Nov 2, 2008

Here today, Ghana tomorrow

November 2, 2008

Based on last Friday's official settlement...

INDU: +11.3%
SPX: +10.5%
NDX: +10.8%
COMPQ: +10.8%
RUT: +13.9%

Amazingly, the best performing stock market in the world is Ghana’s, up a whopping 64% YTD. Now, there are questions about liquidity (some days no shares trade), the size of the market, etc, but it is still very impressive. I guess those who were hailing the emerging markets and their ability to continue growing despite the burgeoning recession around the world were right-Ghana has been able to decouple from the rest of the world. I wonder how their less stable neighbors Togo and Ivory Coast are fairing?


Last week was a humdinger, with the markets soaring on Tuesday over 10% and holding those gains through the week to post the best week on the S&P500 since 1974. Not bad for the 79th anniversary of Black Tuesday. There was much speculation about why the market soared that day: the GDP report, the pending Fed meeting, attractive stock valuations, or the end of mutual fund tax loss selling. My favorite came from a rather cantankerous large cap manager who stated that the market “finally had to go up so it could have a higher starting point for its next collapse”. I’m not quite that bearish from these levels, but I found it entertaining and certainly a sign of the times in our business when even fully-invested growth managers are bearish.


The 41st edition of the Stock Trader’s Almanac cites a seasonal phenomenon which begins this week. Historically, the best time to own stocks has been November 1 to April 30, while the worst time has been May 1 to October 31, (an obvious statement this year). Much like Tuesday’s rally, there are many theories as to why this seasonal trade has worked so well. One thing is certain, owning stocks in November has really paid off over the years as it is the #1 performing month for the S&P 500 since 1950 (with similar results for the Dow and the NASDAQ). Keep this in mind as you plan out your asset allocation. Most investors have forgotten about the strength in both November and the subsequent five months as mutual fund redemptions hit a second consecutive monthly record in October, -$17 billion. The pre-2008 record, Oct 2002, preceded an increase in the S&P of 28% over the next 14 months.

As a result of the record redemptions and overall investor caution, money fund assets now represent 25% of the value of the stock market ($3.4 trillion vs. $13.3 trillion). Many of the more cynical in the group will note that the drop in the denominator has pushed this ratio, but there has also been quite a rise in the denominator. According to Ned Davis Research, historically when this ratio hits 11%, the market has rallied an average of 12% over the next year.


Last week I discussed the improvement in the Libor-OIS spread, and Libor continued dropping this week. Libor dropping signals that banks are beginning to trust each other once again, and is a required first step in unthawing the credit markets. Lending remains tight-I have included a chart below which shows that senior credit officers have been very reluctant to lend, comparable to 2001 and 1990. Some chatter coming from the government is that they are very anxious for all the capital they have thrown at the banks to make its way into the private sector instead of being hoarded. This will eventually happen, but will take time.

Junk yields are still very high, some 1200bps above treasuries. The last big peak we saw, also October 2002, preceded the mother of all small cap rallies as the Russell 2000 soared 52% from Nov 1, 2002 until the end of 2003. Now, I don’t know if that was really the mother of all small cap rallies, but it was a big one and I liked the way that sounded.


The FOMC met, and true to form, the Fed cut 50bps from the Fed Funds Rate Target, pushing it down to 1%. I don’t want to get into the criticisms of 1% rates getting us into this mess in the first place, but I do find it interesting that many are viewing the cure to our problem as being the same ill that got us here in the first place-cheap money. Paul Volker, the last true steward of the US dollar, would be rolling over in his grave if he were dead. Instead he is fighting for a regime change. The chart below shows this rate, quarterly, since 1978. Although this weeks’ reduction doesn’t show up yet in this chart, it now equals the low set June 2003 of 1.0% with expectations of another cut in December being priced into the market.

GDP came in at -.3% versus the consensus of -.5%, and the market seemed to take it well, rising roughly 10% on the day. This is a first estimate, and I would expect downward revisions with each subsequent report. The details of the report were not especially attractive, with consumer spending down 3.1%, durable goods orders down a whopping 14%, and exports weak as a result of the slowing global economy. Additionally, the price index was up to 4.2%, which to me seems a bit more in line with the inflation rate the average consumer is facing, at least when compared to the ludicrous rate of 1.1% in the Q2 report. The strength in the GDP report came from government spending, which isn’t a big surprise.

This week a number of key reports hit the tape, including ISM, consumer confidence, factory orders, construction spending, wholesale inventories, and the typical weekly unemployment drabble. For those of you who like to keep score, I have included a scorecard below for your entertainment.

Street Estimate
Actual Result

ISM Manufacturing

ISM Prices Paid

Construction Spending

Factory Orders

ABC Consumer Confidence

ISM Non-manuf

Wholesale Inventories


Earnings continue to limp in, and I can’t help but think about the impact of the market on company’s earnings. How is it that a depressed market impacts earnings per share (EPS)? Through their pension plans. A year ago 90 %(+) of the S&P 500 companies had their pension plans fully funded. I don’t know the recent figure, but you can bet with all asset classes dropping like a rock over the past 12 months, the impact to pension plans is being felt. Remember that any shortfall in a plan now runs through the financial statements, and can hurt reported EPS (I tried to keep that as simple as possible for all the non-accountants on this list). For those of you who found even that explanation too complex, remember this: “market bad, EPS bad; market good, EPS good”. In other words, companies with pension plans are impacted in both directions when the value of the plan rises and falls, and EPS can be impacted accordingly. With the huge fall we have had in the market, it seems obvious to me that companies are going to start taking EPS hits beyond those caused by the slowing economy. Will this be another shoe to drop on the market or is it already priced in? The most recent estimate I have seen is that the impact is over $100 billion for the companies in the S&P. That’s a pile of cash, even though it’s only a fraction of what the new leader of Obama-nation spent on this election.

Speaking of the Election

It’s tomorrow and will be historic which ever way it turns out. I’ll be watching the results crawl in, but will be more focused on the earning reports coming in all week.

As I close this the MSCI Asia Pacific Index is up almost 5% with a loosening of the credit markets receiving credit for the rise.

Have a great week. As always, I’m happy to remove you from the list, just let me know.


new office # (562) 430-3232

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