Political Calculations
Unexpectedly Intriguing!
July 31, 2017

The S&P 500 and, by extension, the entire U.S. stock market, was about as boring as boring could be in Week 4 of July 2017.

How boring was the week? Well, when you consider that the week's biggest event for market volatility occurred on Thursday, 27 July 2017 when, in the space of 30 minutes after lunch on the east coast, the S&P 500 lost 0.5% of its value (about 12 points), before going back to recover most of it by the market's close, ending the day at 2475.42, less than two and a half points below where it opened.

That's apparently what constitutes a market freakout in what has been this summer's low volatility environment. But that got us thinking - how much would stock prices have to change from where they are at today to constitute a legitimate freakout session?

The answer is revealed in the following chart, where we're plotted the daily closing value of the S&P 500 against its trailing year dividends per share.

S&P 500 Index Value versus Trailing Year Dividends per Share, 30 September 2015 through 28 July 2017

In this chart, what matters most is the relative period of order that has existed since 30 March 2016, where we find that with respect to the mean trend curve for the relationship between stock prices and trailing year dividends per share, we find that the S&P 500 is just under the middle of the range that we would expect it to be. If reversion to the mean means anything for the stock market, that's the mean the market would be reverting to in its current state of order.

It would only be if stock prices were to move outside the red-dashed curves that we would become concerned about the potential a breakdown in the current period of order, which given where the S&P 500 closed on Friday, 28 July 2017 at 2421.10, would either mean a decline of nearly 100 points or an increase of more than 100 points.

As a general rule of thumb, we would only really get interested in the daily action of the S&P 500 when it changes by more than 2% of its previous day's closing value (about 50 points in today's market). A more significant threshold would be if the stock prices were to alter their trajectory by two standard deviations, or 66 points for today's market.

So that's where we're at. We'll close out this bit of analysis by looking into the future for the S&P 500, which is pretty much behaving almost exactly like we anticipated last week.

Alternative Futures - S&P 500 - 2017Q3 - Standard Model - Snapshot on 28 July 2017

We believe that investors are focusing on 2018-Q1 in setting stock prices, which continues to be consistent with investor expectations for the timing of the next Fed rate hike.

Here are the headlines that caught our attention during the fourth week of July 2017.

Monday, 24 July 2017
Tuesday, 25 July 2017
Wednesday, 26 July 2017
Thursday, 27 July 2017
Friday, 28 July 2017

Meanwhile, Barry Ritholtz covered the positives and negatives for the U.S. economy and markets. And speaking of Barry, he took part in a Freakonomics' podcast with Ken French, Gene Fama and John Bogle on the topic of "stupidest thing you can do with your money" and is also featured in Meb Faber's new book, The Best Investment Writing, Volume 1!


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July 28, 2017
Little Black Book of Junk Science Cover - https://3.bp.blogspot.com/-kq8GpEVWNmc/WXnnGsg9z2I/AAAAAAAAPTY/2xCXKIxhMpAYOQKCkzN8PV9vhSXZmDEkQCLcBGAs/s1600/Berezow-cover-Little-Black-Book-of-Junk-Science-2017.jpg

The American Council on Science and Health has published a guide to many of the various kinds of junk science that often makes the news: The Little Black Book of Junk Science!

The book was written by the ACSH's Dr. Alex Berezow, who contributed two of the examples that we covered as part of our Examples of Junk Science series that primarily focused on pseudoscience in finance, economics and social sciences.

The Little Black Book of Junk Science however focuses more on where junk science is to be found in the fields of nutrition, biology, medicine and chemistry, which are the fields where the ACSH's staff has expertise. Here's a quick sampling what we thought were some of the book's more fun-related content:

Vaginal steaming

Endorsed by actress Gwyneth Paltrow, vaginal steaming claims if a woman sits over steaming water made with certain herbs, it will balance her hormones and help her uterus. A review declared it "sorcery for your vagina."

Toilets

The reason your toilet doesn't work is because our government passed a law restricting flushes to 1.6 gallons each. Junk science claims that this is necessary to conserve water, even though water is not a scarce resource in most of the United States. It's also recycled efficiently in our sewage systems.

Genetic ancestry

Genetic ancestry tests use a small dash of science and a heaping scoop of speculation. Though your DNA contains information about your biogeographic ancestry, some commercial genetic ancestry tests may be little more than horoscopes. If you want to predict whether you will like cilantro or not, they are fine.

Earthing

Earthing is the belief that running around barefoot somehow connects you to Earth's energy, which will improve your health. The exact opposite is true. We invented shoes because it protects our feet from injury and infection. Tell the neighborhood hippies to put their sandals back on.

Colon cleansing (Colon hydrotherapy)

Liquids go in your mouth, not in your butt. Unless you're constipated, there is no reason to give yourself an enema. Your body naturally detoxifies itself.

You can get the book in one of two ways. You can download a PDF version of the book for free or you can buy a physical copy from Amazon. Of the two, we'd recommend the physical copy, just so you can leave it sitting out where that special someone you know who can use this kind of information will see it!

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July 27, 2017

The Federal Open Market Committee (FOMC) are the decision makers at the Federal Reserve who meet every six weeks to decide how to set short term interest rates in the United States. They held their most recent meeting on Wednesday, 26 July 2017 where, frankly, they didn't decide on very much....

The Federal Reserve kept interest rates unchanged on Wednesday and said it expected to start winding down its massive holdings of bonds "relatively soon" in a sign of confidence in the U.S. economy.

Key Points:

* FOMC says: "Committee expects to begin implementing its balance sheet normalization program relatively soon" (vs "this year" in June statement)

* FOMC appears to strengthen characterization of current inflation trend, removing word "somewhat" to describe how far inflation measures are running below its 2 percent target at present

* Looking ahead, however, FOMC sees inflation remaining "somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term" (unchanged from June)

If you want to know more about what the Fed's July 2017 statement changed from the statement it issued six weeks earlier, the Wall Street Journal's "Parsing the Fed" posts on its Real Time Economics blog has you covered!

For our purposes, we'll using the timing of the Fed's meeting schedule to update our Recession Probability chart, which indicates what the odds of a recession in the U.S. will be up to one year into the future from the indicated dates.

Recession Probability Chart - 2 January 2014 through 26 July 2017

With the Federal Funds Rate effectively set at 1.16% (the midpoint of the FOMC's current target range between 1.00% and 1.25%) and the slightly declining spread in the yields between the 10-year and 3-month constant maturity U.S. Treasuries declining slightly, the probability of a recession occurring within the next 12 months of 26 July 2017 ticked up to... 0.26%, which is to say that there's little very probability that the National Bureau of Economic Research will declare that a national recession began in the U.S. during this period at a later date based upon Jonathan Wright's recession forecasting method.

Previously on Political Calculations

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July 26, 2017

It's still early in the third quarter of 2017, but compared to the third quarter of a year ago, distressed U.S. firms experiencing distress are cutting their dividends at a slightly accelerated pace.

Cumulative Announced Dividend Cuts in U.S. by Day of Quarter, 2016-Q3 vs 2017-Q3

Compared to the two previous quarters of 2017 however, 2017-Q3 is seeing a faster pace of dividend cuts than 2017-Q2 did, but is about on the same pace as 2017-Q1.

Cumulative Announced Dividend Cuts in U.S. by Day of Quarter in 2017, 2017-Q1 vs 2017-Q2 vs 2017-Q3, Snapshot on 2017-07-25

Looking at the firms that have announced dividend cuts in 2017-Q3 into 25 July 2017, all but one are concentrated in the oil and gas sector of the U.S. economy. The one that wasn't in that industry is the Blackstone Group (NYSE: BX), a private equity firm that has been recognized as being "the largest owner of real estate in the world", which acquired much of its current holdings with the active assistance and encouragement of both the Obama administration and the Federal Reserve during what we've previously described as the initial inflation phase of the second U.S. housing bubble.

Data Sources

Seeking Alpha Market Currents. Filtered for Dividends. [Online Database]. Accessed 25 July 2017.

Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 25 July 2017.

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July 25, 2017

In June 2017, sales of naturally and artificially-sweetened beverages in Philadelphia subject to the city's plummeted to be more than 40% below their estimated pre-tax quantities.

That wasn't what Philadelphia's political leaders were expecting to happen, where the following chart shows how many millions of ounces of sweetened beverages were estimated to have been sold in Philadelphia in each month before the city's controversial beverage tax took effect in January 2017, how many ounces city officials expected to be sold after the tax went into effect, and finally the actual quantity of sweetened beverages subject to the city's tax in its first six months of existence.

Estimates of Quantity of Sweetened Beverages [Millions of Ounces] Subject to Philadelphia Soda Tax, 2017

Even though months of actual data were shouting that Philadelphia Beverage Tax collections were falling short, it wasn't until 13 June 2017 that city officials finally acknowledged that the depressed sales of sweetened beverages subject to the city's new beverage tax would result in the city missing its $46 million revenue target for the tax in its first six months of being in effect. The city subsequently moved the goalposts for its first six-months estimate to $39.7 million later in the month.

We can now confirm that Philadelphia appears set to miss that lowered mark by several hundred thousand as well, where data recently provided by the city after the 20 July 2017 payment date for beverage taxes imposed through the end of June 2017 indicates it will have collected just $39.3 million in the first half of 2017. The following chart shows our estimate of the amount of revenue that Philadelphia city officials would have reasonably expected to collect each month from the beverage tax based on the seasonal pattern for soft drink distribution in the U.S. along with the amount the city has reported collecting in the tax' first six months of being enforced.

Desired vs Actual Estimates of Philadelphia's Monthly Soda Tax Collections, Jan-2017 through Jun-2017

The sad part is that June is typically the peak month for soft drink distribution in the United States, which then typically remains elevated through August each year, before entering a steady downtrend as seasons change from summer, to fall, and then to winter. If the volume of soda being distributed in Philadelphia in June 2017 is any indication of where those sales will reach their typical seasonal peak in 2017, we anticipate that the city can expect that severe shortfalls in its expected beverage tax collections will persist over the next several months.

As recently as 18 July 2017, city officials would appear to be in severe denial of that reality. Here is a report noting the view of the Philadelphia Beverage Tax by the Pennsylvania Intergovernmental Cooperation Authority (PICA), who recently reviewed and approved the city's budget for its 2017-2018 fiscal year, which captures the reaction of Philadelphia's City Finance Director, Rob Dubow, which can be taken as a direct indication of the mindset of Philadelphia Mayor Jim Kenney and Philadelphia City Council members (emphasis ours):

The new sweetened-beverage tax also received some criticism. PICA staff said there is financial risk associated with the $92 million revenue estimate for the beverage tax.

“In particular, there is uncertainty related to the size of the tax base, the impact of the tax on consumption, and the rate of enforcement,” the staff wrote, noting that in the first six months of the tax, the city lowered its initial projection of $46 million to $39.7 million. City officials said the slow start was due to the transition implementing the tax and “seasonality,” meaning that people consume more soda during the summer months and during the November and December holiday season.

During Tuesday’s meeting, Dubow said the city still expects to make the $92 million mark.

Based upon all our observations to date, we can say with some confidence that no, the city will not make the $92 million mark for the full calendar year of 2017, nor will it make the mark over its fiscal year from July 2017 through June 2018. Absent significant inflation, subsidy, or other compensating factor, it will instead fall well short of that mark.

The next question that Philadelphia's city leaders will have to address is who is going to be disappointed because it will fall short of its revenue estimates and won't be able to pay everything that they've promised to pay with the beverage tax proceeds. Will it be the families of the remaining 4,500 of the 6,500 children who were promised their kids would be enrolled at no cost in the city's new all-day pre-K program? Will it be the "massive Philly parks and recreation upgrade" that the city's voters were promised? Or will it be city employees, including policemen and firefighters, whose unions are looking for raises like the ones that other city employees got last year just after the city first passed its beverage tax?

Or better yet, will it be some combination of all three or some other beleaguered interest within the city? Stay tuned!

Previously on Political Calculations

Presented in reverse chronological order....

Coming Soon

The Philadelphia Beverage Tax is facing legal challenges that are currently working their way through Pennsylvania's state courts. However, we think there may be a valid federal case against it, the litigation for which has yet to begin, which will impact other cities that have either implemented similar taxes or are considering doing so.

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July 24, 2017

In Week 3 of July 2017, the S&P 500 continued to set new all time highs, with the newest peak closing value of 2473.83 set on Wednesday, 19 July 2017.

No real surprise there, right? With investors apparently focused on 2018-Q1, the S&P 500 is behaving pretty much as our dividend futures-based forecasting model anticipated.

Alternative Futures - S&P 500 - 2017Q3 - Standard Model - Snapshot on 21 July 2017

Coming into the fourth week of July 2017, we anticipate that our dividend forecasting model will be affected by the echoes of past volatility in stock prices during this week and the next, where we expect that our model's projections will fall on the high side of the actual trajectory of the S&P 500. This is an artifact of our model's use of historic stock prices as the base reference points from which we project future stock prices, where we've found that simply "connecting the dots" of the projections on either side of the period affected by the volatility echoes has worked well as a tool to correct the effect. Because of the short duration of the upcoming echo, we'll leave that as an exercise for you!

To help save time and effort, you'll only want to do that with the projections associated with how far forward in time investors are currently focusing their attention. While you can use our alternative futures chart to help determine which point of time in the future investors are focusing upon, we're test driving the CME Group's FedWatch Tool for that purpose.

Here, you will be looking for the timing of when investors are betting real money that the Fed will change its Federal Funds Rate. Currently, the FedWatch tool is indicating the following probabilities of the Fed changing short term U.S. interest rates from their current range of 100-125 basis points (bps, or 1.00%-1.25%) at each of their meetings near the end of upcoming quarters:

  • 2017-Q3 - 20 September 2017
    • Maintain at 100-125 bps = 92.2%
    • Increase to 125-150 bps = 7.7%
    • Increase to 150-175 bps = 0.1%
  • 2017-Q4 - 13 December 2017
    • Maintain at 100-125 bps = 53.0%
    • Increase to 125-150 bps = 42.8%
    • Increase to 150-175 bps = 4.0%
    • Increase to 175-200 bps = 0.1%
  • 2018-Q1 - 21 March 2018
    • Maintain at 100-125 bps = 42.2%
    • Increase to 125-150 bps = 44.5%
    • Increase to 150-175 bps = 12.0%
    • Increase to 175-200 bps = 1.2%
    • Increase to 200-225 bps = 0.1%

Looking at these probabilities, we see that it is not until 2018-Q1 that investors will give the greatest likelihood that the Fed will act to change the Federal Funds Rate by increasing it by 25 bps, which would make that the future point of time to which investors are currently focusing their attention.

Expectations about the Fed's plans for short term U.S. interest rates is however just one of many factors that can affect how far into the future investors are looking today. New information about the business environment for U.S. companies can also drive investors to shift their forward-looking focus to different points of time in the future, which will be a factor throughout the current earnings season now underway, so it will to your advantage to also keep up on that kind of news.

Speaking of which, here are the potentially market-moving headlines that caught our attention during the past week.

Monday, 17 July 2017
Tuesday, 18 July 2017
Wednesday, 19 July 2017
Thursday, 20 July 2017
Friday, 21 July 2017

For a short list of the week's positive and negative markets and economy news, Barry Ritholtz has you covered!

On an afternote, we incorrectly identified last week as Week 3 of July 2017, which we've since corrected in that previous post. This is an unfortunate consequence of our spending much of our time in the future, where we occasionally lose track of exactly where we are when we shift back to the present (it's timey-wimey, wibbly-wobbly stuff - just bear with us and we'll eventually get it sorted out!)

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July 21, 2017

If you work for a modern American corporation, whether at an office or from home, you have the kind of conference calls that only today's modern Internet technologies make possible: really awful ones.

You know what we mean, and so do the creative minds at I-am-bored, who posted the only possible way to make it through the ordeal of interacting with your professional colleagues in the online world with any shred of your sanity intact: by turning each Skype, Lync or Facetime meeting into a game of Conference Call Bingo!

Here's the basic game card:

Conference Call Bingo Card

Armed with this card, rather than multitasking as most Americans workers might attempt during such an event, you now have an incentive to hang on every word spoken during each conference call so you can catch every one of the typical statements made by the attendees of today's conference calls as they make them, where we encourage you to shout "Bingo" if you get five in a row. Or get all four corners and the center square. Or, for a real challenge, see if you can completely fill your card during the duration of the call!

Of course, you should set your headset or microphone to mute when you announce each victory. Your managers will greatly appreciate your concentrated focus on the matters being discussed during their calls and presentations, but even though they and your company's IT department are the ones who hooked you up to today's online meeting technology, we're afraid that because they did, they're not eligible to play....

Previously on Political Calculations

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July 20, 2017

Last November, the USDA published a report that provides some insight into the kinds of food and drink items that recipients of its Supplemental Nutrition Assistance Program (SNAP), which used to be called "Food Stamps", are buying up with their government-issued EBT cards.

In the chart below, we've taken the Top 10 items from Exhibit 6 of the report, which lists the millions of dollars of eligible food and drink commodities that SNAP recipients were determined to have bought in transactions using their EBT cards, and shown how the spending for those items compares to the total amount of spending that was counted in the study.

The Value of What's in the Shopping Carts of SNAP Benefit Recipients, 2016

Together, SNAP benefit recipients purchases of the Top 10 food and drink categories accounted for over one-quarter of all the spending on eligible food and drink items captured in the report. The most popular category, soft drinks, alone accounted for over 5.4% of all purchases, or about $1 of every $18.38 spent.

It's important to recognize that SNAP recipients will often use a combination of their regular income and their SNAP benefits to purchase groceries. For example, a single individual in New York City who has $825 in income per month can augment that income with a monthly SNAP benefit of $194 per month (a lower amount of SNAP benefits can be obtained for such single, childless, working-age individuals with incomes of as much as $1,285 per month).

Since these benefits are exempt from federal, state and local income taxes, and are also exempt from state and local sales taxes, SNAP recipients can maximize their benefits by using them to buy items that would otherwise be subject to state and local sales taxes. For example, in New York once again, items like carbonated soft drinks, candy and grocer-prepared food like sandwiches, are subject to the state's sales tax rate of 4%, where the city of New York would pile on an additional local sales tax rate of 4.49%, which makes it possible for SNAP benefit recipients to buy 8.49% more of these kinds of groceries in New York City with their benefits than they can with their regular income.

And for that matter, that much more than what people who don't receive SNAP benefits can buy with the same amount of cash, although the amount of this kind of extra tax-free benefit will vary by state, city and county!

Data Source

Garasky, Steven, Kassim Mbwana, Andres Romualdo, Alex Tenaglio and Manan Roy. Foods Typically Purchased by SNAP Households. Prepared by IMPAQ International, LLC for USDA, Food and Nutrition Service, November 2016. [PDF Document].

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July 19, 2017

There is a rather strong correlation between changes in the acceleration of nominal private sector debt in the U.S. and the direction of growth for the nation's real GDP growth rate. In a nutshell, we've found that "nearly 88% of periods in which the trailing twelve month average of private debt acceleration declined or was negative occurred when the U.S.' real GDP growth rate was falling", indicating that changes in the acceleration of private debt is a good predictor of the direction of GDP growth.

So what does the Federal Reserve's latest data for the change in the growth rate of private debt in the U.S. economy tell us today?

Acceleration (Change in Year Over Year Compounded Growth Rate) of Private Debt in the United States, January 2007 - March 2017

If we go by past history and assume that the momentum in 2017-Q1 will continue into 2017-Q2, there's a really strong likelihood that the U.S.' real GDP growth rate for the soon-to-be reported quarter of 2017-Q2 will have expanded over the 1.4% rate of growth that was reported for 2017-Q1.

That's it - we're going to keep the analysis short and sweet today! If however you want to know more about how and why this forecasting approach works, please follow the links below....

Data Sources

U.S. Federal Reserve. Data Download Program. Z.1 Statistical Release (Total Liabilities for All Sectors, Rest of the World, State and Local Governments Excluding Employee Retirement Funds, Federal Government). 1951Q4 - 2017Q1. [Excel Spreadsheet]. Online Database. 8 June 2017. Accessed 18 July 2017.

U.S. Bureau of Economic Analysis. Table 1.1.1. Percent Change from Preceding Period in Real Gross Domestic Product.
1947Q1 through 2015Q3 (second estimate). Online Database]. Accessed 18 July 2017.

References

National Bureau of Economic Research. U.S. Business Cycle Expansions and Contractions. [PDF Document]. Accessed 14 December 2015.

da Costa, Polyana and Ponder, Crissinda. How Fed Moves Affect Mortgage Rates. (Timeline for Federal Reserve Quantitative Easing Programs QE 1.0 through 3.0). [Online Article]. 17 September 2015. Accessed 14 December 2015.

Previously on Political Calculations

Political Calculations. The Position, Velocity and Accelration of Private Debt in the U.S.. 5 November 2015.

Political Calculations. The Correlation Between Decelerating Debt and Falling GDP. 12 November 2015.

Political Calculations. QE and the Acceleration of Private Debt in the U.S.. 18 November 2015.

Political Calculations. Private Debt Decelerates in 2015Q3, Real U.S. GDP Follows. 15 December 2015.

Political Calculations. Slowing Private Sector Debt and the Slowing Economy. 16 March 2016.

Political Calculations. Private Debt: U.S. Growth Likely Rebounding in 2016-Q2. 28 June 2016.

Political Calculations. Private Debt in U.S. Rebounds in 2016. 27 September 2016.

Political Calculations. Acceleration in Private Debt Boosts U.S. GDP. 19 January 2017.

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July 18, 2017

Carbon dioxide. It's not just a constituent gas in the Earth's atmosphere, it's also an alternative economic indicator for the entire planet's economy!

Or at least we'd like to make it into one, with the idea that changes in human activities are accompanied by changes in energy production, where additional carbon dioxide finds its way into the atmosphere as a by-product of those activities.

To that end, the following chart shows the average Parts Per Million (PPM) of carbon dioxide that has been measured at the Mauna Loa Observatory in each month from January 1960 through June 2017.

Parts per Million of Atmospheric Carbon Dioxide in Earth's Atmosphere, January 1960 - June 2017

In this chart, we see both the rising trend for the concentration of atmospheric carbon dioxide along with its seasonal variation, as the amount of carbon dioxide in the air has increased with economic growth around the world. In our next chart, we'll focus just on the year over year change in the amount of CO2 measured in the Earth's atmosphere.

Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 1960 - June 2017

In this chart, we've identified two anomalous periods, in 1997 and in 2015, where large scale wildfires in Indonesia greatly skewed the amount of carbon dioxide entering into the Earth's atmosphere, which was subsequently measured at the Mauna Loa Observatory in Hawaii. With the end of the spike for the 2015 Indonesia wildfire, we find that the year over year change in the pace at which carbon dioxide is being added to the atmosphere has fallen back to the typical range it has been outside of anomalous events since 1997, and in fact, we find it in the lower end of that range, suggesting a cooling global economy in June 2017 after a period of growth.

We also confirm a rising trend over time in considering the bigger, longer term picture, which coincides with the economic performance of the global economy. In our next chart, we'll account for the annual seasonality in the data by calculating the trailing twelve month moving average of the year over year change data, where we'll also identify major economic events that coincided with those changes.

Trailing Twelve Month Average of Year-Over-Year Change in Parts per Million of Atmospheric Carbon Dioxide, January 1960 - June 2017

Following the end of the 2015 Indonesia wildfires effect on atmospheric carbon dioxide, the trailing twelve month average is presently falling rapidly, which will continue through much of the rest of this year as the levels of CO2 in the air resume changing in step with productive human activity around the globe and its seasonal variations.

And if you want to see where the growth has or hasn't happened, say between 2012 and 2016, check out the new nighttime map of Earth!

Data Source

National Oceanographic and Atmospheric Administration. Earth System Research Laboratory. Mauna Loa Observatory CO2 Data. File Transfer Protocol Text File].
Updated 5 July 2017. Accessed 5 July 2017.

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July 17, 2017

In the second week of July 2017, Fed Chair Janet Yellen may very well have single-handedly reversed the momentum for short term interest rate hikes at the U.S. Federal Reserve.

Writing at Real Investment Advice, Lance Roberts had perhaps the best summary of what happened when the Fed's Yellen testified before the U.S. Congress on Tuesday, 11 July 2017:

As I noted in yesterday's missive, Yellen's recent testimony on Capitol Hill sent robots frantically chasing asset prices on Thursday even before testimony began. The catalyst was the release of prepared testimony which included this one single sentence:

"Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance."

And on that statement, doves flew and algorithms kicked into to add risk exposure to portfolios. Why? Because she just said that rates will remain low forever. As my partner, Michael Lebowitz, noted yesterday:

"Per Janet Yellen’s comment, the 'neutral policy stance' is another way of saying that the Fed funds rate is appropriate or near appropriate given current and expected future economic conditions.

Two weeks ago, several fed officials were working hard to set the expectation that the Fed would hike its Federal Funds Rate again at its upcoming September 2017 meeting, in the current quarter of 2017-Q3, where investors were split between that quarter and 2017-Q4 as being the most likely timing for the Fed's next move to increase U.S. short term interest rates.

But after Yellen's congressional testimony, investors are betting that won't act to increase interest rates again until the first quarter of 2018 (2018-Q1), at the earliest.

We've been paying attention to CME Group's FedWatch Tool, which uses Fed Fund futures to anticipate the level that the Federal Funds Rate set by the Fed will be on the dates when the Fed meets. In the following chart, which we've animated, we'll scroll through what those futures indicate the probabilities for how the rate will be set after its upcoming September 2017, December 2017 and March 2018 meetings.

CME FedWatch Tool, 2017-Q3, 2017-Q4, 2018-Q1 Federal Funds Rate Probabilities, Snapshot on 2017-07-14

With the Federal Funds Rate currently set between 100 and 125 basis points (bps), the CME FedWatch tool is indicating that the market is betting that the Fed will hold its rate at that level through the end of 2017, where increasing it by a quarter percentage point only becomes the most probable outcome after its 21 March 2018 meeting, and even then, it gives only 45% odds of it doing so.

At least, as of when we took a snapshot of the data on 14 July 2017. There is a lot of time between then and now where a lot can happen.

Now, the cool part is that because the Fed influences how far forward in time investors are willing to look ahead, we can use the information provided by CME's FedWatch tool to identify just how far forward. And given what we've found out in the last week, it is very much in the ballpark of 2018-Q1, which would appear to match what our dividend futures-based model for forecasting the value of the S&P 500 suggests.

Alternative Futures - S&P 500 - 2017Q3 - Standard Model - Snapshot on 14 July 2017

If that holds, unless 2017-Q3's earnings season is accompanied by significant dividend increases, we may be near the peak for the S&P 500 in the quarter.

Of course, it's possible that new information about business conditions in the U.S. or the efforts of more hawkish Fed officials might succeed in directing investors to refocus their attention on points of time in the nearer term future, which would affect stock prices correspondingly, but for now, we think that the Fed is unlikely to shift the market's attention on the future in the absence of compelling data for it to do so.

Meanwhile, the news headlines for Week 2 of July 2017 back up what the FedWatch tool indicates about the future focus of investors.

Monday, 10 July 2017
Tuesday, 11 July 2017
Wednesday, 12 July 2017
Thursday, 13 July 2017
Friday, 14 July 2017

Elsewhere, Barry Ritholtz captured the pluses and minuses for the U.S. and global economy in Week 2 of July 2017.

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July 14, 2017

While necessity is the mother of all invention, the father all inventions is a problem that's begging for a solution.

That's really the only explanation, other than ruthless corporate marketing, that accounts for the existence of the Euphori-Lock, a technological marvel developed by the Ben & Jerry's Homemade Incorporated, a wholly-owned subsidiary of Unilever for the purpose of denying unauthorized access to the standard pint container of the premium ice cream maker's products once it has reached your home freezer.

The following 60-second commercial demonstrates the kind of problem that the Euphori-Lock was made necessary to solve.

Before you ask, yes, it's a real thing that you can actually buy via Amazon or at Ben & Jerry's stores. We found out about out the ice cream pint lock from Core77, who had this to say about the sad need for the invention:

If you cannot restrain yourself from stealing another person's food or dipping into another person's ice cream, you are an animal who's wearing clothes. I hope you fall down an escalator that's going up.

Of course, this isn't the first time that Ben and Jerry's questionable ice cream technology has been featured at Core77.

And we haven't even mentioned the company's latest evil, of which we can only say that at least it's not a BRRR-ito!

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July 13, 2017

Wolf Richter sounds the alarm about the S&P 500's current price earnings ratio:

This chart shows those adjusted earnings per share for all S&P 500 companies (black line) and the S&P 500 index (blue line). I marked July 2012 and March 2014 (via FactSet, click to enlarge):

Wolf Richter: S&P 500 Change in Trailing 12-Month EPS vs. Change in Price: 10 Years

Given that there has been zero earnings growth over the past three years, even under the most optimistic “adjusted earnings” scenario, and only about 2% per year on average over the past five years, the S&P 500 companies are not high-growth companies. On average, they’re stagnating companies with stagnating earnings. And the price-earnings ratio for stagnating companies should be low. In 2012 it was around 15.5. Now, as of July 7, it is nearly 26.

Wolf Richter: The Ballooning S&P 500 P/E Ratio, January 1 each year, plus July 7, 2017

In other words, earnings didn’t expand. The only thing that expanded was the multiple of those earnings to the share prices – the P/E ratio. Such periods of multiple expansion are common. They’re part of the stock market’s boom and bust cycle. And they’re invariably followed by periods of multiple contraction.

Before we go any further, let's acknowledge that Wolf would be absolutely right if earnings were the fundamental driver of stock prices.

Unfortunately, they're not. Instead, dividends serve that function (here's the math and several years of forecasting results to back that claim up).

From that perspective, the seeming inexplicable levitation of stock prices is completely understandable during this period of time. When Wolf looks at stagnating companies in the years between 2012 and 2017, there is perhaps no better example of the kind of performance he describes than oil producers, where beginning in mid-2014, with the crash of global oil prices, their earnings crashed right along with their revenues.

By Wolf's reasoning, there would be no reason for the stock prices of these companies to continue to remain elevated at the levels they reached while they were riding high on the profits from high priced oil. But the boards of directors and management teams at most of the largest of these firms took a risk - they acted forcefully to cut their costs at rates faster than their revenue was falling. And in doing so, they bet that they could ride out the collapse of oil prices.

So even as their earnings crashed, they were able to maintain the cash flow needed to continue making their dividend payments at the same levels they were before the bottom dropped out of their revenues. Their stock prices responded by... not changing very much, keeping more in step with their dividends and not acting anything like what happened to their earnings, which by our theory of how stock prices work, is exactly what they should have done.

But because their earnings crashed, their P/E ratios soared, which is why many capable market observers like Wolf are concerned (emphasis ours).

How long can this period of multiple expansion go on? That’s what everyone wants to know. Projections include “forever.” But “forever” doesn't exist in the stock market. The next segment of the cycle is a multiple contraction.

The 10-year average P/E ratio, using once again the inflated “adjusted earnings,” not earnings under GAAP, is 16.7, according to FactSet. This includes two big stock market bubbles, the one leading up to the Financial Crisis, and the current one, but it includes only one crash. This imbalance skews the results. Two complete cycles would bring the average substantially below 16.7.

Nevertheless, even getting back to a P/E ratio of 16.7 for the S&P 500, when the current PE ratio is 25.6, would signify either miraculously skyrocketing earnings or a sharp contraction of the market. The first option is a near impossibility. And the second option?

Markets overshoot, which is what reversion to the mean entails: the average isn't going to be the floor! And that’s why this type of unsustainably high earnings-multiple is like a tsunami siren where the arrival time of the tsunami remains unknown – and that’s why it is ignored until it’s too late.

Under our theory of how stock prices work, the kind of multiple contraction that Wolf anticipates would happen if, and only if, the financial situation of the most distressed industries of the S&P 500 were to deteriorate to the point where they could no longer avoid dividend cuts. And then, we could see a situation similar to what we saw back in late 2008 and early 2009, provided that the affected companies would sequentially follow each other in taking that action.

Outside of that happening, any major or sudden changes in stock prices would be described as a kind of quantum random walk, where in addition to their expectations for future dividends, the volatility in stock prices is affected by how far forward in time investors are looking.

In all this, you'll notice that we didn't put any weight on the value of P/E ratios for telling us anything actionable or worthwhile about the state of the stock market. We do have some thoughts on how to make the ratio a better indicator of the market's relative valuation, but we're afraid that you'll have to stop thinking horizontally about it.

S&P 500 Average Price Earnings Ratio from January 1871 through May 2017

More on that soon!

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July 12, 2017

There's a really exciting story developing in the international trade between the United States and China, two of the world's largest trading partners.

Here, the legalization of oil exports in 2016 from the United States has subsequently led to a rather dramatic surge in exports of petroleum products from the U.S. to China in 2017.

China imported nearly 100,000 barrels of crude oil per day from the U.S. in the first five months of 2017, 10 times the average in 2016, according to data by the Chinese customs.

The upward trend seems to be picking up speed. In April and May, imports surged to more than 180,000 barrels per day on average.

In February, China became the biggest buyer of U.S. crude oil, surpassing Canada, at a time when OPEC was scaling back its output, according to Bloomberg.

China's own falling production, political uncertainty in the Middle East – on which China has long depended for fuel – and the cheaper price of US oil have contributed to the increase in imports.

According to the U.S. Census Bureau's data on international trade, China imported nearly $496 million of U.S. crude oil, refined oil and other petroleum derived products in May 2017, which was more than double the $214 million of these goods that it imported from the U.S. in May 2016. Altogether, these petroleum exports accounted for 5.2% of all the oil that the U.S. exported to all other countries during May 2017, and 4.9% of the value of all the goods and services that the U.S. exported to China during the month.

For the first five months of 2017, the Census Bureau reports that the cumulative value of U.S. crude oil, petroleum gases and refined petroleum to China totals over $2.76 billion. For just U.S. crude oil exports, China has purchased $1.6 billion, which represents 21% of all U.S. crude oil exports to the world from January through May 2017.

That's a pretty remarkable development when you consider that most of these petroleum product exports are loaded on container ships at growing U.S. port facilities in Texas and Louisiana, where it then must pass through the recently enlarged Panama Canal before transiting the Pacific Ocean to reach Chinese ports.

The chart below shows what those new U.S. exports are doing for the exchange rate-adjusted year-over-year growth rates of U.S.-China trade.

Year Over Year Growth Rate of Exchange Rate Adjusted Trade in Goods and Services Between the U.S. and China, January 1986 through May 2017

The downside to the U.S.' oil exports to China is that it's skewing the year over year growth rate of trade from the U.S. to China upward, which makes the growth rate data less directly useful as a measure of the relative health of the Chinese economy. That's especially true because China is largely substituting U.S. oil products for those produced by other countries, so its economy is not necessarily growing as much as U.S. export data might suggest.

We can however somewhat compensate for that effect by substituting the U.S. to China oil export data from 2016 for each month in 2017, where if we do that, we find that China's economy still appears to be growing fairly robustly in 2017, if at a slightly slower pace than indicated by the unadjusted growth rates shown in the previous chart.

Year Over Year Growth Rate of Exchange Rate Adjusted Trade in Goods and Services Between the U.S. and China, January 1986 through May 2017, with 2016 U.S. oil export data substituted for Jan-May 2017 oil export data

At the same time, the growth of U.S. imports from China suggests that the U.S. economy has likewise grown through the first five months of 2017.

Data Sources

U.S. Census Bureau. Trade in Goods with China. Accessed 11 July 2017.

U.S. Census Bureau. USA Trade Online. Accessed 11 July 2017.

Board of Governors of the Federal Reserve System. China / U.S. Foreign Exchange Rate. G.5 Foreign Exchange Rates. Accessed 11 July 2017.

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July 11, 2017

June 2017 ended the best quarter for dividends in the last three years. Before getting into the tally of dividend data for the month, let's take a quick look at the number of publicly-traded U.S. companies that either increased or decreased their dividends in each month from January 2004 through June 2017 in the following chart.

Number of Public U.S. Companies Increasing (Blue) or Decreasing (Red) Their Dividends, January 2004 through June 2017

Let's get into the numbers that S&P reported for June 2017 (Excel spreadsheet), which coincidentally also marks the end of the second quarter of 2017:

  • 3,778 U.S. firms issued some kind of declaration regarding their dividends in June 2017, which is up from the 3,536 that did so in May 2017 and is also up from the 3,636 that made dividend declarations a year earlier in June 2016.
  • 26 U.S. companies announced that they would pay a special or extra dividend payment in June 2017, down from 48 in May 2017 and also down from 28 in June 2016. For 2017-Q2, 101 firms announced they would make an extra dividend payment, which is up from the 92 that did back in 2016-Q2.
  • Historically, June is traditionally the month with the fewest number of dividend increases announced during it in each year. That said, 73 firms boosted their dividend payments to their shareholders, which was down from 190 in May 2017, but up from the 70 that hiked their dividends back in June 2016. For the quarter of 2017-Q2, some 415 dividend increases were announced, up slightly from the 405 dividend increases announced in 2016-Q2.
  • In June 2017, 21 U.S. firms announced that they would cut their dividends, up from the 18 reported in May 2017, but down dramatically from the figure of 75 that was announced a year earlier in June 2016, when the tally of dividend cutting firms outnumbered the quantity of dividend increasing firms for the first and only time since the Great Recession. For 2017-Q2, there were a total of 53 dividend cuts, which compares with 2016-Q2's total of 123.
  • Seven companies simply omitted making any dividend payment in June 2017, down from the ten that did in May 2017, but up slightly from the five that did in June 2016. In 2017-Q2, a total of 19 firms passed on making dividend payments during the quarter, which was down from the 35 that did back in 2016-Q2.

Taking a closer look at dividend cuts, the pace at which dividend cuts were announced during 2017-Q2 in our near-real time sampling was similar to that of 2017-Q1, so we'll omit showing that chart in favor of showing the year over year comparison between 2017-Q2 and 2016-Q2.

Cumulative Number of Public U.S. Companies Decreasing Their Dividends by Day of Quarter, 2017-Q2 versus 2016-Q2

Taking a closer look at our sample of dividend cuts collected from dividend declarations reported by Seeking Alpha and the Wall Street Journal, we found that the oil and gas industry showed the highest level of distress, which is attributable to the decline of oil prices throughout the quarter, which negatively impacted their revenues and profits.

Sampling of Dividend Cuts by Industrial Sector, 2017-Q2

Financial industry firms combined with Real Estate Investment Trusts (REITs) to make up the second-most negatively impacted sector of concentrated distress in the U.S. economy, where many of these firms were faced with the fallout from the Federal Reserve's decision to hike interest rates in the first quarter of 2017, which was followed by a second rate hike announcement in June 2017.

The only other industrial sector that stood out as experiencing an unusually high level of distress during the quarter was chemical manufacturers, particularly those who produce agricultural fertilizers. Those dividend cut actions followed bad winter weather events in late April 2017 that harmed the nation's winter wheat crop over a four-state region that accounts for nearly 50% of its annual production.

Data Sources

Standard and Poor. S&P Market Attributes Web File. [Excel Spreadsheet]. Accessed 7 July 2017.

Seeking Alpha Market Currents. Filtered for Dividends. [Online Database]. Accessed 10 July 2017.

Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 10 July 2017.

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July 10, 2017

Over the last two weeks spanning the middle of 2017, the S&P 500 has mostly gone sideways even as its components have become more schizophrenic. The analysts at Deutsch Bank have an intriguing hypothesis about why that is (via ZeroHedge, we've added the highlighted links to the referenced figures):

Looking at the transition from "low-volatility, high-dividend shares to high-volatility, low-dividend shares", the German bank says that in recent months, shares with low volatility and high dividends are seen as alternatives to bond investment. Amid falling interest rates, risk-taking money had not been satisfied with investing only in defensive stocks as an alternative to bonds, but had also been investing in technology stocks.

Interest rates (investment yields) have trended back downward since 2H of last December, prompting greater risk-taking (see chart above), and "amid the slowdown in corporate earnings growth, the market focused on technology stocks like FAANG with robust fundamentals."

As a result, the implied volatility of technology stocks in January-May had dropped to the level of defensive stocks in early 2016. Investors who had bought defensive stocks as an alternative to bonds when yields were in decline at the start of last year could buy technology shares in terms of risk volume.

This is why tech shares offered the best return in the Jan-May period, something which as Bank of America showed yesterday has led to the best outperformance for the mutual fund industry since 2009. As shown in Figure 32, the volatility of excess returns in US technology stocks was around one-third that of defensive stocks. Technology shares had lower dividend yields than defensive stocks, but the difference was tiny, comparing with the scale of excess returns in line with price movements (Figure 32). We see that technology shares had the lowest risk and highest returns this year through May. The financial sector largely underperformed due to the low interest rate.

Inversely - and obviously - rising long-term rates have an adverse effect on excess liquidity, damaging the P/Es of US technology shares, which were in the front-line of risk-taking (Figure 31).

The FAANG stocks of Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), Amazon.com Inc. (NASDAQ: AMZN), Netflix Inc. (NASDAQ: NFLX) and Alphabet (formerly Google, NASDAQ: GOOGL) are those that had previously been driving the Nasdaq index (Index: IXIC) to record highs, which thanks to their large market caps and overlap with the S&P 500 (Index: INX), have provided momentum for that stock market index as well.

Until the last month, when the S&P 500's upward growth has largely stalled out as a result of the downward pressure provided by the FAANG stocks, which have offset positive factors that have boosted other stocks, particularly those of banks and other financial firms.

From our perspective, this dynamic is leading investors to shift their forward looking focus from 2017-Q4 toward the nearer term future of 2017-Q3, although we would estimate that they are still placing a heavier emphasis on 2017-Q4 in setting their expectations while making their investment decisions.

Alternative Futures - S&P 500 - 2017Q2 - Standard Model - Snapshot on 07 July 2017

That dichotomy is reflected in the news headlines that caught our attention during Week 4 of June 2017, where you'll see a lot of major figures at the Fed trying to push investors to look at the nearer term future, while Week 1 of July 2017 saw something of a respite. There's more good stuff at the bottom of this post, and since they're here for our historic reference, we recommend scanning through them quickly and scrolling down to the bottom....

Monday, 26 June 2017
Tuesday, 27 June 2017
Wednesday, 28 June 2017
Thursday, 29 June 2017
Friday, 30 June 2017
Monday, 3 July 2017
Wednesday, 5 July 2017
Thursday, 6 July 2017
Friday, 7 July 2017

Meanwhile, Barry Ritholtz listed the economic pluses and minuses for both Week 4 of June 2017 and Week 1 of July 2017.

Finally, just because we're now in 2017-Q3, here's what the alternative futures for the S&P 500 look like for the quarter now underway.

Alternative Futures - S&P 500 - 2017Q3 - Standard Model - Snapshot on 07 July 2017

Remember that each indicated trajectory corresponds to investors focusing upon the indicated future quarters - when they split their attention, as we believe they are now with 2017-Q3 and 2017-Q4, the actual trajectory of the S&P 500 will fall in between the two quarters.

The alternative future trajectories shown will also change as the expectations for dividends to be paid out in each future quarter change. Other than that, since we use historic stock prices as the base reference points for projecting future stock prices, we also have to take account of the echoes of their past volatility, where we anticipate that our dividend futures-based forecasting model will overshoot actual stock prices during the last week of July, and will understate future stock prices in the second through fifth weeks of September 2017.

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