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Along with the recovery in the housing sector, the American economy has also seen a sharp rebound in the auto industry, another major employer. The biggest factor in the optimism for 2013 U.S. auto sales is the advanced age of so many of the 245 million cars and light trucks now on the road. The average car on the road in the U.S. is now a record 11 years old, industry executives say and about 20% are 16 years old. When customers wheel their rattletraps into showrooms, they’re also finding credit is relatively cheap and available. Banks that weren’t financing are financing now. A third engine for U.S. auto demand is a volley of new cars and trucks that offer customers significant advances in fuel efficiency, safety and entertainment technology compared with cars made 4 or 5 years ago, let alone 11 years ago.
This has been a huge benefit for Canada as well as the pent-up demand in the U.S. market is leading to a resurgence here, since the U.S. is the destination for about 80 per cent of the vehicles put together by the five auto makers that operate assembly plants in Ontario. The rebound is finally leading to new jobs in the industry in Canada after auto makers and parts companies hired only grudgingly in the slow recovery after the industry bottomed out in 2008-09 and Chrysler LLC and General Motors Corp. went into Chapter 11 bankruptcy protection. Hiring is now picking up speed along with the recovery.
Central banks all continue to do their part in turning around financial markets. Recent announcements from the world’s major central bankers all continue to support easy economic policies, including record-low interest rates and more credit availability, at least until they see inflationary pressures emerging. But that has not been an issue. However, as shown in the chart below, the impact of these easing moves on stock prices is starting to lose its veracity. With each successive round of quantitative easing (QE), stocks have had less of a rally. The results of QE3 have been the most disappointing as stocks are actually now lower than they were when the announcement initially came back in September. It could just be the ‘fatigue factor’, the realization that rates really can’t drop any further and that the U.S. Federal Reserve is ‘out of bullets’ for additional easing moves. There are also some views that the impact of these rate moves are only temporary, and that the evidence of the Japanese experience in the 1990’s shows that lower interest rates do not always stimulate growth, at least not in a deflationary environment.
Our view continues to be that lower interest rates should and will lead to stronger growth but the impact has been lessened this time as consumers reduce debt first. Ultimately the most positive impact for the stock market from the reduction in interest rates comes from the relative valuations of stocks versus bonds.
The chart below shows the relative return that could historically be expected from stocks given current interest rates, current corporate bond yields and the one-year forward earnings yield for stocks. At these levels, stocks are effectively giving almost 900 basis points in additional earnings yield per year over corporate bonds versus an average level over the past 25 years of about 400 basis points.
So the answer to the question at the top of the last chart would be; Stocks are Cheap! There would be only two other reasons for this historical relationship to be so out of whack; either earnings are about to collapse (we still see global earnings growth of at least 5% over the next year) or interest rates are about to head substantially higher (not according to any Central Banker in the world).
Anyone notice how the stories of ‘Peak Oil’ and substantially higher oil prices in the long-term have disappeared from the news columns over the past year? The substantial growth in ‘oil rich natural gas deposits’ in North America over the past few years, shale gas formations and ‘fraccing’ on shallow wells has lead to a boom in oil production in the U.S. As shown in the chart below, oil production in Texas has more than doubled over the past year to over 2 million barrels per day. U.S. oil production will probably grow to over 16 million barrels per day over the next five years, easily making it the world’s largest producer of oil. More importantly, given growing Canadian production as well, the U.S. would be able to meet all of its 20 million per day consumption of oil from North American sources alone.
Not only would this probably limit further sharp increases in oil prices, it could potentially change the nature of U.S. political relationships with many Middle Eastern countries since the U.S. would no longer be as dependent on them for oil imports. Stay tuned!