end.
Yes, there are negatives stemming from the crisis in Europe. But in my opinion, even if Europe were to implode, it might actually be good for U.S. companies. How? If the Eurozone countries split up and started creating tariffs among themselves, it would likely benefit American companies. Moreover, the reestablishing of central governments in each of these European countries would be a positive economic benefit for the U.S. because we would have a competitive advantage on currency and corporate strength. To me, the biggest concern is the uncertainty of it all. At the speed they are moving at in Europe, it doesn’t appear that we will see a complete resolution for months, if not years.
I believe that the major negative facing our country is Washington’s complete ineptitude. The Congressional super committee’s failure to come up with a compromise on a financial plan is a classic example. The U.S. is facing $44 trillion in deficits over the next decade and this group of twelve could not agree on a mere $1.2 trillion in reductions. While the issues in Europe are wreaking havoc on the financial markets, at least they are dealing with their problems; U.S. leaders have yet to step up to the plate to deal with ours. In spite of Washington’s incompetence, however, the extraordinarily high levels of corporate profits, rock bottom interest rates, and a stable banking environment provide for a favorable appreciation in the stock market. If we want “real change” in Washington, we need to make a change.
As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
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