Archive for October 9th, 2012
Tuesday, October 9th, 2012
October 2, 2012
- Highlights, key takeaways and perspective on the recent BCA Research Investment Conference.
- The eurozone crisis and China’s slowdown remain risks, but are somewhat offset by optimism about US markets.
- Politics will remain a force underpinning uncertainty and volatility.
I try to attend BCA Research’s annual conference in New York City, my stomping ground, whenever I’m able. On September 10 and 11, I sat in on two days of panel discussions on a variety of topics, and today’s report will provide some highlights and perspectives.
One of the interesting features of the conference was electronic audience polling, and I’ll share some results throughout this report. Through these polls and in conversations with other attendees, it was clear the mood was relatively optimistic, with 43% of respondents to one poll saying they were overweight risky assets. However, the mood among many of the panelists was decidedly less optimistic.
Can the euro be saved?
- Bernard Connolly, chief executive officer of Connolly Insight LP; his 1995 book, “The Rotten Heart of Europe,” outlined the flaws in the proposed euro project and cost him his job at the European Commission
- Dhaval Joshi, BCA’s Chief European Strategist
Connolly presented the negative view on the euro, stressing that budget deficits and wide yield spreads in the eurozone periphery are symptoms of the problem, not the problem itself. He views the single currency project as fundamentally flawed from the beginning and said it will be “virtually impossible to sustain.”
Connolly outlined several possible resolutions to the eurozone crisis, each of which has problems:
- Relying on austerity to squeeze costs in competitive countries would bring depression, default and—most importantly—social and political upheaval. Complicating the problem is the fact that Ireland and Spain experienced housing bubbles four times larger than that of the United States. Defaults and bankruptcies could mushroom in these countries.
- Massively depreciating the euro would lead to an unacceptable (≈70%) rise in inflation in Germany.
- Moving Europe to a full transfer union would require a perpetual transfer from Germany of about 10% of German gross domestic product (GDP).
Connolly said he believes that European Central Bank bond purchases will only delay required adjustments in peripheral countries and allow debt ratios to continue to rise.
Joshi agreed that Europe’s monetary union had fundamental flaws from the outset, but he focused more on worries associated with Germany and its “export bubble” and “lopsided economy,” with net exports having been the virtual sole contributor to growth since the introduction of the euro. This means Germany has become highly vulnerable to swings in global demand, in addition to being the global “shock absorber.”
The audience was asked whether Germany’s hardline attitude was justified, and voted overwhelmingly that it was:
Source: BCA Research Inc., as of September 18, 2012.
Joshi’s key question is whether the imbalances are corrected in a violent V-shape through euro disintegration, or more gradually in an extended L-shape, with the monetary union kept largely in place. He believes most politicians (and voters) would prefer an L-shaped outcome versus a depression.
At Schwab, we believe the flaw of the euro—a common currency that has shared monetary policy but disparate fiscal policy and cultural differences—has been exposed by the sovereign debt crisis. However, eurozone countries will have a difficult time “checking out” due to the high costs of a currency breakup. While continued accommodations for Greece’s “special case” may not continue, they demonstrate the commitment of policymakers to try to keep the euro together.
Debating China’s economic future
- Michael Pettis, professor of finance, Peking University
- Victor Gao, director of the China National Association of International Studies; former translator for Deng Xiaoping
Pettis said he believes China faces an inevitable and painful transition, with economic growth falling to a 3-4% rate in the next decade. Its growth model involves a systematic transfer of wealth from the household sector to support growth, and three mechanisms facilitate this process:
- Undervalued currency: a direct subsidy on the net export sector, but a consumption tax on households.
- Widening gap between Chinese wage growth and productivity growth: reduces labor’s share of GDP.
- Financial repression: low interest rates transfer wealth from savers to borrowers.
Pettis said he believes that as marginal returns on capital slow, it will become more difficult to find economically viable projects. China’s savings rate will need to decline and its consumption-to-GDP ratio must increase, which will only occur if household income captures a larger share of GDP. Pettis outlined four policy options:
- Reverse transfer mechanism from households to other sectors, leading to a sharp increase in the value of the yuan and potential major recession (unrealistic).
- Gradually reduce distortions, which could take a decade (they’ve run out of time).
- Massive privatization program to transfer wealth from state sector to households (politically difficult).
- Expand government debt to absorb private-sector debt (possible, but economically inefficient).
Gao countered with a far-more-upbeat assessment, though he liberally relied on history and China’s great transformation over the past three decades. He said he expects China’s economy to continue to grow at close to 8% thanks to four megatrends he doesn’t believe will change: industrialization, modernization, urbanization and globalization.
At Schwab, we believe that as China’s economy matures and shifts from over-reliance on government investment to increased private consumption as a percent of GDP, slower growth is likely the new normal. However, this transition won’t be accomplished overnight; the government will likely need to enact market-based reforms and reduce its grip on the economy, and the transition could be accompanied by bumps in the road.
Our view on China’s economic trajectory is in keeping with the results of a poll during the conference:
Source: BCA Research Inc., as of September 18, 2012.
US economy, policy and market outlook
- Norman Ornstein, resident scholar, American Enterprise Institute
- David Stockman, former budget director for President Ronald Reagan
- David Rosenberg, chief economist, Gluskin Sheff and Associates
- Laszlo Birinyi, president and founder, Birinyi Associates
- Richard Bernstein, CEO and founder, Richard Bernstein Advisors
Ornstein spoke over lunch on day one and presented three key themes:
- The high level of political dysfunction in Washington. The key problem is a shift by both parties toward more adversarial parliamentary-style interaction within a system designed to be based on consensus-building.
- Political dysfunction and gridlock breeds disenchanted voters. A culture has evolved in which politicians are no longer held accountable for spreading lies. Biased reporting in the press amplifies differences between parties and makes it difficult for voters to identify those responsible when things go wrong.
- Politics will remain a source of volatility for markets if Barack Obama is reelected. A Mitt Romney win and Republican control of the Senate could lead to a “mother of all reconciliation” bills that repeals the Patient Protection and Affordable Care Act, makes the Bush tax cuts permanent, eliminates sequesters and turns Medicaid into block grants.
I wholeheartedly agree that more years of infighting and discord in Washington is the most likely outcome, regardless of the election results, and that politics (globally) will remain a source of uncertainty for markets.
Stockman followed Ornstein and unleashed a furious attack on Federal Reserve policy on the grounds that it’s creating an addiction to cheap money and enabling the government to spend beyond its means. He said he believes that aggressive Keynesian monetary and fiscal policies have prevented a cleansing of financial imbalances and have contributed to the massive build-up of debt over the decades (I couldn’t agree more).
Stockman said he believes the fiscal governance process is broken and that both Democrats and Republicans have become “free lunch” parties, telling voters fairy tales about the fiscal mess. He also indicated that he believes Congress will only be able to manage compromises that last three to six months, and that the US Treasury bubble will burst at some point, resulting in a severe recession.
Rosenberg was also characteristically gloomy, saying that he believes the United States is not decoupling from the rest of the world and that he expects a shock in trade numbers in the next several quarters.
Both Birinyi and Bernstein were more optimistic, making a strong contrarian bull case for US stocks. Bernstein’s “Wall Street” sentiment indicator (tracking strategists’ stock-allocation recommendations) is at its lowest point since tracking began in 1986.
Bernstein said he believes the problems in the rest of the world will ensure a continued flight to safety into dollar assets and that US stocks will continue to outperform global benchmarks. He acknowledged the risk that earnings have likely peaked, and if the dollar appreciates, small-cap domestic stocks will likely outperform larger-cap multinationals. (I agree with this assessment.)
Birinyi posited that there’s no “average” or normal bull market—that group rotation exists but is random. He said he believes we’re in the fourth and final leg of the bull phase that could lead to a 1,500 level in the S&P 500 index by the end of this year.
Although the outlook among many panelists, regardless of topic, was relatively gloomy, the outlook of the audience was a bit more optimistic (including yours truly). Yes, the eurozone is still a mess, China’s growth is weaker than many believe, and neither the Fed nor US politicians are distinguishing themselves. But at some point, the negative tail risks get priced in, leaving an opening for positive tail risks. I think that’s what’s been driving stock prices higher, and I continue to believe the US market will outperform most other global indexes.
One of the final poll results is consistent with my view:
Source: BCA Research Inc., as of September 18, 2012.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
Copyright © Charles Schwab & Co., Inc.
Tuesday, October 9th, 2012
by Gideon Rachman, FT.com
Over the past three years, conventional wisdom divided the world’s major economies into two basic groups – the Brics and the sicks. The US and the EU were sick – struggling with high unemployment, low growth and frightening debts. By contrast the Brics (Brazil, Russia, India, China and, by some reckonings, South Africa) were much more dynamic. Investors, businessmen and western politicians made regular pilgrimages there, to gaze at the future.
But now something odd is happening. The Brics are in trouble. The nature of the problem in each nation is different. But there are also some broad difficulties that link them. First, for all the hopeful talk of “decoupling”, the Brics are all affected by weak western economies. Second, all five nations are finding that endemic corruption is eroding faith in their political systems, and imposing a tax on their economies.
China remains the daddy of the rising powers. It is the second-largest economy in the world – and easily still the fastest growing Bric. And yet the country feels more uncertain about its economic and political future than in many years. As a Chinese friend put it recently: “Our economy is slowing sharply, our next leader has disappeared, and we are sending ships towards Japan.” Xi Jinping has since reappeared – as mysteriously as he disappeared in the first place. But political tensions remain high, with the trial of Bo Xilai about to start and a crucial party congress approaching.
Copyright © FT.com
Tuesday, October 9th, 2012
by Don Vialoux, EquityClock.com
Stocks in the US traded lower on Monday in what amounted to a relatively quiet day with Columbus day in the US and the Thanksgiving holiday in Canada. Volume for the S&P 500 was the lowest since July 3rd when markets closed early for the Independence day holiday. Support remains apparent at the 20-day moving average as investors await for earnings season to begin on Tuesday after the closing bell. Alcoa will kick off the period and analysts are expecting that earnings will be nil (0), down from the 15 cents per share reported in the year ago period. Alcoa is currently resisting off of its 200-day moving average ahead of the report, a significant level to overcome in order to continue the recent positive trend for the stock. Positive seasonal tendencies for Alcoa are set to begin at the end of this month, well after the quarterly report is released.
Today marks a key date within our seasonal models. October 9th, on average over the past 20-years, has marked the end of the weakest three week period of the year as earnings warning season drags on equity price action. Earnings warnings were certainly prevalent this year. Of the 103 companies of the S&P 500 that provided EPS commentary, 80 of them issues negative guidance, or just under 80%, amounting to the worst warnings season in 11 years. From peak to trough, the S&P 500 and TSE Composite saw declines of around 3% over the past three weeks, ending the period closer to the flatline as markets attempt to overcome resistance at 1475 on the S&P 500 and 12,500 for the TSE Composite. Between now and the end of October, volatility is typical as investors digest earnings and allocate portfolios prior to the end of the year. Seasonal trends for many sectors and indices turn definitively higher after October 28th with consumer stocks tending to lead the way during this holiday spending influenced period. Average return for the S&P 500 from October 9th to the end of the year is 5.82%, while election years return a slightly less 4.2%.
With the October 9th date now upon us, which sectors tend to do the best between now and the end of the year? The last quarter is typically all about the consumer as holiday spending drives stocks related to the season higher. This means that Consumer Discretionary, Consumer Staples, and Technology are all poised to benefit from positive seasonal influences. Seasonal tendencies for Technology turn positive on October 9th, on average, meaning that investors should now be looking for signals to buy. On the charts, negative profiles for technology companies are presently acting as a burden. Of course apple broke below its 50-day moving average on Monday and a head-and-shoulders topping pattern is apparent. Downside target for Apple is to $620 as it concludes its typical period of seasonal weakness prior to its earnings report. As Apple weighs on the sector, the Technology ETF is showing a similar head-and-shoulders topping pattern with targets of approximately 3% lower than Monday’s closing values. Short-term weakness is likely to provide ideal entry points for this seasonal trade, which typically tops out into January and February.
I will be on BNN this evening at 4:50pm to discuss the above topics as well as the outlook for the market for the intermediate-term. Tune in!
Copyright © EquityClock.com
Tuesday, October 9th, 2012
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Tuesday, October 9th, 2012
by John Hussman, Ph. D., Hussman Funds
Examine the points in history that the Shiller P/E has been above 18, the S&P 500 has been within 2% of a 4-year high, 60% above a 4-year low, and more than 8% above its 52-week average, advisory bulls have exceeded 45%, with bears less than 27%, and the 10-year Treasury yield has been above its level of 20-weeks prior. While there are numerous similar ways to define an “overvalued, overbought, overbullish, rising-yields” syndrome, there are five small clusters of this one in the post-war record: November-December 1972, July-August 1987, a cluster between late-1999 and early 2000, early 2007, and today. The first four instances preceded the four most violent market declines in the post-war record, though each permitted a few percent of additional upside progress before those declines began in earnest. We do not know what will happen in the present instance, particularly over the short-run. But on the basis of this and a broad ensemble of additional evidence, we estimate that the likelihood of deep losses overwhelms the likelihood of durable gains. To ignore those four prior outcomes as “too small a sample” is like standing directly underneath a falling anvil, on the logic that falling anvils are an extremely rare occurrence.
On the economic front, Friday’s employment report was interesting in that total non-farm payrolls (the “establishment survey” figure most widely quoted in news reports) came in slightly below expectations, but total civilian employment (the “household survey” figure used to compute the unemployment rate) jumped enough to produce a drop in the unemployment rate to 7.8%. While the difference was certainly an outlier in terms of typical correlations between establishment and household figures, it wasn’t the sort of outlier that would justify the suggestions of political conspiracy that were bandied about over the weekend.
The fact is that on a month-to-month basis, there is only a 50% correlation between the establishment and household employment figures, rising to about 90% correlation for year-over-year changes. The household data is notably more volatile, but the establishment figure makes up for the lower volatility with significant after-the-fact revisions, particularly around economic turning points. The month-to-month changes above and below the 12-month average are about 50% larger in each direction for the household survey than for the establishment survey. What’s interesting is that these changes are often matched by changes in the reported size of the labor force, which is why they don’t usually result in large changes in the unemployment rate from month-to-month. For example, in January 2000, the household figure jumped by over 2 million jobs, while the establishment figure increased by only 248,000 jobs. But the unemployment rate held steady at 4% because the reported labor force also increased by over 2 million workers.
From that perspective, the unusual feature of last month’s report was that the increase in reported household data exceeded the increase in the reported labor force by an amount that statistically occurs only about 6% of the time. Yes, it was an outlier, but it wasn’t even a two standard deviation event. I would expect some give-back in that “excess” household survey growth, and based on the extent of revisions to establishment survey data around economic turning points, I also expect that the September establishment survey figure will ultimately be revised to show a net loss of jobs on the month. So as a whole, my impression is certainly that the September report presents a healthier picture of the employment situation than will survive later revisions, but there isn’t evidence to suggest any manipulation of the data.
At the same time, nothing in the most recent data changes my view that the U.S. economy has already entered a recession. The ISM purchasing managers data came in slightly above expectations, but broader data from regional ISM surveys as well as Federal Reserve surveys remain well below-average. European purchasing managers data has been dismal. As Markit notes, “It seems inevitable that the region will have fallen back into recession in the third quarter.” And even if we take the recent employment report at face value, the year-over-year growth in non-farm payrolls is presently just 1.37%, and we’ve never yet seen a decline in payroll growth below 1.4% year-over-year except during or just prior to U.S. recessions. This time may be different, but is difficult to see why that expectation is sensible given the broader context of economic evidence.
Meanwhile, the balance sheet of the Federal Reserve presently comes to about $2.8 trillion, with an average duration of 7.3 years, meaning that a 100 basis point change in interest rates would be expected to impact the Fed’s position by about 7.3% on the basis of bond price changes. Now, keep in mind that the Fed presently has just $54.7 billion in capital, which means that the balance sheet is leveraged by over 50-to-1, or put differently, the balance sheet has just 1.95% capital coverage. The unpleasant arithmetic here is that a 27 basis point change in bond yields (1.95%/7.30%) would effectively wipe out the Fed’s capital. While the Fed doesn’t mark its balance sheet to market, and can therefore run an insolvent balance sheet without immediate consequence, it should at least be a subject of public understanding that monetary policy becomes fiscal policy 27 basis points from here. Over time, of course, the Fed earns interest on its bond holdings, and that interest is normally handed over to the Treasury for public benefit. Presently, a 30 basis point increase in yields over a one-year period would wipe out even this interest, at which point the government would be paying interest on its debt simply to cover the Fed’s losses, with no net benefit to the public. That is, unless one believes that the Federal Reserve’s manipulation of financial markets is of equivalent benefit in and of itself. We don’t, and it is likely that investors will discover that in an uncomfortable way over the coming quarters.
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
As of last week, the stock market remained characterized by an overvalued, overbought, overbullish syndrome and a variety of other conditions, and we continue to estimate very weak prospective returns per unit of risk on a blended horizon from 2-weeks to about 18 months. The longer-term outcomes from overvalued, overbought, overbullish syndromes have been more reliably negative than the short-term outcomes, where unfavorable long-term conditions are often ignored by speculators in pursuit of short-term momentum. That has always made our investment discipline uncomfortable in late-stage bull markets, as we saw in 2000 and 2007. That said, our “two data sets” challenge in 2009-early 2010 (see the most recent Annual Report for an extensive discussion) makes it easy to assume that our investment stance is simply pinned to a defensive mode – despite the fact that we removed most of our hedges in early 2003 when we had no such concerns about the relevance of Depression-era data.
While we place a great deal of emphasis on reducing the potential for deep capital losses, it would be incorrect to assume that our investment stance is inherently defensive regardless of market conditions. This is particularly true for Strategic Growth Fund, which has the ability not only to remove all hedges, but also to leverage its investment position using call options. While the Fund has not taken that sort of position since the inception of the Fund, that outcome is the result of market conditions that have produced a 13-year period of total returns for the S&P 500 that – even today – remains below the total return achieved by holding Treasury bills. Market conditions will change; valuations will change – and when those changes emerge, we will not have to concern ourselves again with the question of whether our hedging approach is robust to Depression-era data.
Particularly in Strategic Growth Fund, it is important to recognize that while we are conservative with respect to the risk of major capital losses, the Fund’s strategy is aggressive in its ability to vary its exposure to market risk. Presently, that aggressiveness may be on the defensive side, but there is a reason why aggressively positive exposures are part of our investment strategy and are written into the Fund Prospectus, and that reason is that we fully expect market conditions that warrant those positive exposures. I doubt that we’ll observe another market cycle that does not allow for such positions.
There is no doubt that we have been uncomfortable with a defensive stance and extremely negative return/risk estimates – as we were in 2000 and 2007, as the market comments from those points will attest. We view the market as richly valued on the basis of normalized earnings and prospective cash flows, with overbullish sentiment, overbought market action, and facing the prospect of an unrecognized recession already in progress. The evidence is not encouraging with respect to what has normally happened next.
We are very familiar with the tendency of investors to believe that prevailing conditions are immutable and that some new feature of the investment landscape has changed the way that the markets work. If anything, my impression is that we risk having overestimated the prospective growth rate of future cash flows, which would leave our estimate of 10-year S&P 500 total returns somewhat too high at about 4% nominal. Nevertheless, what matters is that valuations and prospective returns will fluctuate, and we have no need for the market to move to deep undervalue in order to justify removing our hedges. It certainly did not achieve deep undervalue in 2003. Of course, the 2009 low represented moderate undervaluation on our estimates (our estimate of 10-year prospective total returns moved briefly above 10% annually), but we had profound concerns about the out-of-sample nature of market conditions at the time. The coming cycle will have a whole range of aggressive and defensive opportunities, and we are looking ahead to those. At present, market conditions are associated with some of the most negative market outcomes in the historical record. Our investment stance is sensitive to the prospective returns and risks that we estimate. Present conditions are what they are. What is certain is that those conditions will change.
Strategic Growth Fund remains fully hedged, with the put option side of the Fund’s hedges raised closer to prevailing market levels at a cost in time-premium of just over 1% of assets looking out to early 2013. Strategic International Equity remains fully hedged, and Strategic Dividend Value is hedged at about 50% of the value of its stock holdings – it’s most defensive stance. Strategic Total Return continues to carry a relatively short duration of about 1.4 years, meaning that a 100 basis point change in interest rates would be expected to impact the Fund by about 1.4% on the basis of bond price fluctuations. The Fund also holds a small percentage of assets in utility shares and precious metals shares.
Prospectuses for the Hussman Strategic Growth Fund, the Hussman Strategic Total Return Fund, the Hussman Strategic International Fund, and the Hussman Strategic Dividend Value Fund, as well as Fund reports and other information, are available by clicking “The Funds” menu button from any page of this website.
Copyright © Hussman Funds
Tuesday, October 9th, 2012
“A Kid’s Market”
by Jeffrey Saut, Chief Investment Strategist, Raymond James
October 8, 2012
Last week a particularly wily Wall Street wag asked me, “Hey Jeff, do you know why everyone is underperforming the S&P 500?” “Not really,” I responded. He said, “Because the S&P has no fear!”
That exchange caused me to recall an excerpt from the book The Money Game. I like this story:
“My solution to the current market,” the Great Winfield said, “Kids. This is a kid’s market. This is Billy the Kid, Johnny the Kid, and Sheldon the Kid.” “Aren’t they cute?” the Great Winfield asked. “Aren’t they fuzzy? Look at them, like teddy bears. It’s their market. I have taken them on for the duration. I give them a little stake, they find the stocks, and we split the profits,” he said. “Billy the Kid here started with five thousand dollars and has run it up over half a million in the last six months.” “Wow!” I said. I asked Billy the Kid how he did it. “Computer leasing stocks, sir!” he said, like a cadet being quizzed by an upperclassman. “The need for computers is practically infinite,” said Billy the Kid. ”Leasing has proved the only way to sell them, and computer companies themselves do not have the capital. Therefore, earnings will be up 100% this year, will double next year, and will double again the year after that. The surface has barely been scratched. The rise has scarcely begun.”
“Look at the skepticism on the face of this dirty old man,” said the Great Winfield, pointing at me. “Look at him, framing questions about depreciation, about how fast these computers are written off. I know what he’s going to ask. He’s going to ask what makes a finance company worth fifty times earnings. Right?” “Right,” I admitted. Billy the Kid smiled tolerantly, well aware that the older generation has trouble figuring out the New Math, the New Economics, and the New Market. “You can’t make any money with questions like that,” said the Great Winfield. “They show you’re middle-aged, they show your generation. Show me a portfolio, I’ll tell you the generation.”
… “The Money Game” by Adam Smith
“The Money Game” was penned by an acquaintance of mine, namely Jerry Goodman, who took the nom de plume of legendary economist Adam Smith, author of the groundbreaking book “The Wealth of Nations,” first published in 1776. I met Jerry a few years ago at the offices of my friend Craig Drill, eponymous captain of Drill Capital, where another icon hangs his hat. That icon (Dr. Albert Wojnilower) is also from an era gone by when he, and his counterpart, rattled markets every time they spoke. Back in the 1970s and 1980s Al Wojnilower was affectionately referred to as “Dr. Gloom,” and his counterpart Dr. Henry Kaufman was deemed “Dr. Doom,” but I digress.
Expanding on the Great Winfield’s wisdom about a “kid’s market,” he goes on to say, “the strength of my kids is that they’re too young to remember anything bad, and they are making so much money they feel invincible.” He rented kids with the idea that one day the music will stop (it did partially in 1969-70, then completely stopped in 1973-74) and all of them will be broke but one. That one will be the Arthur Rock* of the new generation; Winfield will keep him.
I revisit “A Kid’s Market” this morning because of my opening “wily wag” quote and given the fact that most of the investors I talk to that are currently under-performing the S&P 500 (SPX/1460.93) are pretty young and thus have little fear of the downside. Indeed, with the SPX better by 16.17% YTD the bar has been set fairly high. Interestingly, while the SPX rallied 1.3% last week, the real winner was the recently maligned D-J Transportation Average (TRAN/5046.43) that rallied more than 3%. Recall that back in mid-May many pundits were chanting about the breakdown in the TRAN, below its March reaction low, and scared investors by not only suggesting a BIG decline was coming for the D-J Industrial Average (INDU/13620.15), but that a Dow Theory “sell signal” had been registered. At the time I argued against that view because according to the way I was taught Dow Theory the reaction “low” being used was not correct. To be sure, what subsequently happened was a downside non-confirmation, leading to a greater than 12% gain for the Industrials from that June 4th low, which brings us to this week.
Over the weekend many market mavens have been chanting about the yearly market leaders, like Apple (AAPL/$652.59/ Outperform), failing to rally with the overall stock market last week. While true, I don’t think such observations are a predecessor of a major stock market decline. Likely, the recent market strength was anticipating Friday’s better than expected employment report and trading types “sold” the good news. And despite partisan conspiracy-theorizing (like GE’s former CEO Jack Welsh who opined, “Unbelievable jobs numbers … these Chicago guys will do anything … can’t debate, so change numbers”), Friday’s employment numbers were impressive. However, drilling down into those numbers shows that of the 873,000 people that found jobs, 600,000 had to settle for part-time work. Moreover, of the 114,000 jobs added last month, 110,000 were in what the Liscio Report termed, “The eat, drink and get sick” group, namely bars, restaurants, and healthcare. As Barron’s notes, “All, and then some of these revisions, came via the 101,000 jobs added in the local government education category. What the Liscio duo calls ‘excitable types’ [and] professes to see evidence of political manipulation.”
Manipulated, or not, while the cries of a “double top” in the SPX around 1475 are pervasive, I don’t believe them, just like I didn’t believe them a few months ago. As scribed in this report two months ago, when many sages were talking about a double top referencing the March/April 2012 highs at 1422 basis the SPX, I noted that the S&P 500 Total Return Index (and many other indices) was already trading to new all-time highs and was pointing the way higher. That’s still the case. Further, trading volume is abysmal (see chart on page 3), suggesting portfolio managers are still too defensively positioned. That gleaning is reinforced by an insufficient net-long position in the hedge fund community of only 46.5%, as well as a five-year high “short sale” position. Meanwhile, the money supply is surging, commodity prices are at the same level as five years ago (save gold), dividend increases in the SPX companies are at a record high (+20% y/y) despite those companies’ dividend payout ratios plumbing generational lows, a “put option” from the world’s central banks (read: liquidity), epoch low mortgage rates that are heading lower (see chart on page 3), rising home prices, well you get the idea.
To these points, increasing home prices, combined with better stock prices, are lifting consumers’ net worth and encouraging “fence sitters” to buy a house (University of Michigan “good time to buy a house” survey is at its highest level since 2004). That in turn is helping the banking system, which is why bank stocks are up about 26% YTD. While there are numerous Strong Buy-rated bank stocks, with yields, from our fundamental analysts, such as Huntington Bancshares (HBAN/$7.19), BB&T (BBT/$33.64), and Community Bank System (CBU/$28.41), I continue to think one of the best ways to invest in the banking complex is using the FBR Small Cap Financial Fund (FBRSX/$19.84) managed by David Ellison. I met David in the 1980s when he was managing Fidelity’s Select Financial Funds before associating with Friedman, Billings & Ramsey. David is my kind of investor because, like me, he considers “cash” to be an asset class. He demonstrated that when in the 1Q08 he raised 40% cash in his mutual funds, QED!
The call for this week: Third quarter earnings season kicks off this Thursday with Alcoa’s 3Q12 report. Plainly, for the rally to stay intact earnings cannot disappoint. And despite my sense that CEOs have stepped to the sideline on any spending until the November election and a resolution on the fiscal cliff, last week’s economic reports were good. Both PMIs were better than expected, vehicle sales jumped to 14.9 million units, refinance applications surged by 47%, and Friday’s employment report implies Industrial Production will probably look good on the next release. Therefore, despite this morning negative earnings story in The Wall Street Journal, I think the upcoming earnings reports will not disappoint. This morning, however, such worries, combined with Iran hostilities, the Syria/Turkey situation, a slowing economy, the presidential election, the fiscal cliff, and talk of a double-top in the SPX, are all coming together, leaving the pre-opening futures off 7 points. What the bears fail to realize, however, is that in the short-run there is not a linear relationship between the fundamentals and stock prices. Near-term support exists at 1450 – 1455. Major support resides at 1400 – 1422. With a full load of internal energy I think any pullback will be contained by one of those support zones.
*An American venture capitalist who was an early investor in companies like: Intel, Apple, Teledyne, etc.
Copyright © Raymond James