Market retrospective - week of 23 October 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Halfway point”

"Business is always a struggle. There are always obstacles and competitors. There is never an open road, except the wide road that leads to failure. Every great success has always been achieved by fight. Every winner has scars.... The people who succeed are the efficient few. They are the few who have the ambition and will-power to develop themselves.” – Herbert N. Casson (1869 - 1951) Canadian author

Overview

Last week saw the markets hitting 10,000 again and, since this time it was on the upside, that was a good thing.

This week saw another milestone – the anniversary of the 1987 market crash on the 19th. As it happened, this October 19th saw the establishment of another new high for the year. October, 1987, made what’s happened recently look like a tea dance in comparison. The drop all happened in one day – none of this stretching it out over a few months. Of course, the media was all over themselves in a contest as to who could do the most dramatic wail and gnash job in professing the ending of the world as we knew it.

I have to admit, it was interesting to watch that day. You know how when you go to the gas station and when you’re filling your tank, the numbers just go whirring by? That’s exactly how the market average numbers looked on our computers – and they were going straight down. A similar percentage drop happening today would equate to a one day cratering of over 2000 points. An attention getter to be sure.

Here are two points from that. First, when it was going on, like now, no one – of course – knew how it would turn out. (Six months after the event, the averages had recovered back and were higher than they were on the 18th of October.) Additionally, like now, good companies didn’t become bad simply because their share prices dropped.

Conclusion? Bad events have happened to the markets and economy before and they will again. Having a strategy that includes high quality investments and holding to it – in spite of the pouting pundits of pessimism – will always ultimately stand you in good stead.

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.)

"It has been a lovely rally. I think right now is a beautiful time to take some money off the table and to really try to protect it rather than to go for broke by expecting a super recovery back up to '07 highs. I wouldn't give it a awfully high probability of another crash. I don't see anything from what I look at that would indicate that. But everything I look at tells me that something here is not right." - Odd Haavik, managing director & CEO, Charles Monat Associates

"We're at equilibrium here based on corporate profits, earnings and expectations. The market tells you what's going to happen in the future, and when expectations are fulfilled it sells on the news. There's not really all that much to look ahead to. The market made its prediction, the prediction's coming true, now the jury is out for the next quarter." - Michael Cohn, chief investment strategist, Atlantis Asset Management

“Markets are in a 10-year bull run. We’re in for a really good run, particularly looking at pessimism out there by the investor.” - Neil Hennessy, portfolio manager & CIO, Hennessy Funds (A prime example of contrarian thinking, i.e., if “everybody” is saying or doing something, then success is likely by taking the opposite tack.)

"Right now we've got a market where we've got an excellent stream of news, both on the macro side and in terms of results for the last five or six days and we've got a market which is failing to go up. A market that fails to go up on good news is probably a market that's going to go down and there does seem to be a bit of a change of mindset here. I think we've got a bit of results fatigue." - Nick Parsons, head of strategy, National Australia Bank

“The equity rally can continue but the drivers will definitely change in the next couple of quarters. We think that the junk rally — which has pushed markets higher throughout this year — will peter out and that the quality stocks — individual quality stocks — will basically take over the lead." - Franz Wenzel, senior investment strategist, AXA Investment Managers

“Business spending on equipment and software rose at a 7.3% annual rate in the third quarter. High tech is definitely doing well and is going to come out of the gate first here in terms of positive growth. I expect a 12.7% increase in fourth-quarter spending on equipment and software vs. the third quarter.” - Brian Bethune, economist, IHS Global Insight

“The rising market continues to surprise most people. A lot of people were looking for a lot weaker earnings season and looking for that as a potential catalyst for a correction, but that’s not been the case. The markets are going to see a ‘V-shaped’ bottom and that stocks are going to be higher a year from now than they are today. One of the most crowded trades is long gold and short dollar. So, when we start to see a positive turn in GDP, those two trades are going to unwind.” - Brian Belski, chief investment strategist, Oppenheimer

"We've seen incredible returns in emerging markets in the last six months to a year. If that continues, that definitely spurs demand for commodities. The bears are winning right now. People are buying commodities, anticipating higher demand moving forward. There have been huge returns in equity markets and people are looking for other ways to get returns than just investing in stocks." - Adam Gould, senior portfolio manager, Direxion Funds

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

“Very early this year, when the consensus was predicting a 1% real economic growth rate for the third quarter, we were forecasting 3%. Now, the consensus is up to 3% and we are at 4%. Meanwhile, our forecast for the fourth quarter has jumped to a super-charged 5.5%.

While forecasting government data is fraught with peril, our optimism is based on the facts of a rebound in retail sales, a shrinking trade deficit, a slight uptick in home building, continued government spending and the rebuilding of business inventories - not blind optimism.” – Brian S. Wesbury, chief economist, First Trust (I’m with him…)

Starts for single-family homes increased 3.9% in September – the sixth increase in the last seven months – for a total gain of 40.3% since the bottom in January/February. The rate of home building remains far below the underlying demand for housing (about 1.6 million per year), based on population growth and “scrappage” (for reasons such as fires, disasters, and knock-downs). – US Department of Commerce (As a result of these data, inventories can continue to decline rapidly even as building continues to recover and add to the GDP growth.).

The cost of attending a four-year nonprofit private college increased 4.3% in the 2009-2010 academic year compared to a year ago, bringing the average annual price to $35,636, according to the College Board.

Growing at an even greater rate was the cost of going to a public college. Public in-state college costs rose 5.9%, bringing the average cost to $15,213. Out-of-state students saw their costs rise 6% to $26,741. All costs include tuition, fees and room and board. Public four-year colleges have increased in cost since they get less money per student from the state, so tuition is replacing money from the state. (Establishing 529 Plans can be a big help for kids and grandkids…)

“According to the US Department of Commerce, producer prices fell in September. Prices have been volatile in recent months, with September’s drop following a 1.7% gain in August. During the past six months, producer prices are up at a 5% annual rate.

Core prices for crude goods were up 3.6% in September and are up at a 63.3% annual rate in the past three months. What these core measures show is that inflation is in the production pipeline, percolating below the level of finished goods. The Fed is still implementing an incredibly loose monetary policy even as economic conditions are changing to make that policy less and less desirable. A revival in monetary velocity coupled with extremely loose monetary policy means higher inflation is going to hit the US economy over the next couple of years.” – Brian S. Wesbury, chief economist, First Trust

A gauge of the US economy's prospects rose for a sixth-straight month in September to a two-year high, according to The Conference Board, suggesting the US recovery was building steam. Its index of leading economic indicators rose 1% to 103.5, the highest level since October 2007. It said the sixth month growth rate for the index was at its highest pace since 1983.

The United States has the advantage of being the world's safe haven in times of panic and, as long as it retains that reputation, its debt sustainability won't be in doubt. According to the US Treasury Department, US debt held by the public stood at $7.53 trillion as of October 19th. That’s 53% of total output and up by about $1.5 trillion from one year ago.

Recent debt auctions have generally been well-received and major foreign investors, including China and Japan, have maintained their purchases. Those two countries together held $1.53 trillion in US Treasury debt as of August, up from $1.13 trillion a year earlier. (For all the talk of foreign ownership, the folks at home hold 7 times what the top two buyers do. Probably not time to be doing any vein opening just yet…)

Perspective
“Halfway point”

The halfway point I’m referring to is regarding the so-called “earnings season.” About half of the publicly traded companies have reported their results for the July – September quarter. Here’s a very cool piece of news to begin. Of all those companies – 80% have reported better than expected results. That’s fact. Were the expectations too low? Maybe. If so, why?

Here’s a little insight about these cats who create the expectations. None of them get paid for being too far off – up or down. So, very few have the fortitude to stand up and say – good or bad – I think that the consensus (herd mentality) is wrong and here are my numbers. That’s why, with the markets trending as they are, you get a lot of reports with the tag line of “better than expected.” I would add that consistency in hitting the target is quite hard and that’s why good analysts are well worth listening to. But, I digress…

The market, as noted by some in the Tea Leaf section, has passed 10,000 but can’t seem to decide what to do next. Sure, some of the companies yet to report will help provide some near-term direction but – as soon as those numbers are out – it’s back to “what have you done for me lately?” The fourth quarter comparisons should be fairly easy to beat since last year’s Q4 was – to be polite – atrocious. So, what do we do now?

In another of the many wonderful adages that Wall Street is known for, one that always rings true is that “you can’t go broke taking profits.” So, should you take a little something off the table now that the future as predicted by the markets six months ago has come to pass? Sure, why not? But – oops. Here’s the catch.

If I have a good company that still has a fundamental reason for owning it – as opposed to having bought it strictly for a trade – why sell it? Maybe I sell part and find a quality opportunity in an area that hasn’t recovered as much and invest there. The option is that you accept that a correction is a probability and just ride that out. Corrections come and go – they’re normal. Worst case, they give you a chance to buy something you’ve wanted more cheaply than what it has been selling at.

Human nature being what it is when it comes to investing, many people don’t want to do that. In retail, they call those markdown sales. In investing, many people won’t buy until whatever has gone up quite a lot. Never have understood that but it is more the rule than the exception.

Here’s the deal. Everybody has different needs, money available to invest, time lines for investing, goals, concerns and, yes, fears that need to be put into the mix. That’s why some talking head on TV, a website or magazine article is NOT the way to determine what’s best for you.

Find someone you can trust, someone who you know will work with your best interests in mind and make recommendations accordingly. That way, you know that whatever is going on in the daily noise of the markets, you are set up as you want to be to get you to where you want to go.

All my best,

Mike
509-747-3323

Closing values as of 23 October 2009 /
Dow Jones 9972 S&P500 1079 NASDAQ 2154 Oil $79.62/bbl Gold $1,055.50/oz