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