CEO pay is rigged | Barry Ritholz

From Barry Ritholz:

CEO pay is rigged.

If that sounds more like a late-night presidential tweet than a fact, let’s consider the evidence.

The compensation packages of the chief executive officers of America have been rising faster than just about any rational metric upon which they are supposedly based. “CEO pay grew an astounding 943% over the past 37 years,” according to a recent Economic Policy Institute analysis. EPI further observes this was a far faster growth rate than “the cost of living, the productivity of the economy, and the stock market.”

CEO compensation isn’t the pay for performance its advocates claim. Instead, it is unmoored from any rational basis.

We may blame corporate boards for allowing this abuse to happen, a breach of their duty of stewardship, but why isn’t more being done about it?

Those in the best position to press for changes in executive pay are the giant fund companies like BlackRock Inc. and Vanguard Group Inc….. Vanguard Chairman and CEO Bill McNabb said in an interview last fall that rather than only rely on proxy votes, the firm has been pressuring companies behind the scenes to pare back outrageous packages. That approach makes sense, given that the indexing giant, for the most part, can’t simply sell the stock of uncooperative companies without uncoupling their funds from the indexes they are trying to track.

It looks like passive investing is part of the problem. Membership of an index ensures that a stock will be supported by passive, index investors. Plus boards can use stock buy-backs to support their own stock price, giving them partial control over the major performance metric on which they are rewarded.

Only active fund managers will dig deeper and rate management on their ability to create long-term value. Unfortunately their influence over stock prices is shrinking.

Source: Excessive CEO Pay for Dumb Luck – Bloomberg View

ASX 200 slows as resources fall

The Australian Resources sector has been on a tear over the last 12 months, something I was slow to pick up on. China’s PBOC stepped in to boost a slowing economy, sending property prices surging. But now the central bank is tightening monetary policy and housing price growth is slowing.

China House Prices

The ASX 300 Metals & Mining Index is losing momentum, falling below its long-term trendline. Declining Twiggs Money Flow, with peaks near zero, warns of selling pressure.

ASX 300 Metals & Mining

The fall has slowed advance of the ASX 200. Resistance at 5800 is proving stubborn. Breach of support at 5600 would complete a double top reversal, warning of a primary down-trend. But declining Twiggs Money Flow indicates no more than medium-term selling pressure at present, recovery above 5800 is more likely and would signal a test of 6000*.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Dow Jones Industrials

Dow Jones Industrial Average closed the week above 21000 for the first time. Twelve months ago the index was at 17000, an increase of 23.5 percent. Shallow retracements since then signal buying pressure, highlighted by Twiggs Money Flow troughs above zero. The latest trough, higher than zero, reflects growing enthusiasm from investors.

Dow Jones Industrial Average

Prices are rising faster than earnings in expectation of future growth. Clearly the Dow is in Phase III of a Bull Market. As I pointed out in December, this could last for several years.

Forward P/E turns back up

Dow Jones Industrials

Dow Jones Industrial Average continues to climb, heading for a target of 21000. Rising troughs on Twiggs Money Flow signal strong buying pressure.

Dow Jones Industrial Average

The S&P 500 follows a similar path.

S&P 500

With the CBOE Volatility Index (VIX) close to historic lows around 10 percent.


However, at least one investment manager, Bob Doll, is growing more cautious:

“…we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.”

Forward P/E Ratio

Bob Doll’s view is reinforced by recent developments with the S&P 500 Forward Price-Earnings Ratio. I remarked at the beginning of February that the Forward P/E had dropped below 20, signaling a time to invest.

Actual earnings results, however, have come in below earlier estimates — shown by the difference between the first of the purple (latest estimate) and orange bars (04Feb2017) on the chart below.

S&P 500 Forward Price-Earnings Ratio

In the mean time the S&P 500 index has continued to climb, driving the Forward P/E up towards 20.

This is not yet cause for alarm. We are only one month away from the end of the quarter, when Forward P/E is again expected to dip as the next quarter’s earnings (Q1 2018) are taken into account.

S&P 500 Forward Price-Earnings Ratio

But there are two events that would be cause for concern:

  1. If the index continues to grow at a faster pace than earnings; and/or
  2. If forward earnings estimates continue to be revised downward, revealing over-optimistic expectations.

Either of the above could cause Forward P/E to rise above 20, reflecting over-priced stocks.

Be fearful when others are greedy and greedy only when others are fearful.

~ Warren Buffett

ASX 200 retreats

The ASX 200 broke down below its recent consolidation, signaling another test of support at 5600. There is no indication on Twiggs Money Flow of unusual selling pressure and at present I expect support to hold.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

China: Inflation on the rise

China’s Shanghai Composite Index is approaching resistance at 3300 after respecting its new support level at 3100. Twiggs Money Flow troughs above zero indicate long-term buying pressure. Breakout would provide further confirmation of the primary up-trend.

Shanghai Composite Index

* Target medium-term: 3100 + ( 3100 – 2800 ) = 3400

The rising market is primarily a result of central bank stimulus so investors need to consider the result if this is withdrawn. Rising producer prices warn that underlying inflation is growing. If this continues the PBOC will be forced to retreat.

China: Producer Prices Annual Change

Hong Kong’s Hang Seng Index is also testing resistance, at 24000. A Twiggs Money Flow trough that respects zero would signal long-term buying pressure but that looks uncertain at present.
Hang Seng Index

Europe: Long-term buying pressure

The FTSE 100 is consolidating below resistance at 7350. Rising troughs on Twiggs Money Flow indicate strong buying pressure. Breakout above 7350 is likely and would signal an advance to 7500*. The long-term target is 8000.

FTSE 100

* Target: 7100 + ( 7100 – 6700 ) = 7500

Dow Jones Euro Stoxx 50 is similarly consolidating while Twiggs Money Flow reflects long-term buying pressure. Breakout above 3330 would signal a fresh advance with a target of 3500*.

Dow Jones Euro Stoxx 50

* Target: 3300 + ( 3300 – 3100 ) = 3500

India looks bullish

India’s Sensex is again testing resistance at 29000, while rising Twiggs Money Flow indicates medium-term buying pressure. Breakout would offer a target of 32000* but the index will first have to overcome strong resistance at its 2015 high of 30000.

Sensex Index

* Target: 29000 + ( 29000 – 26000 ) = 32000

We Are Growing Less Positive (But Not Negative) Toward Equities | Bob Doll

Great headline from Bob Doll (Nuveen Investments) latest newsletter.

Bob Doll

“….we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.”

His key points:

  • We believe investors are overly complacent about the state of the global economy and the political backdrop.

  • We remain cautiously optimistic toward equities, but think the pace of recent gains is unlikely to persist and that risks will rise this year.

Still positive on the economy but wary of the political backdrop seems a common theme among investment managers. The timing of any reversal (Doll: 2018) will largely be determined by inflation and interest rates.

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Europe: More bull markets

The FTSE 100 continues to advance after respecting its new support level at 7000/7100. Rising troughs on Twiggs Money Flow indicate strong buying pressure. Follow-through above 7350 would signal an advance to 7500*. The long-term target is 8000.

FTSE 100

* Target: 7100 + ( 7100 – 6700 ) = 7500

A weak correction on Dow Jones Euro Stoxx 50 over the last 6 weeks suggests buying pressure, also reflected by rising Twiggs Money Flow. Recovery above 3300 signals a fresh advance with a target of 3500*.

Dow Jones Euro Stoxx 50

* Target: 3300 + ( 3300 – 3100 ) = 3500

Dow and Nasdaq: It’s a bull market

The Nasdaq 100 is in blue sky territory, having broken clear of its Dotcom high at 4900. Rising troughs on Twiggs Money Flow signal long-term buying pressure. A correction to test the new support level remains likely but this is unlikely to upset the bull market.

Nasdaq 100

The Dow Jones Industrial Average is also in a bull market, headed for a test of 21000. Twiggs Money Flow troughs above zero again indicate strong buying pressure.

Dow Jones Industrial Average

The Dow Jones Transport Average is also in blue sky territory having respected its new support level at 9000. The up-trend provides bull market confirmation required by classic Dow Theory.

Dow Jones Transport Average

ASX banks lead the charge

The ASX 200 followed-through above 5750 after respecting its new support level at 5600, indicating an advance to 6000*. Rising Twiggs Money Flow signals buying pressure.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Australian banks are leading the charge, with the ASX 300 Banks Index testing 9000. A trough high above zero on Twiggs Money Flow indicates strong buying pressure. Breakout above 9000 would signal another advance.

ASX 300 Banks Index

Bank profits have declined for the last two years, but Bad and Doubtful Debt Charges are not a major cause.

RBA Chart Pack: Bank Profits and Bad Debt Expenses

The main culprit is declining return on equity as banks beefed up capital ratios and risk-weighting on residential mortgages in response to pressure from APRA.

RBA Chart Pack: Bank Return on Equity

India’s Sensex meets resistance

India’s Sensex is running into resistance at 29000, with last week’s doji candlestick indicating indecision. Twiggs Money Flow recovered above zero but has since leveled off. Breakout above 29000 would find long-term resistance at 30000 which may prove to be stubborn. Reversal below 28000 would warn of another correction to test support at 26000.

Sensex Index

Reserve Bank chief gently reproves Turnbull’s failings

RBA governor Philip Lowe told the Turnbull government to get moving on infrastructure last Thursday. From Ross Gittins:

Another point worth noting is Lowe’s implication that the budget needs to achieve balance in spite of the huge cost of cutting company tax.
….Note, too, Lowe’s reference to “achieving a balance between recurrent spending and fiscal revenue” (my emphasis).

This isn’t the first time he’s quietly taken issue with Treasury’s longstanding practice of exaggerating the size of budget deficits by lumping spending on capital works in with recurrent spending – unlike the state governments.

Borrowing part of the cost of building infrastructure that will deliver economic and social benefits for 30 or 50 years is in no way “living beyond our means”.

And, indeed, one place higher on Lowe’s to-do list than achieving budget surplus in spite of company tax cuts is the task of “providing adequate high-quality infrastructure to help our citizens be as productive as they can be and enjoy a high quality of life”.

He notes we’ve got a strongly growing population which, if we fail to invest in sufficient infrastructure, including transport infrastructure, can “impair our ability to compete and be as productive as we can be”.

It’s surprising how many people are great advocates of high immigration levels, but won’t countenance the increased spending and borrowing needed to provide the additional infrastructure – roads, public transport, hospitals, schools – used by all the extra people.

Then they wonder why our productivity performance is weak.

Productivity improvements require more than just infrastructure, but it’s a start. A modern infrastructure lowers input costs and makes industry more competitive.

Other structural adjustment, in addition to infrastructure spending, is needed to make Australia competitive in global markets instead of simply digging holes in the ground. Some day the ore and coal may run out, or demand shrink, leaving a hole in exports.

Electricity costs are one of my favorite examples, where the average retail price of electricity is almost 3 times that of the US, Canada and Mexico….and more than 4 times that of India and China. Basic input costs like this help to make economies competitive. Some may argue that Japan and Germany are successful despite similar high electricity costs, but consider how much more competitive they would be if they could match their trading partners.

Source: Reserve Bank chief Dr Philip Lowe gently reproves Turnbull’s failings

A quiet giant of investing weighs in on Donald Trump

Andrew Ross Sorkin discusses a private letter to investors written by Seth A. Klarman, the 59-year-old value investor who runs Baupost Group, a hedge fund which manages about $US30 billion:

While Mr Klarman has long kept a low public profile, he is considered a giant within investment circles. He is often compared to Warren Buffett, and The Economist magazine once described him as “The Oracle of Boston”, where Baupost is based. For good measure, he is one of the very few hedge managers Mr Buffett has publicly praised.

In his letter, Mr Klarman sets forth a countervailing view to the euphoria that has buoyed the sharemarket since Mr Trump took office, describing “perilously high valuations”.

“Exuberant investors have focused on the potential benefits of stimulative tax cuts, while mostly ignoring the risks from America-first protectionism and the erection of new trade barriers,” he wrote.

“President Trump may be able to temporarily hold off the sweep of automation and globalisation by cajoling companies to keep jobs at home, but bolstering inefficient and uncompetitive enterprises is likely to only temporarily stave off market forces,” he continued. “While they might be popular, the reason the US long ago abandoned protectionist trade policies is because they not only don’t work, they actually leave society worse off.”

Investors are hypnotised

In particular, Mr Klarman appears to believe that investors have become hypnotised by all the talk of pro-growth policies, without considering the full ramifications. He worries, for example, that Mr Trump’s stimulus efforts “could prove quite inflationary, which would likely shock investors”.

Much of Seth Klarman’s anxiety seems to emanate from the leadership style of US President Donald Trump.

And he appears deeply concerned about a swelling national debt that he suggests can undermine the economy’s growth over the long term.

“The Trump tax cuts could drive government deficits considerably higher,” Mr Klarman wrote. “The large 2001 Bush tax cuts, for example, fueled income inequality while triggering huge federal budget deficits. Rising interest rates alone would balloon the federal deficit, because interest payments on the massive outstanding government debt would skyrocket from today’s artificially low levels.”

Much of Mr Klarman’s anxiety seems to emanate from Mr Trump’s leadership style. He described it this way: “The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making.”

He also linked this point – which is a fair one – to what “Trump style” means for Mr Klarman’s constituency and others.

‘Shockingly unpredictable’

“The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty,” he wrote. “Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

While Mr Klarman clearly is hoping for the best, he warned: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

From the letter, it is hard to divine exactly how Mr Klarman is investing his fund’s money. His office declined to comment on the letter. His fund has more than 30 per cent in cash. He has lost money in only three of the past 34 years.

The New York Times

Forward P/E for the S&P 500 is falling, so I do not agree that valuations are spiraling out of control. But if, at some point, earnings take a hit, either from tighter Fed monetary policy or a trade war, then we are in for a wild ride.

I do agree that protectionism is dangerous and can lead to uncompetitive industries. Trump has to be careful not to “throw the baby out with the bath water” when abandoning international trade agreements. There are unfair elements that need to be fixed* but once these are addressed the US would stand to gain more than it gives in return.

We will have to assess the impact of tax cuts when the full proposal is on the table. At present I see some good, some bad, so am not too alarmed about the effect on the national debt. Hopefully saner heads will prevail.

But I share Klarman’s concern about Trump’s unpredictability. Though this may be exaggerated by a hostile media, we have seen enough to be concerned.

It would be wise to overestimate the abilities of some of the USA’s competitors (and some allies) and to underestimate his own. Trump faces some shrewd and wily statesmen with many years of experience to whom he must seem like a kid in short pants, full of enthusiasm and naivety. That way way we are less likely to be taken by surprise.

Source: A quiet giant of investing weighs in on Donald Trump

  • The primary source of unfairness, currency manipulation, could be minimized by negotiation of a new monetary order — governing monetary policy and exchange rates — to replace the Bretton Woods system abandoned by Nixon in the early 1970s.

Dow: Expect further advances

The Dow Jones Industrial Average respected support at 20000, signaling another advance. Probably to 21000 but it could carry as far as the upper trend channel at 22000. Twiggs Money Flow troughs above zero indicate strong buying pressure.

ASX 200

* Target: 18000 + ( 18000 – 16000 ) = 20000

ASX finds support

The ASX 200 respected its new support level at 5600. Twiggs Money Flow respected the zero line, suggesting buying pressure. Follow-through above 5750 would offer a target of 6000*.

ASX 200

* Target medium-term: 5800 + ( 5800 – 5600 ) = 6000

Europe: Footsie finds its feet

The FTSE 100 respected its new support level at 7000/7100. Rising Twiggs Money Flow indicates buying pressure. Follow-through above 7350 would signal an advance to 7500* and offer a long-term target of 8000.

FTSE 100

* Target: 7100 + ( 7100 – 6700 ) = 7500

Dow Jones Euro Stoxx 50 is a long way below its 2007 peak at 4500 but has formed a solid base at 3000. Rising Twiggs Money Flow signals long-term buying pressure, while long tails on recent weekly candles indicate shorter term enthusiasm. Recovery above 3300 would signal a fresh advance.

Dow Jones Euro Stoxx 50