High taxes like new Dutch Disease bad for equities (JP Morgan)

JP Morgan had a report (Impact of Tax Rates on Stock Market Returns) how bad it is when you raise taxes. So Obama remaining in power should mean S&P 500 -7 to -14% and Romney +7 to +14%. [PV: history learns that when a democratic president is re-elected that lead to a rise of 20% of the S&P on average] The authors of JP Morgan doesn’t seem to be friends of Obama.

There are reasonably strong relations between higher taxes and more progressive taxing and bad equity returns according to JPM .

If you hike taxes on incomes and makes the system more progressive you could end up like the Netherlands: -5% each year for the S&P.

The returns of the Netherlands could have been worse when the Dutch didn’t had such a favourable treatment of taxes for business (chart below).

At the moment the US scores average for income tax and bad for business taxes.

The results are not that convincing: one could say that the bad results are caused by geography: maybe the Euro crisis produces all the bad returns, not the tax system.
Still, the tax influence seems to be pretty big and then one could better invest in Chile and Poland

The world gets less black: buy

The chart above was yesterday very popular to show too many people are bearish. That could be very well true.

The S&P has not reacted favourably enough on the accelerating credit growth in the US (despite the four big banks where credits declines, so the smaller banks are clearly giving credits) (chart of Bianco).

The help from lower oil prices to the real retail sales (especialy cars of course) and so to the initial claims seems underappreciated.

The comments of Morgan Stanley that the Euro crisis is getting less black is very positive for risk on. It is strange they say it is not a tradable rally because problems are not over, it is still black. Minack should know better: when it gets less black it is bullish. So don’t say it gets less black unless you are becoming bullish or less bearish. Now he is only describing how big the wall of worry is.

The mini cycle of the SP500 : 2012=2011=2010

In the chart the S&P500 is indexed with itself 13 and 26 months ago.
Then you see the regularity of the mini cycle for the S&P500: what a resemblance with 2010 and 2011!
The bears will get their best times only around August, maybe already at the end of May/June when the resemblance will stay strong (it probably will be not as strong as the chart let you believe).
Now the attention is focused on the resemblance with now and 2011, but the comparison with 2010 would be stronger according to me.
By the way, the comparisons with 2010 and 2011 learn that the current correction could be over soon.

ISM and SP500

The last years, after 1998 and especially 2007, the S&P500 rose (and declined) often in line with the ISM. On a yearly base the correlation is high. Deutsche Bank’s Jim Reid and Stephen Stakhiv concluded from the relation between the ISM and the S&P (I took their idea via FT Alphaville and made the charts above) that the S&P is still somewhat undervalued (and in this case that means it offers some hope you can profit from an undervaluation).

For timing for selling equities the indicator was sometimes a disaster: you became optimistic in 2008. For the timing of buying equities it looks somewhat better. At the end of 2002/start 2003, in 2009 and at the end of 2011 you saw equities were way to cheap. Since 2009 it is doing pretty well (no guarantee for the future).
It is clear you mainly can profit when you can forecast the ISM well, then you have some clues where the S&P will go. Especially when you see the ISM dive below 48 for some protracted period you can better say goodbye to equities, but when you see that the ISM will recover distinctively that is a powerful signal to buy equities (when your forecasts are really good).

Unfortunately it is very hard to forecast the ISM (the efficient market forces this: you can earn too much money from forecasting well the ISM, so there is arbitrage to the best ISM consensus models that are hard to beat)
It is not always impossible to forecast the ISM. After 2008 the ISM followed pretty well the average of the preceding seven recessions (as I blogged on the sister blog Beleggen op de golven until the end of 2011). Now we are too far in the cycle and I have another forecasting model. That is doing a reasonable job, but is far from perfect.

Nikkei follows US interest rates

No equity market (including the S&P500) follows so slavishly the US interest rates as the Nikkei Dow Jones. When the yield on 10 year Treasuries risies with 0.01%, the last years the Japanese equities rise on average 0.17% (above the normal rise of about 3% in six months).

So when you make the forecast that the (US) interest rates will rise you also forecast that equity market will go up (17 times as fast in Japan and about 12 times as fast in the US for example)

It looks like we have seen the best of the rally in the past months in Japan. When the Japanese equity market cannot follow enough the rise of US interest rates you often will see troubles. That is a bit odd, when equities seem to cheap you should sell. The reasoning behind that is the rule that when markets no longer react on good news you have to sell (and the other way around).

Amlan Roy(2): the demographic trend of PE’s

Yesterday Amlan Roy was in and enthusiastically he commented in very high pace every chart of his 70 page presentation.
The most popular chart probably is the expected development of the PE of the S&P500 according to the relative development of age cohorts. When you believe this our pessimistic Kondratieff chart ill be too optimistic (the decline will last longer).
The decline of the PE’s will be caused by retired baby-boomers selling ever more desperately their equities to the much smaller younger saving age cohorts.

Amlan Roy thinks just like me that the decline of the PE’s will be smaller because people will have to work to a higher age and will sell equities at a higher age than the Miller Modigliani Doctrine prescribes to get a less miserable income at their old day.

Siegel thinks it will not be that bad because foreigners will buy US equities at a very big scale. There is no choice for foreigners, they have to buy US assets as long as the current account is negative (by economic definition that is true). Foreigners until now choose overwhelmingly for fixed income with its very low interest rates, but the preference can go more into the direction of equities. At the moment you can buy equities that are maybe safer than government bonds with dividend yields of 3 to 4% like Exxon and McDonalds. That looks a lot more attractive than 10 year treasuries with their paltry yield of 2%.

By the way, the correlation between relative development from cohorts of relative dissavers versus savers is not so strong in Europe. That is because the elderly in Europe don’t possess as many equities as in the US, so their liquidating of equities will not hurt so much.

Barrons (Siegel/Epstein): Dow 15,000

Gene Epstein had this week the honour to write the cover story of Barrons. As usual he had something bullish to tell: Enter the bull; Dow 15,000.


For this forecast he leans on Siegel (writer of Stocks for the Long Run). He has, as is so often the case vexed the numbers of the S&P500 since 1871. After cycles of five year with disappointing returns you normally get good returns. That is now the case. Epstein/Siegel see with 2/3 probability the Dow rising above 15,000 in the coming two years and with 50% probability above 17,000.

Siegel thinks that will be possible even when you get almost no profit growth. The big sorrows (the Euro crisis and the American fears for a recession) will gradually diminish. Siegel thinks 10-15% rise of the S&P as too pessimistic, he goes for 20%+.

These forecasts are not at all very optimistic (when the consensus is right at 15,000 the PE will only be 12.8), but lots of people will use the cover of the Barrons and say that you have to go short based on the contrarian cover theory (when something is at the front page of an important journal the trend is at its highest point and will go in the other direction; so now the Barrons is overoptimistic and that has to be punished by the markets).

Dow 15,000 is a quite modest target. We have had bestsellers with Dow 36,000 and 100,000 at the cover. Because since then the Dow has plummeted nowadays everybody is too much of a coward to impress with a Dow at e.g. 25,000 or 50,000 in 2018 even while that is possible. For 25,000 you don’t need much, only about the current profit margins, continuing implementation of innovations and nice growth in the Emerging Markets.

McClellan Market Report sees lower markets until June because of dollar commitments of traders position a year ago (PragCap)

Based on the commitment of traders analysis of the Dollar the McClellan Market Report (hat tip Pragmatic Capitalism http://pragcap.com/big-stock-market-top) predicts that we will see a correction in the S&P that will last until June and then the S&P should ascend to heaven.
Since the credit crisis this was an incredibly good predictor, but I can’t make the story why with a lag of a year it is saying so well what the S&P should do. Correlation is no causation, so take care with the signal.
Still it is curious it is doing so well and some people take the signal serious since some time.

Kostin (GS) sees S&P500 at 1325 with low low volatility

Kostin of Goldman Sachs still cannot be persuaded to go for higher targets for the S&P at the end of 2012. Het thinks PE’s will not change much, in the short run they can rise a bit and then they can go don somewhat. Profits in the US can rise with 3% in 2012. So PE’s and profits are not pointing to an exploding or imploding S&P500.
The macro fundamentals are getting more encouraging for the US, 2% GDP growth should be possible. With the help from central banks liquidity has gone up and so volatility is forced lower for equities (VIX). That should mean that PE’s can rise in the short term.
Later in 2012 the profit margins will decline and that should lead to lower PE’s as he thinks (and when true should be normal).

The chart with the equity risk premium (ERP) shows that equities have been too cheap in Q3 2011 and that GS thinks on the short run the ERP will improve to what has been average since Lehman. The ERP will move with the profit margins and these will deteriorate in H2 (GS). The top down estimates are pretty much n step of what GS (Kostin) thinks and the market has that priced in (not the bottom up forecasts).
This can surprise a bit to the upside, especially when volatility will remain low and then PE’s can be a bit better than Kostin calculates.

Golden Cross S&P: most of the time favourable

The past years we had a few times a death cross and that originated prophecies of very bad times for equities that not came trough. Now we have had a golden cross for the S&P500 and as the name indicates that promises golden mountains for the equity markets. The 10 week average is again above the 40 week average. It should be better when the 40 week average was in a rising trend but that is not yet the case.

In the table you can see that since 1948 and especially 180 a golden cross is often followed by rising share prices. It is not a very reliable signal, so much is the probability of rising equity markets not going up (that probability is almost always above 50% for longer periods).
Source table: Bianco

American pension funds will invest more in emerging markets and hedge funds

Deutsche Bank held under a big number of US pension funds a poll what asset categories will be expanded in 2011 (or sold).(with $1200B assets).
The bull market for emerging Markets should continue. Also hedge funds can enjoy a lot more money in 2011 (you don't know what you get in a hedge fund, but they promise to deliver absolute returns and that is what is en vogue). Also private equity can enjoy better times.
For US equities the prospects are not so good and also long Trashuries are not popular, but Treasuries will get support from Solvency II.
Remarkable is that gold is becoming less popular and commodities more popular, while the diversifying properties of gold are the last quarters hugely better than for commodities (they follow Chinese equities).

Barron's: people too afraid for rising bond yields and not afraid for equities

the most emailed article of the investment journal Barrons was: In Love With Stocks Again. Steve Sears demonstrates that equity investors are falling asleep. In a vry short period the risk premium of equities has evaporated if you take for that the difference between the pricing of puts and calls (puts no longer way too expensive compared to calls, see chart part skew). Also the implied volatility (CBOE volatility VIX) has gone down to rather low levels. Also the buying of the number of puts versus calls has gone down(differently than in the Netherlands, but that is closer to the Euro periphery than for Americans). Sears interpretes that positively that equities love equities again, but normally you must take this kind of articles as a contrarian indicator.

In e.g. the article Double Hex they are very pessimistic (fortunately) about the coming monetary tightening in China, the vanishing of profit margins on steel and the slowing down of growth in Germany and the rest of Europe on the high euro.

The most curious article was: "Why higher bond yields aren't bad for bonds".
I dont know what can be worse for bonds on the short run than than higher bond yields. The writer of the article knows that higher yields mean lower prices, but he remains in love with bonds. Preferrably long dated municipality bonds. But also credits, especially high yield (with exception of the worst C ratings, something I agree with him) is his first choice.
The writer is right that when the rise of bond yields goes only very slowly or about as fast as implied by the yield curve, that a rise of bond yields is favourable for long term bond investors (and certainly for pension funds that calculate its liabilities at current (swap or bond) yields).
But he supposes yields will go up because economic growth will recover(he prefers high yield). If that is the case, then the Fed will stop with QE2 and people will worry about exit2. Chartists already see higher lows in bond yields and around April we had much higher bond yields than now. Bond yields can easily surpass the April highs when the market doesn't see QE3 arriving. In that case bond yields will rise much faster than the yield curve priced in and bond investors will regret they haven't invested in equities (or for the prudent ones in convertibles). So, buying bonds because you see rising bond yields is utterly nonsense.