November 2, 2009
"Years of practice enable the trader to act on the instant when the unexpected happens as well as when the expected comes to pass." - Jesse Livermore
Weekly percentage performance for the major indices
Based on last Friday’s official settlement...
The market fell again this week, much more convincingly than the prior week as volume surged. The press typically looks for singular reasons to explain daily stock action, and the list of contributors to this week’s downturn is long, formidable, and somewhat contradictory: valuation, economic data, the dollar, inflation, health care, ineffective government policy, weak lending, a flailing consumer, a long held view that stocks have come too far too fast, inflation, deflation, above consensus GDP, loose monetary policy, spiking crude, rising savings rates, unemployment, the end of mutual fund fiscal years, and weak capital spending. Our concern arose when the Dow Transports made double top and rolled over (see chart below, courtesy marketwatch.com). Dow Theory asserts that the transports and the industrials must confirm each other when making new highs; that when manufacturers’ are producing more they must also be shipping more. The Transports have acted as a canary in the coal mine for many market corrections.
John Roque, strategist at WJB Capital, notes that only 38% of stocks now reside above their 50 DMA versus 88% three weeks ago. Why is this significant? It confirms what we inherently know-the market has been losing steam. In Dow Theory parlance, the market is in phase 3-the distribution phase.
Last week we lamented investor complacency surrounding the market and the lack of skepticism after a 60% run. We noted that the VIX had dropped from highs over 80 a year ago to the low 20’s. Right on cue the VIX spiked to over 30 this week, including a 24% gain on Friday alone. And what of the lack of volatility we discussed? Over the past seven trading days the Dow has experienced six triple digit moves. It looks like this idyllic ride is about to experience a bumpy road. Hang on tight!
Actual Consensus Prior
CaseShiller Home Price Index -11.3% -11.9% -13.3%
Consumer Confidence 47.7 53.5 53.4
Durable Goods Orders 1.0% 1.0% -2.6%
Durable orders ex-transports 0.9% 0.7% -0.4%
Chain Deflator 0.8% 1.4% 0.0%
GDP-advanced 3.5% 3.2% -0.7%
Initial Claims 530K 525K 531K
Continuing Claims 5797K 5905K 5945K
The big news on the economic calendar was the advanced GDP report for Q3, which came in ahead of consensus at 3.5%. This positive GDP report has been hailed as the end of the Great Recession. We’ll reserve our judgment on that conclusion for another note, but will comment that the report was anything but clean. The Nominal GDP measure was actually below forecast as it rose 4.3% versus consensus of 4.6%. The difference was a 0.8% gain in the deflator versus an expected 1.4%, which gave the real GDP measure a 0.6% boost.
As they (whoever “they” are) say, the devil is in the details. Government stimulus was significant in pushing the GDP measure into positive territory. I have seen estimates that the Cash for Clunkers package added 1.0% to GDP (personal consumption added 2.4% overall). On the back of the home buyer’s tax credit, residential construction added 0.5% to GDP, which is the first positive contribution to GDP from that segment since late 2005.
In a slap in the face to the weak dollar proponents running our government, it is interesting to note that imports grew faster than exports (see net export chart below). State and local spending declined due to their current budget crises and inability to deficit spend (at least legally) while Federal Government spending, not hampered by balanced budget constraints or other such common sense requirements, grew by 8%.
David Rosenberg observed “The OECD estimates that the amount of stimulus injected into the U.S. economy is equivalent now to 5.6% of GDP. So if we were not seeing at least a statistical recovery in the economy, well that would mean real trouble.”
Housing prices rose once again versus the prior month, but declined on a year over year basis by 11%. Consumer confidence missed consensus and fell significantly from the prior month as the unemployment picture continues to weigh on the consumer psyche.
A Note from Ron Paul
“Anytime the central bank intervenes to pump trillions of dollars into the financial system, a bubble is created that must eventually deflate. We have seen the results of Alan Greenspan's excessively low interest rates: the housing bubble, the explosion of subprime loans and the subsequent collapse of the bubble, which took down numerous financial institutions. Rather than allow the market to correct itself and clear away the worst excesses of the boom period, the Federal Reserve and the U.S. Treasury colluded to put taxpayers on the hook for trillions of dollars. Those banks and financial institutions that took on the largest risks and performed worst were rewarded with billions in taxpayer dollars, allowing them to survive and compete with their better-managed peers. This is nothing less than the creation of another bubble. By attempting to cushion the economy from the worst shocks of the housing bubble's collapse, the Federal Reserve has ensured that the ultimate correction of its flawed economic policies will be more severe than it otherwise would have been.”
Sorry Mr. Taxpayer
CIT Group filed for bankruptcy to cut $10 billion in debt after the credit crunch dried up its funding and a U.S. bailout and debt exchange offer failed. CIT listed $64.9 billion in debt in its Chapter 11 filing. The U.S. Treasury Department said the government probably won’t recover much, if any, of the $2.3 billion in taxpayer money that went to CIT December 21, 2008.
CIT said it plans to exit quickly due to support from bondholders, who voted in favor of a prepackaged plan. CIT has $1 billion from investor Carl Icahn to fund operations while it reorganizes. The company had asked bondholders to exchange $30 billion in debt for new securities and equity. Debt holders rejected the exchange offer.
CIT’s largest unsecured claim holders were Bank of America at $7.5 billion and Bank of New York Mellon with a claim of $3.2 billion. Citigroup also has a $2.1 billion claim.
Cash for Clunkers
Edmonds.com is estimating that the Cash for Clunkers program cost taxpayers $24,000 per vehicle sold. They estimate that 82% of sales would have happened anyway and thus the handout of up to $4,500 really only enticed 18% of the buyers of 690k vehicles sold under the program.
And this is the crown jewel of the Administration’s stimulus plans? I’d hate to see the ones that didn’t work.
2009 vs. 1982
From David Rosenberg: “this is not the onset of a sustainable secular bull market as we had coming off the fundamental lows of prior bear phases, such as August 1982, when:
• Dividend yields were 6%, not sub-2%.
• Price-to-earnings multiples were 8x, not 26x.
• The market traded at book value, not over two times book.
• Inflation and bond yields were in double digits and headed down in the future, not near-zero and only headed higher.
• The stock market competed with 18% cash rates, not zero, and as such had a much higher hurdle to clear.
• Sentiment was universally bearish; hardly the case today.
• Global trade flows were in the process of accelerating as barriers were taken down; today, we are seeing trade flows recede as frictions, disputes and tariffs become the order of the day.
• A Reagan-led movement was afoot to reduce the role of government with attendant productivity gains in the future; as opposed to the infiltration by the public sector into the capital markets, union sector, economy and of course, the realm of CEO compensation.
Commercial Real Estate
Billionaire investor Wilbur Ross-“All of the components of real estate value are going in the wrong direction simultaneously. Occupancy rates are going down. Rent rates are going down and the capitalization rates (the return that investors are demanding to buy a property) are going up.”
U.S. office vacancies hit a five-year high of almost 17 percent in the third quarter, while shopping center vacancies climbed to their highest since 1992, according to the property research firm Reis Inc.
U.S. negotiators obtained promises from China to eliminate obstacles blocking the sale of wind-power equipment and pork to China. Responding to a U.S. demand for greater intellectual-property protection, China said it will launch a four-month campaign to stop theft of copyrighted material through the Internet. The U.S. agreed to stop accepting trade-protection cases against China. Both countries pledged to refrain from "abusing" trade-dispute procedures, including submitting complaints to the World Trade Organization.
Last week I was critical of the seasonal adjustment for New Home sales. The King Report noted that without the seasonal adjustment, new home sales for September were 31K versus foreclosures of approximately 40K in California alone for the same month. The decline from August was 16% versus a typical 10% decline.
Good Money after Bad
The U.S. government doesn't have an alternative to going along with a third multibillion-dollar rescue for troubled auto lender GMAC, experts said. "We are in too deep for us to sensibly back out now. We will probably lose less money by putting in more now," said Douglas Elliott, a fellow at the Brookings Institution and a former investment banker. Bailout talks with the Obama administration continue, but the third rescue may have essentially begun, according to the New York Times, which notes that GMAC sold $2.9 billion of bonds backed by the FDIC.
The Feds obviously haven’t learned one of the basic tenets of investing “don’t throw good money after bad.”
We remain net neutral, with a long bias towards higher quality names and a short bias towards lower quality and higher beta names. Oil has backed down from its recent high of over $80 to $77, and we will look for a spot to enter a long position in the commodity at a lower price, certainly below $70, on anticipated continued weakness in the dollar.
I am traveling to the 39th Annual AEA Classic in San Diego this week as a guest of B. Riley and Company. In my view this has always been the best small cap tech conference of the year. Attendance appears to be down once again this year as Wall Street continues to cut back. I have found that the future success of groups of stocks are inversely proportional to the attendance at their conferences, and I hope to find some interesting pieces of information which I can share with you next week.
Have a great week.
Because this rally has been a "race to rubbish," the quality names have largely been ignored and still represent decent value.–Al Lockwood, value manager, reader and friend.