Market retrospective - week of 2 October 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Continuing recovery – NOT a prelude to collapse”

“The record of history is absolutely crystal clear: that there is no alternative way so far discovered of improving the lot of the ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.“ - Milton Friedman (1912 – 2006) American economist; winner of Nobel Prize in Economics

Overview

This last month certainly went a long way toward reinforcing the folly of listening to the conventional “wisdom”.

Remember? “September is bad – watch out. It’s the worst month of the year for the stock market.” Except, of course, like this time when it wasn’t. Here’s something about the markets I constantly have had reinforced to me over the years – if “everyone” is doing it, or believes it, do the exact opposite…

The three major stock indexes had their best quarters in 11 years as both the Dow Jones and S&P 500 had gains of 15% over the most recent three month period. The NASDAQ, home of the major tech and newer growth companies, was up 15.7% over the same time. We don’t see gains like those in most year periods. More manifestation of the V-shaped recovery we’re involved with now.

Now the doomsayers are out saying “well, okay, you were lucky in September. But October? You really better watch out now. Historically, this month is a total giant killer. You’ll probably get totally smooshed this month.” Unless, of course, you don’t.

The point is no one knows what the markets will give you in the short-term. We could continue higher or we could get a correction or they could just slip-slide sideways. They are completely unknowable. However, over the long term, the markets are inevitable in their upward trend.

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 equities will now trade above my previous target for this year, in large part because earnings will be higher than we previously anticipated.” - Jason Todd, investment strategist, Morgan Stanley (This is significant in that, until last week, he had been predicting that the market would fall 14% from today's levels by the end of the year. Now he’s saying that the S&P 500-stock index is likely to rise somewhat between now and year's end and could be up as much as 15% before it “gets into trouble.”)

"Once again, we will see a lot of companies beating estimates as the earnings season gets going in earnest in October. This time, sales are going to be an even bigger surprise than profits. Sales have been slow to recover as consumer spending has remained muted. Companies have been holding up profits by cutting costs. Now, as the recession shows signs of ending, sales could surprise the analysts, although sales still are likely to be down from a year ago. Stronger-than-expected sales would boost profit margins and give the stock rally fresh fuel. This would also be a welcome sign that earnings are being driven by customer demand and not cost cutting.” - Jeffrey Kleintop, chief market strategist, LPL Financial

"The outlook for global equity markets will stay favourable over the next months — further price gains are expected, driven by higher multiples and a recovery in earnings. An increase in new company orders and industrial production are positive impulses for corporate profitability.” - Gerhard Schwarz, head of global equity strategy, UniCredit

The latest weekly survey by the American Association of Individual Investors found that bearishness among investors stood at 44.5%, above the long-term average of 30%. Many of those investors are still drifting to what they perceive as safer investments. In August, investors moved $42.9 billion into bond funds and only $3.9 billion into stock funds, according to the Investment Company Institute, the mutual fund trade group. (Please note my comments in the overview. The stock market often rewards the contrarian; so many analysts see investors' doubts as one of the strongest signals that the rally will continue.)

“There are positive economic surprises that are going to come in the rest of the fall. That’s what the leading economic indicators and markets are telling us. Today’s positive feedback loop is a mirror image of the negative feedback loop during the fall and winter of last year. Better economic numbers lead to better corporate earnings outlook, which leads to rising corporate and bond prices which in turn improves balance sheets and more economic growth.” - John Merrill, founder/CIO, Tanglewood Wealth Management

"I think we're starting a 10-year bull market. During that time, the Dow will double for sure from current levels. Stocks are the only reasonable money-making investment in this current environment of low interest rates. Why put your money into a 30-year U.S. government bond at 4% and wait 30 years to get your money back? Instead, buy the Dow Jones Industrial Average. The 30 components are yielding a 3% dividend and, unlike Treasuries, offer a growth opportunity. Plus, with trillions in cash on the sidelines waiting to get in the game, the market's headed in one direction: Up.” - Neil Hennessy, chief investment officer, Hennessey Funds

“We’re hitting a little bit of a soft spot in economic growth. We would not be surprised to see a 5% plus pullback in the marketplace. I still think we’ll be higher by year-end as third- and fourth-quarter economic growth and corporate earnings outpace expectations.” - Michael Mullaney, money manager, Fiduciary Trust Co.

"Economic data rarely move in a consistent pattern. We should not be surprised that there are bumps in the road. Unfortunately, investors want the latest data to always be better than the previous ones and that is unrealistic. Thus, they react wildly." - Joel Naroff, Naroff Economic Advisors

“Don’t confuse the economy with the stock market. We’re in the beginning of a new bull market and you can’t confuse backward looking jobless numbers with the stock market.” - Jordan Kimmel, market strategist, National Securities

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

“The employment situation has remained much weaker much longer than the overall economy. In September, the jobless rate rose to the highest level since 1983. There are two reasons for the disconnect between the economic recovery and the labor market. (Unemployment numbers are always the last indicator to turn for the better.)

First, productivity growth has been rapid of late, part of the ongoing process of technological change that rivals (and may surpass) the industrial revolution. Second, corporate leaders still think the recent spurt in growth will be short-lived and so are being overly cautious. In the short term, productivity growth lets companies raise production even as they continue to cut jobs. Over time, though, higher output with lower labor costs mean more profits, which will help stimulate rapid job growth once companies become more confident about the staying power of the recovery. When the labor market eventually turns positive, it will do so with a vengeance.”- Bob Stein, senior economist, First Trust Advisers

The International Monetary Fund raised its forecast for 2010 global economic growth to 3.1% from 2.5%.

September US car sales - General Motors posted a 45% drop in September US light-vehicle sales, while Chrysler's sales fell 42%. Ford saw a much more modest drop of 5.1%. Among Japanese auto makers, Toyota said its September US sales declined 16% from a year earlier, while Nissan saw its results fall 7% and Honda said its sales slid 23%. (Seems to me that GM and Chrysler’s problems are more related to product choice and quality than incentives…)

The ISM Manufacturing index fell short of consensus expectations, but remained above 50, signaling expansion. An average of 52.8 over the past two months is the highest since 2006. According to the Institute, an index reading of 52.6 is consistent with an annual rate of real GDP growth of 3.6%. (Given the impact of the recession and how low the overall index was several months ago, the fact that the index is above 50 for two straight months is a very positive sign.)

According to Crane Data LLC, nearly 78% of taxable money-market funds, the traditional parking place for savings, are offering 0.1% or less in annualized yield. On a $10,000 balance, that will earn you a maximum of 83 cents -- yes, $0.83 -- in monthly interest income. All told, these funds hold $1.3 trillion. (As noted, these “parking places” are for emergency funds and other short-term needs only – they should not be considered as a long-term investment…)

The 30-year home mortgage rates were the lowest since the week ended May 22, at 4.81 %, after hitting an all-time low of 4.61% in March, according to the Mortgage Bankers Association. (Rates a year ago averaged 6.33%.)

Perspective
“Continuing recovery – NOT a prelude to collapse”

Jim Cramer, the quiet fellow seen on CNBC, put what’s going on in the markets right now rather well I thought when he said this week that, “the fundamentals of the economy are simply canceling each other out. Depending on their perceptions, an investor can make both bullish and bearish cases for the market, depending on which reports they choose to emphasize. This is pushing and pulling stocks in different directions, as each side acts on the data it deems most important. That’s why we can go from relapse to recovery in a single day.”

There’s also something else helping to move/support the markets.

There remain a large number of professional money managers who totally missed the rally and have continued to wait for the drop they’re sure “has to come.” With two positive quarters now in the books, and no drops of substance over that time, these folks are desperate to catch up with their benchmarks. (Benchmarks being the stock indexes that their efforts are compared with.) Since 78% of managers have outperformed the S&P 500 so far this year, they don’t want to be in that bottom half. No one will want to have them manage their money for them. So, these managers are scrambling to be picking up stocks every time the market pulls back.

Let’s consider some facts that make this market NOT at all like the 30s environment that the media is currently suggesting we resemble. They didn’t get the depression they were hyping a year ago – I guess this is their fallback.

The markets initially recovered from the crash in 1930 when President Hoover signed an income tax reduction bill into law. However, against the advice of economists and his advisors, in 1931, he then signed into law the trade protectionist Smoot-Hawley tariff act. That then led directly to the subsequent cratering of both the economy and the markets. So far, the DC crowd hasn’t gone to those extremes and there’s nothing on the radar that suggests that type issue is out there…for now.

So, why should this V-shaped recovery continue? Some of the reasons are noted above. For example, the ISM Manufacturing numbers improvement. Inventories have dropped too low and that is being reflected in new orders and production. Consumer spending is up – and not due to any “stimulus”. Residential construction increased 4.7% in August –that’s the strongest month since 1993! Small business incomes are up on a 7.6% annualized basis – that’s big.

Tax hikes and inflation won’t be in evidence next year and both can still be dealt with in a transitional manner that would prevent the pulling out of the economic rug.

Sure, we could have a correction. So? That’s all part of a normal market rotation and there’s lots of folks waiting for that just to get in the game and not miss out. Wait, you say. What’s to miss out on? We’re up over 50% since March…there can’t possibly be more to go on the upside? Or can there?

I firmly believe that we can go back up to 12,000 on the Dow Jones and 1200 on the S&P 500. That’s about another 40% increase from here and would only put us back to where we were in late 2007. Every post-recession market I’ve been in has seen a recovery that, eventually, went past the previous high so I’m not too far out on a limb here. If the health care, cap and trade and income tax issues can, respectively, be reduced or eliminated, we would likely see higher numbers than these.

Remember – the future’s so bright, you’ll have to wear shades…

All my best,

Mike
509-747-3323

Closing values as of 2 October 2009 /
Dow Jones 9487 S&P500 1025 NASDAQ 2048 Oil $69.73/bbl Gold $1,003.20/oz.