Category: ALA Nano Learning 360

Purchasing Managers Index (PMI)

Every month, hundreds of economic indicators are released by various government agencies and industry organizations.  On the very first business day of each month at 10 AM EST, the Purchasing Managers Index or PMI is released by the Institute for Supply Management (ISM).  It is the official “kickoff” to the month’s economic calendar.  Wall Street analysts pay close attention to this indicator, because it can jolt the markets in a big way.  

The ISM is a non-profit group boasting more than 40,000 members engaged in the supply management and purchasing professions.  Because members are employed at all levels of the supply chain, they may have unique and early insight to a change in trends.   It is for this reason that the PMI is considered to be a leading economic indicator. 

The PMI is a composite index based on the diffusion indexes for the following five indicators at equal weights:

-New Orders (seasonally adjusted) 20%

-Production (seasonally adjusted) 20%

-Employment (seasonally adjusted) 20%

-Supplier Deliveries (seasonally adjusted) 20%

-Inventories 20%

The interpretation of the PMI is very straight forward.  A PMI index over 50 represents growth or expansion within the manufacturing sector of the economy compared with the prior month.  A reading under 50 represents contraction, and a reading at 50 indicates an equal balance between manufacturers reporting advances and declines in their business.

For the month of April, the PMI came in at 56.8%, indicating a domestic economy that continues to grow.   If you would like to track the PMI or learn more about this important leading economic indicator, I encourage you to visit the ISM website at:   www.instituteforsupplymanagement.org.

When you read about inflation in the financial press, chances are the article will reference the Consumer Price Index (CPI) that is constructed and released by the Bureau of Labor Statistics (BLS).    The CPI measures price changes for a basket of goods and services, and it is the most widely cited measure of  inflation.  It is used to adjust wages, salaries, and pensions, and it is probably one of the most closely watched economic statistics. 

CPI is released mid-month by the BLS to reflect price changes in the preceding month.  Therefore, CPI is considered to be a lagging indicator;  the economic event (inflation) may already be underway. 

To get a better understanding of future inflation expectations, investors look at something called “inflation breakeven”, which is the difference between the yields on U.S. Treasury bonds and Treasury Inflation Protection Securities (TIPS) of the same maturity.   A quick example using current data will help to illustrate the concept:

10 Year Treasury Rate as of April 18th:   2.87%

10 Year TIPS Rate as of April 18th:              .71%

Inflation Breakeven Rate:                            2.16%

In other words, as of April 18th, 2018, investors are expecting inflation to average 2.16% per year for the next ten years.   

As you can see from the chart below, inflation expectations have been rising steadily since early 2016.  The Fed watches the breakeven rate and has acknowledged it is one of their preferred metrics for gauging inflation expectations.   Looking at data from 2008 to the present, a move above 2.50% on the breakeven rate may prompt the Fed to move more aggressively in raising interest rates.  

Please note, the information contained in this segment is for educational purposes only and does not represent a solicitation or recommendation to buy any security that is mentioned.   

Thomas A. McDevitt, CFA, CFP, EA

215-990-0781

tom@phillyfinancialplanning.com

Part of being a successful investor is recognizing important inflection points in market sentiment.    When prices and valuations are stretched and you start to get stock tips from your barber, it may make sense to trim risk, raise cash, and become defensive.   On the other hand, when investors are in panic mode and selling stocks indiscriminately, it’s probably a good time to put together your shopping list and do some buying. 

Investor sentiment clearly moves in cycles and is best captured in the above graphic.

When we speak of fear and greed, a natural question emerges: Is there a way to quantify investor sentiment so as to make it measurable and meaningful across time?   The answer of course, is yes.  There are many statistics that can be useful when measuring fear and greed, including the put/call ratio, VIX, investment advisor bull/bear ratios, mutual fund flows, and many others.  

I have found that CNN’s Fear & Greed Index does a good job at capturing the most important variables pertaining to investor sentiment.   It is updated regularly throughout the course of the trading day and will range in value from 0 (extreme fear) to 100 (extreme greed).  

Below, I identify and help to explain the rational of some of the major variables that are included in the Fear & Greed Index.

Junk Bond Demand – When yields on junk bonds relative to safer bonds widens, investors are fearful of taking on additional risk.    

VIX – VIX is derived using the Black Scholes model.  Given the observed prices of puts and calls in the market, we can use reverse engineering to calculate expected volatility.  When investors are fearful, VIX will begin to rise in value. 

Put – Call Ratio – When investors are buying more puts relative to calls, they are concerned about falling prices.  Conversely, when investors are buying more calls relative to puts, they are exhibiting a higher risk appetite. 

Many years ago, Warren Buffett once said “Be fearful when others are greedy and be greedy when others are fearful.”  The same is true in 2018 as it was in 1637……..when the Tulip Mania finally peaked and then suddenly crashed.    

Please note, the information contained in this segment is for educational purposes only and does not represent a solicitation or recommendation to buy any security that is mentioned.   

Thomas A. McDevitt, CFA, CFP, EA

215-990-0781

tom@phillyfinancialplanning.com

Doubleline Capital founder and CEO, Jeff Gundlach, (aka, the “Bond King”) made some interesting comments at the 2018 Mauldin Economics Strategic Investment Conference this month, and a lot of investors took notice.

Specifically, he said that “something big” was about to happen in the gold market.  After building a huge base for the better part of five years, he continued, gold appeared to be ready to “break out” of the $1,360 – 1,400 area (this price level has proven to be prior resistance;  see chart above).  If gold indeed moved above the $1,360 – $1,400 area in the weeks or months ahead, he further commented, gold could see an explosive $1,000 point rally. 

During his presentation, Gundlach went on to show a chart that was simple and compact, but incredibly powerful.   The chart itself comes from Incrementum out of Liechtenstein, and it is our Chart of the Month. 

David Felder (of the Felder Report) recently commented that investors should avoid FANG stocks (Facebook, Amazon, Netflix, and Google) due to their lofty valuations and should instead focus on a basket of gold mining stocks which he has dubbed “BANG”.  The BANG basket represents Barrick Gold (ABX), Agnico Eagle (AEM), Newmont Mining (NEM), and Goldcorp (GG).  

Felder believes that this sector is significantly mispriced and has explosive upside potential once valuations begin to normalize.  

In his analysis of the major gold producers, he said that the discounts on this group are more significant than they were in the early 2000s, the end of the last major gold bear market.  Felder also added that the companies’ profitability is significantly better than it was at the previous market lows 15 years ago.

As a big fan of the mining sector, I would like to supplement his analysis with a ratio that I have been following for over 20 years:   the HUI-to-Gold ratio.   Basically, the idea is to value gold mining equity values in relation to gold prices.   To start, the HUI Index is the NYSE ARCA Gold Bugs Index.   It is a modified equal dollar weighted index of companies involved in gold mining. The HUI Index was designed to provide significant exposure to near term movements in gold prices by including companies that do not hedge their gold production beyond 1.5 years.

Dividing the HUI Index by the price of gold will yield a fraction that, in the last 20 + years, has ranged from a high of .62 to a low .9.   At the present time, the HUI-to-Gold ratio is .14, very close to the 20 year bottom that occurred in 2015.   Gold mining shares have rarely been this cheap in relation to gold prices, which is one reason I support Felder’s recommendation to ditch FANG and buy BANG.

The information contained in this article is for educational purposes only and does not represent a solicitation to buy any security mentioned.   Always consult your financial professional before making any investment decision. 

Thomas McDevitt, CFA, CFP, EA

tom@phillyfinancialplanning.com

215-990-0781

The Buffett Indicator is a widely used tool for the valuation of US stocks. In a 2001 interview with Fortune, Buffett stated that “It is probably the best single measure of where valuations stand at any given moment.”

When I think of the Buffet Indicator, I think of it as a “national price-to-earnings ratio”.  Instead of using the price of an individual equity in the numerator, the Buffet Indicator uses the market capitalization all stocks in the U.S. at a point in time.    

The numerator that is often used is the FRED designation for Line 41 in the B.103 balance sheet (Market Value of Equities Outstanding/NCBEILQ027S), available on the Federal Reserve website.  You can also use the Wilshire 5000 Total Market Index, which is considered to be the broadest measure of U.S. stock market values. 

The denominator is simply Gross Domestic Product (GDP), a national income figure. 

                   Buffet Indicator =  Market Cap of U.S. Equities  ÷  GDP

 As of May, 2018, the Buffet Indicator stands at 142.10%, which is the second highest value since 1950 to the present.   The chart above is provided by Doug Short, PhD of Advisor Perspectives.

Although the Buffet Indicator should not be used to make short – term investment decisions, it should give you a sense of what inning we are in the current bull market.  Based upon the latest reading, it should seem obvious that we are closer to the 9th inning than the 1st inning. 

This guest post was written by Thomas McDevitt, CFA, CFP, EA.  All opinions are his own. The above references an opinion and is for educational purposes only.  It is not intended to be investment advice.  Seek a duly licensed professional for investment advice prior to making investment decisions.