Market retrospective - week of 4 September 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Should we be tapping the brakes?”

“We have tried spending money. We are spending more than we have ever spent before and it does not work. . . . After eight years of this administration, we have just as much unemployment as when we started . . . and an enormous debt to boot!” – Said in 1939 by Treasury Secretary Henry Morgenthau, (1891 – 1967), after a doubling of federal spending failed to relieve the Great Depression.

Overview

I don’t know why the media is so bent on making September look like some black hole for the market. (See Sam Stovall in the first Tea Leaf entry.) Maybe it’s because we didn’t get the depression they wanted for us last year and then the markets have come back much this year – in spite of their constant reminders to “watch out”. To be fair, lot of pros are still way behind the curve on this too…and many of them are trying to jawbone it down as well.

Let’s consider some longer-term investment data using the S&P 500 Index as representing the stock market.

Over the past 10 years, we’re down 24.5% - due almost entirely to 2008. Over the past 20 years, we’re up 8.2%. If you invested $1 in 1926 - and adjusting for inflation and taxes – you would have had $2,270 through the end of July, according to Ibbotson Associates. You want really long term? According to the Center for Retirement Research at Boston College, after inflation, from 1883 through 2008, the stock market has averaged a return of 7.6%...maybe a little better as of now.

The point is that worrying about a month in the greater scheme of things doesn’t really make mush difference.

Short-term, the markets are unknowable. Long-term? They’re inevitable.

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.)
“Since 1929, the S&P 500 index has lost an average 1.3% in September. But, the index has gained about 2% in the 14 Septembers that followed the end of bear markets.” - Sam Stovall, chief investment strategist for U.S. equity research, S&P (So, if by month end we get that average drop, we’d still be up 11.2% for the year – hardly anything to worry about.)

"Food is driven by upwardly mobile population growth worldwide. Infrastructure is driven by increasingly wealthy nations building better infrastructure to both help their citizens and stay globally competitive. The drivers of increasing global demand for both are incontrovertible." -Stephen Roseman, CEO, Thesis Capital hedge fund

“After a 50% move, there is still a question of ‘is it a bull market?' I continue to see skepticism concerning the market from both Wall Street strategists and commentators--this is a positive. As I have been saying since late March, this is a new bull market that, as far as trajectory, the current experience most closely resembles the bull market that began in 1982 and that market did not have its first correction until 424 days. The bearish case is always more intelligent and more articulate as it is looking at current events and current data, while the bullish case is looking at what is yet to come, not what has been.

First, history tells us that employment is ALWAYS a lagging indicator and that it is the last of the economic indicators to pick up once the economy picks up; that it will continue to rise does not really tell me anything that I, nor the market, does not already know. The only thing limiting banks to lend, households to spend and companies to invest is sentiment.” - Jeff Rubin, head of research, Birinyi Associates (I think he nails it in his last sentence.)

“The stimulus is not failing because it is too small or because too much of it is being saved. It’s failing because Congress can only redistribute existing demand, not create new demand. This recession will eventually end. The more serious, long-term danger is that President Obama’s Europeanization of the economy will bring the same slow growth, stagnant wages, job losses, high taxes, and lack of competitiveness that have plagued Western Europe, leaving the United States at an ever-growing disadvantage with Asian countries not so afflicted.” – Brian Riedl, Senior Research Fellow, Heritage Foundation

“Financial markets will probably remain in this sweet spot for some time. While the economic data have almost uniformly surprised on the upside, the leading central banks have credibly signaled to the markets that monetary conditions are set to remain extremely accommodative. Stocks will benefit as growth picks up and bonds will be helped by central bankers’ reluctance to lift borrowing costs.” - Riccardo Barbieri, Head of international economics, Banc of America Securities-Merrill Lynch (Riccardo makes a lot of sense with this.)

“It's too early for the unemployment rate to be coming down. Of course we're still losing jobs. What I would take encouragement from is the fact is the trend in the rate of decline in jobs is still improving." - Nigel Gault, chief US economist, IHS Global Insight

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

“No one likes it when the unemployment rate hits a new high, which it did in August. But the details of the employment report are much better than the rise in the jobless rate suggests. Private-sector payrolls declined 198,000 in August, which is the smallest drop in a year. In addition, private payrolls were revised up slightly in June/July. What makes this even more remarkable is that the federal government increased the minimum wage in late July, so August was the first month that reflected job losses related to this forced wage hike. Right on cue, employment among teenagers fell 150,000 in August (seasonally-adjusted).

The second good sign for the labor market is that broad measures of wages seem to be rising again. Average hourly earnings went up 0.3% for the second straight month, the largest gains so far this year. The economy is in a V-shaped recovery. Given the deepness of the recession and the fact that employment tends to be a lagging indicator, it will take time for the economic recovery to translate into job gains, but we believe payrolls will start expanding by the end of this year and that the unemployment rate will not be going to 10%+ as the consensus expects. Corporate profits were up at a 24% annual rate in the first half of 2009, suggesting businesses have re-built the ability to expand payrolls.” – Brian S. Wesbury, chief economist, First Trust (Responding to news of the US unemployment rate having moved up to 9.7%. FWIW, I strongly agree with his premise.)

“The Federal Reserve has made $14 billion in profits on loans made in the last two years. The US central bank also earned about $19 billion from interest and fees charged to institutions that tapped liquidity facilities during the global financial crisis. If the Fed had invested the same amounted loaned out in three-month Treasury bills since August 2007, it would have earned only $5 billion in interest.” – Financial Times, London

“Asian markets are more closely tied to the S&P 500 than to China's Shanghai Index. There is very little direct correlation between percentage changes in the Chinese equity markets and the rest of Asia. China is a closed stock market, driven primarily by domestic concerns, as opposed to the US markets. Now, if we were to look at the rest of markets in Asia, their drive and their movements will be much more correlated with the S&P or the Dow Jones and here is where we are having some of the problems." - Andrew Freris, senior investment strategist, BNP Paribas Wealth Management

“Manufacturing expanded for the first time since January, 2008, while the overall economy grew for the fourth month in a row. The index of national factory activity rose to 52.9 in August from 48.9 in July. A reading above 50 indicates expansion in the manufacturing sector.” - Institute of Supply Management

“Productivity, the amount of output per hour of work, rose at an annual rate of 6.6% in the April-June quarter, the largest advance since the summer of 2003. Economists expected an increase of 6.4%, matching the government's initial estimate last month. Worker productivity is the single biggest factor in determining living standards. Increases in productivity can help boost living standards because companies can increase wages financed by rising output.” – US Department of Labor

“The US economy does not need a second fiscal stimulus package; instead the government should cut spending over the next two years. Most economists in the semi-annual poll were concerned about the outlook for the US government budget. Also, they doubted health-care reforms proposed by the Obama administration would lower costs while increasing access and maintaining quality.” - National Association for Business Economics (NABE) survey

“On a slightly more encouraging note, the average and median duration of unemployment improved, largely the result of back-to-back declines totaling some 624k in the number of people unemployed for 15 to 26 weeks. This indicates that most of the sharp drop in the number of people continuing to collect weekly jobless pay was the result of workers returning to work rather than running out of benefits. If that develops into a trend, overall employment gains should soon follow.” - Nomura Global Economics

Perspective
“Should we be tapping the brakes?”

No one talks about inflation anymore. Consumer prices, what we pay for stuff, and producer prices, what the people who make our stuff pay for their stuff, are both down a ton over the last year. Matter of fact, consumer prices dropped the most in one month since 1949 and the producer prices are down the most since the end of WWII. That’s cool, but it’s kind of misleading as it’s almost all due to how much oil dropped over the past year. ($140 per barrel last July – less than $70 on Friday.)

If we just look at this year, those same prices are up around 2%. The not so good news is that it looks as if it’s going to be going higher. Next year, we’ll probably be okay but come 2011, things can get less comfortable.

The Federal Reserve, in order to keep the economy from tanking, has been putting in a bunch of money (aka, liquidity injections) for over a year now and will continue to do so for “an extended period.” At some point though, they will have be taking money out and letting the interest rates rise. Here’s the problem, in my opinion.

I think the economy is really on its way back in a major way and we are on the verge of a V-shaped recovery – in spite of current fiscal policies that, shall we say, aren’t designed to boost growth – which will create a very nice boost in our GDP. If the brakes, in the form of steadily higher interest rates, are applied now, we can get the benefit of less inflation.

Higher rates don’t automatically equate with an end to our recovery. In 1982, when we were pulling out of a really tough recession (10.8% unemployment for 10 months running), the Federal Funds rate (0.00% – 0.25% today) was 8.50%. In mid-1984, it was 11.5% and the recovery kept going.

The point is that the sooner we start raising the rates, the better off we’ll be longer-term. Like raising taxes doesn’t create economic growth, neither is easy money a good long-term stimulant for the economy. The longer the wait, the tougher it’s going to be all around.

The good times keep on coming…

All my best,

Mike
509-747-3323

Closing values as of 4 September 2009
Dow Jones 9441 S&P500 1016 NASDAQ 2018 Oil $67.70/bbl Gold $994.70/oz