I stumbled upon a research article titled, Stuck in Part-Time Employment by Jonathan L. Willis at the Federal Reserve Bank of Kansas City. The analysis is interesting because Willis divides the labor force into 3 skill segments (low-skill, middle-skill, and high-skill) and notes the number of jobs in the middle-skill segment continues to languish below pre-recession levels while both the low-skill and high skill segments have long surpassed pre-recession highs. Willis explains the economic forces behind weak job growth in the middle-skill segment are likely structural, possibly due to advances in technology and increases in globalization.
"... the economy has five million fewer middle-skill jobs than in December 2007. If the employment growth rate over the past four years continues, it would take an additional 13 years for the number of middle-skill jobs to return to December 2007 levels. Given this long-term weakness in labor demand, elevated PTER (Part-Time for Economic Reasons) in middle-skill jobs appears to be a structural issue."
Willis goes on to contrast this with job performance in the low-skilled segment, which surprisingly maintained positive job growth during the recession. Therefore, the weakness in low-skill jobs was likely a cyclical factor, explains Willis. The level of PTER in the low-skill segment has steadily decreased during the recovery. If the labor recovery continues, PTER in the low-skill segment will return to pre-recession levels by mid-2020.
Finally, Willis notes demand for high-skill labor has been the strongest segment.
I thought this analysis was quite insightful into the dynamics of the U.S. labor market, particularly relative to the typical 2 segment breakdown of low-skill versus high-skill.
2/21/2017 0 Comments
Interesting write-up from Jeffery Kleintop at Charles Schwab titled, The market sees nothing to worry about - that might be about to change. He urges caution and sees investors as overly complacent. His reasoning stems from the upcoming political elections in Europe, mainly the French election. He goes on to explain how the markets sold off prior to the U.K. referendum and the U.S. presidential election in 2016. The following graph illustrates his thinking.
This analysis is particularly concerning to me because the S&P 500 has had a maximum intraday drawdown of only 1.9% since the election during which time the market has rallied 10.6%.
The maximum close-to-close drawdown has been only 1.4%.
2/19/2017 0 Comments
A nice article was published in The Financial Analysts Journal titled, Are Cash Flows Better Stock Return Predictors Than Profits? by Stephen Foerster, CFA, John Tsagarelis, CFA, and Grant Wang, CFA. I thought the research was insightful wanted to recap the findings here.
To summarize the conclusion of the article; cash flows are better predictors of stock returns than profits, meaning the statement of cash flows is more useful to forecast returns than the income statement. Furthermore, the cash flow statement constructed using the direct method, as opposed to the conventional indirect method, offers additional explanatory value.
To explain the analysis, the authors provided an example of a statement of cash flows using the direct method and compared this to the indirect method.
The cash flow from operations, using the indirect method, is broken down into more detail when the cash flow statement is constructed via the direct method. Subcategories of operating cash flows using the direct method are: direct business, financing, tax, and one-time items (not shown in example above). This breakdown of operating cash flows allows for an easy elimination one-time items. The authors conclude the more detailed breakdown of operating cash flows offers additional explanatory value of future stock returns not available from the indirect statement of cash flows or the income statement. Definitely worth a read for those who like getting into the details.
The banks are back on top. The financials sector is the best performing sector over the past year up 39.4%, easily surpassing the 22.8% return of the S&P.
Looking at the five industries in the financial sector, the banks rise to the top with a 46.8% return.
Even after the big rally, the S&P 1500 financial sector still sports a pretty low forward P/E ratio of 16x versus 17.6x for the S&P 500 overall. The S&P 1500 bank industry has a slightly lower forward P/E ratio of 15.7x and a healthy dividend yield of 3.3%. Looking at only the large banks, the valuation is even lower. The S&P 500 financials has a 14x forward P/E. Sources: spindicies.com & fidelity.com
The banks are well capitalized, and in a good position to benefit from a pickup in economic activity and lending. The lower valuation of the financial sector is in part due to the lower growth prospects versus the S&P 500. CFRA research puts the long-term growth rate of earnings in the financials sector at 8.1% vs 10.6% for the S&P 500. So the PEG ratios of the financials and the S&P are both right around 1.7x. According to CFRA, banks have historically traded at a 10% discount to the S&P 500 multiple.
The fundamentals for the sector are positive. Deposits are increasing and loan losses are historically low. Net interest margin for the industry is at a historically low level, but this may change as the Fed raises rates and allows its balance sheet to constrict.
Two ETFs in the sector which I would recommend are $XLF and $VFH. I prefer $VFH because it has a lower concentration of top holdings.
The economy appears to be picking up steam. The Atlanta Fed GDP Now forecast for 1Q17 GDP is 3.4%.
Let's assume the Atlanta Fed is right. Economic growth is picking up from 1.9% growth in 4Q16 to 3.4% 1Q17.
Cyclically oriented sectors of the economy may see increasing growth. All but one of cyclical sectors have all outperformed the S&P 500 Index over the past year. The consumer discretionary sector is the only laggard.
The underperformance of the consumer discretionary sector can be seen more clearly in the next chart.
What is the cause of this underperformance and is it likely to reverse? The consumer discretionary sector includes some industries undergoing significant secular shifts. For example, the retail industry has been dealing with a huge shift to online shopping at the expense of brick & mortar stores. The restaurant industry is also dealing with a drop in traffic, similar to traditional retail. The media industry has been shifting to over-the-top content delivery rather than the traditional cable bundle. Although there will be winners and losers as a result of these shifts, I don't see them as negative for the sector overall. Consumer discretionary spending should continue to have a moderately positive outlook based on growing discretionary income and a labor market near full employment. I recommend buying $XLY or $VCR to overweight the sector. Amazon, $AMZN, has the largest market capitalization in the sector, and the allocation to $AMZN is 12.8% and 10.2% for $XLY and $VCR respectively. I prefer $VCR because the concentration of the top 10 holdings is 42% as opposed to 53% for $XLY.
Michael Grove, CFA