"Less Bad" Trumps Idiocy

All I can say is "phew", at least for now.  The palpable furor spewing forth from the House regarding the AIG debacle seems to have died down after a number of executives agreed to give back 50% of the bonus and both the Senate and the President himself threw cold water on the concept of voiding valid contracts.  The situation had the potential to turn even uglier, and the fact that it didn't should lead us to breathe a sigh of relief.  

The question remains, however, "has the damage been done?"  The common wisdom is that the equity markets shot skyward on Monday based on the release of the details behind Treasury's "Toxic Asset Purchase" plan (I think that the housing data was actually the main driver, but we'll hit that in a second).  On the surface, the plan seems like it may work: the Government will provide low rate loans and big leverage to private companies willing to invest in financial institutions' "bad assets" alongside it, potentially persuading investors to bid lower prices than they might without the "sweeteners".   In this scenario, the majority of the risk will be taken by us, the taxpayers, while the rewards are split much more evenly.  Is it me, or is it only a matter of time before Mssrs. Frank et all start jumping on this issue as well?  You can be rest assured that the very investors Treasury are courting have this in the fronts of their minds. 

You see, while the plan itself looks doable, all things equal, execution is still a big question mark.  The essential private investors may well be looking at the plan with a wary eye for fear of the Government trying to claw back profits they deem "excessive" down the line. Time and time again, we've seen the rules changed mid-game, and this may well cause institutions to take great care before jumping in with a "partner" which has proven to be less than reliable.  There is absolutely no trust between Wall Street and the Government at this point (probably for good reason on both sides), and the Government simply cannot execute the program by itself.  A very sticky wicket, indeed!  So while I think that the program is a good step in the right direction, the seemingly unbridled enthusiasm that the announcement generated may well be misplaced. We should be watching the execution phase very carefully, as the success of the program may well be extremely important in the "de-gumming" of the credit markets.  With this uncertainty in mind, I am holding onto my small hedge (SDS) that was recently initiated, and I actually added to it yesterday afternoon.

Short term hedge notwithstanding, the "less bad" data has continued to roll in, especially within the housing sector.  The Fed's actions of a week ago (expanding of its balance sheet, purchasing more agency mortgages, buying treasuries outright) has driven mortgage rates lower and spurred a huge 32.2% week over week jump in mortgage applications (with a ton of refinancing activity).  This argues for the continuation of the improvement we witnessed in existing home sales (up 5.1%) and starts (up a whopping 22.2%) in February.  As I've been writing lately, the bargain hunters are beginning to line up, rates are low, the Spring selling season is upon us and I'm confident that January's home sales and months of inventory numbers marked the bottom.  Now, if we can just get the velocity of money going (banks making loans), we'd really be getting somewhere!  This has obviously been absent, and we desperately need to see it in order to sustain anything beyond an anemic recovery on a long term basis.

Continuing with the "less bad" theme, the 4Q GDP number was revised lower, but only slightly so, to -6.3% from -6.2%.  While this is the ultimate in "old news", it is interesting to note that the Street was looking for -6.6%, so we'll chalk it up to a small victory.  Additionally, the weekly unemployment claims data was terrible as expected, but it seems to be leveling somewhat in the mid 600K's (continuing claims rose to another high, however, meaning that it's still tough to find a job once you've lost one).  This is not good at all in the absolute, but it seems as if the velocity of job losses has begun tapering off.  With this said, the 4 week average of initial claims (which smoothes out the data and is, as a result, the number that I watch more than the simple weekly data) actually ticked down ever so slightly for the first time is a while. Whether this is a blip or the start of something more meaningful remains to be seen, but this should now be an important number to watch for inflection points.

So where do we stand here?  At the risk of being a little too short term oriented, I believe that we see a pullback in here.  The market moved about 25% from the low in about 3 weeks (March is likely to post the biggest monthly gain since '74).  Some of the recent buying was probably in the form of end of quarter "window dressing" from funds not wanting their investors thinking they missed the rally.  The trading desks I've talked to tell me that there's still limited true long buying out there and that a good deal of the recent rally has been driven by short covering.  I also believe that folks may have gotten a bit ahead of themselves regarding the pace of potential future economic improvement. This is going to be like turning an oil tanker around, not a speedboat.  So I think that we might be in store for some disappointments here and there, especially regarding consumer spending. Finally, we're heading into the corporate "confession season" in which companies generally tend to lower earnings guidance.

HOWEVER, should a pullback occur, my thought is that the market will make a higher low (720-750?), and prepare for another move to the upside as we head through earnings season. We should continue to get more and more "less bad" data as we head through Spring, which may help to pull in real buyers.  The real question then will be, "is this is the start of a new bull market?"  THAT is a tough one, and it depends on a whole host of issues.  Bear market rallies can last a while, sucking poor unsuspecting investors in before whacking them again.  I'll just put it this way: if I'm right, I'll enjoy the rally while it lasts, but I'm casting a VERY wary eye on the dollar, inflation, and interest rates.  These interconnected forces have the propensity to stop any potential recovery in its tracks, and while they are likely not to come into play until some point well into next year, come into play they will!!!  But that's a story for another day.....

Have a great weekend.  In the 60's in NYC.  Time to start stretching and working on the putting stroke!

TRB 

Unintended (?) Consequences

Lots to go over this week!

While I try not to be too political (both sides of the aisle tend to rub me the wrong way in one way or the other), the events this week leave me no choice but to rant a little, giving everyone a view into my fiscally conservative leanings.  The trigger?  The great AIG bonus smackdown.

First off, let me say that the idea of giving bonuses to the "geniuses" at AIG who nearly brought down the global financial system makes me nauseous.  The populace is pissed, and rightly so. The whole idea of a bonus used to be based on performance: both of the individual and the company.  If an individual makes a bunch of money for a firm, there should be no reason that they should not be compensated for that performance.  This is central to the idea of meritocracy that has governed the growth of this great country AND SHOULD CONTINUE TO DO SO IN THE FUTURE, lest we slip into a system that has been shown, time and time again, to be destructive.  However, if a company in and of itself is in trouble, then even those strong performers should not be immune to a small (or nonexistent) bonus pool, as it is their choice to work at that institution.  

With this said, the whole idea of writing contracts for employees with guaranteed bonuses strikes me as simply bad business.  It takes away the incentive that a bonus is supposed to represent.  It takes away the incentive for the employee to do right by the company rather than him or herself.  It just takes on the aura of a guaranteed lottery ticket every February, when bonuses are generally paid out.  However, at some point along the way, some smarty pants management team decided to guarantee bonuses in certain employee contracts, and once the floodgates opened, it became essential for other companies to follow suit in order to attract and retain talent.  

Does the whole idea make sense?  No.  Are the bonus payments in extremely poor taste given the current environment?  You bet.  Should they be returned?  For moral and just employees, the answer is a resounding yes.  Should they be forced to be returned by Congress? ABSOLUTELY, POSITIVELY, NOT!!!!!!!!!!!!!  I believe that the utterly politically fueled, bombastic "debate" going on in Congress at the moment is pure nonsense and a waste of time when time is of the essence.  When Charlie Rangel is allowed to wax poetic about folks (other than him) "stealing" from the taxpayer and people actually listen to him, I know that the end of the world is here.  

At issue here is the whole idea of the contract, which according to the dictionary is a voluntary, enforceable, legally binding, agreement between 2 competent parties.  The Government is trying to void valid contracts, and this is very, very dangerous precedent.  If Congress can find something illegal in said contracts, have at them.  If not, well then it's THEIR fault for not attaching language in their agreement to bail AIG out that would allow them to rescind bonuses (which would have been, you guessed it, a contract!).  In my opinion, the Government itself should be held accountable for not being prudent in this matter (and we all KNOW that there were more a few people in DC that were very much aware of what was going on in this regard a while ago).  FOR SHAME!

Look, I don't like the fact that undeserving parties are receiving payouts.  It goes against everything I stand for.  More and more people are hurting.  It's not "right".  At the same time, however, I very much fear that we are diluting the very fabric of what the country was built on: the rule of law.  What Congress in proposing is riddled with unintended consequences (as is usually the case), unfortunately none of which are positive.

While AIG has taken center stage here, the fact of the matter is that what the House has passed has implications for employees at ALL of the institutions that are receiving government aid over $5bln.  They are proposing to RETROACTIVELY tax bonuses (paid after the beginning of '09) for employees working at these companies with a family income over the "magic" $250k level at 90%.  While we all know about the major players here (Citi, AIG, Fannie and Freddie, etc.), this impacts many more financial institutions.  This is NOT targeted.  This is going to impact not just the supposed rainmakers, but hard working, smart, employees across a broad swath of financial services.  And it's happening at the exact time when we need these people to work as hard as they can to get us out of the mess we're in.

Beyond this, I see 3 major issues that the bill creates:  1) It is a huge distraction from the real matters at hand (most essential being getting the credit markets flowing); 2) it brings the risk of a "brain drain" from the major US financial institutions towards foreign institutions which are NOT subject to the same compensation taxes, creating a potentially huge competitive disadvantage; 3) it creates a major risk in terms of ability of the Government to attract much needed private capital to the "public/private" partnerships that it is envisioning to purchase the "bad" assets off of banks' books.  I view the last issue as the most disturbing.  If the Government insists on continuing to change the rules mid-game, I have to assume that the very investors that it seeks to invest alongside it are going to be extremely reluctant to do so in fear of future profits potentially disappearing into Government coffers at some point.  Not good. Not good at all.  

As far as the market goes, I think we've taken a step backward here.  We need to drive non-Government investment into the riskier assets being held by the banks in order to really get credit flowing, and the "bonus bill", I fear, has set this process back before it even got going. The market has had a great run on signs that Fed and Treasury actions were actually gaining some traction.  I believe the actions of Congress at least delays the essential follow-through.  At the same time, the market is bumping up against technical resistance.  It's time to play some short term defense here. While I still believe that we have the potential to see some "less bad" data over the next couple of months, and while I still feel that we may well have put the lows in, I reinstated my market short (SDS) this morning.  Even if we have put the lows in and a bottoming process has begun, this process is going to be marked by "pops and drops", and I have the feeling that we're in store for the latter over the near term.

You Win Some, You Lose Some - YCS, DXO, TBT, Gold

Running the risk of being a little long winded this week, I did want to mention the unprecedented move by the Fed as it decided to directly purchase long term Treasuries in order to drive mortgage rates lower.  Mission accomplished.  Treasuries and the stock market surged, the dollar dropped like a stone, and gold reversed earlier losses and ended the day nicely higher.  

I must admit that while, as you all know, the action itself was not a surprise to me, the timing caught me off guard.  I had expected the Fed to make this play in late April when it releases estimates for financing needs.  I believed that at that point, investors would get a sense as to how much Government debt will flood the market, driving Treasury prices lower and putting pressure on the Fed to counteract selling.  Nonetheless, I was mistaken on the timing of Fed action and paid the price with the short Yen play (YCS), giving up my hard fought gains as the US dollar got whacked.  Unfortunately, the aggressive move of the Fed puts a wild card into play with regard to YCS.  Given the fact that I'm a long term dollar bear, and given what the Fed has done (as well as the fact that there's no reason to believe that they won't do it again), I have used the Yen weakness vs. the US Dollar today to move to the sidelines with an unbelievably small gain (maybe I'll drop by Starbucks with the winnings later).   The Fed is being very aggressive here, and I'm not going to fight it on a near term basis.

On the other hand, the Fed helped us out on the oil trade, as investors began to contemplate the potential for a weaker dollar and for "reflation" that the Fed action may eventually bring. The Fed is very actively fighting deflation, trying to avoid the economic spiral that falling prices bring.  As it continues to throw everything, including now the kitchen sink, at the issue, folks are starting to consider a "reflation" trade, in which hard assets (the "stuff" that makes the world go 'round) rise in value.  It's not that we're looking at runaway inflation anytime soon. Demand is still very anemic and supply is still adjusting downward.  However, as I mentioned last week, investors make a living out of trying to anticipate changes in trends.  The trend today is for flat/lower prices.  The trend of tomorrow, however is likely to be a reversal towards higher prices given extremely low rates and the massive amount of Government "pump priming" going on.  Add in very positive long term supply demand fundamentals and a global economy that seems to be inching closer to a bottom, and oil looks interesting indeed.  We might need to see a bit of consolidation here given the recent strong move in crude and anemic near term demand.  However, I'd be looking for weakness in DXO as an opportunity to add to positions.  

Staying with the "Rambo Fed" theme, let me make a brief mention regarding my stance on the short long-term treasuries trade (TBT).  I've mentioned more than once that I am absolutely not expecting TBT to rise in a straight line and that we should be patiently be building positions as it ebbs and flows.  One of the reasons for this is that I have been expecting exactly what the Fed actually did this week, which took the air out of the TBT.  However, while the near term purchase of long term treasuries by the Fed will act to put the brakes on the trade for a time, we should not lose sight of the long term consequences of all of the programs that are being put in place: higher inflation, lower dollar, higher rates.  With this said, I used the pressure on TBT on Wednesday to add to my position.  

Finally, a word on gold.  I've been long the yellow metal for a long time (in the form of GLD), recently trading around a core long term position.  I must admit that the "consensus" nature of being long gold bothers the heck out of me.  The sentiment indicators surrounding gold are leaning strongly on the bull side.  There are a bevy of commercials on TV for companies looking to buy gold jewelry from consumers for cash.  The old gold bugs keep coming out of the woodwork.  This tends to give me pause in a pretty big way as I try to look to zig while others are zagging. 

However, I cant get past the fundamentals:  the printing presses are wide open, not just here but around the world.  Paper money is being created out of thin air.  What this basically means is that currencies around the world are being devalued, not necessarily against each other (it seems as if we're in an age of competitive devaluation) but against other stores of value (gold being a big one).  This looks likely to continue for a while.  Therefore, it's very tough for me not to be a long term bull on gold. 

This said, the market tends to try to make fools of the greater consensus.  So for those of you long gold, I'll suggest this: pay close attention to the charts.  Watch the $880 level closely on the downside.  This is where support lies.  On the other side, watch $1000, which is a level of strong resistance.  I would be holding core positions here and would be looking to add on a breakout above $1000.  Yes, you'd be buying higher, but my confidence that gold is ready for its next leg up (perhaps toward the '80's high of $1600) would be much, much stronger at that point.  

That's it for this week.  Have a super weekend, and spread the word!

TRB 

Well, THAT Was Fast......

So long, sunny NC.  Hello frigid NYC.  Don't get me wrong, I love the wicked city, but there sure is something about playing golf in early March.  So I come back with a heavy heart and a lighter wallet as Dad and his den of thieves took this northern boy for a few smackers.  No matter: it was well worth it!

General Equity Market/Economic Comments

So, no sooner had I returned home than the equity markets shot aggressively higher (making me look a good deal smarter than I actually am), driven by mildly positive comments from Citi and B of A (these days, ANYTHING positive out of those 2 could be seen as a minor miracle and should also be taken with a grain of salt given the utter lack of credibility at those 2 institutions), talk of amending "mark to market" rules and reinstating the "uptick" rule, and a surprisingly positive (all things relative) retail sales report.  I'd say that an 11% move in 3 days would be considered a stellar "pop" in the pops and drops scenario that I mentioned last week, and I must say that the magnitude of the strength has surprised me, illustrating just how oversold the market was, at least on a short term basis.

Last week, we discussed the idea of looking for "less bad" data going forward as the impetus for a true bottoming process to begin.  While I wholeheartedly believe that this process will take a good deal of time, complete with a trip down to retest the lows (if these are indeed in), I also think that we're at the beginning of a period where ALL news will not be terrible, at least on a relative basis.  So while it's very probably too soon to break out any party hats, it at least seems plausible that the front end of the process has slowly started to begin, and remember that you have to start somewhere.

This said, let's have a look at the goings on in the consumer space this week.  While it is true that February's retail sales number was still down very slightly (0.1%), it was nicely above the consensus estimate and actually UP 0.7% when you exclude auto sales.  On top of this, January's data was revised upwards from a gain of 1% to a gain of 1.8% - the first monthly sales gain in 6 months.  Holy shnikeys!  

Now, there's good news and bad news here.  With the savings rate up to 5%, this was a surprise to me and anyone else who's been paying any sort of attention, and it was very welcome.  It shows that, at least as of now, the consumer hasn't completely and utterly disappeared.  It also suggests that, perhaps, the upcoming consumer confidence data may be "less bad" than it has been, which again, might be fodder for further near term gains.  This, coupled with a down 1% inventory number for the month helps with the thought I laid out last week about employment losses beginning to move towards a peak (see the "It's Spriiiing Agaiiin" post).  

This, however, leads to the bad news: the 4-week average of initial unemployment claims continues to creep higher and will likely continue to do so, at least for a while longer.  So while I think we might be in the process of topping out in terms of initial claims, I doubt the number shoots lower soon.  It is for this reason (AND the subsequent continued rise in savings I expect) that I think we may be setting up for disappointment in sales next month, especially if folks feel that the downward trend has been broken.  However, this is a month away, and we'll cross that bridge when we get to it.

Quickly expanding upon my housing market comments from last week, foreclosures indeed continue to rise unabated, which is obviously not a good thing.  However, remember you have to start somewhere, and with this in mind, I'd point out that there was a MASSIVE and successful auction of foreclosed homes at the Jacob Javits center in NYC this week.  The bargain hunters are beginning to appear, and I'd expect this to continue as we head into the Spring.   I'll repeat, prices are likely to continue to drop nationally through the back half of the year, BUT we seem to entering the initial period of PRICE DISCOVERY, which is where the healing must start. 

The trick to investing is to keep your eyes ahead.  One has to look not at what's going on today, but rather at any evidence that may point to a change in trend in the future.  The equity market is a discounting mechanism: it most often takes into account what is going on today weeks of months in advance.  This is why I believe that watching the talking heads on financial TV is a COLOSSAL waste of time and a detriment to the average investor, as they yell and scream about this or that.  Do me a favor:  unless you're day trading, turn it off.  Read a book.  Watch Oprah.  Listen to music.  Anything else.

Boiling it all down, the question here is, "does the recent move have legs?".  In my opinion, the answer is "yes, but they're short ones".  I would not be surprised to see consolidation here, with a pullback next week as investors digest this week's action.  However, I also believe that we may well see some more "less bad" data to help us along, perhaps moving the S&P towards 800 before this bear market rally is complete.  I'd be looking to take money off the table at that point and trade back into SDS.  Remember, bottoms are marked by pops and drops, and we're probably just getting started with this process here.

Short Yen Update

As you know, a few weeks back I suggested those with a more aggressive bent take a look at going short the Japanese Yen vs. the U.S. Dollar by buying YCS (Short Yen ETF).  After an initial, violent move in our favor, the Yen/Dollar has been consolidating recently, which is what I expected.  I feel, however, that we might be ready for another move in the right direction here.  

Let's take a look at a couple of reasons I lean in this direction generally.  Fist, Japan is a very insular nation, and this leads to general, long-term issues.   Immigration policies are quite strict, and this leads to a very big demographic issue.  Only 27% of the population is under 25 years old and 54% is over 40.  21% are over 65, compared to the global average of 7.5%.  The birth rate has declined from 2 million per year in '73 to 1.1 million, and this continues to drop. So the issues here are: 1) there are a disproportionate number of retirees vs. entrants into the workforce, suggesting long-term pressure on economic growth; 2) the cost of caring for the elderly is likely to be high (sounds familiar, but they're well ahead of us on the timeline and they DO NOT have a stream of immigrants to pick up the slack).

With this as a backdrop, there are near-term issues that suggest that the Yen could continue to weaken even given the recent drop.  The 4th quarter GDP number was once again nasty, falling 3.2% (12%+ annualized), and expectations are that this trend is likely to continue.  Yes, growth in the US is terrible as well at the moment, but the thought is that we should see improvement well before they do.  Second, Japan is running a current account deficit for the first time in 13 years. Therefore, the pressure is very high and growing for the government to do something to help Japan's iconic exporters.  One of the things that the Government has been prone to do on this front is to intervene in the currency markets, driving the Yen lower in order to make Japanese goods cheaper on international markets.  They have yet to do this, but I have a feeling it's coming.

Importantly, something interesting happened this week (and thanks to Dennis Gartman for pointing this out).  The normally quiet Swiss National Bank intervened in the currency market this week for the first time since the mid '90s, driving the Swiss Franc lower in order to stave off deflation and boost exports.  Now, it's been a while since ANY central bank has intervened openly, and I think that, with the seal broken, it's only a matter of time before Japan does the same.  Soooooo, after a period of consolidation between 96-98 Yen/Dollar, I think that the move above "par" (100) is imminent. 

Oil Update

Finally, I want to take another look at my view on oil.  I initiated a partial position in DXO (double long crude ETF) last week with the thought that we're may be seeing the worst of the economy in the USA while China is preparing yet another dose of stimulus to their economy. Additionally, and importantly, OPEC seems to have found some discipline, helping out on the supply side of the equation.  

With the latter point in mind, OPEC meets this weekend to discuss oil quotas, and I'd expect yet another cut.  The main players: the Saudis, Iranians, and Venezuelans have all made it quite clear that they are in favor of a large production cut, so it's a forgone conclusion that this will be done.  Given that the market, as mentioned before, is a discounting mechanism, crude has moved higher in advance of the meeting, but I'm not looking at this as a short term trade.  So if there's a "sell the news" decline post this weekend, I'd use it to add to positions as there are a couple of other interesting tidbits to consider.

First, the Russian oil minister will be at the meeting as an observer.  As you know, Russia is a major exporter of oil as well, and the importance of his presence at the meeting should not be lost.  It seems as if we could be moving towards at least a bit of near-term coordination between major exporters (OPEC and Non-OPEC) in terms of output, which could further drive crude supplies lower.  

Finally, looking at the futures market, there has been some interesting activity in crude as well. In a crude bull market, the futures can trade in (or near) something called "backwardation", where contract prices in the near months trade at higher levels than contracts in the outer months.  In a bear market, the futures trade in "contango" which is the opposite.  Recently, we've been in a contango market, and a very wide one at that.  However, recently the contango has narrowed substantially, which is a bullish sign suggesting that supply might be closing in on near-term demand.  Stay tuned here. 

Again, I don't view this as a trade.  Oil is a depleting asset, and an important one at that.  Unless you think that the global economy will forever be in the tank, you want to opportunistically get long oil in one way shape or form.  Now, as the economy tries to find its footing, concerns regarding demand will pop up, driving oil lower.  However, demand will eventually return, and my eyes are on the supply side at the moment, which to me is flashing green.  Many may want to play this by owning shares in the major oil companies, which is fine.  However, I lean towards wanting to play the commodity itself, given Washington's constant yammering  about "windfall" profits taxes and the like. 

That's all for this week.  Have a super weekend, despite the fact that many of us can't hit the links (yet)!

TRB

It's Spriiing Agaiiin.......

....kind of.

I know that it's not technically Spring yet, but as I write this morning from stupendous, lovely, headed to 70 degrees, Wilmington, North Carolina, it sure as heck feels like it! Global warming be damned! Get me to the golf course! In this day and age of telecommuting, I've half a mind to pull up the stakes and set up shop down here. We'll have to run that by the wife first, though.

Anyway, there is a point here. The equity markets have, as I figured they might, broken to new lows, with the S&P 500 standing at about 670 as I'm writing. As I mentioned last week, I thought we'd be looking at a "6-handle" before too long, and sure enough, it certainly didn't take too long to get there. This, I feel is both a blessing and a curse. It's a curse due to the obvious.....stocks have been solidly and relentlessly in the tank. The blessing is that I think that we are starting to get to levels off of which a Spring rally (which I've mentioned before) may well commence.

While I still very much believe that any true bottoming process might take a very long time to play out and that the economy has future air brakes waiting to be applied, this process is likely going to include nice-sized pops as well as drops. So I'm going to go out on a limb, staring at the carcases of others around me who have done this too early, and say that I believe that we're within 5% from marking at least a near term low, which is close enough. This said, I sold my position in SDS (short S&P ETF) on it's strength early this afternoon. Sooooo, let's take a look at a couple of things that are leading me in this direction (or along the path to oblivion).

Employment Report
Wait! Don't stop reading!!! I swear I'm not (too) crazy. I realize full well that the February jobs report released this morning was horrendous. Hear me out though.

The ~650K jobs lost was the worst monthly number since 1949 and the 3rd worst on record. The unemployment rate broke through 8% to 8.1%, marking the fastest 3 month rise in the rate since '74. While I do believe that unemployment will head through 9%, if we're not currently at the nadir in the pace of monthly job losses, I figure we're darn close. As I've said before, a spark to get the market going a bit may well be the pace of economic decline becoming less dramatic, and in terms of monthly job losses, we might be seeing the worst right now (at least I hope so. Daddy needs a JOB!).

I'm not arguing for the numbers to look anywhere close to good anytime soon. All I'm looking for is for them to look "less bad". One thing that gives me hope here is the fact that businesses are really taking the hatchet to inventories, even at a faster pace than sales are declining, and this is absolutely necessary for us to move back into supply/demand balance. This is not to say that sales won't continue to decline in here. The savings rate (now at 5%) is likely to head towards the 60's-80's average of 8% (and remember that spikes higher in times of stress are the rule, not the exception). But with companies ratcheting down production quickly now, they will catch up to the demand decline eventually, and if the gap between the production decline and sales decline remains as big as it has been of late, "eventually" may be pretty soon. At that point, we're going to hit more of an equilibrium of output and demand, necessitating fewer job cuts.

Obama Budget
If you haven't logged off already, WAIT!!!! Indulge me. You all well know where I stand on what's happening in the backwater that is Washington DC. The stimulus plan is not close to what it's made out to be. The budget is even worse. It's a disaster. It makes very little sense, and the assumptions that it makes in terms of revenue coming in are laughable (3.4% GDP growth next year???? Are you serious????). It raises taxes on the most productive, innovative, investment-prone part of U.S. society smack dab in the middle of the worst economic downturn since the Great Depression. Ask Japan about how that worked out for them. HOWEVER, THIS IS THE POINT. The equity market seems to be assuming that the budget will go through as is, and I'm saying that it's so bad, there's no way this happens. When investors see evidence of this, I think it's possible fodder for near-term upside.

Now, I'm not saying that the final compromise will be good. It won't be. But investing in the stock market is a game of expectations, and, much like the jobs report, what we're looking for here is a version that's "less bad" than the original - i.e. better than very low expectations. I think - no, pray - that the final version of the budget, as bad as it might be, will not be as socialistic as what's on the table now. With sentiment low and the market in a free fall, this may be enough to help spark something.

Housing
Now, I'm sure I've lost you. I'm entering blogger hell. I'm writing to myself and only myself. But I'll plug along anyway. The most recent pending home sales number was atrocious (down 6.4% Y/Y and down 7.7% in January alone). What in the world would make me cite housing as a potential positive then? It's in the mantra "you have to start somewhere", and I think that I'm seeing signs that the admittedly very long and bumpy healing process in the housing market is beginning to start.

Where, you might rightfully ask? Well, amid the terrible data, one geographic region showed an increase in sales. Where was it? The West - right where the meltdown started. In particular California and Nevada, ground-zero for the bubble, both showed an uptick in home sales. The naysayers may well say, "Sure, but the vast majority of sales were in the form of bank-led sales of foreclosed homes" and that's true. But you have to start somewhere, and the bargain hunters are finally showing some signs of life in the worst-hit part of the country. With builders not building homes, I think that we are looking at peak inventory (if not now, we're pretty darn close), and once again, what we need is "less bad" data going forward. Will we have a full-flegded national housing recovery before '10? I doubt it. Will it be a slow recovery? You betcha. But you have to start the recovery somewhere, and I think we're close.  Remember also that housing sales naturally pick up as we head out of winter, so bargain hunting should pick up in the months ahead.  

Sentiment and Market Internals
Money market fund assets are more than U.S. stock market fund assets for the first time in 11 years. Liquid assets (cash) in stock funds now represent over 6% of total assets, which is the highest level since '01. The AAII investor sentiment index showed the highest percentage of bears since '87 (70.3%) and the lowest percentage of bulls since '93 (18.9%) (FYI sentiment is considered to be a contrary indicator: in other words, when there are a lot of bulls, look out below!). I will admit that sentiment has been lousy for some time and this hasn't put a stop to the carnage in the equity markets, but we're now hitting levels that are historically pretty interesting.

Finally, and I'm kicking myself as I'm writing this, valuations have seem to have gotten to levels that look interesting as well. Now, the valuation argument has been thrown around since the S&P was breaking below 1000, so on the surface and by itself, the argument is pretty lame. The super bears are going to tell you that massive bear markets have generally ended with Price to Earnings ratios (P/E's) in the single digits. This is true, and depending on who you talk to we could be looking at a low in the 500's (or, GULP, even lower) on the S&P if this were to be the case. However, I don't think we get there as many past bear markets have been marked by super-high inflation - which tends to drive P/E multiples down. This is not an issue now (although this may well be a story for another day - stay tuned), and the majority of recessions have ended up driving the market to somewhere around 11-12X.

This said, if you smooth out earnings over the past cycle, you're at around 11-12X, which to me seems like a reasonable, if not cheap, price to pay for the market, warts and all. The U.S. economy is not going the way of the DoDo (although the current administration seems to be trying its best). The credit market will eventually thaw (BAA spreads are at least somewhat encouraging and the high yield market seems to be open at the moment). Corporate balance sheets are in pretty good shape considering. I think that for long term investors, one should be dipping the toe, ever gingerly, into admittedly murky waters here.

How, you might ask? One of the places that's beginning to look interesting to me is oil. Obviously, the price of crude has been decimated, falling over $100/bbl in the past year. However, with China increasing its stimulus package (and if past experience is a guide, their stimulus package might actually include stimulative projects! Heck, they might even finish them in the next couple of years!), and with the potential of the U.S. soon seeing the worst of the downturn, oil demand might be nearing its low point. At the same time, OPEC seems to have found some discipline and is actually, really, curtailing production (will wonders never cease!). So the supply side looks decent here as well.

With this in mind, I bought DXO this morning, which is a double long crude play. This has been absolutely crushed, falling from the high $20's to about $2.30 since last summer. Oil is a depleting asset, I believe that we're in the depths of the economic morass, and it seems to me a pretty good place to look for potential upside.

That's it for this week. Sorry for the delay (had to go out and play some golf in the wonderful Carolina sunshine. Don't ask about how I did). Have a super weekend, and pass along the blog to anyone you feel might be interested!

TRB