Market retrospective - week of 3 July

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “It’s a bull market”


“Hope is the magic elixir of capitalism and capitalism is optimism monetized”. – Dennis Kneale, Media & Technology Editor, CNBC

Overview
“You may start your engines”

The above phrase is used to begin the Indianapolis 500 race. I use it since this coming week will begin the long anticipated earnings reports for publicly traded US companies. From these revelations – it has been said – we will be able to determine just how the markets and, ultimately, the economy will be doing through the end of the year.

This past week, the markets completed its very best quarter in just about 10 years. While the week itself was less than exciting since the holiday was coming, things should be picking up a bit very soon.

The companies will be reporting how they did this second quarter compared to the year ago period. I think it’s safe to say the results will be lower. There are two keys to be looking for.
If a company puts up better than expected numbers, their stock will likely go up. They may be lower than last year’s but “not as bad” as what the back room types had thought. The other is how do they see their markets developing over the rest of the year and later.

It could be an interesting week, to be sure.

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.)

“Jeremy Siegel, market historian and finance professor at the University of Pennsylvania’s Wharton School, is forecasting an annualized return of 8.0% (after inflation) for the S&P 500 over the next ten years. Siegel sees the S&P 500, which is up 4.0% this year through June 29, ending 2009 up 10 - 12%. Siegel believes that the economy is going to grow faster than expected over the next six months. He sees a V-shaped recovery, but says the upward slope of the V will not be as steep as usual.” – quoted in Kiplinger Magazine

"Equity markets have entered a phase of reality checks, during which the expectation-driven rise from the March lows has to be beefed up by hard economic data." - Gerhard Schwarz, head of global equity strategy, UniCredit

"We're seeing a classic bull-bear battle here." - Tom Schrader, managing director for U.S. equity trading, Stifel Nicolaus Capital Markets

“The summer forecast for stocks is higher. Both the valuations and volatility measures are pointing to a higher market. You've lost some of the impetus, but we'll probably grind higher through the summer. It's more of two steps forward and one step back. The market's widely anticipated ‘pull back’ may not materialize; the market may have caught its breath with the sideways move stocks made in the last couple of weeks.” - Tobias Levkovich, chief U.S. equities strategist, Citigroup

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

Stimulus package ~ One of the inherent problems with the Obama Administration’s $787 billion stimulus plan is that 60% of the package was never going to have much of a stimulative effect, according to Congressional Budget Office Director Douglas Elmendorf. With respect to the other 40%, initiatives capable of providing real stimulus will be among the slowest to come online. Contracts totaling $152 billion had been let as of June 19, but only $53 billion has been spent in the four months since the stimulus bill was enacted, according to Recovery.gov. The Department of Transportation has spent just $369 million of the $19 billion it has appropriated for highways, airports and other construction projects.

Oil prices/demand ~ The International Energy Agency slashed its forecast for world oil demand over the next five years, saying that by 2013 global demand will average 87.9 million barrels a day, 3.7% fewer than it expected in December and 7% fewer than it expected last July. Richard S. Eckaus, professor of economics at the Massachusetts Institute of Technology, published a paper titled "The Oil Price Really Is A Speculative Bubble".

He wrote that "there seems to be a preference for the claim that the price increases are the result of basic economic forces: rapid growth in consumption, pushed particularly by the oil appetites of China and India, the depreciation of the U.S. dollar, real supply limitations, current and prospective and the risks of supply disruption, especially in the Middle East." He briefly explored - and debunked - each of those possibilities and wrote that the price of oil is behaving much like any other speculative bubble.

Home prices in the 20 major metros ~ Home prices fell in April at a slower pace than forecast, a sign the plunge in real-estate values is abating. The S&P/Case-Shiller home-price index decreased 18.1% from a year earlier, following an 18.7% drop in March. The measure declined 19% in January, the most since the data began in 2001.

Price declines are likely to keep moderating as demand steadies and distressed properties account for a smaller share of transactions

Pending sales of homes (national) ~ According to the National Association of Realtors, pending sales of previously owned US homes rose slightly in May v. the expectations of it being unchanged. This now makes the fourth straight monthly gain.

US factory orders ~ Orders to US factories increased in May by the largest amount in nearly a year, further evidence that the nosedive in manufacturing is nearing an end. The Commerce Department said total orders rose 1.2% in May, better than expected. The back-to-back increases in April and May were the first consecutive gains in nearly a year.

Jobs data ~ US employers cut 467,000 jobs in June, more than expected, while the unemployment rate rose to 9.5%, the Labor Department said on Thursday. However, new weekly claims for jobless benefits fell in the latest week, largely in line with expectations. Continuing claims for regular benefits fell again. Finally, employers are planning fewer layoffs than at the same time last year.

The point is that the unemployment rate is NOT an indicator of what’s to come but a reflection of what has been. As is always the case in economic recovery periods, it will be the last of the major indicators to turn positive – well after the economy is moving ahead.


Perspective
“It’s a bull market”

This is what’s known as a declarative statement. For those of who still may be having a bit of a tough time getting your mental arms around this, here is some of the rationale for my position.
Our economy has never healed in a perfectly straight line, with all aspects of the economy getting better at the exact same time; it has way too many moving parts. So, let’s consider how some of those parts are doing.

Among the categories that have bottomed include such areas as housing activity and prices, car production, business inventories and capital spending. Reports show that durable goods shipments are improving and family wealth, that is the combination of real estate and investment holdings, was better at the end of the quarter, due to the market movement.
What about the talk about “everyone” is saving and only “buying the basics?”

Let’s look at that a little more closely as well. The top 20% of US income earners are disproportionately – through personal and retirement accounts – large owners of stock. (For the record, the top 20%, 77% of which had two or more income earners, had incomes exceeding $91,705.) According to Tobias Levkovich, these consumers are much more driven by what happens to stock prices than real estate values. Further, since they also make up more than 40% of the 70% that consumer spending represents in the economy, they have a strong impact. They are feeling wealthier and are more inclined to make whatever purchases they are inclined to do.

As Dennis Kneale, the gentleman I quote at the beginning has said – and with which I agree wholeheartedly – “I reject the doomsday proclamations that the consumer psyche has been altered permanently; we want what we want.” There is a pent-up demand in the system that will also aid in the recovery.

The biggest problem I perceive in investors is psychological – it’s as if this recession stuff has never happened before. Well, it has – the problem is that it just hasn’t happened within the memory of most investors…they were in 1974 and 1982. As it happens, we had no long-lived recessions of any sort from 1982 until 2002 - and that was just a speed bump. So, people have no frame of reference.

Those two periods had record high interest and inflation rates and credit defaults that were just as ugly as what has gone on recently. Looking back, it’s easy to anecdotally say well, it all turned out all right. I can assure you we didn’t know that when it was going on.

In terms of cycles alone, I feel I can make the case that we’re going higher. When you look at the 10 worst GDP declines going back to 1958, the fourth quarter last year is included. What’s also important to note - courtesy of the Bureau of Economic Analysis – is that the market was higher in every instance within one year of that bad quarter. The average gain has been 24%. That average gain, based on the year-end close, would get us to about 10,800 on the Dow…that’s up another 30% from Friday.

The fact is that ALL bull markets move higher before fears decline.

By the time many feel it’s okay to get back into the pool, a move has taken place that makes them hesitate even more. The former fear of losing it all has now been replaced by a fear of buying right before we go down again. So, they get frozen by emotional inertia as the markets work themselves higher.

New bull markets tend to keep may people nervous and in their low to no return savings vehicles. Let the record reflect that it takes discipline to step in and buy when the media and their friends are all saying “better watch out.”

In order for you to participate in the bull market, you have to have this discipline. The discipline to be objective – to position yourself for what’s coming and not be concerned by what’s already occurred – is what makes for a successful investment style.

Just so you know. In every recession I’ve experienced, (1974 to date) the previous market high was ultimately passed and exceeded. If that’s the case, we’re about 5,500 points below that on the Dow right now, so don’t feel as if the train has already left the station. There are still plenty of great seats available…

All my best,

Mike

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Closing values as of 2 July 2009: Dow Jones 8280 NASDAQ 1796 S&P500 896
Oil $66.34/bbl Gold $930.40/oz