It's been ages. Hope all is well with everyone. The rest of the summer was pretty good. Golf was spotty but plentiful, the house is in general order, and I'm oh so close to hanging my own shingle.
I've got a lot on the plate at the moment, but I did want to write a brief, brief update as I think that it's of importance timing-wise. In my mind, the market is top heavy and is close to pulling back in a potentially meaningful way. The quick and dirty is as follows:
1) Revenues are not following earnings, and I don't expect them to for some time. We can't cost cut our way to prosperity, and while earnnings results have looked good on the surface, revenue growth has not gone along for the ride. The optimists will say that they will eventually, and they're right. However, when "eventually" might be is the question. While in hindsight it was logical that investors gave companies a pass last quarter (revenue growth will most always lag earnings growth early in a recovery), in order to move higher (or not move lower) I think that the bar has been raised.....and many companies aren't likely to clear it. The big multi-nationals might be in better shape than anyone in this regard, but I believe that the market has pulled the time-line of revenue growth well ahead of reality, epecially given the state of the consumer.
2) Valuations are now looking rich vs. what will likely be anemic earnings growth post the '10 pop (off of EXTREMELY easy compares).
The market is trading at around 20x operating earnings (i.e. ex the BS). While I realize that folks want to look ahead and base valuations off of what earnings will be 12-18 months in the future, I think that the earnings picture is going to get more cloudy vs. less over the next 6 months as we move away from the initial recovery stage.
3) Trading volumes and stock market action have started to diverge.
The most recent up-leg in the broader market has been accompanied by declining volume levels. This is not what a healthy rally is supposed to look like. History shows that this is not likely to last, and my bet is that the market follows the volume.
I think that we have to question whether the inventory re-stock has run it's course here in the absence of job creation and real demand. Expect the holiday season to be weak (perhaps even weaker than the recent predictions indicate). In my opinion, the market is pricing in a more positive trajectory than is logical. Some of the charts are beginning to flash red. It's time to say "thank you" and take $ off of the table.
TRB
Wednesday, October 21, 2009
Tuesday, July 7, 2009
Hello Old Friend, It's Been A While
I'm still here! Between getting this house finished, trying to find employment, and writing a business plan (more on that at some point down the line), I've obviously been a touch delinquent in posting my most recent thoughts. At the same time though, I've pounded everyone as to why this economy might take its sweet time in healing fully enough that I thought that rather than hammering home the same points, I'd let the situation begin to play out, which it now seems to be doing.
Investors seem to be finally coming around to the fact that many of the ubiquitous "green shoots" aren't going to bloom anytime soon. While trying to will the market to new heights, many folks were turning a blind eye to the weeds infesting the garden. The fact of the matter is, while it looks like we're past the worst, the market seems poised to price in a scenario that's more rosy than real (can you tell I've been working outside?). This is not to say that we're in nosebleed territory yet per se, its just that a whole lot of things have to go right to keep us in the mid 900's on the S&P, in my opinion.
So the market has pulled off of its highs as a couple of bad economic reports started to join the "less bad" and investors have been forced to realize that the economic growth that may be forthcoming (which in and of itself is an improvement from what we've been experiencing) is indeed going to be a slow grind vs. a typical post-recession bounce. In my view, this is the first step in the process of getting us to what I believe will be a higher low before moving higher later. Unfortunately however, it might ultimately be a little lower than we are here.
Let's take a look at a couple of issues on the economic front. First off, we got a dose of reality with the most recent employment report, which showed a much worse than expected decline of 467K and a jump in the unemployment rate to 9.6%. To be fair, this is still very much better than the peak job loss numbers in the high 600K's, and anyone who wasn't expecting the unemployment rate to keep heading north must be living under a rock, but nonetheless it did break a trend of improving data on this front. This plus a worse than expected consumer confidence report did its part in smacking the market to its senses.
We need to look at the employment situation in concert with the overall spending/saving environment to get a handle on the economic drag the consumer is likely to have. The savings rate has now jumped to 7% (as I had expected) as consumers, both employed and unemployed, have squirreled away their money post the market and housing armageddon. This is significant. It is most certainly a positive for the long term, as consumer balance sheets must be repaired for spending to increase in earnest again in the future. However, on a near term basis, it is likely to act as a major drag on economic growth.
The consumer accounted for 70% of economic growth at the peak. The savings rate has moved from 0% to 7%. This, all else being equal, produces -4% hit to GDP. Of course, all else is not equal, with the Government trying to fill the hole with massive spending programs. However, when one drills down into said programs, you're left not wanting to hold your breath that they're going to all that sustainable. Sooooo, the main driver of the economy is likely to be held back substantially for a while and while the Government has come along to plug the hole on a near term basis, we're probably in store for below trend economic growth (and therefore, earnings growth) as the buying power runs out.
Another piece of the puzzle that argues against the economy shooting higher anytime soon is the transportation sector. As I've written in the past, what we really need to see is any rumblings of improvement coming from the producers of things to be confirmed by news out of the movers of things (and their respective market averages). This is simply not happening. The latest numbers out of the ports are showing container shipments down 22% y/y. The rail traffic data is getting worse, not better, with June's result down 22% vs. down 16% in the 1Q. The averages are showing similar results, with the Dow Transports not confirming the Dow Industrials move to new highs. This is NOT what new bull markets are made of. Until we see a change in the news out of the transportation sector, its going to be hard to argue for a robust move up forthcoming in the economy.
Turning to the market itself, the internals are so/so. I've already mentioned the issue with the non-confirmation of the transports, but there are a couple of other issues of which to take note. First off, the Lowry data (which I've mentioned before - measures the amount of supply and demand for stocks) has taken a big turn for the worse. While selling pressure has stayed somewhat consistent, buying power has recently dropped like a stone - back to the lows seen in March. Additionally, the Yen/Euro currency cross, which traders look at as a sign of investors' willingness to take risk, looks like it's worth monitoring, although it's still positive. Finally, the S&P breaking 900 violates a level of technical support. So one can't write off the possibility of more upside to come, one must be vigilant.
I'm rooting for the market here. Believe me, I'd much rather be extolling the virtues of an imminent rally that will take the country out of the dumps. That would be better for all of us poor souls who are wandering in the wilderness at the moment. This said, I will point out a couple of things that are on the more positive end of the spectrum.
As I wrote earlier, the realization that the market has gotten ahead of reality is the first step in the process of making that all important higher low. The realization will lead to acceptance and the lowering of expectations. Now, while this is occurring, you can expect volitile markets with bouts of downside, both in terms of stock prices and expectations themselves. This is where I'll get more interested.
The market is driven by expectations. It moves when they are bested or missed. Expectations need to be brought down from levels where the surprise is more than likely going to be on the downside to levels where the surprise is more than likely to be on the upside, and there are indeed indications that the there can be upside surprises in the future.
The data in the housing market continues to improve slowly. The improvement is not in a straight line, nor should we expect it to be, but there are pieces moving in the right direction. Home re-sales were up for the 2nd straight month in June for the first time since '05. Pending home sales were up for the 4th consecutive month for the first time since the peak. California home prices rose for the 3rd month in a row, and the percentage of foreclosure sales has moved down to 30% from 50% of the total. California was ground zero for the housing implosion, so this shouldn't be taken for granted.
Even on the job front, which is obviously difficult, there are hints that we're closing in on the worst. Planned layoffs in the ADP survey were down for the 5th straight month, and are at the lowest levels seen since March of last year. Weekly claims have been headed lower and are poised to break into the 500Ks for the first time in a while. Should this occur, it could represent the definitive move lower in claims that one looks for to signal the recession's end. Stay tuned.
The point here is this: we're in an adjustment period which may not be pleasant but is necessary. Before too long, it'll be time to dust off the screens, shake out the cobwebs, and take a look at individual stocks on the long side once again. The time to act might not be now, but the time to prepare is here. Fair value on the S&P looks to be around 960, so in the end, it depends on how cute you want to play it. For me, I've got my long positions, but I'm going to stay hedged for now.
'Till next time!
TRB
Friday, June 12, 2009
April Showers Bring May Flowers. What Do June Showers Bring?
Ooof. The weather is getting me down. I feel like Sisyphus as I try to drain and clean a pond in my backyard: every time I get close to getting it done, we get a deluge. Maybe I'll have it finished by the end of Summer! However, the weather did hold off enough for Red Bird Senior and yours truly to place 3rd out of 134 in the Metropolitan Father/Son golf tourney. Shocker!!!
Frankly, the stock market has been mostly a yawner lately as it consolidates the strong gains seen since the March lows, but as usual there have been some pretty interesting things going on under the surface. So let's take a look.
First of all, I've gotten a few questions regarding whether or not I feel the recession is over. As far as I'm concerned, it's all really semantics, but my answer is that it's probably drawing to a close. There have been a number of data points that suggest we may pull out of negative growth somewhat soon.
First off, as I've written before, the initial unemployment claims data have been heading in the right direction of late, and this week's number was no exception. Claims fell to 601K and seem ready to break a long uptrend. I'd like to see a number in the 500k's to make me more comfortable with the end of recession call, but it looks like we may well head there soon. Sticking with employment data, the May payroll data came in much, much better than expected, with the U.S. shedding "only" 345K workers during the month. The number is nothing to write home about in the absolute, but considering that we've been losing jobs at a pace of 500K/month recently (and when one considers that the peak was in the 700K's) this is a positive development.
The "better" unemployment data has seemingly translated to better consumer confidence as well, as this morning's consumer confidence data showed a rise to a 9 month high, and retail sales showed only its second positive reading this year (albeit a less than stunning .5% rise) last month.
Secondly (and something the press seemingly glossed over) the Richmond Manufacturing Index showed a nice, nice spike to the upside for May, which has seemingly confirmed some of the recent chatter about a tentative bottoming in manufacturing. Now there are 2 sides to every story, and this might be indicative of inventory restocking, but we'll take it nonetheless.
So it looks as if we might be close to bidding the recession (in the official sense of the word) adieu. However, this does NOT necessarily mean bright skies and carefree days ahead in my view. This recovery is going to be agonizingly slow and frustrating. Signs do not point to an economic pop by any means. While initial claims have shown improvement, continuing unemployment claims have not. In fact, they rose to a new historic high of 6.8mm last week, showing how hard it is to find a job (don't I know it!). Additionally, while the drop in payrolls was a pleasant surprise, the unemployment rate keeps on trucking higher, rising to a whopping 9.4% last month. When one takes into account those that have "given up" on looking for a job, and add them back to the potential workforce, you get a "real" unemployment rate of 16%!!! Not the stuff a robust rebound in consumer spending is made of. In my view, the conditions argue for continued consumer thrift, and those who hold consumer cyclical names (which have rallied more than the market off of the lows) might want to take a long, hard look at booking some profits (or smaller losses) in here.
As far as the overall market it concerned, the real question now is "what's priced in?". The market is a discounting mechanism, generally moving in advance of economic reality. Think about it: the equity market began its recent rally in early March, well before all of this "green shoot" nonsense came about. At some point, investors are going to have to look beyond the fact that we've probably seen the worst and factor in that the recovery is likely to be like watching paint dry. The outlook for corporate earnings growth still looks tenuous. Interest rates are rising. The Government will have to pay for its largess in the form of higher taxes. The consumer is wary, beaten up, and still carries a mountain of debt.
In my view, the market is ahead of economic reality at this point, and it will have to adjust. Ahhh, but WHEN it will do so is another question! We're heading into the end of the 2Q, and many portfolio managers have been underinvested. Therefore, we can't rule out a "window dressing" rally as we head to the end of the month ("Window Dressing" refers to managers buying or selling positions before quarterly statements are sent out to make the impression that they were in or out of names for the entire quarter). Time will tell, but it's certainly a possibility. Nonetheless, I'd still be hedged.
One final point market-wise before I move on. The Transports have STILL not confirmed the new high in the Industrials. They took a peek at a new high yesterday, but closed below yet again. And looking at the data coming out of the transportation sector, we're not seeing what we need to see to be overly bullish overall here. The American Truckers Accn. announced that tonnage was down 13% in May, and the IATA noted that cargo traffic was down 21.7% in the same month. The latter was the 5th straight month of -20% numbers. This speaks volumes regarding the state of end demand out there, and it's obviously not good. We want to see action in the makers of things match the action of the movers of things to give us that warm and fuzzy feeling, and it ain't happening at this point. Stay tuned, but if the Transports can't confirm, this would be a bearish sign for the market overall.
Now, let's take a look at oil. which has been hot as a pistol. As regular readers know, I've been bullish for a couple of months, buying the DXO (double long crude ETF), back in early March. The reasoning behind this position was a view that we were about to see an improvement in the global economy, the announcement of the Chinese stimulus package, inklings of better OPEC discipline (sort of), the decimation of the oil price, and the high but declining contango (see March 13th post). Well, we've gotten what we asked for and then some! I said back then that I was entering DXO not as a trade, but as an investment due to what I feel is a solidly positive long term backdrop for crude, especially when considering the needs of the emerging markets.
This week, we got a nice dose of positive news, with U.S. inventories down sharply, the IEA raising its demand estimate for the first time since September (the number itself was small, but remember that I'm more interested in the change in trends. You should be too). Finally, things seem to be heating up in oil-rich Nigeria, with the MEND rebels pledging new acts of violence on the oil industries assets. This has had the effect of pushing crude prices into the low $70's and the DXO into the high $4's.
With all of this said, I have taken 1/3 of my DXO position off of the table. While I still have a favorable view of oil long term, there are a bevy of reasons that I can point to for taking this action: 1) I'm up 100%+ since early March, and I very much enjoy playing with the house's money; 2) My initial target on crude was $75. $73 is close enough; 3) While supplies have moved lower, they're still above average; 4) the contango (positive spread between spot prices and futures prices) have moved from very wide to more normal, suggesting that near term upside might be petering out.
I've moved the profit into a small position in UNG, an ETF tracking natural gas, with the reason being that the spread between the price of crude and nat gas has hit an unprecedented (and in my view) unsustainable level of 18:1. Gas has been crushed this year, and I feel that even a very sub-par economic recovery may well lead to gains as utilization picks up.
Now, with this said, there are reasons that the spread is high: 1) gas supplies are high; 2) gas is not a depleting asset (at least at the moment) as there have been some substantial new fields found recently; 3) The development of liquefied nat. gas makes it transportable over the ocean, and this is a relatively new development. This will translate into the ability of gas-rich countries to export. However, many of these developments which will lead to increased supplies, will play out only over time, and my call is that prices over the intermediate-term can rise in spite of them. This is more of a trade. Near term patience might be needed, but I'm guessing that we have a nice gain by year-end.
Finally, let me leave you with a couple more tidbits on the bond market. We raised another $130bln in debt this week. The 10-yr auction in the middle of the week did not go over well. The 30-yr was better. I don't care too much. Russia is out saying essentially that they'll not buy more as they diversify their reserves. At the moment, 30% of their reserves are held in U.S. Treasuries. China is signalling that while they will buy more, they'll buy less. This is in the face of our intention to issue $2trln this year. Only one way for rates to go as a result.
The backup in the bond market is having an impact on a most important economic driver: housing. 30-yr Mortgage rates (which generally are priced off of the 10-yr Treasury) have risen 50bps since the May low. This has put the breaks on a red-hot refinance market, with the most recent data showing applications are down 11.8% and at the lowest level since November. Mortgage applications are down 7.2%. Watch this space. Another arrow in the "not so fast" quiver.
Let's pray for sun this weekend!
TRB
Frankly, the stock market has been mostly a yawner lately as it consolidates the strong gains seen since the March lows, but as usual there have been some pretty interesting things going on under the surface. So let's take a look.
First of all, I've gotten a few questions regarding whether or not I feel the recession is over. As far as I'm concerned, it's all really semantics, but my answer is that it's probably drawing to a close. There have been a number of data points that suggest we may pull out of negative growth somewhat soon.
First off, as I've written before, the initial unemployment claims data have been heading in the right direction of late, and this week's number was no exception. Claims fell to 601K and seem ready to break a long uptrend. I'd like to see a number in the 500k's to make me more comfortable with the end of recession call, but it looks like we may well head there soon. Sticking with employment data, the May payroll data came in much, much better than expected, with the U.S. shedding "only" 345K workers during the month. The number is nothing to write home about in the absolute, but considering that we've been losing jobs at a pace of 500K/month recently (and when one considers that the peak was in the 700K's) this is a positive development.
The "better" unemployment data has seemingly translated to better consumer confidence as well, as this morning's consumer confidence data showed a rise to a 9 month high, and retail sales showed only its second positive reading this year (albeit a less than stunning .5% rise) last month.
Secondly (and something the press seemingly glossed over) the Richmond Manufacturing Index showed a nice, nice spike to the upside for May, which has seemingly confirmed some of the recent chatter about a tentative bottoming in manufacturing. Now there are 2 sides to every story, and this might be indicative of inventory restocking, but we'll take it nonetheless.
So it looks as if we might be close to bidding the recession (in the official sense of the word) adieu. However, this does NOT necessarily mean bright skies and carefree days ahead in my view. This recovery is going to be agonizingly slow and frustrating. Signs do not point to an economic pop by any means. While initial claims have shown improvement, continuing unemployment claims have not. In fact, they rose to a new historic high of 6.8mm last week, showing how hard it is to find a job (don't I know it!). Additionally, while the drop in payrolls was a pleasant surprise, the unemployment rate keeps on trucking higher, rising to a whopping 9.4% last month. When one takes into account those that have "given up" on looking for a job, and add them back to the potential workforce, you get a "real" unemployment rate of 16%!!! Not the stuff a robust rebound in consumer spending is made of. In my view, the conditions argue for continued consumer thrift, and those who hold consumer cyclical names (which have rallied more than the market off of the lows) might want to take a long, hard look at booking some profits (or smaller losses) in here.
As far as the overall market it concerned, the real question now is "what's priced in?". The market is a discounting mechanism, generally moving in advance of economic reality. Think about it: the equity market began its recent rally in early March, well before all of this "green shoot" nonsense came about. At some point, investors are going to have to look beyond the fact that we've probably seen the worst and factor in that the recovery is likely to be like watching paint dry. The outlook for corporate earnings growth still looks tenuous. Interest rates are rising. The Government will have to pay for its largess in the form of higher taxes. The consumer is wary, beaten up, and still carries a mountain of debt.
In my view, the market is ahead of economic reality at this point, and it will have to adjust. Ahhh, but WHEN it will do so is another question! We're heading into the end of the 2Q, and many portfolio managers have been underinvested. Therefore, we can't rule out a "window dressing" rally as we head to the end of the month ("Window Dressing" refers to managers buying or selling positions before quarterly statements are sent out to make the impression that they were in or out of names for the entire quarter). Time will tell, but it's certainly a possibility. Nonetheless, I'd still be hedged.
One final point market-wise before I move on. The Transports have STILL not confirmed the new high in the Industrials. They took a peek at a new high yesterday, but closed below yet again. And looking at the data coming out of the transportation sector, we're not seeing what we need to see to be overly bullish overall here. The American Truckers Accn. announced that tonnage was down 13% in May, and the IATA noted that cargo traffic was down 21.7% in the same month. The latter was the 5th straight month of -20% numbers. This speaks volumes regarding the state of end demand out there, and it's obviously not good. We want to see action in the makers of things match the action of the movers of things to give us that warm and fuzzy feeling, and it ain't happening at this point. Stay tuned, but if the Transports can't confirm, this would be a bearish sign for the market overall.
Now, let's take a look at oil. which has been hot as a pistol. As regular readers know, I've been bullish for a couple of months, buying the DXO (double long crude ETF), back in early March. The reasoning behind this position was a view that we were about to see an improvement in the global economy, the announcement of the Chinese stimulus package, inklings of better OPEC discipline (sort of), the decimation of the oil price, and the high but declining contango (see March 13th post). Well, we've gotten what we asked for and then some! I said back then that I was entering DXO not as a trade, but as an investment due to what I feel is a solidly positive long term backdrop for crude, especially when considering the needs of the emerging markets.
This week, we got a nice dose of positive news, with U.S. inventories down sharply, the IEA raising its demand estimate for the first time since September (the number itself was small, but remember that I'm more interested in the change in trends. You should be too). Finally, things seem to be heating up in oil-rich Nigeria, with the MEND rebels pledging new acts of violence on the oil industries assets. This has had the effect of pushing crude prices into the low $70's and the DXO into the high $4's.
With all of this said, I have taken 1/3 of my DXO position off of the table. While I still have a favorable view of oil long term, there are a bevy of reasons that I can point to for taking this action: 1) I'm up 100%+ since early March, and I very much enjoy playing with the house's money; 2) My initial target on crude was $75. $73 is close enough; 3) While supplies have moved lower, they're still above average; 4) the contango (positive spread between spot prices and futures prices) have moved from very wide to more normal, suggesting that near term upside might be petering out.
I've moved the profit into a small position in UNG, an ETF tracking natural gas, with the reason being that the spread between the price of crude and nat gas has hit an unprecedented (and in my view) unsustainable level of 18:1. Gas has been crushed this year, and I feel that even a very sub-par economic recovery may well lead to gains as utilization picks up.
Now, with this said, there are reasons that the spread is high: 1) gas supplies are high; 2) gas is not a depleting asset (at least at the moment) as there have been some substantial new fields found recently; 3) The development of liquefied nat. gas makes it transportable over the ocean, and this is a relatively new development. This will translate into the ability of gas-rich countries to export. However, many of these developments which will lead to increased supplies, will play out only over time, and my call is that prices over the intermediate-term can rise in spite of them. This is more of a trade. Near term patience might be needed, but I'm guessing that we have a nice gain by year-end.
Finally, let me leave you with a couple more tidbits on the bond market. We raised another $130bln in debt this week. The 10-yr auction in the middle of the week did not go over well. The 30-yr was better. I don't care too much. Russia is out saying essentially that they'll not buy more as they diversify their reserves. At the moment, 30% of their reserves are held in U.S. Treasuries. China is signalling that while they will buy more, they'll buy less. This is in the face of our intention to issue $2trln this year. Only one way for rates to go as a result.
The backup in the bond market is having an impact on a most important economic driver: housing. 30-yr Mortgage rates (which generally are priced off of the 10-yr Treasury) have risen 50bps since the May low. This has put the breaks on a red-hot refinance market, with the most recent data showing applications are down 11.8% and at the lowest level since November. Mortgage applications are down 7.2%. Watch this space. Another arrow in the "not so fast" quiver.
Let's pray for sun this weekend!
TRB
Sunday, May 31, 2009
Forgive Us Our Debts.....
As regular readers know, one of the issues I've been harping on is the probability that the economic recovery that lies ahead might not live up to expectations in terms of its vigor. One of the main reasons I feel this way is the presence of pending consequenses of the drunken sailor spending binge the US Government is currently on (and it's showing absolutley no signs of jumping on the wagon anytime soon, by the way. See GM, GMAC, etc.). The consequences of large, unproductive spending programs are higher interest rates (as investors in our debt demand more interest), higher taxes (as the Government tries to find other ways to pay for spending programs), and a lower dollar (as the Treasury "creates" currency out of thin air - the more they print, the less it's worth).
I've always thought that a little logic goes a long way in looking at markets and picking stocks. Logic seems to be in short supply on the Street these days with everyone still pushing quantitative models and algorithmic trading no matter how many times they get burned by them. So be it: that works in our favor. While the consequences of massive Government spending are more than likely to play out in fits and starts over time, play out they will unless the prevailing attitude on the Hill changes quickly. It would be illogical for them to play out any other way. With this in mind, let's focus in on what's been happening in US Government Bond-land lately, as last week was an interesting one.
First, let's take a look at a couple of numbers:
1) The total U.S. debt last year = $9.4trln........Today = $11.3trln........'12 estimate = $14-15trln. ........U.S. GDP estimates = ~$13trln
2) Interest on U.S. debt = 4% of the total budget now...........Kiplinger estimate = 11% by '13
3) U.S. Government debt issuance is running at an average of slightly under $500bln/quarter. This is 7X the rate of issuance before the crisis hit.
4) We issued $101bln in debt last week alone.
5) Goldman estimates that the U.S. will sell $3.25trln of Treasuries in this fiscal year.
Want a little more perspective? Check out http://www.usdebtclock.org/
Now, S&P caused a big stir last week after it downgraded the UK's credit outlook from stable to negative, which got folks talking about the good old USA. S&P is concerned about the UK's debt load heading to 100% of GDP from 67% today, but they forgot to mention Uncle Sam's indebtedness. Nonetheless, it doesn't take a genius to realize that the U.S. is in exactly the same leaky, debt-laden boat as the UK in terms of where we are today (we're slightly worse off on the debt to GDP measure at 70%) and where we're headed tomorrow (by the way, as a point of reference, Canada's debt to GDP is currently at 29%. I smell a short U.S./long Canadian dollar pair trade here). While Moodys came out and affirmed the USA's AAA rating later in the week, helping the bond market get back on its feet, aren't the rating's agencies the ones that missed the ENTIRE mortgage mess in the first place??? Should we really be putting much faith in what they're telling us? All you have to do is a little basic math (and use, you guessed it, a little logic) to figure out where this boat is headed.
Sooooo the bond market gyrated on all of this news, with yields breaking out as investors wrung their hands about the new supply coming to market and the negative vibe that was hanging in the bond pits all of the sudden. However, a decent 7yr Treasury auction caused investors to breathe a sigh of relief and generated a rally towards the weekend. Phew!!! Glad that's over! Well sorry. Unfortunately it's not. It's just starting. I'm not interested in one auction and how well bid it is. I'm interested in the long term trend, and in this case the trend is becomming your friend.....if you're bearish on long term Treasuries. As my friends at Strategas say regarding long term U.S. bonds, "It's hard to quadruple the supply of anything and not have the price go down". Amen.
You see, there seemed to be a bit of a shift last week. The Fed came out and said that it was, once again, ready to buy long term Treasuries outright to try and stem the rise in yields that seems inevitable. But this time around, rather than rally the market, traders ignored the Fed, looked at the fundmentals, and drove yields higher (remember, price moves in the inverse direction as yield), signalling that the "bond market vigilantes" (a term used for bond traders who keep the market honest, despite what the Government might want rates to do) may be back. 10-year yields rose hard, breaking through initial and trend resisitance on the charts on consecutive days before falling back on Friday. 30-year yields have broken through resistance as well.
The moral of this story? As long as Washington insists that the cure for private sector overleverage is public sector overleverage, interest rates are heading higher and the dollar is heading lower. It's as simple as that. We are currently not atacking the root casue of the main problem hanging over our economy. We're simply pushing the solution out. As a result, we're looking at an anemic economic recovery as we sap the private sector to pay for public sector largess. It looks like bond investors are starting to figure this out. At some point, equity investors will too.
So how does one "play" this situation? If you're in TBT, stay there. If it retreats a little after the recent gains, buy more. If you're not in, get in. As we issue more and more debt, potential buyers of said debt (read China) will demand higher rates to compensate. This is the way it has worked in the past and this is the way it'll work in the future.
If you're in GLD stay in. You'll hear a lot of folks with a lot of varying opinions on gold, but use your head, look long term, and be logical. The dollar looks iffy due to our large and growing debt issue. China is beginning to argue for using something other than the dollar as the global reserve currency. China and Brazil just announced a trade pact in which they will pay for goods in local currency vs. the dollar. This is not the last you'll hear of this and it argues for being short the USD and long of gold.
Fundamentals argue for owning "stuff" vs. fiat currencies (especially ones who's debt loads look precarious) and gold is some of the "stuff" that folks should want to own. China sure does. They've increased their holdings of the shiny stuff by 70% since '03 and have been vocal about doubling their horde as a percentage of reserves going forward. If you don't own gold you might get a chance to move in a little lower as it consolidates the recent gains, but look to get in on dips. A upside break through $1003 gets us to $1300 on the charts, so I'd be keeping some powder dry to buy the breakout as well.
What does this mean for the equity markets? They sure have been hanging in there of late as more "green shoots" have emerged for the economy. Last night, Chineese manufacturing data came out and showed further expansion, allowing for more hope that a global recovery has begun. I'm not going to argue with that. It was the premise behind the bullish call I made in March. However, I continue to be concerned about the pace of recovery vs. expectations, and I'm wondering what earnings growth is going to look like going forward as a result.
This week may well be very interesting as we're approaching a test in the Dow Theory (in which one needs to see both the Industrials average - the makers of things - and the Transport average - the movers of things - moving in the same direction with the same conviction). The Industrials are looking like they want to test the highs while the Transports still have a bit to go before getting there. If both the Industrials and the Transports can break to new highs, we might very well be off to the races on another leg up. If the Transports don't "confirm" a break to new highs in the Industrials by hitting a new high itself, this would be a bearish situation. Only time will tell, but with bonds (which have been leading stocks in term of direction) not behaving well, I've got my eyes peeled!
I've always thought that a little logic goes a long way in looking at markets and picking stocks. Logic seems to be in short supply on the Street these days with everyone still pushing quantitative models and algorithmic trading no matter how many times they get burned by them. So be it: that works in our favor. While the consequences of massive Government spending are more than likely to play out in fits and starts over time, play out they will unless the prevailing attitude on the Hill changes quickly. It would be illogical for them to play out any other way. With this in mind, let's focus in on what's been happening in US Government Bond-land lately, as last week was an interesting one.
First, let's take a look at a couple of numbers:
1) The total U.S. debt last year = $9.4trln........Today = $11.3trln........'12 estimate = $14-15trln. ........U.S. GDP estimates = ~$13trln
2) Interest on U.S. debt = 4% of the total budget now...........Kiplinger estimate = 11% by '13
3) U.S. Government debt issuance is running at an average of slightly under $500bln/quarter. This is 7X the rate of issuance before the crisis hit.
4) We issued $101bln in debt last week alone.
5) Goldman estimates that the U.S. will sell $3.25trln of Treasuries in this fiscal year.
Want a little more perspective? Check out http://www.usdebtclock.org/
Now, S&P caused a big stir last week after it downgraded the UK's credit outlook from stable to negative, which got folks talking about the good old USA. S&P is concerned about the UK's debt load heading to 100% of GDP from 67% today, but they forgot to mention Uncle Sam's indebtedness. Nonetheless, it doesn't take a genius to realize that the U.S. is in exactly the same leaky, debt-laden boat as the UK in terms of where we are today (we're slightly worse off on the debt to GDP measure at 70%) and where we're headed tomorrow (by the way, as a point of reference, Canada's debt to GDP is currently at 29%. I smell a short U.S./long Canadian dollar pair trade here). While Moodys came out and affirmed the USA's AAA rating later in the week, helping the bond market get back on its feet, aren't the rating's agencies the ones that missed the ENTIRE mortgage mess in the first place??? Should we really be putting much faith in what they're telling us? All you have to do is a little basic math (and use, you guessed it, a little logic) to figure out where this boat is headed.
Sooooo the bond market gyrated on all of this news, with yields breaking out as investors wrung their hands about the new supply coming to market and the negative vibe that was hanging in the bond pits all of the sudden. However, a decent 7yr Treasury auction caused investors to breathe a sigh of relief and generated a rally towards the weekend. Phew!!! Glad that's over! Well sorry. Unfortunately it's not. It's just starting. I'm not interested in one auction and how well bid it is. I'm interested in the long term trend, and in this case the trend is becomming your friend.....if you're bearish on long term Treasuries. As my friends at Strategas say regarding long term U.S. bonds, "It's hard to quadruple the supply of anything and not have the price go down". Amen.
You see, there seemed to be a bit of a shift last week. The Fed came out and said that it was, once again, ready to buy long term Treasuries outright to try and stem the rise in yields that seems inevitable. But this time around, rather than rally the market, traders ignored the Fed, looked at the fundmentals, and drove yields higher (remember, price moves in the inverse direction as yield), signalling that the "bond market vigilantes" (a term used for bond traders who keep the market honest, despite what the Government might want rates to do) may be back. 10-year yields rose hard, breaking through initial and trend resisitance on the charts on consecutive days before falling back on Friday. 30-year yields have broken through resistance as well.
The moral of this story? As long as Washington insists that the cure for private sector overleverage is public sector overleverage, interest rates are heading higher and the dollar is heading lower. It's as simple as that. We are currently not atacking the root casue of the main problem hanging over our economy. We're simply pushing the solution out. As a result, we're looking at an anemic economic recovery as we sap the private sector to pay for public sector largess. It looks like bond investors are starting to figure this out. At some point, equity investors will too.
So how does one "play" this situation? If you're in TBT, stay there. If it retreats a little after the recent gains, buy more. If you're not in, get in. As we issue more and more debt, potential buyers of said debt (read China) will demand higher rates to compensate. This is the way it has worked in the past and this is the way it'll work in the future.
If you're in GLD stay in. You'll hear a lot of folks with a lot of varying opinions on gold, but use your head, look long term, and be logical. The dollar looks iffy due to our large and growing debt issue. China is beginning to argue for using something other than the dollar as the global reserve currency. China and Brazil just announced a trade pact in which they will pay for goods in local currency vs. the dollar. This is not the last you'll hear of this and it argues for being short the USD and long of gold.
Fundamentals argue for owning "stuff" vs. fiat currencies (especially ones who's debt loads look precarious) and gold is some of the "stuff" that folks should want to own. China sure does. They've increased their holdings of the shiny stuff by 70% since '03 and have been vocal about doubling their horde as a percentage of reserves going forward. If you don't own gold you might get a chance to move in a little lower as it consolidates the recent gains, but look to get in on dips. A upside break through $1003 gets us to $1300 on the charts, so I'd be keeping some powder dry to buy the breakout as well.
What does this mean for the equity markets? They sure have been hanging in there of late as more "green shoots" have emerged for the economy. Last night, Chineese manufacturing data came out and showed further expansion, allowing for more hope that a global recovery has begun. I'm not going to argue with that. It was the premise behind the bullish call I made in March. However, I continue to be concerned about the pace of recovery vs. expectations, and I'm wondering what earnings growth is going to look like going forward as a result.
This week may well be very interesting as we're approaching a test in the Dow Theory (in which one needs to see both the Industrials average - the makers of things - and the Transport average - the movers of things - moving in the same direction with the same conviction). The Industrials are looking like they want to test the highs while the Transports still have a bit to go before getting there. If both the Industrials and the Transports can break to new highs, we might very well be off to the races on another leg up. If the Transports don't "confirm" a break to new highs in the Industrials by hitting a new high itself, this would be a bearish situation. Only time will tell, but with bonds (which have been leading stocks in term of direction) not behaving well, I've got my eyes peeled!
Talk to you on Friday!
TRB
Tuesday, May 12, 2009
Flying the Coop
Many may well ask, "Where has this guy been the last couple of weeks?" The simple answer is that I have been lifting boxes and directing movers. I am now officially a suburbanite. I have left the wicked city behind to live the life of a country squire, at least for a time. I have traded in the incessant honking and gawking touristos of Mulberry Street for the singing of birds, stinging of bees, and sweet country (or at least more country than NYC) air of Locust Valley, Long Island. While I've yet to acquire the "lock jaw" made famous by Thurston Howell III, I'm sure it's right around the corner.
Honestly, being a lifelong city-boy, I would have thought that my pangs of regret would be a little more biting, but honestly I kind of like it. We'll see if this lasts when I have a craving for good Thai food at 9:30pm, but so far so good. So amidst the boxes and bugs, I'll shoot off a little blog just to let everyone know I'm alive.
Question: How far can the market rally based on "less bad" data and a bogus, highly publicized, bank "stress test?"
Answer: Farther than I thought it could.
When one pontificates about the equity markets for an extended period of time, one thing's for sure: even the best of us will get a few short term calls wrong every once in a while. Sooooo, while I take solace in the fact that my investment call has been spot on (1000 on the S&P by early 2010) my trading call over the past few weeks has been "pants" (i.e. pretty darned awful) as they say in my old haunt of Hong Kong. I think that I simply underestimated a couple of things: 1) the sheer desire of folks to believe that things are not just "less bad" but getting good; 2) the amount of despair that was evident in early March; 3) the fear harbored by long-only managers of "missing" the rally (especially given performance last year); and 4) the fear of hedge funds about a short squeeze. C'est la vie. No need to look in the rear view mirror. Let's take a look at what we're up against right now.
First off, I stand firm in my belief that, at least for the intermediate term, the lows are in. The data that have been streaming in have indeed been less bad, and they may continue to be so. Without rehashing the numbers, the weekly unemployment claims, while still very high, have been moving in the right direction of late. This is something that continues to bear watching, but is important to getting consumer confidence going. This said, confidence has indeed ticked up. One can see anecdotal evidence of this by taking a stroll in the malls. This past weekend, I had the pleasure of spending a little time at the Americana, a collection of high end stores (don't ask me why I was there) in Manhassett. The shops and restaurants were packed, and folks were actually buying things! Let the bells ring out!!! In addition, the consumer pick-up looks to have been confirmed by the unloading numbers coming from the port of Long Beach, CA, where we saw a nice jump in activity (largest number of box unloads since November). We'll see how long this lasts, but it did grab my attention.
Additionally on the positive side of the ledger, as I've written about before as a potential positive for 2010, inventories are extremely lean pretty much across the board. As an example, let's look at the ridiculously bad auto industry. About 12mm cars are scrapped each year, and while this may or may not be decreased in the future as consumers try and squeeze the last ounce out of their old beaters, lets use this number as a point of reference. The auto industry is now only producing slightly over 9mm cars on an annualized basis. The math is not difficult. If demand can steady, it should mean good things for auto makers next year (if they can survive the next 6 months). And it's not just autos. Production has been slashed in a multitude of sectors as companies adjust to lower levels of demand. IF demand holds here (which it may well do given the stimulus that's about to kick in), this has to be seen as a positive for the economy as a whole. This is why I think that it might be a bit pig headed for folks to argue that there is little chance for positive economic growth in the second half of the year.
Finally, let's take a look at housing. Housing inventories have started their decent, which is where any (long) recovery must start. Yes, a lot of this has to do with foreclosed home sales, but there is nascent demand. One has to watch the action in the bond market here (I'll get to that in a sec), but rates are still quite low, and as we head through the Spring/Summer buying season one would guess that the numbers improve for a time further.
So, yes Virginia, there are some better things afoot, and there are continued reasons why I believe that the market should logically be trading higher than on March 9th. Additionally, looking at the internals there are other supports around. Volume has picked up on the positive side, volatility has broken well below it past support, and the near term technicals are flashing green, at least for now. On top of this, short interest is still very high and the shorts are feeling the pain, and money managers are desperate to "make up" the lost ground that they (and their investors) endured last year. So can the rally continue even after a fabulous run (8 of the past 9 weeks in positive territory)? Sure it can.....but I'm not betting on it. I'll leave that to the more brave.
"Why would this be?" you might ask. For one, the market looks very "overbought" here on a couple of measures. The relative strength index broke through 70, suggesting a short-term top. Selling pressure has not pulled back enough for me to buy into a major extension of the rally from here. The "stress test" which dominated the press for a couple of weeks and seemingly caused investor optimism has come and gone, and we'll be back at looking at what are still difficult bank fundamentals over the next few months. The secondary market is on fire as companies use the better market to raise capital, and let's just say that they are not going to sell stock to the public when managements feel that their stocks are dirt cheap. And finally, I do not like the action I'm starting to see in the Government bond market.
Rather that drone on about all of this, I want to focus on the stress test and the bond market (which to me is my biggest bugaboo on a longer term basis). As far as the widely anticipated and leaked stress test goes, I say BALDERDASH. This thing was as manipulated as a steel cage match between Andre the Giant and Hulk Hogan. The Fed came in with their results, the banks all cried and pouted, and the Fed relented. A couple of facts? Bank of America's original "capital hole" was pegged at $50bln. The official result? $35bln. Citigroup's original hole? $35bln. Final tally? $5bln!!! When all was said and done, the banks' combined deficit was $75bln. The amount of TARP money left? $100bln. How convenient! Don't believe the hype; the banks are not in good shape. With this thing out of the way, the proof will be in the pudding going forward, and we'll see how they all look when the commercial real estate losses come in earnest this summer. As you can tell, I'm somewhat skeptical.
As for the Government bond market, it seems as if folks are beginning to figure out how much supply will have to come to market to support the ever growing panoply of spending and lending programs we have going on. And if you want to watch something really chilling, have a gander at this: http://www.youtube.com/watch?v=PXlxBeAvsB8&feature=player_embedded.
It seems as if no one even has their hands around where all the Fed lending has really gone! Our deficits are out of control (thanks for the $17bln in budget cuts Mr. President. That'll help, really), and by some counts our public debt is on its way from going from 40% to 80% of GDP. I'm all for focused, logical, job producing stimulus, but I guess that's really an oxymoron.
This is wild and woolly, and we're going to have to pay the piper at some point. The way we'll pay? Higher interest rates, higher taxes, and a devalued dollar. As far as rates go, the last treasury auction was not so hot, with investors demanding higher rates. Get used to that. We've already seen the initial salvo in terms of higher taxes. Get used to that too. As far as the dollar goes, China is already making big noise about their unease in keeping so much of their reserves in USD assets (bonds) and they have been buying gold hand over fist (holdings are up 73% since '03).
Now, all of this is not going to blow up overnight. The impact of these problems will be felt over time. However, when one asks me whether we've seen the absolute lows and if we're in a new secular bull market, I have to shrug my shoulders. We may well be in a long tailed cyclical bull market at this point, which could extend into 2010 as the economy recovers from the lows, but what I'm talking about above could very well put the air brakes on in a big way in the future and frankly, it scares the heck out of me. So while it may be that we ride the recovery for a while, I think that it behooves EVERYONE to keep a very watchful eye on this stuff in terms of the long term, have core positions in gold, oil and TBT and add to them on weakness. While economists are prattling on ad nauseum about not being worried about inflation given the state of the economy at the moment, we all should be looking out past the immediate horizon with a very wary eye.
As for the more immediate thesis, I'm still feeling that we have a summer pullback coming of about 10-15% from here as the pudding might not be as tasty as folks are making it out to be. However, I continue to feel that the market will eventually work higher as we ride the wave of an economic recovery into 2010. After that, Katie bar the door cuz it's going to get interesting!
Yours with a smile!
TRB
Honestly, being a lifelong city-boy, I would have thought that my pangs of regret would be a little more biting, but honestly I kind of like it. We'll see if this lasts when I have a craving for good Thai food at 9:30pm, but so far so good. So amidst the boxes and bugs, I'll shoot off a little blog just to let everyone know I'm alive.
Question: How far can the market rally based on "less bad" data and a bogus, highly publicized, bank "stress test?"
Answer: Farther than I thought it could.
When one pontificates about the equity markets for an extended period of time, one thing's for sure: even the best of us will get a few short term calls wrong every once in a while. Sooooo, while I take solace in the fact that my investment call has been spot on (1000 on the S&P by early 2010) my trading call over the past few weeks has been "pants" (i.e. pretty darned awful) as they say in my old haunt of Hong Kong. I think that I simply underestimated a couple of things: 1) the sheer desire of folks to believe that things are not just "less bad" but getting good; 2) the amount of despair that was evident in early March; 3) the fear harbored by long-only managers of "missing" the rally (especially given performance last year); and 4) the fear of hedge funds about a short squeeze. C'est la vie. No need to look in the rear view mirror. Let's take a look at what we're up against right now.
First off, I stand firm in my belief that, at least for the intermediate term, the lows are in. The data that have been streaming in have indeed been less bad, and they may continue to be so. Without rehashing the numbers, the weekly unemployment claims, while still very high, have been moving in the right direction of late. This is something that continues to bear watching, but is important to getting consumer confidence going. This said, confidence has indeed ticked up. One can see anecdotal evidence of this by taking a stroll in the malls. This past weekend, I had the pleasure of spending a little time at the Americana, a collection of high end stores (don't ask me why I was there) in Manhassett. The shops and restaurants were packed, and folks were actually buying things! Let the bells ring out!!! In addition, the consumer pick-up looks to have been confirmed by the unloading numbers coming from the port of Long Beach, CA, where we saw a nice jump in activity (largest number of box unloads since November). We'll see how long this lasts, but it did grab my attention.
Additionally on the positive side of the ledger, as I've written about before as a potential positive for 2010, inventories are extremely lean pretty much across the board. As an example, let's look at the ridiculously bad auto industry. About 12mm cars are scrapped each year, and while this may or may not be decreased in the future as consumers try and squeeze the last ounce out of their old beaters, lets use this number as a point of reference. The auto industry is now only producing slightly over 9mm cars on an annualized basis. The math is not difficult. If demand can steady, it should mean good things for auto makers next year (if they can survive the next 6 months). And it's not just autos. Production has been slashed in a multitude of sectors as companies adjust to lower levels of demand. IF demand holds here (which it may well do given the stimulus that's about to kick in), this has to be seen as a positive for the economy as a whole. This is why I think that it might be a bit pig headed for folks to argue that there is little chance for positive economic growth in the second half of the year.
Finally, let's take a look at housing. Housing inventories have started their decent, which is where any (long) recovery must start. Yes, a lot of this has to do with foreclosed home sales, but there is nascent demand. One has to watch the action in the bond market here (I'll get to that in a sec), but rates are still quite low, and as we head through the Spring/Summer buying season one would guess that the numbers improve for a time further.
So, yes Virginia, there are some better things afoot, and there are continued reasons why I believe that the market should logically be trading higher than on March 9th. Additionally, looking at the internals there are other supports around. Volume has picked up on the positive side, volatility has broken well below it past support, and the near term technicals are flashing green, at least for now. On top of this, short interest is still very high and the shorts are feeling the pain, and money managers are desperate to "make up" the lost ground that they (and their investors) endured last year. So can the rally continue even after a fabulous run (8 of the past 9 weeks in positive territory)? Sure it can.....but I'm not betting on it. I'll leave that to the more brave.
"Why would this be?" you might ask. For one, the market looks very "overbought" here on a couple of measures. The relative strength index broke through 70, suggesting a short-term top. Selling pressure has not pulled back enough for me to buy into a major extension of the rally from here. The "stress test" which dominated the press for a couple of weeks and seemingly caused investor optimism has come and gone, and we'll be back at looking at what are still difficult bank fundamentals over the next few months. The secondary market is on fire as companies use the better market to raise capital, and let's just say that they are not going to sell stock to the public when managements feel that their stocks are dirt cheap. And finally, I do not like the action I'm starting to see in the Government bond market.
Rather that drone on about all of this, I want to focus on the stress test and the bond market (which to me is my biggest bugaboo on a longer term basis). As far as the widely anticipated and leaked stress test goes, I say BALDERDASH. This thing was as manipulated as a steel cage match between Andre the Giant and Hulk Hogan. The Fed came in with their results, the banks all cried and pouted, and the Fed relented. A couple of facts? Bank of America's original "capital hole" was pegged at $50bln. The official result? $35bln. Citigroup's original hole? $35bln. Final tally? $5bln!!! When all was said and done, the banks' combined deficit was $75bln. The amount of TARP money left? $100bln. How convenient! Don't believe the hype; the banks are not in good shape. With this thing out of the way, the proof will be in the pudding going forward, and we'll see how they all look when the commercial real estate losses come in earnest this summer. As you can tell, I'm somewhat skeptical.
As for the Government bond market, it seems as if folks are beginning to figure out how much supply will have to come to market to support the ever growing panoply of spending and lending programs we have going on. And if you want to watch something really chilling, have a gander at this: http://www.youtube.com/watch?v=PXlxBeAvsB8&feature=player_embedded.
It seems as if no one even has their hands around where all the Fed lending has really gone! Our deficits are out of control (thanks for the $17bln in budget cuts Mr. President. That'll help, really), and by some counts our public debt is on its way from going from 40% to 80% of GDP. I'm all for focused, logical, job producing stimulus, but I guess that's really an oxymoron.
This is wild and woolly, and we're going to have to pay the piper at some point. The way we'll pay? Higher interest rates, higher taxes, and a devalued dollar. As far as rates go, the last treasury auction was not so hot, with investors demanding higher rates. Get used to that. We've already seen the initial salvo in terms of higher taxes. Get used to that too. As far as the dollar goes, China is already making big noise about their unease in keeping so much of their reserves in USD assets (bonds) and they have been buying gold hand over fist (holdings are up 73% since '03).
Now, all of this is not going to blow up overnight. The impact of these problems will be felt over time. However, when one asks me whether we've seen the absolute lows and if we're in a new secular bull market, I have to shrug my shoulders. We may well be in a long tailed cyclical bull market at this point, which could extend into 2010 as the economy recovers from the lows, but what I'm talking about above could very well put the air brakes on in a big way in the future and frankly, it scares the heck out of me. So while it may be that we ride the recovery for a while, I think that it behooves EVERYONE to keep a very watchful eye on this stuff in terms of the long term, have core positions in gold, oil and TBT and add to them on weakness. While economists are prattling on ad nauseum about not being worried about inflation given the state of the economy at the moment, we all should be looking out past the immediate horizon with a very wary eye.
As for the more immediate thesis, I'm still feeling that we have a summer pullback coming of about 10-15% from here as the pudding might not be as tasty as folks are making it out to be. However, I continue to feel that the market will eventually work higher as we ride the wave of an economic recovery into 2010. After that, Katie bar the door cuz it's going to get interesting!
Yours with a smile!
TRB
Friday, April 24, 2009
The Song Remains the Same
"Feeling good, Winthorp!" ~ Billy Ray Brown, "Trading Places"
Last week, I seriously thought that TRB might be going the way of the dodo (bad sushi = bad times), but I'm back with a spring in my step and a twinkle in my eye as I look towards the 80 degree weather that's in store for us up here. The good news? Golf is in the air. The bad news? My lawn is in terrible shape. It's absolutely embarrassing. If there was any doubt to my neighbors that I'm a city boy, this should do the trick! Hopefully I'll be able to tackle both my swing and my lawn this weekend as both are in similar disrepair.
Anyway, on to the markets. Honestly, I wish I had something brand spanking new to say here, but I'm afraid I'm going to sound like a broken record. The equity market, on the surface, has been acting well for the past couple of months. This week it fell for the first week in the past 7, and not by very much when all was said and done. In my opinion, while the first 4 weeks of the rally were very well supported by fundamentals and market internals, I think that the quality of the upward thrust of the past couple of weeks has been somewhat suspect. I'm going to go out on a limb and say this: the old trader's adage "sell in May and go away" will be prescient this year.
It seems as if the bank "stress test" is what completely dominated the market psyche this week, which when you really look at it, is kind of stupid if you asked me. On Monday, equities really took it on the chin when a report suggested that of the 19 banks undergoing the test, 16 would be shown as being "insolvent" under stressed conditions. Then the market got a boost the next day when Treasury Secretary Geithner said that the majority of the banks had more than enough capital. On Friday, the press cited the release of the RULES of the stress test (and earnings, which I'll get to in a sec) as the reasons for the rally.
Regarding Monday, the assumption that 16 of the 19 banks would be insolvent seems REALLY aggressive (although, I guess we can't rule anything out these days). Regarding Geithner's comments, the question really lies with what set of banks to which he was really referring. Was he saying that most of the banks in the USA (the vast majority of which are small community banks) are more than well capitalized, or was he referring to the majority of the 19 banks undergoing the stress test? I'm going to go with the former here, which, if true is a tad misleading. Regarding today, all I can say is, "Really???" You have to be kidding me.
The crux of the issue here is that ALL of this is pure economic/political theatre. It means absolutely nothing regarding fundamentals. The Government has made it all too clear that, even if a bank fails the test, it will not let the bank go under. In these cases, the Government will probably have to convert preferred shares into common and "quasi nationalize" a few more banks, but at the end of the day, those who are holding their breath expecting the resolution of the stress tests to result in more lending better have good lungs.
You see, what seems completely lost on the powers that be is that excessive lending is exactly what got the banks in trouble in the first place. Regulators SAYING that banks have sufficient capital should absolutely NOT change anything regarding the current reluctance of the banks to rev up lending. The banks (supposedly) know their business, and to think that managements are going to go back to the willy-nilly lending practices that dominated the past decade is plain ignorance. In fact, given what the economy looks like at the moment, it would be absolutely natural and rational for bank lending to retrench anyway. So not only should banks be lending less, but given the artificial and irrational level of lending that we saw coming into this, banks should naturally be lending a LOT less when compared to a year or 2 back. This would be (GASP!) a sound business decision for a freaking change, and while it will more than likely mean that economic activity is less than robust for a while as the banks reset, it will also mean that the banking system comes out of this period in much better shape.
What may happen however, and what would be a BAD business decision, is that the Government quasi-nationalizes a few banks and begins to forcefully push an agenda of them making more, potentially unsound, loans. Folks, we need a sound, rational, functioning banking system, and while a push for more lending might be good for a short-term pop in the economy, all this would do would be to push out the resolution of the problem and the real, lasting economic recovery along with it. The point is that a true recovery is going to entail stabilization before recovery, and true stabilization is going to require time. Patience is not a strong suit for either the American people or the Government, and I think that the risks here are: 1) either the pace of recovery will disappoint (which we can deal with); or 2) the Government tries to FORCE a recovery in lending, which would lead to an extension of the problems and a prolonged period of difficult times. Let's hope with all of our might that risk number 1 is all we have to tackle.
Now, regarding 1Q earnings folks seem to making a big deal that results have come in generally better than expected. On the surface, this is true as upside earnings surprises have nicely outpaced negative ones. However, along with the upside surprises on the bottom line (earnings) have come frequent doses of NEGATIVE surprises on the top line (revenues). So what does this tell us? It tells us that companies are doing a bang up job in the cost cutting department (for which they should be congratulated), but sales are not so hot. For more evidence of this, if one looks at daily corporate tax receipts, the downward trend has not changed and this doesn't bode well for revenues. Finally, a lot was made about how "good" some of the banks' results have been, but when one takes a closer look, one finds that the majority of these earnings gains came from trading (notoriously volatile) and interesting (albeit legal) accounting.
So taking all of this into account, while one can't argue with the earnings results (and we should be grateful that they're coming in better than the vastly reduced guestimates of research analysts), one can take a bit of a wary look at their sustainability and quality. For me to dub an quarterly release "strong", I need to see at least a couple of things: 1) strong revenues; 2) strong margins; 3) strong earnings. We're only seeing one of these in general now. Just as the saying goes, "you can't spend your way out of recession", and you can't cost cut your way out of one either. At some point you run out of cost cutting ammo and you NEED revenues to kick in. This is likely to take a while and I'm concerned about the impatience of the market. To end on a high note though, companies are running lean and mean, so when revenues do begin to improve we should see a nice earnings pop along with them. This leaves me increasingly optimistic regarding '10.
Finally, looking at market internals, I'm still concerned about the lack of volume accompanying the recent rallies. While Friday's volume was decent, the above average volume has been coming on the down days, not the rallies, which gives me pause. Additionally, we've seen a big jump in insider selling of late, with corporate insiders selling 8X more stock than they're buying. The last time I saw the selling to buying ratio hit this level was at the top of the market in 2007, and again, this makes me a bit nervous.
Net/net, it's been a good run. There are pockets of improvement showing up. I think we've seen the cycle bottom. I believe that the S&P 500 is likely to hit 1000 by mid 2010. However, I also believe that the pace of economic recovery is likely to disappoint as we move into the summer and the new issues are likely to gain brain space (commercial & industrial loans, credit cards, non-residential construction) even though they're lagging indicators. My guesstimate? The S&P bottoms somewhere between 750 and 800 this summer, before setting up for the run to 1000 in the Fall and into 2010. My advice? Have some "dry powder" and a wish list of companies you want to own so that when the time comes, you can take advantage.
Cheers!!! It's Southside weather!
TRB
Sunday, April 19, 2009
Ooooof
Due to what can only be described as a cross between dengue fever and the hantavirus, I didn't get around to the blog this week. I'll be posting next week.
TRB
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