Market retrospective - week of 8 May

Contents: Overview; Tea leaf readings; Economic reports; Oil prices; Market trends; Conclusion

Put a fork in it

It’s done. The recession, that is.

It may not be deemed officially over yet. That takes a while since the number crunchers have to see the data after the fact in order to call it. Here are a few of the reasons I’m saying it now.

“Studies have shown” – one of my favorite phrases – that new claims for unemployment insurance usually peaks one to two months before the official economic bottom is made. The high point was likely the March figure. April was lower and there’s really nothing on the horizon that should cause it to increase again.

Having said that, overall unemployment probably has not peaked – it’s the most lagging indicator of how we’re doing. Defaults and foreclosures are also lagging indicators – data based on events already passed.

The speed with which money goes through the economy is termed “monetary velocity.” Last fall, it effectively came to a dead stop. When there’s no money going through an economy, it’s like a car engine without oil – it locks up. I believe improving monetary velocity is a key indicator of when we recover.

One component of monetary velocity is consumer spending. In the first quarter this year, it gained 2.2%. Based on the trends now, it looks as if it go be up again this quarter.
Another component is consumer prices. Those fell at an annualized rate of over 12% in the last quarter of 2008. First quarter of this year – prices are up 2.2%.

Bottom line? The trend is our friend.

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.

“The average one-year bear market rally off of the bottom has risen more than 43 percent and it's likely, there is still room to go higher. Another factor is that there are lots of investors who missed the moves and are sitting with large cash hordes.” – Tobias Levkovich, chief US equities strategist, Citigroup

"I am enormously optimistic about the future of this country over time." – Warren Buffett

“The economy should pull out of the recession and start growing again later this year.” - Ben Bernancke, chairman, Federal Reserve Bank

"It looks like the psychology of the market is really changing. Positive news is taking the market higher and negative news leaves it flat, while it used to be sell first and ask questions later." - Ryan Detrick, senior technical strategist, Schaeffer's Investment Research

“There will be a surprising rebound in the US economy in the second half of 2009. Most of our clients have missed this rally, but there’s plenty of scope for some more, as long as the economic data goes from mixed—which is what we have right now—to decisively positive.” - Larry Kantor, head of research, Barclays Capital

"A lot of the stuff that is happening in the financial markets is because Wall Street is smelling an economic bottom. That's bringing bids back into the market place for not just equities, but for commodities and bonds. I'm sure we'll keep creating things to worry about, but the impact of these things is decaying. The scare impact is less if the economy has bottomed and is moving up again and I think that's the case." - James Paulsen, Wells Capital Management

Economic reports from the past week

Construction spending ~ The Commerce Department reported Monday that construction spending increased 0.3 percent in March, after five straight declines, as strength in nonresidential projects and government building offset a further slide in housing. Economists surveyed by Thomson Reuters had expected spending to drop 1.5 percent.

Pending home sales ~ Economists polled by Reuters had forecast no change in pending home sales in March. Instead, the Pending Home Sales Index, a forward-looking indicator based on contracts signed in March, increased 3.2 percent to 84.6 from a level of 82.0 in February, and is 1.1 percent higher than March 2008 when it was 83.7.

Car sales ~ 70% of car shoppers plan to buy a new, rather than a used vehicle, according to Kelley Blue Book.

S&P 500 Index ~ The S&P 500, the best indicator of the overall US market, turned positive for the year on Monday when it closed above 903. Banks, retail companies and commodity companies have provided most of the strength.

US service sector ~ The Institute for Supply Management's non-manufacturing index rose to 43.7 from 40.8 in March, according to a report on Tuesday that will raise more hopes that the world's largest economy has hit bottom and may now begin to recover. The services sector represents about 80 percent of U.S. economic activity, including businesses like banks, airlines, hotels and restaurants.

LIBOR ~ The LIBOR (London Interbank Offered Rate) that banks charge for three-month dollar loans fell below 1 percent for the first time as credit markets showed signs of thawing. The rate, set by the BBA in London, determines borrowing costs on about $360 trillion of financial products worldwide, ranging from home mortgages to corporate bonds.

GM ~ GM says it may offer current shareholders a reverse stock split that would give them one share of new stock for every 100 shares they currently own. GM said in an SEC filing that the reverse split deal would be part of an agreement with the Treasury Department to swap at least half of GM's debt to the government for company shares. The filing says both sides are still negotiating the terms of the debt swap, but the government would own at least 50 percent of the company.

Chrysler ~ Chrysler LLC will not repay U.S. taxpayers more than $7 billion in bailout money it received earlier this year and as part of its bankruptcy filing. This revelation was buried within Chrysler's bankruptcy filings last week and confirmed by the Obama administration Tuesday.

Unemployment ~ US private-sector job losses slowed much more than expected in April, hitting their lowest since November last year, according to a report by ADP Employer Services on Wednesday.

Productivity ~ According to the Department of Labor, productivity, a measure of employee output per hour, rose at a 0.8 percent annual rate, compared with the 0.6 percent decline reported for the fourth quarter.

Budget “cuts” ~ President Obama yesterday proposed cutting $17 billion from the federal budget -- barely one half of 1 percent of the scheduled spending of $3.4 trillion. Virtually every dollar “saved” would automatically go towards new spending instead of deficit reduction.

Bank stress tests ~ The results of the stress tests revealed that 10 banks need to raise $74.6 billion in capital. The idea is to ensure that they can remain solvent in a much worse economic climate than we’ve been through. One of the banks, Bank of America, has to raise $34 billion for itself. Citigroup, Wells Fargo, GMAC LLC and Morgan Stanley are the other more well knowns that need to raise money. Citi, Wells and Morgan Stanley have already announced new stock offerings to help to do just that.

JP Morgan Chase, Goldman Sachs, AmEx, BB&T, State Street, Met Life, Bank of New York Mellon, US Bancorp and Capital One were the large institutions that didn’t need to raise additional capital.

Tim Geithner, Treasury Secretary, said in a press conference that he was "reasonably confident" the banks could raise the needed capital. Federal Reserve Chairman Ben Bernanke said the results should provide "considerable comfort" about the health of the banking system.

Oil prices

Where I live, gas is about $2.39 for a gallon of unleaded. The price has been going up steadily for some time. Sure, there’s been a rebound in oil prices from a low of $33.55 in February but, given the overall economy; this rise doesn’t make much sense. Oil has gained more than 70 percent. It settled at over $58 per barrel on Friday. This is happening when oil supplies are at the highest level we've seen in the US since 1990 and demand is at its lowest level since September, 2001, and an almost 8 percent decline from a year ago. According to basic economics, oil should be lower – certainly than what it is now.

Let’s see what the nice people at the NY Mercantile Exchange, where the crude oil contracts are traded, have to say about the situation.

The traders are of the opinion that oil remains technically strong today, despite rather bearish fundamentals, because the traders are following the equities market and its hopes for recovery. Recovery equals more oil usage at some point. So, as a trader, if I buy the stuff at today’s prices, I can deliver it at that future point for a nice gain.

Probably a bigger driver – at least according to the Merc folks – is new money coming in from passive funds. They are reallocating assets away from precious metals and into energy holdings. It's this money flow - rather than the fundamental supply/demand data - that's driving oil prices higher.

And now, with money that has been sitting on the sidelines coming in, investors will likely help keep the run going up - buying more oil and natural gas just to have some exposure to the sector.

Market trends

I think the markets are looking a little tired. This does not mean I am altering my positive view of the trend of things. It simply means that, especially with the stress test results out of the way, the only news we have forthcoming is basically economic reports. While important, they aren’t likely to fire up things a great deal.

We could have as much as a 10% drop in the indexes from here and not, in the greater market scheme, be in any trouble. However, I’m not really looking for a big drop.

I think we may be moving into the summer doldrums where the markets just kind of churn around on themselves as they get used to the air up here. Sideways is the more likely move, trading in a range for a while.

Conclusion

I think most retail investors have less equity exposure now than most should because of the huge hits the markets have provided. You can’t base your future on what has recently happened. Moreover, you can’t you grow your money if you have placed it into “safe” investments like Treasurys, CDs, bonds or savings accounts. The reason is, when you look at the record, your rates of return over time – especially when you factor in taxes and inflation – cannot protect you from loss of your buying power. I sure don’t see that changing at all.

As companies do better coming out of this period, the individual shares that represent ownership will appreciate in value. The individual shareholders, mutual funds, retirement plans, trusts and all that own them will benefit. Many companies will also provide dividends as an additional benefit of ownership. Neither of those are offered by the “safe” investments.

While I do see this as, literally, a generational opportunity to own some of the best companies in the world at huge discounts, I’m not advocating an across-the-board just own stocks solution. I am advocating that you create a plan – or review the one you have – to ensure that your assets are properly allocated for each goal you have. Likely, there will some stocks and some bonds to help you get to each of your goals.

Please keep this in mind. In investing, there is no one size fits all. That’s one reason why generic information from media “experts” or web sites or magazines are of little value. If you put all your investments in one type investment – whatever it is – and/or you treat all your investable assets as having one goal, you aren’t really an investor…you’ve become a fortune teller.

All my best,

Mike
509-747-3323

Closing values as of 8 May 2009:
Dow Jones 8574 NASDAQ 1739 S&P500 929 Oil $58.64/bbl Gold $917.30/oz