Dave Gonigam – February 21, 2012
- Reality sets in at last: Another Greek bailout… but no hard rally. What gives?
- Obscure but vital indicator going parabolic: Chris Mayer with “one heck of a scary chart”
- Another ominous chart: Abe Cofnas on why stocks might be getting ahead of themselves
- The litigious society: $19.5 million award for misusing exercise equipment, $750,000 sought for “improper law school admission”
- Avoiding a double-dip… a gold coin quip… an email rumor clarified… and more!
It’s come to this: No one’s impressed by the latest Greek bailout.
Another $170 billion in debt so Greece can keep up payments on (some of) the debts it took on previously? “Bailout Just Buys More Time,” according to a headline at The Wall Street Journal.
Even some of the eurocrats themselves are starting to get it: The Financial Times got its hands on a memo that’s been making the rounds in the last week.
“It warned,” reports the salmon-colored rag, “that two of the new bailout’s main principles might be self-defeating. Forcing austerity on Greece could cause debt levels to rise by severely weakening the economy, while its €200 billion debt restructuring could prevent Greece from ever returning to the financial markets by scaring off future private investors.”
Thus, an underwhelming response in the markets: The Dow is up 50 this morning, cresting 13,000 for the first time since 2008. But last fall, a deal like this would have been good for 300 points.
European stocks actually sold off — which CNBC chalks up to profit-taking, natch.
It took two years, but the crowd is finally figuring out that Greece isn’t fixed, and isn’t going to be fixed. Thus, The 5 forges ahead to seek out new outlier territory.
“This is one heck of a scary chart,” says Chris Mayer.
Before we reveal it, however, some background: The chart depicts “return on equity” — a helpful yardstick that demonstrates profit margin isn’t all it’s cracked up to be.
“Let’s say a company has $10 in sales and earns one dollar,” says Chris by way of example. “We would say that the company has a 10% net profit margin. But what’s really important is how much capital it took to generate that dollar.”
“Take two businesses. One has equity invested of $5, and the other has $15. Neither has any debt. Both generate $10 in sales and both generate $1 in profits, for a 10% profit margin.”
“But the return on equity (ROE) of the first business is better, at 20% ($1 divided by $5) compared with the second, which is 6.7% ($1 divided by $15). So you see that the profit margin itself tells only part of the story. All other things being equal, the market pays up for the higher ROE.”
With that in mind, witness the return on equity for the market as a whole, both for the U.S. and for the world. “It’s been rising as if shot out of a cannon,” says Chris.
“It’s not a perfect indicator,” Chris hastens to point out. “The market peaked in March 2000, well ahead of the peak in ROEs. The market also bottomed ahead of the bottom in ROEs.”
“But the scary part of the chart is where we are now. In January 2012, we sat at a peak not seen since the 2000 peak. We are way above the long-term average.”
Chris says there are three ways to drive ROE higher: “You can take on debt, you can raise profit margins or you can increase your asset efficiency (do more with fewer assets). In the U.S., it’s the latter two that drove ROE higher lately. But it certainly will be tougher to make similar gains in 2012 — especially with the macro risks hanging out there.” Like Europe.
“I think it is safe to say it is unlikely that ROEs can climb much further or for much longer. It seems unlikely they can stay here for very long.”
That makes this a stock-picker’s market. Fortunately, Chris has some favorites right now — like this one.
“The S&P 500 is likely to be in play over the next two weeks,” warns our monitor of market sentiment Abe Cofnas.
He’s been eyeing the S&P relative to the Bloomberg Financial Conditions Index. The BFCI monitors stress in the U.S. markets. It tracks money market spreads, bond market spreads and assorted stock market indicators… and how far they deviate from historical norms.
Here they are plotted together on a chart. “Pay special attention,” says Abe, “to the huge spike down in the middle. That’s the financial collapse in September 2008.”
“As you can see, for the most part, there is a close co-movement. What’s interesting is when it diverges from being a coincident indicator.”
“Right after the ’08 collapse, the S&P 500 actually lagged the BFCI. This showed the market sentiment was oversold or too pessimistic.”
“This time we are seeing something very different. The S&P 500 is probing resistance levels, but the BFCI is not. This indicates that the crowd’s sentiment is too optimistic — or at least is not being confirmed by financial conditions.
“The takeaway from this divergence is that the S&P 500 price action is not sustainable. In other words, get ready for a change in expectations.”
Precious metals are moving up strongly as the holiday-shortened week begins. Gold has reclaimed $1,750 — currently at $1,752. The bid on silver is up to $34.09.
Oil is holding its own at $104.85 after moving up in thin holiday trading, driven once again by headlines from Iran. Iran suspended oil sales to Britain and France yesterday — a “so there” move ahead of a European embargo on Iranian oil that takes effect in July.
Meanwhile an Iranian military commander is making noises about preemptive moves against “our enemies” if the government feels its interests are threatened.
One thing’s for sure: If the atmosphere remains this tense for months to come… and oil prices stay this persistently high as a result… it will mean windfall for U.S. energy producers even bigger than the one Byron King already foresees.
The Federal Reserve is out with its two most reliable recession indicators… and both continue to point away from a double dip…
- The Chicago Fed National Activity Index is signaling weak growth. The number fell slightly last month, but its three-month average continues to inch up and now stands at its highest level since last March
- The Philadelphia Fed State Coincident Index slumped in December from 78 to 64… but it’s still well above the 50 level that historically signals a recession.
For whatever reason, we have a bulging file of, um, interesting lawsuits this morning.
Cybex International, the maker of fitness equipment, has agreed to pay $19.5 million to a Natalie Barnhard, a woman from New York State who was paralyzed when she was crushed by a leg extension machine.
Sounds straightforward enough. Except Barnhard is a physical therapist… who thought the machine was for shoulder stretches.
The settlement was less than the $44.5 million Barnhard won in court last November. “If you look at [Cybex’s] balance sheet and see what payment of the full judgment would have done to it, bankruptcy was a real possibility,” says her attorney Kevin English. “Natalie’s a great person. She had no desire to force a bankruptcy.”
All told, it’s been a rotten couple years for Cybex CEO John Aglialoro. He’s the fellow who backed the movie adaptation of Atlas Shrugged.
Despite a box office take that recouped not even half of the production costs, he’s moving ahead with plans to film the second installment of a planned trilogy. Release is tentatively scheduled for this coming October.
For a truly awesome moment in the law, however, we turn to the case of Morgan Crutchfield. She’s a law student in Tennessee who’s racked up $80,000 in education debt.
In a suit filed last week, she claims her school should have never admitted her.
The Duncan School of Law accepted her even though she had not completed her undergrad degree… and is thus ineligible for the bar exam.
She won’t have her bachelor’s from Lincoln Memorial University till June. “Plaintiff has, however,” according to the complaint, “completed 54 hours of law studies credit, obtained and used $79,560 of student loans and expended 2½ years of her life during her law studies.”
Crutchfield is seeking $750,000. The mind boggles…
“The $20 Double Eagles found in the ceiling in France made me think,” writes a reader after Friday’s issue.
“If those coins were Spanish doubloons, would Spain have come in with a restraining order claiming that they had salvage rights?”
The 5: Ha! As long as you’ve brought it up, the sordid case of Spain’s legal looting of Odyssey Marine is ending with a whimper this week.
“Spain said Monday that it will soon send hulking military transport planes to Florida,” reports the Tampa Bay Times, “to retrieve 17 tons of treasure that Tampa-based Odyssey Marine Exploration found but ultimately lost in U.S. federal courts.”
A federal appeals court dealt the final blow earlier this month.
“Did you know that if you sell your house after 2012, you will pay a 3.8% sales tax on it?” writes a reader passing along a persistent email rumor.
“That’s $3,800 on a $100,000 home, etc. When did this happen? It’s in the health care bill and goes into effect in 2013.”
“Why 2013? Could it be to come to light only AFTER the 2012 elections?”
“This bill is set to steal from the retiring generation who often downsize their homes. Does this make your November and 2012 vote more important?”
The 5: Well, seeing as the last time we knocked this one down was nearly 18 months ago and our readership has grown 20% in that time, it’s worth another go.
Yes, come next year, there’s a new 3.8% tax on the investment income of couples earning more than $250,000 a year ($200,000 for singles). However… it does not apply to the first $500,000 of profits from the sale of a personal residence ($250,000 for singles).
So it’s an “eat the rich” measure. Which makes it no less an outrage… but its effects won’t be as widespread as chain emails would lead you to believe.
As always, consult your own tax pro before making any decisions. (No, the lawyers didn’t tell us to say that, but it seems prudent anyway.)
Regards,
Dave Gonigam
The 5 Min. Forecast
P.S. “Oil didn’t hit $103 by accident,” a reader wrote in over the weekend. “Abe Cofnas recommended the weekly $101.25 oil binary contract (long).”
“I got into the trade for $36/contract on Monday and came out with $100/contract on Friday. And no, I did not sell half of my position on Wednesday. Thanks Abe!”
Indeed, Abe’s readers had a terrific week last week. Following his guidance, they had a chance to collect 116% on oil, 15% on Germany’s DAX index and 25% on the Australian dollar… a combination far outweighing a loss in a gold play. And all of that played out in four days or less.
We’re getting closer to reopening membership in Abe’s trading advisory, Fear & Greed Trader. Watch this space.