Market retrospective - weeek of 6 November 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Unemployment rates and the markets”

“Labour was the first price, the original purchase, the money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased.” - Adam Smith (1723-1790) Scottish Political Economist

Overview

The markets had a nice week, with all three major indexes adding at least 3.2%. Some major mergers, i.e., Stanley Works and Black & Decker, a $44 billion takeover of one of the country’s major railroads by Warren Buffett – calling it “a bet on the country” –analyst upgrades of industry leaders GE, Macy’s, Amazon and Traveler’s and productivity jumping at fantastic rates all combined to overcome the announcement on Friday that the national unemployment rate had moved up to 10.2%. (I’ll address that in the Perspectives section.)

If you read the Tea Leaf comments and add to them the data that is showing up in the Economic reports, I truly believe you have to be very positive about the trend of both the markets and the economy, in general.

I understand that for many people – in light of the seemingly never-ending fear mongering and negative spin put on by many pundits and media outlets – it’s hard not to succumb to that stuff. Let me defer to the ever-understated “Whispering Jim” Cramer for a summation. He says, “Watch out for the constant drumbeat of negativity. The bear’s comments since the March lows have been the biggest money-losing strategies ever.”

I don’t always agree with him. He is spot on here, however. You invest for your future – not the past…

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.)

"I read it (the unemployment report) as a relatively constructive number, because the trend continues to improve. The headline number of course will keep consumer confidence under pressure, but I'm not that hopeful that the consumer is going to make a big contribution to this recovery anyway. I do think we're in the early stages of a global recovery, but I think it's going to be led by the business community, not by the consumer, and so this does nothing to change that point of view." - David Joy, chief market strategist, RiverSource Investors (I agree with the biz lead recovery…)

“On the one hand, we show that stock returns over the past 40 years were virtually in line with the long-term historical average. On the other hand, bond returns were not only much higher than their historical averages but were also higher than their current yields. This high bond return is due to higher interest rates in the 1970s and a subsequent declining-interest-rate environment. This scenario for bonds is very unlikely to repeat in the future, given today’s low-interest-rate environment. Investors who hope bonds will outperform stocks in the coming years will likely be disappointed.” – Roger G. Ibbotson, finance professor, expert on capital market returns, Yale School of Management

“Historically there is little or no correlation between the price of gold and stock markets. Over the past 10 years, the correlation between gold prices and the S&P 500 index was 0.01--that is, virtually no correlation. Over the past year, that correlation was about 0.25, which is still minuscule.

However, indirectly, if strengthening gold prices in tandem with an ever-weakening dollar leads to significant inflation, then that would clearly have negative implications for the stock market. Keep in mind that on an inflation-adjusted basis, gold reached an all-time high of almost $2,300 an ounce in January 1980. So, even if gold doubled in price now, it would still fall below that peak.” - Paul Wigdor, president, Superfund USA Inc., a broker-dealer offering managed futures funds denominated in the dollar and in gold

"We remain constructive on the nascent recovery but skeptical about broad market valuations in both equities and in the commodities space...as central banks deploy exit strategies. An increase in volatility should as usual bring both risks and opportunities for the quick and the steady. Traders, stock pickers and buyers on dips should benefit as things progress." - John Stoltzfus, analyst, Ticonderoga Securities

"There will be a good chance we will look back to see that Q3 was in fact the bottom, that Q4 was the tipping point and the recovery started aggressively in Q1 of fiscal '10." - John Chambers, CEO, Cisco

“We’ve actually seen more good news than bad across a broad spectrum of economic data. We look at the initial jobless claims as another piece of economic data we’re pretty happy with. The most important thing is the non-farm productivity number.” - Art Hogan, chief market analyst, Jefferies & Co.

Since 1930, (which is as far back as the Commerce Department's GDP numbers go), the NY Yankees have been a harbinger of average of 5% GDP growth in years following a series victory, healthy by any measure. In years in which the Yankees didn't win the World Series (either they lost or didn't make it) U.S. output expanded at an unspectacular 2.9%.

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

Wall Street analysts are forecasting S&P 500 earnings will increase 25% in 2010, the fastest growth in two decades. Investors are paying the lowest so-called price-to-earnings growth ratios since 1995. - Bloomberg

The US manufacturing sector grew in October for the third consecutive month and at a faster rate than was expected. The October reading was the highest since April, 2006. - The Institute for Supply Management

US construction spending made its largest gain in a year in September and home building rose 3.9 %, its largest gain since rising 4.2% in July 2003. – US Commerce Department

The Pending Home Sales Index, based on contracts signed in September, rose to the highest level since December 2006. It was the eighth straight monthly rise in the index, the longest streak since the measurement started in 2001. - The National Association of Realtors

First-time homebuyers, along with buyers who have owned their current homes at least five years would be eligible for extended and expanded tax credits. First-time homebuyers -- or anyone who hasn't owned a home in the last three years -- would still get up to $8,000. Buyers who have owned their current homes at least five years would be eligible for tax credits of up to $6,500. To qualify, buyers in both groups have to sign a purchase agreement by April 30, 2010, and close by June 30. These credits are not likely to be extended beyond that time.

The Federal Reserve left interest rates near zero and slightly upgraded its reading of the economy. The central bank affirmed its plan to keep rates at a record low for an extended period in the face of still high unemployment and low inflation.

You have to go back almost 50 years to find two straight quarters where productivity, which is output per hour worked, has boomed as rapidly as it has in Q2/Q3 of 2009. Nonfarm businesses increased their output at a 4% annual rate in Q3 and they did this while cutting the number of hours worked at a 5% rate. – US Department of Labor

“There are increasingly strong signals that the world economy is in recovery, with a number of leading developed economies and China clearly in a growth phase. The composite leading indicator of economic activity in our 30-member states rose in September from August. Leading indicators…point strongly to growth in Italy, France, the United Kingdom and China, while tentative signals of expansion have emerged in Canada and Germany. A recovery is clearly visible in the United States, Japan and all other OECD economies and major non-OECD economies.” - The Organization for Economic Cooperation and Development

Perspective
“Unemployment and the markets”

Unemployment rose to 10.2% - the highest level since 1982. (For the record, unemployment at that time peaked at 10.8% - and held there for six months.) This is what the “nattering nabobs of negativity” focus on. (I don’t know who came up with that but it does flow nicely…) And it’s not good – no doubt about that. It’s a mental and fiscal drag for everyone. Here are some of the reasons the markets didn’t just crater on Friday when that number came out.

First, and not to be a smart guy, it wasn’t as if it was totally unexpected. Next, the unemployment index is the very last indicator that will turn positive in any recovery. That’s why it’s called a trailing indicator. Now, consider all the comments and data in the Tea Leaf and Econ sections. That stuff extrapolates trends of the future – not what’s already in the rearview mirror. Markets are totally forward-looking – unemployment numbers are totally backward looking.

Let’s analyze the report itself.

The number of jobs lost in October was much lower than had been the case in the months before. It is continuation of a trend of diminishing numbers of new filings over the past several months. Further, temp jobs — often a leading sign of overall job growth — have increased for the third month in a row. Typically, payroll numbers turn higher an average of four and a half months after the temp numbers begin to rise.

In addition, average hourly earnings are up at a 2.8% annual rate in the past three months, a slight acceleration from earlier this year. Productivity growth has been extremely rapid also. Over time, higher output with lower labor costs means more profits, which will help stimulate rapid job growth once companies become more confident about the durability of the economic recovery.

Finally, the ISM Manufacturing Index reported that its employment index increased by 6.9 points to 53.1. The 6.9 point increase tied the largest monthly gain since the huge economic recovery in the early 1980s – when we had a similar recession. The level of the index, significantly above 50, suggests payroll gains should start sometime in the next couple of months.

Bottom line is that, behind the gloomy headlines, the trends are already rapidly shifting to the positive. It won’t be long before even the most negative natterers will have to acknowledge that…

All my best,

Mike
As of 6 November 2009 /
Dow Jones 10,023 S&P500 1069 NASDAQ 2112 Oil $77.56/bbl Gold $1,096.80/oz