Market retrospective - week of 19 June

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “Reform and regulation”

“You can never plan the future by the past.” – Edmund Burke (1729 – 1797) Irish political philosopher and statesman

Overview

“Running in place”

The markets continued their lack of movement this week. The averages finished a bit lower than last but the difference was nothing significant; the Dow being down 3% was the “worst” of it. Oil ran into some profit-taking while gold was about unchanged. I don’t think we’ll see much stock movement in any direction until the second quarter earnings reports begin in earnest after the 4th.

We did have two pieces of good economic news this week. One was the drop in total unemployment, breaking a string of 21 straight increases in continuing claims. The other was the Index of Leading Economic Indicators – designed to forecast activity in the next three to six months – rose more than expected and the highest increase since 2004.

It wasn’t that long ago that we were in a similar sideways situation in the markets. About eight months after the big decline of July, 2002 – as we are now – the markets were back to even with where they were. In market history, it takes about eight to nine months after a big blow off to start getting some traction back to the upside.

Using history again, looking at the markets of 1974 and 1982, we again have beaucoup money parked in various places all earning, effectively, nothing. These were also the only other times that stocks have been as cheap as they have been over the recent period. Further, from an analytical standpoint, a sideways market is usually seen as a positive indicator.

I can’t pinpoint the time when the market really digs in and starts getting back up toward its previous highs but, in my opinion, it’s a whole lot sooner than later.

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.)

"With all the carnage we went through, this is the opportunity of a generation to own great companies at just ridiculously low valuations. Wall Street can deal with recessions—we had 10 in the last 60 years. The abyss, the true crisis mode, is over." - Nadav Baum, managing director of investments, BPU Investment Management

"Despite significant weakening in the near-term economic outlook, projected fiscal deficits and the high fiscal costs of government support of the US financial sector, we still believe that the US government's credit strengths continue to outweigh its weaknesses." - Nikola Swann, analyst, S&P. (The rating agency cited the US dollar's reserve status and the US economy's openness to trade as supporting the AAA rating, which has traditionally given US Treasury bonds the status of a safe-haven investment.)

“The jobless-benefit rolls always stabilize or decline right around the end of the recession." - Abiel Reinhart, economist, JPMorgan Chase & Co

“I look at the [market weakness] as a buying opportunity. I’ve been bullish for a while … When the March lows were set and when we climbed out of there, we saw the worst past us.” - Gary Hager, president and founder, Integrated Wealth Management

“There is an inverse relationship between revenues and taxes. Revenues are determined by economic growth and capital appreciation which is impelled by innovation. Higher tax rates do nothing to raise revenues over any significant period of time (more than one year).” – George Gilder, co-founder, Discovery Institute

“Risk aversion has eased, while inventory rebuilding and new business spending bode well for an economic recovery that could provide a dramatic surge in corporate profits by year end.” - Abby Joseph Cohen, senior investment strategist, Goldman Sachs

“To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the NASDAQ bubble.” – Paul Krugman, in 2002, Nobel Prize in Economics (accountability not a requirement for the prize)

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

Housing starts ~ According to the Commerce Department, US builders broke ground on more houses than forecast in May, offering a sign that the industry’s slump, now in its fourth year, may be approaching an end. The 17% increase in housing starts to an annual rate of 532,000 followed a 454,000 pace the prior month. Building permits, an indicator of future construction, also rose more than estimated.

Inflation indicators ~ US wholesale prices rose less than anticipated in May as food costs dropped. The Labor Department reported that its producer price index, (PPI), fell 5% over the last year, the biggest slide since 1949.

The cost of living in the US, as measured by the Consumer Price Index, (CPI), rose less than forecast in May, culminating in the biggest 12-month drop in prices since 1950. The CPI is the broadest of the three monthly price gauges from Labor because it includes goods and services.

TARP funds ~ Ten of the largest U.S. banks, including Goldman Sachs, JPMorgan Chase and Morgan Stanley, repaid billions of dollars in taxpayer bailout funds Wednesday, getting out from under the government's thumb. Banks have been anxious to return funds taken from the $700
billion Troubled Asset Relief Program to escape the many strings attached, including restrictions on executive compensation.

State taxes ~ Faced with gaping budget holes, 23 states have raised taxes this year and 13 more are considering doing so as they set out to approve 2009-2010 budget agreements, according to a report by the Center on Budget and Policy Priorities, a liberal think-tank. In most cases, the tax increases come on top of cuts in public services. The raises include income, sales and business taxes and take aim at anything from slot machine licenses to motel room taxes. Another popular target is alcohol and tobacco.

California ~ Moody’s warned California’s credit ratings could face a “multi-notch” downgrade if the state legislature can’t agree on a budget soon. These comments come of the heels of a similar warning made by S&P earlier in the week as the state battles its current budget shortfall.
Moody’s cautioned that “the state's cash situation will deteriorate to the point where the controller will have to delay most non-priority payments in July.” Such a downgrade would make California ineligible for more favorable interest rates, pushing the cash-strapped state’s borrowing costs up.

Perspective

“Reform and regulation”

I chose Mr. Burke’s comment for this week’s note as I believe that’s what the DC types are doing now with their calls for reform…trying to “fix” the future based on the past.

Beginning last year with the mark-to-market accounting fiasco and allowing Lehman Brothers to fail – among other things – I’m of the opinion that government is what led us into the type recession we’ve had. As Groucho Marx once said: “Politics is the art of looking for trouble, finding it, misdiagnosing it and then misapplying the wrong remedies.” That started last fall and has been massively compounded since January.

These people have NO grasp of the financial markets and how they inter-connect. You have politicians who are driven by polls being advised by professors and lawyers. None of them – okay a minute percentage of them, maybe – have ever managed investment funds, made buy and sell decisions about stocks professionally or, God forbid, had to deal directly with an investor. And yet, these ivory-tower commandos are trying to dictate to and regulate a complex, multi-faceted industry.

Further, the people assigned to create all this regulation seem to come from the “government knows best; all consumers are potential victims” school of illogic. These are representatives of the same group who brought us – and want to revive – the Community Reinvestment Act. (See the Paul Krugman quote in Tea Leaves.) That was the law that forced banks and other lenders to make loans to “under qualified” borrowers and led directly to the housing challenge. Oh yes, please may I hear more “wisdom” and “guidance” from those people…

Proper rules of the free market, capitalistic world should ensure that people – and companies – pay for their own mistakes…not government. Arthur Seldon, a British economist, said, "risks which cannot be removed or shifted profitably must be born by the entrepreneur. He will generally do so only as long as his expectation of profit outweighs the chance of loss." If the Feds take that risk away through short-minded regulations designed to fight the last war, so to speak, you don’t have capitalism.

And please understand that capitalism hasn’t failed in this recession – government has. The recovery has been created through a strong monetary policy response – due to smart people at the Federal Reserve, primarily – and the normal types of events that occur in the latter stages of a recessionary recovery.

Minimal stimulus money has hit the economy, so far. The spending bill that just “had to be passed” last fall has had no discernible impact as yet. And, due to its size, the degree to which it ultimately proves to be helpful is open for debate.

I hope that, during what will be a long and spirited debate about all these high-cost, low benefit reforms, knowledgeable people with influence will be able to prevent the government from creating more long-term problems with their “good intentions.”

All my best,

Mike

509-747-3323

PS If you, or someone you know, has suffered the death of a spouse, been divorced or changed jobs and has a retirement plan they’re not sure what to do with, please let them know I can be of help. Thank you.

Closing values as of 19 June 2009:
Dow Jones 8539 NASDAQ 1827 S&P500 921 Oil $69.40/bbl Gold $934.30/oz