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