Market retrospective - week of 21 August

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Still improving by the day”


“There is far more danger in a public monopoly than there is in a private monopoly, for when government goes into business it can always shift its losses to the taxpayer. The Government never really goes into business, for it never makes ends meet and that is the first requisite of business. It just mixes a little business with a lot of politics and no one ever gets a chance to find out what is actually going on.”-- Thomas A. Edison (1847 – 1931) American inventor, scientist and businessman (I guess some things never change…)


Overview


Year to date, the Dow Jones is up 8.3%, the S&P500 up 13.6% and the NASDAQ up 28.2%.
Please see the Perspective section for comments this week.


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 think the recession is ending right now. The economy may grow by 3% in the next couple quarters and by 1.5% to 2% next year.” - Abby Joseph Cohen, senior investment strategist, Goldman Sachs Group Inc.


“We predict a correction of about 10% but don't think investors should rein in positions. We feel pretty comfortable telling our clients to make sure they're fully invested. A substantial portion of this rally is still yet to come.” - Bruce McCain, head of strategy, Key Private Bank


“Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: ‘By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.... The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.’ “ - Warren Buffett, American businessman (who apparently reads a lot of Edison’s work…)


"It's usually the other way around—everybody expects a rally so much that it never happens. Everybody is now looking for a correction. The question is, is it expected it so much that it gets totally faded?" - Uri Landesman, head of global growth strategies, ING Investment Management (he raises a good point…)


"Unless you're convinced that this rally was entirely an illusion, then you have to look for opportunities to get in. Getting in the middle of a long-term rally is a hell of a lot better than not getting in at all." - Michael Kresh, president, M.D. Kresh Financial Services


"People who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.
With real inflationary possibilities down the road, I would much rather own equities at 9000 on the Dow than have a long investment in government bonds or a continuously rolling investment in short-term money." – Warren Buffett (Pay very close attention to this advice…)


"I would say the bank failures are not necessarily a bad thing. When a bank fails, we've got a deeply troubled institution that cannot lend money. If we go in and resolve the failure, the cleanup of that situation ... will enable the institution to get on with lending. The (dollar) numbers are bigger today because everything's bigger today. I don't think the failures are any larger today proportionate to the economy. The FDIC cleans out the problem loans. So it really does cleanse the system and help us get lending started again, which is what we need." - William Isaac, former FDIC Chair during the S&L crisis of the 80s



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


Manufacturing in the New York region grew in August for the first time in more than a year and factory activity in the US Mid-Atlantic region turned positive in the same period. The Federal Reserve Bank of New York’s general economic index had its first expansion since April 2008, while the Philadelphia Fed factory reading rose for the first time on 10 months.


These reports indicate that companies are restarting assembly lines after slashing inventories at a record rate. Economists project growth will resume this quarter, helped by stabilization in manufacturing and housing. – US Federal Reserve Bank



“Seventy-three percent of Baby Boomers who own a Traditional IRA are not planning to convert it to a Roth IRA in 2010, when the previous household income limit of $100,000 will be eliminated. Any investor who converts in 2010 will have two years to pay the taxes. Among households with an income of $100,000 or more, 57% don’t even know that the income limits on Roth IRA conversions will be eliminated. The combination of lower account values, historically low income tax rates, conversion income limits lifting and the ability to pay the tax bill over two years provide a rare opportunity to potentially increase your income in retirement by hundreds, and even thousands, of dollars each month by eliminating taxes through a Roth IRA.” - USAA Wealth Management


Sales of existing homes in July jumped at the fastest rate in 10 years. Sales of single-family homes increased 7.2% in July from a month earlier million units. The monthly increase was the largest since 1999, when the NAR began collecting data for all types of homes -- its measure includes condominiums and cooperative apartments. It marked the fourth monthly rise in a row. Sales also were up 5% from July 2008, showing the first gain from the year-earlier level since November 2005.- National Association of Realtors

Falling commodity prices took a huge bite out of producer prices in July, pushing them down 0.9%. However, we already know that commodity prices are higher in August, which means overall producer prices will bounce back next month, renewing what we expect to be a generally upward trend. Although “core” producer prices fell 0.1% in July, this follows an unusually large 0.5% gain in June. Higher inflation is evident in core producer prices deeper into the production chain. Core intermediate prices increased 0.2% in July, the second straight gain; core crude prices rose 2.9%, the third straight gain.


These higher core prices show that monetary velocity is rebounding and loose monetary policy is having an impact on the economy. Despite this, the Federal Reserve is likely to remain incredibly loose at least through the end of the year, which means the underlying trend of higher inflation will continue. – First Trust


“The recent conversion of Citigroup's shares into common has netted the Treasury a $10 billion (unrealized) profit. Treasury converted $25 billion of their $52 billion in preferreds at $3.25 and with the closing yesterday at $4.48 the stock has appreciated over 40 percent.


Each penny increase in the stock price produces a $76 million unrealized gain. (Who says pennies don’t mean anything???)


As we understand it, the Treasury isn't restricted as to when it can sell its common stake and while it may be a bit early and we think the sale of their common stake isn't imminent (though it would be nice to make a big profit while saving the system & getting out), we also don't think of them as a long-term holder." – UBS report (For everyone who thought the government wasted money helping banks out…it’s similar to how the Feds made out when they bailed out the S&Ls)


Professional money managers are buying into the rally in a big way:

75% believe the world economy will improve in the next 12 months. That's the highest level in nearly six years and up from 63% in July.
Average cash balances have fallen to 3.5%, the lowest since July 2007.
34% of managers surveyed are now overweight stocks, the highest since October, 2007.
Risk appetite is also increasing, to the highest levels in two years. - Merrill Lynch Survey of Separate Account Fund Managers

Perspective
“Still improving by the day”


I used this quote from Jim Cramer last week and it still seems applicable.
While I’m surprised that we haven’t had some sort of correction yet – correction being defined as a drop of 5% to 10% - I’m not upset, as many seem to be, that the market has had the seeming audacity to go up when so many have decided the move is not warranted/justified/whatever. I’m wondering if Mr. Landesman isn’t on to something in his musings.


What’s really interesting to me is that so many people – both within the investment industry and without – are still working so very hard to talk themselves out of this market move. It’s pervasive in the words I hear in ads with references to a tough economy, the “yeah, but…” kinds of responses I get to my views and the news always adding hedge clauses about what negatively “might, could, may” happen, in spite of the positive economic reports. Why can’t the “might, may or could – or even will” – turn out great?


I just flat don’t get why there can’t be a positive forward view instead of being hung up on what’s already happened that was, for sure, not so good. A guy who I think really has the current mindset figured out is Brian Wesbury. He’s an economist with First Trust. Here’s what he says…


“Those who were pessimistic about stocks and the economy early this year are going through the classic five stages of grief. First, they denied a recovery was going to happen anytime soon. Then, they lashed out with anger at those who spotted signs of the recovery. Now, they are bargaining and reluctantly admitting the existence of the recovery that they did not see coming, but belittling it. Next, as things keep moving up, we can expect them to get depressed…we don't expect acceptance to fully set in until late next year.”


American companies and individuals are now sitting on record mountains of cash. Why? I haven’t the foggiest. Must be worry or fear about the markets and economy. If that’s the case, here are my questions.


What are you worried about? Why are you afraid? What is out there in the economy that is causing this frozen at the switch type response? I have yet to receive a definitive answer to those questions. It’s all emotional, to be sure, because it’s sure not justified by the facts. Unfortunately, emotions always trump logic.


Confusion could likely be part of it. Given what the current crop of “wizards” in DC are doing, one can’t fault that response. (For example, in talking with a couple car dealers this past week – who have yet to see any money from the CFC deal- the response was if they (DC) can screw up something as relatively easy as this, how bad would a government run health care system be. But, I digress.)


This tendency, as one astute gentleman of my acquaintance put it this week, of being “fashionably frugal,” is not how to move forward. It takes fortitude, it takes conviction and it takes a view of and toward the future that is positive. And yes, you do have to put your money to work – whether it’s in your business or in a high quality investment plan – or both. Take to heart what Mr. Buffett said about cash equivalents (savings accounts, money markets, Treasurys) in the Tea Leaves section.


The current conventional wisdom – a term which, in my experience, may be current but usually isn’t wisdom – has it that “look here, stocks in this decade have effectively produced no return.” Due to 2008, there’s a modicum of truth there. Those people are saying, “be safe – put all your money in bonds.” As used to be said in my old neighborhood on the South Side of Chicago when a less than insightful thought was offered - “what, are you nuts?”


Interest rates and inflation are likely to be moving higher over the next couple years. That isn’t necessarily a bad thing as long as it can be somewhat controlled. The point is they aren’t going lower. If you put all or most of your money in bonds, CDs and the like, you WILL have a major erosion in your buying power and have NO protection against inflation – a major challenge for those in or near retirement. Safe, you would find to your dismay, is a relative thing.


You don’t invest using what worked last year – that’s an invitation to consistent underperformance. Check the record yourself. NO ONE knows how any of the markets will do year to year or what segment will be best. That’s the case for asset allocation.


The reason the returns have been historically higher for stocks in the US than ANY other investment over our entire history is simple. There is risk in putting that money to work in a business or in equities – the return, though likely - is NOT guaranteed. And some of your investment money should be in for sure type stuff – but NONE of it that is meant to be used more than 3 years from now.


To me, the only thing that we have in common with the 1930s is what FDR said early on and that is fear itself. Try to look at the markets and economy objectively and see that there is little to no basis for the fears the media and self-serving politicians and market types are putting out there.


Now, as JFK would have said, it’s time to move forward with vigor. And, finally, as Mr. Kresh so eloquently put it, “getting in the middle of a long-term rally is a hell of a lot better than not getting in at all."


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 21 August 2009
Dow Jones 9505 S&P500 1026 NASDAQ 2020 Oil $73.48/bbl Gold $955.70/oz