Market retrospective - week of 14 August

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “The Wall of Worry”

“Trying to predict the future is like trying to drive down a country road at night with no lights while looking out the back window.” - Peter F. Drucker, Austrian-born American business consultant, (1909-2005)

Overview

Even though the major indexes closed just slightly lower this past week from the week before, stopping the market’s run at four up weeks in a row, “let the record reflect” that all three of the major indexes are still up year-to-date: The Dow's up 6.2 %, the NASDAQ, 26%, and the S&P, 11%. While we still haven’t recaptured what we lost late in the third quarter and into the fourth quarter last year, we are definitely trending the right way.

Have you noticed how the media seems to always overplay the negative in the markets, economy and investing? For example, a headline at the close on Friday said, “Stocks Snap Four Week Winning Streak.” Reading that, I’d be inclined to think things were really ugly. I mean, to snap something is painful. In reality, the Dow was only down 0.006% - 60 points – from Friday to Friday. Maybe it’s just me but my headline would have been more like, “Stocks just miss extending rally for fifth week.” That, in my opinion, would have been more forthright.

The point is that when you’re reading market comments, hearing opinions, evaluating information – do yourself a huge favor. Do like Paul Harvey used to do – get the rest of the story. What is the reason the person is writing or saying something about the topic?

Contrary again to what the web pages, ads and talking heads would have you believe, there is no one size fits all when it comes to investing. Your needs, situation, timing, abilities and feelings are the key to building a successful investment result. Finding someone you can trust to take all those personal considerations and who will communicate with you in a manner with which you are comfortable will do much to defend you from the – as Mr. T would have it – the “jibber-jabber” and get you to where you want to be.

Tea Leaf Readings
(I use this term to describe quotes from a number of opinion leaders about current market and economic events – what they see happening now and their expectations.)

"“We can expect a lot of volatility in stocks. When you have these rapid increases, almost without correction, you will definitely have a correction at some point.” - Mark Mobius, executive chairman, Templeton Asset Management Ltd.

“There’s always a real risk that a rally is going to be tested. Investors are thinking that giving up some upside to hedge the downside is a very reasonable investment profile.” - Stephen Wood, chief market strategist for North America, Russell Investments

“The combination of a highly accommodative Federal Reserve monetary policy, the end of the panic and the relaxing of the mark-to-market accounting is boosting economic activity. Over the next 12 to 18 months, we expect higher stock prices, more inflation, higher bond yields and a relatively stable dollar. The economy is improving – stimulus or not.” – Brian Wesbury, chief economist, First Trust (I definitely agree with his overall view and conclusion.)

“The news on the economy is that it’s recovering, the news on corporate profits is that they’re recovering. That’s what’s bolstered the stock market.” - Nick Sargen, chief investment officer, Fort Washington Investment Advisors

“Cost of Government Day for 2009 was August 12. On average, working people must toil 224 days out of the year just to meet all costs imposed by government. In other words, the cost of government consumes 61.34% of national income.

Cost of Government falls 26 days – almost a full month – later in 2009 than last year’s revised date of July 16. In 2009, the average American will have to work an additional 43 days out of the year to pay off his or her share of the cost of government compared to 2000, when COGD was June 29.” – Americans for Tax Reform

"Stock investors are making overly optimistic assumptions. The key stimulus has already come into the consumer and has helped in the last few months. But for the third and fourth quarters looking ahead, I am not so sure things will be as good." - Mohamed El-Erian, co-CEO and co-CIO, PIMCO (A smart guy to be sure. He’s also in charge of one of the largest bond portfolios in the world – and bonds usually don’t do so well when stocks go up…)

Economic reports from the past week (with occasional translations…)

Productivity, a measure of how much an employee produces for each hour worked, rose at an annual 6.4% pace, more than forecast, after a 0.3% gain the prior three months. Labor costs fell by 5.8%, the most in eight years, more than double the first quarter's 2.7% decline. – US Department of Commerce

The US trade deficit widened less than forecast in June, reflecting a second consecutive gain in exports spurred by a pick-up in economies throughout the world. The gap increased 4 % to $27 billion from $26 billion in May. Exports gained 2%, helped by stronger demand for goods such as semiconductors and aircraft engines, while imports rose 2.3%, led by a higher cost for oil. Increases in both exports and imports signals that the global slump is coming to an end. Investor sentiment improved around the globe this month, turning bears into bulls in five of the world’s biggest stock markets as earnings and economic data topped estimates. – US Department of Commerce

Officials on Wednesday left interest rates near zero but suggested the economy is on more stable ground. The Fed plans to continue purchases of up to $300 billion of Treasury securities through October. The one upgrade came on the economy: "economic activity is leveling out" is definitely a bit more positive than their "the pace of economic contraction is slowing," statement of June 24th. – Federal Reserve (This is Fed-speak for they think the recession is over…)

The average taxable money market fund yielded 0.08% for the week ended August 4, according to iMoneyNet.com. (Tax-free rates would be lower.) At that rate, a $10,000 investment would return 15 cents a week or $7.80 a year, according to USA TODAY. Nearly one-quarter of these money funds have no yield. The average money market fund charges about 40 basis points per year for expenses. It is estimated that 80% of all funds are waiving some or all of their expenses to keep share prices from falling below $1. - Peter Crane, editor, Money Fund Intelligence (Money markets accounts are NOT investments – they’re just parking places for money. There is still over $2 trillion parked in these type things – fuel for the markets…)

Initial claims for jobless benefits rose by 4,000 to 558,000 on a seasonally adjusted basis in the week ending August 8. The tally of continuing claims -- those drawn by workers for more than one week -- fell by 141,000 during the week ended August 1 to 6,202,000 -- the lowest level since April 11. – US Department of Labor

US business inventories fell by a slightly more-than-expected 1.1% in June. Companies continued to reduce merchandise amid weak demand. The need to rebuild inventories in almost all industries will keep the economic recovery going. It was also reported that business sales at all levels rose 0.9% in June after being flat in May. This marked the first increase in total sales since July 2008. – US Department of Commerce

Perspective
“The wall of worry”

An old stock market adage has it that a bull market climbs a wall of worry. My way of interpreting that is that the markets go up even when current events – or some yet to come – cause many to worry that the results of these events will make the markets drop. Given the extremely positive market results of the past 5 months, it would seem to be true as many today continue to worry about some aspect of the economy.

Markets are cyclical and values fluctuate – daily, quarterly and annually. Mr. Drucker’s opening quote is especially true about the markets. Day to day results are simply a function of how the investing public feels that day. However, real investing, as opposed to trading, is all about longer term results – say, in excess of three years. For that reason, I can’t be worried about the outcomes. Whether I consider just my time in the industry or I study the history of markets, the results have always been positive.

Let’s consider that historical record…keeping it, for these purposes, relatively recent and look at the data back to 1970. And these results include 2008.

The annual return for US bonds has been 9.30%. For international bonds, with a bit more risk, has been 9.70%.

US stocks have returned annual results of 9.5% with international stocks up 9.70%. Pretty good, right? The key is that you would have had to stay the course and not bail when the media scaredy cats were running about.

Inflation over these almost 40 years has averaged 4.5% per year. The 70s and most of the 80s were pretty tough in that category. So, netting out the inflation, returns on both stocks and bonds in and out of the US was about 5%. At that rate, you were doubling your money every 14 years.

Since I hitched a ride with Mr. Drucker, I can’t tell you if this will be the case going forward…but I sure am inclined to think it will be pretty close. Near-term will likely be tough for bonds with interest and inflation rates rising but it reinforces the case for asset allocation and not being all in one investment class.

Let’s now consider what some folks who are supposed to know what they’re talking about have to say. The Blue Chip Economic Indicators national survey of private economists released this past week showed about 90% of the respondents believed the economic downturn would be declared to have ended this quarter. "Debate now centers on the speed, strength and durability of the recovery," the survey said. That will always be the subject of debate –especially if, occasionally, you substitute the word “correction” for recovery…

There’s a lot of talk right now about big government saving America. I don’t think big government saves us from anything. At the end of the day, it’s all about economic freedom, market competition and free enterprise that remain the great engines of American growth.

Government “programs” are similar to the result you get when you put sugar in the gas tank – for sure, don’t try that at home.The greatest source of stimulus for both this new bull market and the economic recovery is profits. Profits – not taxes - are what drive stocks, business and eventually - the economy. The current party in power never seems to grasp that. To be fair, the Federal Reserve played a big role in cushioning the banking system. Ultimately, the self-correcting actions of American businesses are what always drive this economy.

I’m an optimist because we remain a market-driven economy. Based on what I’m seeing, it would sure seem that most people in the country still fell that way and want it to remain so.

As the always subdued Jim Cramer has put it, “don't let the press confuse you. We are almost at Dow 9,400 because things are better than you think - and still improving by the day.”

Nothing to worry about – the future’s so bright, you have to wear shades…

All my best,

Mike

509-747-3323

Closing values as of 14 August 2009
Dow Jones 9321 S&P500 1004 NASDAQ 2009 Oil $67.47/bbl Gold $949.20/oz