I must admit that I'm the type of person who generally tends to have an opinion on just about anything. However the recent action in the equity market has left me scratching my head a bit. Just when I think I've got it figured out and we can move on, the market turns and I'm left saying "huh"? So this week, I wanted to simply pull a little list together of tid-bits received over the past week or so to think about for no other real reason than clear my mind.
1) The State of the U.S. Consumer
Investors made a lot about the weekly jobless claims number holding in at around 650K, and it's certainly nice to see the number not getting a lot worse, so I'll chalk this up as a small positive (less bad data continues). However, the continuing claims number and the 4 week moving average (which tends to smooth out the more volatile weekly data) continues to inch higher. Additionally, the January job loss data has now been revised 3X from 598K to 741K. February's numbers haven't been revised yet, but they will be, and we'll once again be headed in the wrong direction in this respect. Given that employment trends are the laggiest of lagging indicators, I don't want to put too much weight on this, but let's chalk that up to a negative, all else being equal.
On the housing front, numbers were released that showed 7% of all homeowners as being 30 days late on mortgage payments, up 50% year over year, and 40 % of subprime borrowers 30 days late, up a whopping 73%. So while it looks like the housing market itself is trying to find a bottom, current borrowers are still under a large degree of pressure, and the trends (remember, we're looking for changes in trends here) are still going in the wrong direction.
At the same time, the ABC consumer confidence survey is showing some signs of trouble after inching up for a bit and causing optimism. Investors who have been playing the rally (as the "cyclical playbook" might suggest) via consumer cyclical names (i.e. retailers) might want to take a second look here. The most recent survey came in at -50, the lowest level in weeks and close to its worst levels of -54.
Finally I'd point out once again that the savings rate currently stands at about 4%. It was 11% in the early 80's. It was 16% in '74. It's simply screaming to me that it's going higher and that does not bode well for the consumer spending outlook. Couple this with a 3.5% decline in consumer credit in March, and I think that it's pretty tough to argue for a strong consumer-led economic rally anytime soon. Even if the rally does continue, I can't see the consumer leading us out as it would normally. This is not a "normal" cycle.
2) Business Inventories
It looks as if the nation's business managers are doing a very respectable job of managing inventory levels in here, which is a solid positive. Overall inventories were reported down 1.5% while durables were down 2.5%. This was in the face of sales actually rising for the first time in 8 months. While I'm not sure how sustainable the sales rise is, the inventory control is a solid positive for the economy, as it means: a) that further large economy-draining production cuts are not in the cards, at least in the near term; and b) that if I'm wrong and sales are ready to shoot higher, we'll really be in business as factories will have to step up production and hiring to meet demand, which could be the beginning of a virtuous cycle.
3) Commodity Prices
Positive action here of late. The direction of commodity prices can be seen as a leading economic indicator as the demand for the "stuff" that drives the world obviously moves before construction and the like can begin. Interestingly, the price of lumber, which has been in a brutal bear market given the state of housing, has rallied over 30% in the past few weeks, and copper, platinum, palladium, and oil have also moved nicely higher. Now, some of this action is more than likely tied to speculators who are playing what they see as a potential bottoming in the global economy vs. demand for practical purposes, but the move is a positive nonetheless.
4) Market Technicals
Much more of a mixed bag here. The VIX (volatility index) has broken lower after holding the 40 level for the longest time, which is solidly positive (less volatility is better for the market and the VIX is generally negatively correlated to the equity market). So technicians are likely looking at this turn of events as a major one.
On the other side, however, is the fact that the Dow has been rising on lower and lower volume, which could mean that we're running out of steam. What you'd want to see is the market rising on increasing volume, suggesting increasing participation and conviction. With this in mind, it's worth looking at the Lowry data, which measures supply and demand for equities by looking at upside volume going into advances and downside volume going into declines. Just as the overall volume market is signaling a tired market, the Lowry data is not yet supportive of an extended rally from here either. Generally, the start of an extended bull market is marked with a large decline in selling pressure, and we have not seen this. Rather, selling pressure has only been moving slowly and stubbornly lower, so this is not confirming the advance.
The market can talk to you and tell you things in the way it moves, not just in the direction it in which it moves. Unfortunately the make up of the rally, at least of late, doesn't argue for a huge boost from these levels. While the VIX is a positive that shouldn't be ignored and is something that could well argue for further near term upside, unless the make up of the rally changes it still seems that odds favor that we're at the end of an up-leg vs. the beginning of one.
5) Credit Market
The lack of participation by the credit market in the rally is probably what bothers me the most here. A view into investor confidence can be gleaned from looking at the CI ratio, made up of the difference between medium grade and high grade bond yields. Even in the face of the rally in the equity markets last week, the ratio dropped from 60 to 52, which is a big move and is negative. Additionally credit spreads (between Baa rated bonds and Treasuries) have actually been widening (which is a sign of risk aversion in the credit market) while the equity markets have been rallying, and spreads are now close to their peak. This, again, is not a good sign at all.
The fact that the bond market is not confirming the stock market's move should give us pause here as activity in the bond market is generally seen as a leading indicator of the stock market. Yes, some of the positives that I called for a month or so ago have occurred and the market has, justifiably in my mind, risen. However, a 30% move from the low seems slightly overdone to me given that the economic recovery is likely going to be pretty anemic for a while, and the fact that we're going to have to tackle the issue of the budget deficit and dollar at some point. In addition, expectations, especially regarding the U.S. consumer, seem to be getting ahead of reality.
Now, the market tends to move more than generally anticipated in both directions, and with the VIX breaking down it would be silly for me to write that this is the absolute top of this wave higher. However, I'll repeat that the market internals are arguing that we're at least closer to the end of this move than the beginning, and I'm still of the mindset of being hedged and playing a little defense in here on a short term basis.
I'll repeat what I wrote last week (and about 2% lower): those more prone to trading, it's time to hedge/take profits. For investors, I think you've been given an opportunity to upgrade portfolios. Take advantage by selling the lesser quality names you have left and scale into better names over time at better prices. I think we've found bottom, at least on an intermediate term basis, but we ain't going up in a straight line.
Have a wonderful holiday and enjoy the company of your families! Go Kenny Perry!!!
TRB
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