Sep 7, 2009

At the Cusp of a Sluggish Recovery

At the Cusp of a Sluggish Recovery

September 8, 2009

“Prediction is very difficult, especially about the future.”—Niels Bohr, Danish Physicist

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

INDU: -1.1%
SPX: -1.2%
COMPQ: -0.5%
RUT: -1.6%

The market closed lower during the pre-holiday week as weakness in the financial sector led the market down. The group is still the best performing sector for the past three and six months, bouncing more than 100% in the later period. I have heard from many investors lamenting about their inability to pull the trigger on BofA at $3 or Citigroup at $1. I have to remind them that these institutions are (and were at the time) insolvent, with the only thing keeping them afloat being the government view that they were “too big to fail.” Additionally, when exactly would they have made that decision to purchase either of these stocks, especially given that they both peaked around $52? Any purchase would have been catching the proverbial (OK, it’s not really a Proverb, but you know what I mean) falling knife.

Much has been made in the press about September historically being the worst month in the market. While the record supports this viewpoint, the data is not so overwhelming as to make it a bet worth pursuing. Like many market axioms and statistics that have been put to rest during this unusual year, relying on the wrong history can be expensive. While we have been looking for a correction, it is dangerous to base one exclusively on the calendar. While valuations, fundamentals, and macroeconomic conditions would suggest a tepid environment for the market, exceptionally low rates, easy monetary policy, and heavy stimulus counter the fundamentals and have created an environment where stocks have continued to work in spite of the obvious fundamental issues facing them. As Don Hayes says, the market climbs “a wall of worry.”


Actual Consensus Prior
ISM Index 52.9 50.5 48.9
Chicago PMI 50.0 48.0 43.4
Initial Claims 570K 564K 574K
Average Workweek 33.1 33.1 33.1
Nonfarm Payrolls -216K -225K -247K
Hourly Earnings 0.3% 0.1% 0.2%
Unemployment Rate 9.7% 9.5% 9.4%
ISM Services 48.4 48.0 46.4

The ISM came in above consensus and posted its best reading since June 2007. Additionally, the measure was above 50 (indicating growth) for the first time in 19 months. A large portion of the growth has been attributed to inventory building, especially within the auto sector as some experts estimate 30% of the gain came from auto production. This reading suggests that, for the time being, the manufacturing sector has entered a growth phase.

Jobless claims continue to be weak, and last months’ downtick in the unemployment rate appears to be a statistical fluke as the rate jumped to 9.7%. It certainly seems likely that the rate will exceed 10% by the end of the year. According to Barron’s, roughly 14.9 million people are now out of work, however, the U6 data (which most consider to be a more accurate indicator of those seeking employment) shows over 25 million people seeking full time work. The recoveries exiting the past two recessions were coined “jobless recoveries”, and this one seems to be following the same path.

The chart below, courtesy of Barry Ritholtz, shows the number of unemployed exceeding 27 weeks-the limit for the first filing of unemployment claims. While this number tends to peak near the end of recessions, the magnitude of joblessness in this recession is breathtaking.

Rail traffic continues to be soft, indicating continued soft economic activity. The first chart below, courtesy Railfax, shows that lumber and wood product shipments, typically a leading indicator of construction activity, continue to be weak. The second chart, also courtesy Railfax, shows that total traffic continues to be 20% below that of one year ago.

Goodbye Capitalism
According to the New York Times, the Democratic Party of Japan, soon to govern the country after an electoral landslide, is preparing to roll back what it called American-style capitalism "void of morals or moderation." Party leader Yukio Hatoyama, who is expected to become prime minister, lashed out at U.S. economic policies in a commentary published in a Japanese magazine. "The recent economic crisis resulted from a way of thinking based on the idea that American-style free-market economics represents a universal and ideal economic order," he wrote.

Long time readers know that I loath Congress. It’s not the concept of Congress I find repugnant, but the dysfunctional, borderline criminal organization into which it has evolved over the past 230 years. Apparently I am not alone as a recent Pew poll showed that Congress’s approval rating has fallen to its lowest level in 24 years.

Considering that most educated people I know feel Congress is filled with self-dealing, verbally flatulent morons, I’m shocked that their rating could go any lower.

Aren’t we a bit over due for another Revolution?

Retail Sales/Back to School
Family Dollar announced comps up 1%, citing food stamps as the primary driver of their positive comps. Overall, retail comps were better for August, however, they are still running negative. According to, 14 companies beat comparable store estimates while 12 were below estimates. Twenty companies reported negative comparable same store sales and seven reported positive numbers—the most positive figures since April.

Market Watch reported that chain-store sales for the week ended Aug. 29 fell 0.7% from the year-earlier period, according to a survey released Tuesday by the International Council of Shopping Centers and Goldman Sachs. On a week-over-week basis, sales dropped 0.5%. "Although the back-to-school calendar shifts will, on balance, boost year-over-year sales in August a tad, there was little discernible improvement in the trend during the entire month otherwise," said Michael Niemira, ICSC's chief economist. ICSC forecast August comparable sales to decline 3.5% to 4%.

Commercial Real Estate

According to CB Richard Ellis, the US industrial vacancy rate jumped to 12.4% in 2Q from 11.5% in Q1 and 9.5% in 2008. The nationwide office vacancy rate rose to 16.5% from 15.5% in Q1 and 13.7% last year.

Chrysler Defaults, Again

The US Treasury is learning everyday about the risks of lending OUR TAX DOLLARS to corporations in trouble. The bankrupt remains of Chrysler received a default notice on a $3.34 billion loan from the US Treasury. The company reported a $10.2 billion loss last quarter, highlighted by an $11.8 billion loss on the sale of assets to Fiat. Ironically, the US Government (again, you and I) funded the sale of Chrysler’s operating assets to Fiat, so there is very little left to repay the loans.

There are winners in this deal. Chrysler has spent $55 million on legal fees since their April 30th bankruptcy filing. What is it they say about cockroaches, attorneys and nuclear holocaust?

Cash for Clunkers part Deux
I picked up another anecdotal nightmare story in the auto industry from one of my industry contacts, this one negatively impacting the dealers. Evidently the recent Cash for Clunkers program was so hastily enacted that the rules determining which cars actually qualified for clunker status weren’t clearly defined. My contact told me that they accepted 120 “clunkers” for trade in during the program, but have only been reimbursed for 10 of those. They recently received a request asking for additional paperwork on the remaining 110, with no guarantee that the $4500 credit they issued to new buyers would be reimbursed by the government program.

ISI’s auto survey plunged as the Cash-for-Clunkers program ended in the survey period. They expect sales to be about 10 million this month, which would mean a decline in retail sales of about 2.5% in September after rising 2.5% in August.

BP announced that they had made a “giant” discovery of oil in the US Gulf of Mexico which may contain more than 3 billion barrels. The find is expected to generate 600K barrels of oil per day. Full production won’t occur until 2020.

Merger Activity

Disney agreed to buy Marvel (think Snow White meets Spider Man) in a $4 billion transaction. While it appears the deal has some interesting synergies, it is more important to note that a pick up in M&A activity is viewed as bullish by the market. In the oil services sector, Baker Hughes agreed to buy BJ Services.

Market Valuation
We periodically have included the thoughts of Al Lockwood, midcap manager, budding market strategist, friend of the firm, and all around smart guy. This week Al wrote “It is noteworthy that from a bottom-up perspective, it's becoming increasing difficult to find cheap stocks on an individual company basis.”

Accounting Chicanery
Courtesy of the Big Picture: “It appears that NZ Farming (NZX) ran into a little trouble with the regulators when they accidentally included the suggestion of “fudging depreciation” in their account statement:”


The Hang Seng fell in August for four straight weeks, ending the month down 22% and nearly 30% from its recent highs. China’s market has been a leader during the past nine months, beginning its recovery before most developed countries. We have cited questions about the pace and legitimacy of recovery in China, and it appears that these questions are beginning to concern investors.

The Dollar
Just so there is no confusion, we are bearish on the dollar for the intermediate and long term (think 2-7+ years). The chart below from shows the recovery in the Euro versus the dollar over the past six months. The long term debasement of our currency is borderline criminal, and will eventually be bullish for dollar based commodities (think oil) and negative for US savers and investors.

Municipal Heat
CNN reports that the light at the end of the recession tunnel is distant and dim for the nation's cities, according to a survey by the National League of Cities. While optimistic federal officials hint at an economic turnaround, city finance officers say the picture remains bleak for city governments. This is chiefly because a top source of municipal income, property tax revenue, tends to lag behind changes in the market. Because cities typically phase in property tax assessments, the full weight of declining real estate values in the past two years will not be felt by cities until 2010, 2011 and 2012, city officials say.

The takeaway: Residents can expect cities to continue to cut municipal work forces, services and construction projects, while bumping up taxes and fees, experts say.

Bearish View
Recently David Rosenberg is sounding much more bearish than your author, quite an accomplishment. As he said in Barron’s this weekend “I’m not being purposely bearish. I view it as almost a public service.” He also said that “the scuttlebutt is that the cash-for-clunkers triggered an even greater rush of activity in August and that we will see 14.3 million (annualized) units of auto sales on the month, which would be the highest tally since April 2008 and a 27% MoM increase over July. But the folks at are noting that sales towards the end of the month were tapering off towards an 8 million rate.”

The summer of the “staycation” has ended, and while we face a shortened post holiday week, the race to year end is in our sights. October and December typically include a fair amount of window dressing-October because it’s the year end of many mutual funds and December because it’s the year end for everyone else. September and October represent the last full trading months of the year as both November and December are shortened due to the holidays.

Hoping not to sound like a three-handed economist, we expect the economic news to begin moderating somewhat during the 4th quarter, which may not be enough to sustain the market at these levels. On the more positive side, low rates, easy monetary policy, and moderate expectations create a positive investing backdrop.

Have a great week.


“On the commercial side, I think we are fairly early in the down cycle.”
-Matthew Anderson, Foresight Analytics

Ned W. Brines
O (562) 430-3232

No comments:

Post a Comment