Thursday, June 21, 2012

A Macro View: Michigan Inflation Expectations (17)

In one of my recent articles based on the ISM reports it used lagged linear regressions to derive at a group of stocks that should perform well in a variety of markets and especially well under rising ISM indexes (picking stocks based on the ISM Manufacturing Index with lagged indicators). This time I want to get back to exploring inflation based regressions in choosing stocks similar to the article using the PPI Index. Results from prior regressions on sector returns versus inflation indicators showed that the headline PPI had the highest degree of correlation.

But those regressions did not consider inflation expectations but just recorded levels of inflation backward looking. The University of Michigan Inflation Expectation (MICH) is one such index that takes a survey of consumers based on 1 year forward inflation expectations. Below is a graph of the MICH and CPI headline numbers and core CPI year over year for CPIs. While the MICH index shows to have a low correlation with CPI indicators, inflation expectations could exhibit a stronger predictor of stock movements as current prices are derived from the present state and also the expected state of being in the future. (Click to enlarge)

The first back-test (August 2000 to May 2012) used the 5 lag model as mentioned for the ISM reports. The results showed promise with over an 11% annualized rate of return and over 5% annualized differential return over the flat S&P index. This did mean higher volatility with bigger draw-downs and much bigger gains. But an expectation index is very unlikely to need to incorporate lags to capture delayed effects from events (changes in the index).

The second back-test (August 2000 to May 2012) (results below) used the basic Fama-French 3 factor model with the MICH index as the factor tested against. The results were an impressive 12.3% annualized return and 5.2% annualized return over the flat S&P 1500. The models sharpe ratio vs. S&P 1500 flat-weighted was at a healthy 0.46 and the simple Sharpe ratio was 0.32 during the back-test period. The mean monthly return was 1.29% vs. 0.91% for the S&P 1500 flat and median monthly return was 1.52% vs. 0.57% for the S&P 1500 flat. Stock picks below, divided by Sabrient's Strong Buy and Buy ratings, are based on results of the MICH index for April 2012 and rebalanced on June 13, 2012.
Strong Buys:
Deluxe Corporation (DLX)
Wyndham Worldwide Corporation (WYN)
Discover Financial Services (DFS)

Concur Technologies, Inc. (CNQR)
Carpenter Technology Corporation (CRS)
Helix Energy Solutions Group, Inc. (HLX)
Snyder's-Lance, Inc. (LNCE)
Newfield Exploration Company (NFX)
Norfolk Southern Corporation (NSC)
Smithfield Foods, Inc. (SFD)
Safeway Inc. (SWY)
Universal Health Services, Inc., (UHS)
The Western Union Company (WU)
Health Management Associates, Inc. (HMA)
Humana Inc. (HUM)
Masco Corporation (MAS)
Myers Industries, Inc. (MYE)

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
DFS STRONGBUY 32.83 LargeCap 99 63 79 98
DLX STRONGBUY 23.90 MidCap 64 65 28 65
WYN STRONGBUY 51.68 LargeCap 32 26 42 62

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CNQR BUY 67.75 MidCap 65 8 86 83
CRS BUY 43.90 MidCap 80 80 93 35
HLX BUY 15.28 MidCap 79 86 43 39
LNCE BUY 25.42 MidCap 43 34 46 65
NFX BUY 26.56 MidCap 52 89 65 24
NSC BUY 71.07 LargeCap 89 66 84 72
SFD BUY 20.67 MidCap 53 83 25 45
SWY BUY 17.64 MidCap 45 91 66 29
UHS BUY 39.79 MidCap 97 98 90 67
WU BUY 16.37 LargeCap 88 72 75 57

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
HMA BUY 6.51 MidCap 64 89 55 49
HUM BUY 79.32 LargeCap 89 82 77 35
MAS BUY 13.83 MidCap 39 12 61 99
MYE BUY 16.78 SmallCap 68 31 71 83

Friday, June 01, 2012

A Macro View: ISM May

Overall the ISM reports presented good news although not great with the markets reactions being overshadowed by the poor jobs reports of last week. Even though Tuesday was a light calendar day, the non-manufacturing sectors good news only translated to a slight improvement in the markets sentiment. More specifically, the good news was that the new orders index of both reports rose 2 points or nearly 2 points to 55.5 and 60.1 for non-manufacturing and manufacturing respectively. Also pricing pressures have continued to subside which is discussed below.

The headlines indexes were fair to middling even with the strong headwinds of the Euro crisis and questions about China's continuing growth. Manufacturing PMI was below the market consensus of 54 at 53.5 but on the top end of the consensus range of 51-54.5 by Econoday. The non-manufacturing index was above the consensus of 53.5 by Econoday and MarketWatch with an index of 53.7.

Even with new orders coming in strongly, employment was not for the better. Non-manufacturing dropped the most with a drop of 3.4 to 50.8 and manufacturing dipping 0.4 to a respectable mid 50s range of 56.9. Thus, the services sectors being the bulk of the economy has slowed its growth of hiring last month by respondent. One respondent said, "Reduction of excess FTE [full-time equivalent] capacity and organizational consolidation" which collaborates what the jobs reports stated as increased reliance on part-time staff. Below is a graph of the non-manufacturing employment index since December 2009 with a so-called trend line. Since January the index has trended downward and if it continues will drop below the 50 mark indicating contraction in hiring.

Prices Collapsing
The price index for both reports dropped below 50 since July 2009 at 49.8 and December 2011 at 47.5 for non-manufacturing and manufacturing respectively. The drop was most dramatic for the manufacturing sectors with the drop in the index by 13.5 and net (those responding higher prices vs. those reporting lower prices) dropped from positive 22 to negative 5. Also commodities rising in prices was surpassed by commodities down in price for the manufacturing sectors which is a rare event over the last 3 years. All these facts bring up the dreaded signs of deflation. While slow steady increasing prices are best, falling prices are not good for the economy overall. If the Fed is looking at this data, QE3 might be more attractive or necessary moving forward.

Stock Picks based on ISM Manufacturing Index with Lagged Indicators
The regressions used this time was a continuation of the formulas used from the last report in April but corrected some data issues with the data base. The results were much better than the last backtest results with about a 5% higher annualized rate of return than the flat-weighted S&P index and nearly a 12.5% annualized return. The results showed no overlapping stocks with the last pick selections but on the other hand the turnover rate during this backtest was 7.5% or lower per quarter. Which means that even though turnover was low it did not correlate with the last stock picks. The list below is also filtered by Sabrient's rating system of Strong Buys only. These choices should outperform the market and do especially well if the manufacturing sectors perform well over the next 6 months.
Cascade Corporation (CASC)
Deluxe Corporation (DLX)
Helix Energy Solutions Group, Inc. (HLX)
MarineMax, Inc. (HZO)
Masco Corporation (MAS)
Protective Life Corporation (PL)
SYNNEX Corporation (SNX)
Tyson Foods, Inc. (TSN)
Wyndham Worldwide Corporation (WYN)

New orders gaining momentum should propel the overall index higher for the near future as well as the stock picks above. The strength in new orders must be mostly from domestic sources as new export orders dropped significantly with a drop of 5 for non-manufacturing and 5.5 for manufacturing. Both export indexes stayed above the 50 mark with manufacturing at 53.5 and non-manufacturing at 53 which shows growing export orders but at slower pace. Respondents comments were mostly favorable including Anthony Nieves from the non-manufacturing report stated, "The majority of the respondents' comments are positive and optimistic about business conditions and the direction of the economy."

ISM Non-manfucturing Addendum: 24 Stocks...
In the last post (9 Stocks That Should Perform Well When The ISM Index Rises) about the ISM reports for May, I included the results from regressing stock returns in the S&P 1500 versus the ISM manufacturing report headline index (PMI) with 5 additional factors being 5 lags. This post will present some of the findings based on the non-manufacturing ISM report.

Since the Institute for Supply Management has only recently presented the composite index (NMI) since 2008, it limits the ability to back-test over the desired 10 year duration. The underlying indexes have been supplied since around mid-1997 so a composite index is possible to derive from the data as the ISM states.
The new Non-Manufacturing Index, NMI, consists of:
Business Activity 25%
New Orders 25%
Employment 25%
Supplier Deliveries 25%

I ran two regressions from mid-2000 to May 2012 using the four indexes above and adding the price index. The price index would be the most likely to be non-linear and in any case we would expect a negative correlation with the market overall. The second regression I ran used the composite along with the 5 underlying indexes and achieved a 10% annual gain. Good but inflation being mixed in with the other with opposite expected signs could have limited its forecasting abilities.

The first regression used the 5 indexes and then added the business activities index again, which essentially doubled its input. The results were better with returns closely matching the ISM manufacturing at 12% annualized returns. Below are some of the picks from the first regression with the first set being Strong Buys rated by Sabrient Systems.
Cascade Corporation (CASC)
Deluxe Corporation (DLX)
Helix Energy Solutions Group, Inc. (HLX)
MarineMax, Inc. (HZO)
Masco Corporation (MAS)
Tyson Foods, Inc. (TSN)
Wyndham Worldwide Corporation (WYN)
As expected the results from manufacturing and non-manufacturing would overlap and the above list is simply a subset of the manufacturing list enumerated in the last blog post of Strong Buys from Sabrient Systems. The list below are Buys as rated by Sabrient Systems derived from the above regression.
Crocs, Inc (CROX)
Coventry Health Care, Inc.(CVH)
The Hartford Financial Services Group, Inc. (HIG)
JetBlue Airways Corporation (JBLU)
M/I Homes, Inc. (MHO)
Prudential Financial, Inc. (PRU)
PrivateBancorp, Inc. (PVTB)
Select Comfort Corporation (SCSS)
Skechers U.S.A., Inc. (SKX)
Wynn Resorts, Limited (WYNN)
Caterpillar Inc. (CAT)
Health Management Associates, Inc. (HMA)
Humana Inc. (HUM)
Myers Industries, Inc. (MYE)
Norfolk Southern Corporation (NSC)
Smithfield Foods, Inc. (SFD)
Stone Energy Corporation (SGY)

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CAT BUY 83.26 LargeCap 77 92 81 36
HMA BUY 5.99 MidCap 60 94 57 32
HUM BUY 77.12 LargeCap 85 82 67 44
MYE BUY 16.46 SmallCap 61 33 53 87
NSC BUY 63.69 LargeCap 86 73 81 61
SFD BUY 19.09 MidCap 62 82 34 39
SGY BUY 21.61 MidCap 52 66 48 44
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hma cat mye hum nsc sfd sgy
Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CROX BUY 16.10 MidCap 79 58 75 40
CVH BUY 30.46 MidCap 89 71 72 65
HIG BUY 16.10 LargeCap 58 97 27 10
JBLU BUY 4.93 MidCap 98 91 89 83
MHO BUY 12.69 SmallCap 56 25 43 90
PRU BUY 44.75 LargeCap 61 97 36 29
PVTB BUY 13.39 SmallCap 71 50 47 80
SCSS BUY 25.71 MidCap 98 64 79 66
SKX BUY 16.49 SmallCap 81 58 53 83
WYNN BUY 98.17 LargeCap 63 59 80 43

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CASC STRONGBUY 43.80 SmallCap 98 94 92 47
DLX STRONGBUY 22.38 MidCap 59 67 25 56
HLX STRONGBUY 15.83 MidCap 84 86 55 33
HZO STRONGBUY 9.04 SmallCap 41 8 55 96
MAS STRONGBUY 11.73 MidCap 40 13 60 100
TSN STRONGBUY 18.59 LargeCap 60 60 36 49
WYN STRONGBUY 47.59 LargeCap 48 34 46 68

Econoday Report: PMI Manufacturing Index June 1, 2012

PMI 54
Non 53.5

Symbol Rating Price* Market Cap Sabrient Scores
Composite Value Growth Momentum
CASC STRONGBUY 43.80 SmallCap 99 93 91 51
DLX STRONGBUY 22.38 MidCap 60 67 25 57
HLX STRONGBUY 15.83 MidCap 86 86 54 44
HZO STRONGBUY 9.04 SmallCap 41 7 56 97
MAS STRONGBUY 11.73 MidCap 39 15 60 99
PL STRONGBUY 24.98 MidCap 96 78 73 95
SNX STRONGBUY 32.72 MidCap 91 88 75 37
TSN STRONGBUY 18.59 LargeCap 60 58 37 51
WYN STRONGBUY 47.59 LargeCap 47 37 45 63

Cascade Corporation (CASC)
Deluxe Corporation (DLX)
Helix Energy Solutions Group, Inc. (HLX)
MarineMax, Inc. (HZO)
Masco Corporation (MAS)
Protective Life Corporation (PL)
SYNNEX Corporation (SNX)
Tyson Foods, Inc. (TSN)
Wyndham Worldwide Corporation (WYN)

Calculated Risk: ISM Non-Manufacturing Index indicates slightly faster expansion in May

Service Companies Grew at Faster Pace in May | Business |

Calculated Risk: ISM Manufacturing index declines in May to 53.5

America’s jobs crisis | Felix Salmon

New Hires Getting Left Behind on Pay - Real Time Economics - WSJ

Misc Links:
The Capital Spectator: A (Partial) Antidote For Today’s Disappointing Jobs Report

What the Jobs Report Means for the Fed -

A Lagging Recovery -

Even Mediocre Job Growth Coming From Wrong Places - Real Time Economics - WSJ

Broader Jobless Rate Jumps to 14.8% - Real Time Economics - WSJ

Economists React: ‘What a Jobless Recovery Looks Like’ - Real Time Economics - WSJ

CARPE DIEM: Today's Employment Report

Unemployment Rate Rises to 8.2% Over Eurozone Fears | Business |

America's flagging recovery: Third time unlucky | The Economist

America’s jobs crisis | Felix Salmon

The Capital Spectator: Another Month Of Slow Job Growth In May

Calafia Beach Pundit: Jobs growth still moderate

David Smith's Weak data everywhere

Calculated Risk: Trulia: Asking House Prices Unchanged in May

TaxVox » Blog Archive » Billions in Tax Refund Fraud–and How to Stop Most of it

Greg Mankiw's Blog: Barro on the Slow Recovery

Calculated Risk: CoreLogic: House Price Index increases in April, Up 1.1% Year-over-year

Environmental and Urban Economics: The Rural Windfall from Leasing Land to Energy Extraction Companies

Culpability: Is it Barack Obama's economy? | The Economist

CARPE DIEM: The Dakota Model: Booming North Dakota Led the Country in 2011 with Real GDP Growth of 7.6%

Vital Signs: Falling Factory Orders - Real Time Economics - WSJ

Calculated Risk: WSJ: Spain Warns of Losing Access to Markets for Borrowing

Teachers and Income: What Did the Kindergarten Study Really Find?, Bryan Caplan | EconLog | Library of Economics and Liberty

Bruce Bartlett: Rich Nontaxpayers -

CHART OF THE DAY: Here's The Real Reason Obama's Poll Numbers Are Crashing - Business Insider

Why the Euro Zone Could Unravel Shockingly Fast | Business |

Stumbling and Mumbling: Is equal opportunity feasible?

The Danger of External Debts - Philipp Bagus - Mises Daily