of Bonds commanding a premium over Stocks. This being reflected
by an Earnings-yield to Bond-yield ratio greater than one. I used
the PPI(all commodities) to CPI ratio, as means of verification.
There are some powerful investment implications.
Courtesy of BigCharts.com
The chart above is that of the Consumer Discretionary sector
(XLY) vs the Basic Material sector(XLB).
The out performance of the XLB over XLY is dramatic. This is also
a logical extension of the relative performance of PPI over CPI.
Nonetheless, the Consumer sector participated very nicely in this
bull market. Until recently, that is.
Courtesy of BigCharts.com
The chart above is that of the Consumer Discretionary sector
(XLY) vs the S&P-500 Index.
Notice how, despite an extraordinarily impressive climb in the
Stock Market, The XLY has failed to reached its recent high.
This is an ominous sign, suggesting a dangerous change.
I believe that Profit Margins on the most heavily
weighted sectors of the Economy (consumer-oriented)
are about to start declining.
Source: FRB St. Louis
The chart above is that of After-Tax Profits as percent of GDP.
Notice the cyclical nature of this series and the extreme
valuation
Several factors have contributed to this unusual high level
of Profit Margin, including outsourcing, companies hiring
reluctantly, growth abroad, an increasing Capacity Utilization
and a soft US Dollar, to name a few.
The chart above is for a more recent period. After-Tax Profits as
percent of GDP is plotted vs Capacity Utilization divided by
the US Dollar Index(CU/USD).
The Capacity Utilization has been increasing for years.
The US Dollar has been declining for years. Both factors
are well known for their contribution to profits. A reversal
in direction of either one, is not unlikely.
For many investors, it will not be easy to conceive the US Dollar
rallying, or the Capacity Utilization declining significantly.
They would conclude that the CU/USD ratio will not decline.
Those investors should contemplate the chart below.
Source: FRB St. Louis.
The chart above is that of the CU/USD vs the PPI/CPI ratio.
Generally speaking, the PPI/CPI ratio is cyclically moving
directionally in tandem with the CU/USD ratio. As I explained
here, an increasing PPI/CPI ratio will eventually put
a squeeze on profits of the consumer oriented sectors.
So it seems to me that, Profit Margins decline no matter what
happens to the CU/USD ratio.
There is little evidence indicating a reversal of Profit Margins
at this point. The charts above just show the extreme
valuation of this metric. But if I am right, then the
relative weakness shown by the Consumer
Discretionary sector is an early warning.
