Yesterday’s Financial Times carried the lead headline, “Recovery hopes lift stocks and bond yields.” Indeed, the Dow Jones Industrials is testing 11000 for the first time since the fall of 2008, the 10-year treasury is hovering around 4% for the first time since the fall of 2008, and oil is back to over $85 for the first time in 16 months. Even Dr. Copper, the commodity with the PhD in economics, is over $360/lb. for the first time since mid-2008, having bottomed at $124.75 on December 24, 2008.
Investors are clearly voting with their wallets, and the question before all investors is the nature of the recovery. (For a (more or less) formal debate on the issue, we encourage readers to watch the video of the steel cage match from the last Grant’s conference, featuring Jim Grant vs. David Rosenberg and wryly moderated by the FT’s John Dizard.) For today’s discussion, we focus on the basics of consumption, which still is going to account for over two-thirds of GDP. Consumption has been rising. In February, real consumer spending rose 0.3%, the sixth increase in the last seven months, a definitive trend after an extended period of declines. The bulk of the spending was on nondurables like clothing and groceries, while durables spending fell. Unfortunately this spending increase appears to be coming out of the savings rate and government transfer payments. While consumption has been rising, incomes have been flat. We had hoped to see the savings rate continue to increase as family balance sheets come in for repairs from the damage done by deleveraging and asset value declines, but it appears to have peaked: personal saving as a percent of disposable income declined to 3.1% in February from 3.4% in January and its recent high of 6.4% in May 2009. Clearly households are hopeful that current (and future?) spending can be supported by more than income. Old habits die hard.
But again, hope is in the air. The markets are hopeful that the Fed will keep the punchbowl in place, balance sheets are on the mend and the consumer can continue to be the economy’s hero. The interesting point we recently noticed on this convergence of hope is that HYG, the benchmark high yield ETF, and XRT, the ETF consisting of retail stocks, both had recent lows on March 9, 2009 (the Monday after non-farm payrolls came in at -651,000 with an ugly prior period revision, and the unemployment rate broke 8% for the first time in the cycle). Since that date both have been on a tear: The XRT and HYG have generated total returns of 136.3% and 59.0%, respectively.
How much hope is implicit in these numbers? The high yield market over that time has gone from a current yield of 17.1%, or 1420 basis points above Treasuries, to a yield of 11.5%, or 740 basis points over Treasuries (as measured by the Barclays High Yield Index). The average P/E (price/last twelve months’ earnings) of the top 11 holdings of XRT is 30.01. Abercrombie & Fitch (ANF), the second-largest holding, trades at a price of 60.9 times admittedly depressed LTM earnings. Looking forward, the stock is trading at nearly 15 times full year estimates for 2012, which is a normal trailing twelve month multiple, which we interpret as investors in ANF pricing in a recovery two years hence.
Looking at a longer chart of the retail ETF, it’s already back to near its pre-recession highs:
A quick compare and contrast session between now and the XRT’s highs of 3 years ago:
We have lost 7.8 million jobs since then (nonfarm payroll data) The unemployment rate is now 9.7% versus 4.5% Total unemployed workers are now 15.7 million versus 6.5 million Real personal income less government transfers is lower by 6.5%, or $624 billion
These are pretty rich levels, regardless of whether this recovery proves to be incipient or illusory.