Market retrospective - week of 16 October 2009

Contents: Overview; Tea leaf readings; Economic reports; Perspective, “The V-shaped recovery”

"An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today.” – Dr. Laurence J. Peter (1919 – 1990) Canadian author, “The Peter Principle”

Overview

Thursday saw the Dow close at its record high for the year at 10,062. We had some profit-taking Friday, so the index closed just below 10,000. What does that all mean?

Other than it being a psychological barrier and passing it making many individual investors more comfortable, from a fundamental standpoint, it has no real impact on the economy or markets. When the Dow first closed above 10,000 in March, 1999, it was cause for great euphoria – we’d never been that high before. On the other hand, the most recent time it closed above 10,000 was just about a year ago and celebration was not the descriptive term for that occasion.

10,000 is a nice reference point for where we are on the recovery. It's an important hurdle to get past, get through and leave behind. It’s highly likely that we’ll see some backing and filling over the next few weeks after 10,000 and after the earnings season concludes.

We still remain well below our October high of two years ago, so just think of it as a sign pointing us to the higher levels yet to come.

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.)

"Currency will be a big positive impact (on earnings). The lower dollar has many concerns to it, but it has a benefit to multinationals and I think that is a big expectation in terms of the quarter. Positive earnings surprises will be one factor that could keep the market moving higher for now. It appears the estimate for the third quarter earnings compared to second quarter are relatively on par. Given there have been some improvements in the tone of the economy and you have this currency affect, you have some upside." - Chris Sheldon, director of investment strategy, BNY Mellon Wealth management

"Our view is that risk assets will continue to outperform safe assets. That is equities and corporate bonds over Treasurys and cash. The economy is showing signs of recovery, even if growth is less robust than usual after a recession. We have to respect those cyclical positives. You need to own these risk assets, but play the higher quality ones." - Bob Doll, vice chairman and global CIO of equities, BlackRock

"Mid to long-term, I think tech offers you innovation, it offers you globalization and those are really attractive, and at these valuations, especially with the larger cap names, we think that's what next year's going to be about." - David Eiswert, analyst, T. Rowe Price Associates

“We are in the early stages of the recovery and it looks to be a lot stronger than the consensus for modest 2% - 3% GDP growth. Furthermore, the recovery will be V-shaped and is now virtually unstoppable - at least through the first half of 2010. This is because of ‘positive contagion’ in the economy right now, based on leading economic indicators. Most notably, the ECRI's index of Weekly Economic Indicators just hit a new record high.” - Lakshman Achuthan, managing director, Economic Cycle Research Institute (ECRI)

A survey found that 42% of workers think they will need about $500,000 in retirement savings to live comfortably once they stop working. The survey also revealed, however, that only 26% of workers over the age of 55 have set aside more than $250,000 towards their retirement. - Employee Benefit Research Institute

Minutes from the September 23 meeting indicated that policymakers feel that the economic outlook has improved and that job losses are slowing. In turn, most members have upwardly revised economic projections, though overall activity is still quite weak. – Federal Reserve Open Market Committee

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

“The dollar had been strong because the US was a haven in the storm and now that the storm is abating, who needs the dollar? People got exasperated with the tiny returns on safe assets. Investors are sating their renewed risk appetites with developing nations’ stocks, currencies and the commodities some of them produce.” - Edmund Phelps, Columbia University, 2006 Nobel Prize in economics

“We’re in the midst of a classic overshoot of the dollar. The US outlook next year is more favorable than Japan and the euro area, the country’s current-account deficit is narrowing and the bond market isn’t reflecting inflation fears. The 16% rise this year in the Reuters/Jefferies CRB Index of 19 commodities is evidence that the flight to raw materials isn’t widespread.” - Michael Rosenberg, former head of foreign-exchange research, Deutsche Bank AG

“Oil consumption started to slump four years ago as consumers bought more efficient vehicles and countries expanded their use of alternative fuels like ethanol. Demand for oil in the US has fallen by 2 million barrels a day since 2005. A rebounding global economy spurred on mainly by China and other developing nations is expected to boost world oil demand by slightly under 1% next year.” - IHS Cambridge Energy Research Associates (This research report focuses on demand from 30 countries that are part of the Organization for Economic Cooperation and Development and make up 54% of the world's oil demand.)

Many workers in their early to mid 60s, who have lost their jobs, are opting for early retirement in order to collect Social Security benefits. Applications for retirement benefits (2.57 million) for the fiscal year ended September 30, 2009, rose 22% over the 2008 fiscal year – well above the anticipated 15% increase. - Social Security Administration

The number of US workers filing new claims for jobless insurance unexpectedly fell last week to the lowest level since January. New jobless claims have declined for five of the last six weeks.
The four-week moving average for new claims dipped last week, declining for a sixth straight week. The four-week moving average is considered a better gauge of underlying trends as it irons out week-to-week volatility.

Even more encouraging, the number of people collecting long-term unemployment benefits dropped. That was the first time that the so-called continuing claims had dropped below the 6 million mark since late March. This measure has trended lower for four consecutive weeks. – US Labor Department

“Core retail sales (retail sales ex-autos, building materials and gas) were up 0.5% from last month and are up in 3 out of the last 4 months. This shows that consumers have been spending, despite what the conventional wisdom has been saying. Sales at general merchandise stores (department stores and warehouse clubs) increased 0.9% in September and are up at a 13.3% annual rate in the past 2 months.

The revenge of the smokestack continued into September, with another large monthly gain in industrial production and upward revisions for August. Manufacturing output is up at a 14.5% annual rate in the past three months, the fastest pace for the initial stages of any recovery since the one in the early 1980s.

This is not just due to cash for clunkers artificially and temporarily boosting auto production. Excluding autos, manufacturing is up at a 7.5% annual rate, also beating the initial stages of any recovery since the one in the early 1980s. After the last two recessions (1990-91 and 2001), the service sector led, while manufacturing lagged. This time around, the manufacturing sector is leading the way in this V-shaped recovery.” – Brian S. Wesbury, Chief Economist, First Trust

Perspective
“The V-shaped recovery”

As Mr. Wesbury says, I firmly believe we are in the throes of a V-shaped recovery. Let’s talk about what that means.

The US economy has rebounded strongly over this past quarter and the expansion that’s been underway for a while now should definitely prove long-lasting, despite fears by many that it’s about to run out of gas.

In physics, there’s a law that says that for every action, there is an equal – and opposite – reaction. Because the markets and economy got whacked so badly about a year ago, we’re riding the elevator back up to where it was – reverting to the mean is the uptown phrase for this.
Look over these Tea Leaf comments and economic reports – it seems quite clear to me that what the market has been telling us since spring is coming to pass in spades. Remember that the markets are a forecasting-oriented. What’s happening now is in anticipation of what’s to come six to nine months in the future. As the recovery becomes more widespread, the more it gathers strength and momentum, carrying it forward even further.

I think we’re going to see quite large growth across the board being reported for the third quarter and continuing into the fourth. I also think that, as Mr. Wesbury suggests, the industrial/business side of our economy will be leading us – not the consumers. Consumers are coming back, don’t misunderstand – look at the retail sales. It’s just that the strength for the foreseeable future is business driven.

Many studies continue to show that investors – while not quite as standoffish as was the case a few months ago – still are refraining from getting into the markets at levels seen in normal, i.e., not bubble driven, conditions. That’s good because it shows there is still plenty of dry powder out there to keep the market fires going. It also helps to reinforce an old adage of the Street that says that “bull markets climb a wall of worry.” As long as there is a degree of skepticism, we’ll be fine.

It’s when complacency settles in that the lifeboat drills should begin…

When you do invest, stick with quality companies – innovators and leaders in their sectors. And don’t forget to include the overseas markets as well. There are many fine companies all over the globe that will reward you for your foresight.

All my best,

Mike
509-747-3323

Closing values as of 16 October 2009 /
Dow Jones 9995 S&P500 1087 NASDAQ 2156 Oil $78.57/bbl Gold $1,054/oz