Market retrospective - week of 11 Sept 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Why putting all/most of your money in bonds is a bad idea”

“Some see private enterprise as a predatory target to be shot, others as a cow to be milked, but few are those who see it as a sturdy horse pulling the wagon.”-- Sir Winston Churchill, KG, OM, CH, TD, FRS, PC (1874 – 1965)

Overview

We had a nicely positive short week as everyone tried to get back in the saddle after summer vacations. On the 10th, at the end of five up days in a row, we set the highs for the year in all three major equity indexes. On Friday, all three indexes were down almost imperceptibly, as in less than ¼ of 1% at worst and yet the headline writer chose to say that the five day run was “snapped.” Somehow, that kind of drop and snapped don’t seem to fit. Now, if it had been a couple hundred points? That might qualify as snapped.

The Standard & Poor's 500 index is up 54.3% since hitting the low in March and is the second best performing index of the year. The NASDAQ with its tech and new growth companies is far and away the leader, being up 32% for the year. The Dow is up “only” 9.5% this year. In none of these does it appear that anything, other than the ties with the past bad market, has been snapped.

Daily trading volume continues to be light. That’s because there’s really not much new significant news to motivate the big money players. They’re either waiting for the “bad” September to show up (so they can get in, but at lower prices) or they’re just sitting on their money until October and the next round of earnings reports come in. Personally, I think it’s more the latter.

I read something this week that some poll or another found that 87% of investors still don’t believe that the economy is getting better. (Obviously, those are other than the people who read this weekly rant…)

87% is a bunch. Logically, I don’t understand why that number is so high – I really don’t. The economic reports and trends are definitely positive. However, I think it’s fair to say that most people don’t know (or care much) about how the markets and economy fit together. So, when looked at emotionally, and understanding that their “information” is based on inputs provided by the media and the current geniuses in DC, it makes sense. If those groups don’t paint a bleak picture, it’s hard to get the public to buy off on their doomsday prophecies.

As Nobel Prize-winning economist James Buchanan recently observed, politicians (and their media enablers, I believe) lack "any basic understanding of what makes capitalism work."

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.)

“When markets of any type are in transition, you get ‘pinch points.’ At these times, things can seem overly positive or negative, depending on the direction of the trend, until the markets break through.” – Scott St. John, VP, American Pacific Mortgage, Freddie Mac Advisory Board member

“Students who get into more selective colleges are more likely to graduate from them than their peers who attend less-selective schools. At the University of Massachusetts, for example, only 33% of freshmen who enter graduate within six years. Only half of students who enroll in college nationwide end up with a bachelor's degree, a key reason why US inequality has soared in recent decades.”- David Leonhardt, Writer, The New York Times (But at least, thanks to our education system, they feel good about themselves…)

“A lot of people are underinvested in this market and we’ve been climbing a wall of worry all year long. We view this as a significant turning point and maybe the early stages of a longer-term bull market. We expect the S&P 500 to reach 1,200 by year-end.” - Art Nunes, market strategist, IMS Capital Management

“Stocks [will] continue to lead the economy and the stock market is telling us that the economic bottom is in place—now the engine of growth has to come back in and 2010 is going to be the year of the “show me” period. In between there though, we believe stocks go higher, the economy recovers and equities will be the place to be. I expect the S&P to reach 1,120 over the next 12 months.” - Brian Belski, chief investment strategist, Oppenheimer & Co.

“Uncertainty in the markets has led to confusion for some as to whether to buy in or get out. I'm still cautious; people go broke trying to predict the day. There are too many conflicting signals. There's too much government in the markets for me. But you can't buck the trend, you don't want to sell here, but keep your eye on the exit door. You have to be in this market. Things could turn around real quick." - Gordon Charlop, analyst, Rosenblatt Securities

"Don't forget, the retail investor is usually wrong when it comes to the market. Unfortunately, if you follow the sentiment survey by the AAII, (American Association of Individual Investors), it appears your average retail investor has been on the wrong side of this entire rally. To have seen a greater than 50% rally from the lows and the retail investor still doubting the rally gives me confidence that this rally still has legs.” - Ryan Detrick, senior technical analyst, Schaeffer's Investment Research

"To me, the plunge from late last year until March was hedge funds panicking out and most of the rally since was hedge funds reversing their shorts. That's a very professional trading market. Retail investors are just not participating. People have been trying to pick a top for two months. When that kind of attitude prevails, it usually means the market is going to press higher to punish the bears." - Phillip Roth, chief technical market analyst, Miller Tabak

*Analyst comments on Wednesday speech about the health plan. (The prospect of dramatic overhaul of the healthcare system has pressured health insurer shares throughout the year.)

“We’ve betting on the fact that we’re not going to see a broad, nationalization of health care—we believe stocks are clearly priced for nationalization.” - Brian Belski, chief investment strategist, Oppenheimer & C0.

“The speech contained nothing unexpected. There wasn't anything said that is drastically changing the outlook as to what might come out of Congress." - Steve Shubitz, analyst, Edward Jones

"I am even more confident after the Obama speech that the legislative outcomes will be moderate with no threat of a Medicare-like public plan." - Ana Gupte, analyst, Sanford Bernstein

"While we understand the negotiating logic of keeping it on the table for now, we still don't see any higher/better odds that a full fledged public plan can ever make it into a final piece of legislation."- John Rex, analyst, JP Morgan

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

US mortgage applications surged last week to their highest since late May. Rates on 30-year fixed-rate mortgages tumbled to a 3-month low, spurring a surge in demand for home refinancing loans. Applications to buy a home, a tentative early indicator of sales, also climbed, hitting their highest since early January. - Mortgage Bankers Association

Half of the 12 districts saw evidence the US economy had improved by the end of August, although labor markets remained weak and retail sales were flat. Dallas, Boston, Cleveland, Philadelphia, Richmond and San Francisco noted gains. Other areas reported the economy was stable or showing signs of stabilization, while St. Louis said the pace of economic decline appeared to be moderating. – Federal Reserve Bank Beige Book report

“The US government's sweeping intervention in the private sector has taken its toll on the country's competitiveness. The country lost its number one spot to Switzerland partly because of ‘particular concerns on the part of the business community about the government's ability to maintain arm's-length relationships with the private sector and in the perception that the government spends its resources wastefully.’" – World Economic Forum annual survey (It’s even clear from overseas…)

“Confidence rebounded in early September as consumers increasingly expected the economy to improve despite their reluctant conclusion that their own financial situation would remain quite problematic for some time. The 12-month economic outlook index rose the highest since September, 2007.” - Reuters/University of Michigan Surveys of Consumers

“Imports rose 4.7%, the largest monthly advance since 1992 and the second consecutive gain after 10 straight declines. The rebound reflected a 21.5% spike in imports of autos and auto parts, partly due to increased production at US auto plants owned by General Motors and Chrysler. Exports edged up 2.2 %, marking the third straight monthly increase. The export gains reflected big increases in shipments of civilian aircraft, computers, industrial machinery and medical equipment. – US Department of Commerce

Perspective
“Why putting all/most of your money in bonds is a bad idea”

87% of investors don’t think the markets or economy are in good shape. Further, a number of so-called advisors are providing the ultimate in rearview mirror based investing “advice” by looking at the stock market record of the last 10 years as an indicator of what’s to come. And, of course, as “everyone knows”, bonds are “safe.”

Bonds are an important component of an effective asset allocation strategy and, there are elements of truth in all three positions – but they are minimal at best. Let’s try another perspective or two and look at the last thought first.

Almost all bonds (98%+, I’m thinking) issued by reputable companies and governmental agencies at the Federal, State, county or municipal levels are, in fact, quite safe. Most people think that it’s safe if you get back the same number of dollars when the bond comes due as you put in at the outset. For very short-term goals of three years or less, that’s usually a pretty good idea. Using bonds to fund longer-term goals can be quite a painful learning experience – and you don’t learn until the back-end, to make it even worse. Here’s the main reasons why.

If – and as certainly looks likely in our current situation – interest rates and inflation rates rise over the time you hold the bond, you will lose buying power. In American, that means that that you’ll get the same number of dollars back BUT they won’t buy you as much as they did when you put the money to work. Definitely not a good thing.

The other reason has to do with what happens to the value of the bond while you hold it. What if a situation comes up where you need – or want – some money before it comes due? Contrary to conventional wisdom, bonds do, in fact, go up and down in price. What makes them move is the direction of interest rates take after you invest. The rule of thumb is that if interest rates rise while you hold the bond, the value will drop – regardless of credit rating. The opposite is true as well. The longer the time until the bond is due, the more likely you’ll see larger moves in the value. Your payments don’t change.

The last 10 years – primarily due to last year – have the S&P 500 down about 24%. Why would anyone sign up for that? Depends on your time line for a particular goal. Over the past 20 years, the S&P has had an annual average (operative term) rate of return of better than 8%. In this country, since the 1920s, NO other investment has had a better average annual rate of return over time than the stock market. There will be others that will probably do better in any one year but it’s consistency that’s the key to long-term results.

The real answer is that you need a program to manage your investments that will include stocks, bonds and other investments. There is NO one size fits all – contrary to what the media, web sites or magazines would have you believe. Those are all based upon averages.

The truth is that, not unlike other important areas of your life, you need a trusted advisor to help you get to where you want to go in the manner you want to get there – not what an article or software has said.

If you have a trusted advisor, good for you. If you don’t or – like the docs – would like a second opinion, please call on me.

All my best,

Mike
509-747-3323

Closing values as of 11 September 2009
Dow Jones 9605 S&P500 1042 NASDAQ 2080 Oil $69.32/bbl Gold $1,007.00/oz