Jun 22, 2009

Low Volume-Seasonal or Predictive?

“Healthcare is the single largest driver of our multi-trillion dollar deficit.”-Barrack Obama, US President

June 22, 2009

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -2.9%
SPX: -2.6%
COMPQ: -1.7%
RUT: -2.7%

This past week represented the 6th pullback in the market since the March 9th low (see chart below courtesy Bespoke Investment Group). Volume for the month of June has been very light, giving the non-believers and more conservative something to gnaw on. Unfortunately, at this time of year volumes tend to ease off so the lack of the same doesn’t give us much to hang onto. As we have discussed in the past, I am expecting the market to be range bound, certainly for this year and more than likely for an extended time period.

Richard Russell of the Dow Theory Letters expressed concern about the volume trends this month, stating that “In order for a counter-trend rally in a bear market to be sustained, it requires steady or rising buying power plus short covering. Lowry’s Buying Power Index has been declining steadily since May 8. At yesterday’s market close, this Index (demand) was only 24 points higher than it was at the March 9 lows. Furthermore, volume is drying up. This is extremely negative action. Whenever buying power contracts during a rally in a bear market, the prevailing primary bear market forces immediately take over. For that reason, unless the trend of declining buying power soon halts and reverses, I believe that the March 9 lows will be attacked and violated.”

As we discussed a couple of weeks ago, it appears that expectations in the marketplace are for a perfect recovery, which is very unlikely. The best case scenarios, whereby the recession ends this quarter or next, still should leave us with an environment where it could take many quarters or even years for a sustainable market recovery. Remember that the relatively mild recession of 2001 ended around the 4th quarter of that year, yet the market didn’t see a true recovery until March 2003, and the market suffered its worst losses during 2002. Granted the market was coming from a much higher valuation level than where we started this bear market, however, the interest rate environment, credit markets, and consumer spending were all in much better condition than today.

This week’s market action included a shift from the inflation trade (i.e. late cycle commodity stocks) to a more defensive trade (healthcare and utilities) for the first time since early March. The chart below, courtesy of www.finviz.com, shows the sector performance of the S&P 500 last week, where healthcare was the only group posting a positive return.

The big news on the week was the new Obama Administration plan to change the focus of the Federal Reserve from maintaining stable monetary policy to that of maintaining economic growth. The plan also puts Fed in the position of asking the Treasury for permission to utilize some of its emergency powers. Should this come to pass, it would alter the Feds current position as an independent central bank to a more political body. This shift could further undermine an already weakening international view of our currency and economy.


Actual Consensus Prior Period
NY Manufacturing Index -9.41 -4.60 -4.55
May Housing Starts 532K 485K 454K
PPI 0.2% 0.6% 0.3%
Core PPI -0.1% 0.1% 0.1%
Building Permits 518K 508K 494K
Capacity Utilization 68.3% 68.4% 69.0%
Industrial Production -1.1% -1.0% -0.7%
Core CPI 0.1% 0.1% 0.3%
CPI 0.1% 0.3% 0.0%
Initial Jobless Claims 608K 604K 605k
LEI 1.2% 1.0% 1.1%

Housing starts jumped nicely above consensus and the prior month, but still are some 45% below the level of last year. Building permits also came in slightly better than anticipated. The headlines are screaming about an improvement in the housing market, and while these results are not as bad as prior months, they are still just marginally above the lows of January-February and represent very weak levels of activity.

PPI for May came in less than anticipated as declining prescription drug and apparel prices were offset by gains in energy prices.

While initial jobless claims went up by 3K to 610K this week, the number of people collecting unemployment insurance fell by 148K to 6.7 million. Many hailed this decline as a sign the economy is finding a bottom, however, what the figures don’t take into account is the large number of filers who have seen their 26 weeks of unemployment coverage expire. Personally, I feel the improved numbers, which are still bad, are nothing more than a measurement fluke, and we will continue to see unemployment rising for a number of quarters.

CPI came in significantly lighter than expectations (0.3%), posting a month over month increase in May of 0.1%. The key to the miss was a less than anticipated 0.2% gain in energy prices, where a strong gain in gasoline prices was offset by declines in fuel oil, electricity, and natural gas as well as a strong seasonal factor (unadjusted energy prices rose 4.0% month over month). Food prices posted a decline for the fourth straight month, down 0.2%. Excluding these two categories, core CPI rose a modest 0.1% with increases led by new and used cars, medical care services, drugs, and tuition costs. Helping to offset these gains were declines in tobacco products, clothing, airfares, personal care products, and services. Both rent and owners equivalent rent (which together account for 30% of the core CPI) posted modest increases of 0.1%.

Treasury Yields-Flight From Quality?
We have been speculating for some time about what is causing the back up in treasury yields. This past week we had three Fed Presidents espousing their views on the cause. What are their conclusions? Much like the three-handed economist, they each have a different viewpoint.

Better economic data? Yes. Inflation? Yes. Government deficits? Yes

China's investment in U.S. Treasuries fell to $763.5 billion in April, the lowest since June 2008. The drop "seems to stem from net selling of Treasury bills," said Chirag Mirani of Barclays Capital Research. China Daily (Beijing)

Treasuries were hit early in the week when the Treasury said it will auction a record $40 billion in two year notes while adding $2 billion to the 5-year ($37billion) and $1 billion to the 7-year auction ($27B). The curve was pushed steeper as concern over longer term inflation and excess issuance is being raised again.

Credit Conditions
The chart below, courtesy of Investment Postcards, shows the contraction in spreads fro investment grade bonds. While the improvement has been significant, it is only now back to levels normally found near the trough of recessions.

According to ISI, global liquidity spreads have returned to near normal, though there is still a slight premium for liquidity. They feel that the financial crisis is largely resolved, however, the economy's adjustment to reduced risk taking and deleverage will weigh upon global capital markets.

European Troubles
From the London Times: In the European Central Bank's June Financial Stability Report, policymakers warn that commercial banks in the Euro-zone could face an additional $283 billion in losses by the end of next year. "Hard-to-value assets have remained on bank balance sheets, and the marked deterioration in the economic outlook has created concerns about the potential for sizable loan losses," the ECB said. Lucas Papademos, vice president of the ECB, warned that "there is no room for complacency because the risks for financial stability remain high, also bearing in mind that the credit cycle has not yet reached a trough."

Consumer & Corporate Sentiment

While consumers continue to be cautious, corporations have also been cautious, issuing equity as quickly as possible in an effort to pay down debt. What will come next? Eventually I anticipate another M&A cycle given the under-levered businesses resulting from this debt retirement cycle.

Good news for investment bankers, maybe in late 2010 or 2011.

According to Bespoke Investment Group, the percentage of stocks in the S&P 500 above their 50-day moving averages fell to its lowest level in two months. As of Friday morning, 71% of the stocks in the index were trading above their 50-day moving averages. Health care, both consumer sectors, and telecom have seen the biggest decline in breadth, while the utilities sector has increased recently up to 91%. This increase in utilities breadth indicates that investors are rotating money into the most defensive sector as the market takes somewhat of a breather.

Steel producer Nucor raised its guidance last week. The second- largest U.S. steel producer by sales forecast a second-quarter loss that’s narrower than analysts estimated and reported an increase in orders.

Best Buy Co. posted disappointing sales in spite of heavy promotions and the loss of competitor Circuit City.

Fed Ex said the rate of volume drop has leveled off and that they are “seeing signs of stability in the economy.” They experienced a 1% decrease in ground yields on flat volume. They further stated rising fuel prices will have an impact on Q1 results and that they believe they will be poised for growth in the second half of their fiscal year as comparables get easier. The departure of DHL from the marketplace is creating new pricing opportunities for the company.

British Petroleum is saying that emerging market consumption is now driving global oil demand as they are consuming more than developed nations on an aggregate basis. This is giving new fuel (excuse the pun) to the bull case on energy as emerging market economies appear to be recovering earlier than developed economies.

That malfunctioning international body known as the World Bank raised its growth forecast for China for 2009 to 7.2% from their 6.5% forecast in March. They also advised the country to delay any additional stimulus until 2010.

While GDP estimates are rising in China, it is important to note that electricity consumption has not kept pace with the reported rise in economic activity. This could be due to lower manufacturing volume as exports remain weak, however, it could also be a signal that the reported gains are somewhat overstated. The current electricity consumption is more consistent with 1-2% GDP growth.

The market isn’t cheap on an historic basis. S&P earnings may show some growth this year, however, the growth is primarily coming from money losing companies such as GM and a host of banks being excluded from the benchmark. Additionally, with rates continuing to rise, the relative valuation continues to expand.

Long Short Equity Weightings
As this market appears to be topping out, I have been lowering my net long position and presently am down to 20% net long from 25% net long last week and a high of 30% net long in May. While my present target position has been 50% long, 40% short, I have been running higher on the long side since April. As I mentioned last week, I re-initiated shorts in the oil sector and am slightly long the consumer and telecom sectors.

Just Say No!

What would happen if you offered a subsidized program and no one participated? This is what happened as the Federal Reserve received no requests from investors for loans to buy new commercial mortgage-backed securities under the TALF emergency program. Among the acronym soup coming from the government, TALF is a program aimed at reducing borrowing costs and reviving U.S. economic growth.

Real Estate
The chart below is from Paul Kasriel Director of Economic Research at The Northern Trust Company and shows that in recent months the ratio of single-family house starts to sales of new single family home sales is at it lowest level in 47 years. This is not to gloss over the fact that there still is a large supply overhang of new homes for sale that either have been completed or are under construction as well as pending foreclosure activity that is expected to rise dramatically over the next few months.

The chart below, courtesy of StockCharts.com, shows that the CRB, which measures a basket of commodities, has pulled back recently. Remember that this pullback has occurred while oil has continued to move upward, albeit at a slower pace than the doubling in prices that has occurred since early March.

Just Say No to the Governator
According to the Washington Post, California's appeal for emergency financial aid was turned down by the Obama administration. U.S. officials are worried that if they give California what it wants, the federal government will be buried under an avalanche of similar requests from other states. I guess that’s opposed to the avalanche of requests last fall for TARP money from commercial banks?

Moody’s warned they might downgrade California municipal bonds as the state faces a liquidity crisis as early as July. Credit default swaps on the state’s debt have skyrocketed, and according to Barron’s the prices are suggesting that the market is viewing California as a worse credit than Mexico and comparable to Lebanon. Ouch!

Market Risks/Negatives
I just wanted to note some of my ongoing concerns in the market and economy: rising interest rates, spiraling deficits, inflation via a weak dollar, energy prices that may crimp consumer spending, health care costs, an increasing tax burden, and questionable government policies.

Market Opportunities/Positives

Giving equal time to the opportunities in the market, I view positives as excess capacity (see the chart below courtesy of John Mauldin), an available labor pool, improving credit conditions, expanding M2, dollar weakness which benefits exports, and a coinciding improvement in demand from emerging markets.


I have postulated that video games may benefit from the summer trend of staycations, and received these comments from a reader in the industry:

“2008 was still strong from PS3 and WII, guitar hero and call of duty world at war - the industry is investing significantly in some big new releases - DJ Hero (will be big hardware and software), Nintendo DSi - new handheld with many new titles, and both the XBOX 360 and PS3 come with a Blu Ray player which is still growing and will be marketed more thoroughly. Game Stop is opening another 400 stores in 2009. Nintendo has the new WII motion controller and many new games including Tiger Woods golf (no more little cartoon characters) and the new WII Resort and WII Fit plus. There are also a ton of new software titles gaining a lot of $'s - UFC Undisputed, Call of Duty 5, great new EA sports games, etc. We just got back from E3 the industry trade show and there is a lot of positive momentum and optimism for the second half of the year, not to mention big ad spends.”

Health Care Bill
The CBO analyzed the proposed health care bill, one of the President’s priorities, and found that it will cost $1,600,000,000,000 (trillion) over the next decade, excluding Medicare. Given the CBO’s tendency to underestimate government expenditures and overestimate revenues, I would suggest the price tag on this bill probably pushes towards $2 trillion!

Double Standard
Does anyone else find it a bit self-serving that the government, majority stakeholders in 2 of the Big 3, is taking our tax dollars and giving it to people in the form of financing and the Cash for Clunkers program in order to drive sales at their auto manufacturers? If anyone in the private sector were to engage in that type of activity, prison would be their next stop (after, of course, a tongue lashing by the politically correct).

Credit Cards
Reiterating what I said in an earlier note about the proposed credit card bill of rights, David Nelms, the CEO of Discover Financial Services, said recently adopted rules in the U.S. aimed at protecting credit card holders will likely lead to increased interest rates and fees. "There are many consumers that actually will not benefit," Nelms said. "Some of the unintended consequences are going to be difficult for customers."

Early or Late Cycle?
The big question facing investors is whether we should be focused on early cycle or late cycle stocks? The late cycle argument suggests that this time is different (those words always scare me), and that the emerging markets will lead us out of the recession. At this point in the cycle it is unusual for late cycle stocks to be leading the market, except if we were experiencing nothing more than a bear market rally.

The early cycle argument is based upon history, which has shown that during market cycles the early cycle stocks lead the recovery. As you know I have been an advocate of a traditional recovery and that we are experiencing a bear market rally. As with any market it is important to be flexible and let the data guide your opinion, not the other way around.

Cool Website
For winos like myself there is a new website for monitoring your wine cellar/collection called Vinfolio. It allows you to track, analyze, and monitor your portfolio of wine. Additionally, it allows you to buy and sell wine from other users. I plan to use it to help value our wine for insurance purposes.

Twittering in Iran
In response to last week’s elections in Iran, massive protests have been occurring. Despite a crackdown, news of the protests has been pouring out of the country via Twitter and YouTube. If you go to my site (http://weeklymarketnotes.blogspot.com) you can see an embedded video of some of the protesters. .

Scary Flight

A Continental owned 777 landed safely last week after the pilot died during the flight. Two other pilots were able to guide the plane in safely, and evidently the 250 passengers were unaware of the situation in the cockpit.

Sign of the Times
Frugality is the new mantra of US consumers, and it’s no different at the Brines household. Last week I went to Sam’s Club for our summer stocking of the backyard bar. For the first time I can ever recall, the checkout clerk didn’t ask me to sign a waiver stating that my alcohol purchase wasn’t to be resold. I guess I didn’t buy enough?

Note to the neighbors-looks like you’d better bring back up this summer.

I plan to continue moving my portfolio more towards neutral, especially as we enter earnings season. With the markets seemingly priced and anticipating a very robust recovery, I am expecting softness through the upcoming reporting season.

Have a great week and thank you as always for your constant feedback.


“Given the way North Korea has been belligerent to its neighbors and acting like a bully, they aren’t acting properly to join the world economy.”-President Obama

1 comment:

  1. death of a salesmanJune 24, 2009 at 4:09 PM

    oh, good. i now can hear the sagaceous thoughts of the swami nedly. my life is complete.