Dec 13, 2009

Is the Recovery Priced In?

Is the Recovery Priced In?

December 14, 2009

“We have not yet achieved self-reinforcing recovery. We are heavily dependent upon government support so far. We are on a government support system, both in the financial markets and in the economy.”—Paul Volcker

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

INDU: 0.80%
SPX: 0.04%
COMPQ: -0.18%
RUT: -2.42%

After racing up from under 700 to 1100 on weak economic news over the past nine months, the market now seems to be stalling as the economic news is actually coming in better than expected. What gives? More than likely this incipient economic recovery has already been priced into stocks, and then some. David Rosenberg contends that GDP growth of 4% for 2010 is priced into stocks, while the consensus for next year is starting to hover around 2.5%.

The chart below, courtesy of, shows the Russell 2000 (small cap indices) since 2002. After spending 4 ½ years inside narrowly defined trading channels (one up, one down), the indices collapsed, and recently recovered into its old downward trending trading range. The question is whether the index will be able to break through the resistance (dotted red line)? If so, it could be smooth sailing into the mid-700’s.

Many are labeling this period a “goldilocks” scenario for equities. Why? You have a slow recovery with no job growth (note we still have job losses), which means the Fed is more than likely planning on keeping an accommodative stance on rates. Additionally, the Fed has been creating record liquidity, which the economy isn’t absorbing and thus has found its way into the market. Classic supply/demand induced inflation (we’ll ignore collapsing currency induced inflation for today) isn’t on the horizon, so the Fed feels comfortable holding this stance.


Actual Consensus Prior
Consumer Credit -$3.5 bil -$9.3 bil -$8.8 bil
Wholesale Inventories 0.3% -0.5% -0.8%
Initial Claims 474K 455K 457K
Continuing Claims 5157K 5450K 5460K
Trade Balance -$32.9 bil -$36.8 bil -$35.7 bil
Treasury Budget -$120.3 bil $-131.6 bil -$176.4 bil
Retail Sales 1.3% 0.6% 1.1%
Retail Sales ex-auto 1.2% 0.4% 0.0%
Michigan Sentiment 73.4 68.8 67.4
Business Inventories 0.2% -0.2% -0.5%

The University of Michigan Consumer Sentiment index exceeded expectations and is rapidly approaching its pre-recession levels.

Although the market didn’t seem to respond, retail sales came in better than expected for November. Retail sales increased 1.3% for the month, which may bode well for retail stocks as we enter the holiday period. Weather, easy comps, and heavy discounting helped produce the positive result. Margins and profitability are a concern given the heavy discounting. The chart below, courtesy of Econompic, shows the growth in various sectors.

U.S. companies are set to begin hiring again next quarter, according to a survey by Manpower. "Companies are seeing some demand so they don't want to let anyone else go," said Jeffrey Joerres, CEO of Manpower. "They anticipate a slow but positive 2010."

Inventories are likely to decline over the near term to bring inventory-to-sales ratios back into line with company goals. Inventories typically rise once sales pick up. This relationship can be seen in the chart below.

More Bank Accounting Gimmickry

Robert Herz, chairman of the Financial Accounting Standards Board, is set to call on U.S. bank regulators to consider allowing financial institutions to break free from the Generally Accepted Accounting Principles (GAAP). "Handcuffing regulators to GAAP or distorting GAAP to always fit the needs of regulators is inconsistent with the different purposes of financial reporting and prudential regulation," Herz said in prepared text. "Regulators should have the authority and appropriate flexibility they need to effectively regulate the banking system."

Once again, let’s take insolvent banks and make them look solvent. Will this chicanery ever stop?

Hard to Believe, But More Bank Problems are Looming
U.S. banks will have to put structured-investment vehicles and other complex creations back on their balance sheets, in accordance with updated accounting rules. However, they urged regulators to phase in the rules. Sheila Bair, chairwoman of the FDIC, has sympathized with the banks' situation, with the agency indicating that it might consider their request.

Again, if you marked their loans to (or near) market value, brought all of these illiquid and in many cases worthless securities back onto the balance sheets, very few banks would be solvent today.

We are playing a very dangerous game of chicken.

Last Week’s Employment Report

I’m not sure I’ve ever had as many emails on a single topic as I received last week regarding the better than expected employment numbers. Based on the 80 or so emails I received, I’d conservatively guess that most of you aren’t believers. Here is an analysis, from Trim Tabs, that questions the government numbers:

“TrimTabs employment analysis, which uses real-time daily income tax deposits from all U.S. taxpayers to compute employment growth, estimated that the U.S. economy shed 255,000 jobs in November. This past month’s results were an improvement of only 10.2% from the 284,000 jobs lost in October.

Meanwhile, the Bureau of Labor Statistics (BLS) reported that the U.S. economy lost an astonishingly better than expected 11,000 jobs in November. In addition, the BLS revised their September and October results down a whopping 203,000 jobs, resulting in a 45% improvement over their preliminary results.

TrimTabs employment analysis, which uses real-time daily income tax deposits from all U.S. taxpayers to compute employment growth, estimated that the U.S. economy shed 255,000 jobs in November. This past month’s results were an improvement of only 10.2% from the 284,000 jobs lost in October.

We believe the BLS is grossly underestimating current job losses due to their flawed survey methodology. Those flaws include rigid seasonal adjustments, a mysterious birth/death adjustment, and the fact that only 40% to 60% of the BLS survey is complete by the time of the first release and subject to revision.”

Happier now?

As you know I’ve been bearish on the dollar, which recently closed above its 50-day moving average for three consecutive days for the first time since March, when it was still the globe’s safe-haven currency. Such technical indicators can be misleading, but this suggests there could be some short term upside to the greenback. Oil and gold both corrected this week on the rebound in the dollar. I took half my gold position off the table, and will look for another spot to add back to it. As I mentioned a few weeks ago, I have been looking for a correction in oil, and will be looking to initiate energy positions as oil comes in.

Climate Control on the Fritz

The climate talks in Copenhagen coming up this week will create more greenhouse gases than many African countries will produce over the same number of days. Between the limos, private jets, and hot air coming from the 192 delegates, the carbon footprint of this conference is enormous.

On another note, negotiators from smaller, less developed countries (which for some reason include China and India) are posturing before the meetings by telling the US and Europe to pound sand on climate control unless they are going to provide money to these countries. “No money, no deal” said Selwin Hart, an envoy from Barbados. The UN estimates these countries will need at least $145 billion per year! Who would pay for that $145 billion? Break out your checkbook, comrade.

I wonder if they’ll accept dollars?

One question, of course, is whether we are chasing windmills (get it?) trying to solve the green house gas problem? In a recent Wall Street Journal poll nearly 91% of respondents said they don’t believe that humans are responsible for climate change. At that rate, it’s going to be difficult to get the populace to sign off on another expensive piece of legislation.

Manufacturing Green Shoots

Sorry, I know the term “green shoots” is quite nauseating, and no longer part of popular vernacular, however, I couldn’t think of a better title for this section. According to the Associated Press, “U.S. counties with an economy dominated by manufacturing have been outperforming the national average for a variety of indicators of economic stress since March, according to The Associated Press Economic Stress Index. The index calculates stress based on a county's unemployment, bankruptcy and foreclosure rates. Recently, manufacturing counties have been enjoying some of the biggest employment gains of the recovery.”


Democrats Demonstrate they are as Dumb as Republicans
Much like Senator Phil Gramm, who insisted the recession was just in people’s minds, the Democrats are now complaining that Republican negative sentiment is holding down the economy.

Wow! When I say my daily prayers I must remember to be thankful for the morons running our country. It’s much too easy to dismiss this kind of brilliance.

Sentiment-All’s Well
Albert Edwards of Société Générale

“The current extremely low number of equity bears (the lowest since the market top of 2007, see chart below), the likelihood is that the next leg of the long-term structural valuation bear market is closer than people might realize.”

Dubai, Greece and Spain: Part of a Growing Club?

On the heels of the Dubai news a few weeks ago (their stock market is down 17% since then), S&P this week placed the Greece sovereign rating on CreditWatch negative. S&P also cut its outlook on Spain’s debt to negative, but didn’t lower their AA+ rating. "Those countries that had these high growth rates are now in trouble because much of that growth was financed by debt," said Paul De Grauwe, a professor of economics at Belgium's University of Leuven

Where’s the next looming problem? Keep an eye on the UK.

Trade War Continues Brewing
The FT reported that China, claiming that its investigation revealed subsidies that violated international trade rules, put duties on several specialty steel products that it imports from the U.S. and Russia. The Commerce Ministry accused both countries of illegal dumping.

Contract Law Survives!

Bloomberg reported that Republican lawmakers defeated a mortgage “cram-down” amendment that would have given federal judges the power to lengthen mortgage terms, cut interest rates and reduce loan balances for homeowners in bankruptcy court.

Had this passed, contract law as we know it would become moot.

I’ll Have What He’s Having
Roger Lowenstein, the author of ‘When Genius Failed’, called Congress “the drunk at the Fed’s punch bowl.” The easy money policy of Fed Chairman William Martin Jr. during the late 60’s (under pressure from Lyndon Johnson, who had a war and a huge domestic healthcare agenda to pay for, sound familiar?) led to runaway inflation in the 70’s. I would argue that the Greenspan/Bernanke era has featured cheaper money for a much longer time period than that of Martin, and will personally be surprised if we don’t experience something similar, or worse, than the 1970’s.

Fooled Me Once, Shame on Me…..

“The proportion of US borrowers who have slipped behind on mortgage payments will fall in 2010 for the first time since the financial turmoil began in a sign that the nation’s housing crisis is abating,” TransUnion forecast on Tuesday. After studying 27 million consumer records, TransUnion predicts that the rate of mortgage delinquencies will peak in early 2010 before falling towards the end of the year.

Interestingly, it seems that TransUnion made pretty much the same forecast last year, and it was wrong.

Last Year’s Forecast: “The national 60-day mortgage delinquency rate among mortgage borrowers is expected to continue to rise throughout 2008 from a value of 3.53% in the second quarter of 2008 to just over 4% by year end. This is primarily due to the continued economic weakness in certain segments of the country combined with the continuing fallout of the mortgage crisis. Later in 2009 the rise in mortgage delinquency rates will taper off as economic conditions improve and home prices begin to stabilize.”

Put this down as another job I could do in about 20 minutes a week.

Jobs and Elections

Why is the Administration, and more importantly the Dems who are facing reelection, in such a rush to stimulate the economy? Because they know that election results are based upon how people feel about employment and their pocketbook. Weak employment leads to a revolt against the incumbent party.

Recent victims of this reality include Jimmy Carter in 1980, George H. Bush in 1992, the Democratic Congress in 1994, Al Gore in 2000, and the Republicans in 2008.

“Japan’s economy expanded less than a third of the pace initially reported in the three months to September as companies slashed spending. Gross domestic product rose an annualized 1.3%, slower than the 4.8% reported last month,” the Cabinet Office said today in Tokyo. “The revision, which was deeper than the predictions of all but one of the 17 economists surveyed by Bloomberg News, also showed that price declines accelerated.”

They missed that one by a mile.

TBTF Alive and Well
I have harped on TBTF for over a year, contending that the big banks should instead be viewed as Too Big to Survive. One of the results of the bailouts and forced mergers can be seen below as the risk concentration (as measured by deposits) has increased dramatically over the past 10 years, with a significant increase in deposit concentration since the bailouts. Somehow having 35% of total US deposits in the hands of four poorly run, technically insolvent banks doesn’t make me feel confident.

This is the last full week of trading for 2009. Typically the week leading up to Christmas provides positive returns, however, seasonal trades have been backwards this year, so watch out. Institutional investors are typically quiet in the last few weeks of the year, so expect to see volumes continue to decline. The biggest domestic events for the remainder of the year will continue to come from Washington as the Fed meets, Congress tries to hammer out healthcare legislation, and the Administration tries to slip through major tax and spending plans. Outside of the US watch the sovereign debt markets as continued issues could put a damper on this fledgling recovery.

Please not that I will not be publishing next Sunday evening. I may try and get out a very short note Sunday morning if anything relevant occurs during the week. I am heading out of town with my wife for a few days of R&R before Christmas.

Have a great week and Merry Christmas.


“I’d be a bum on the street with a tin cup if the markets were always efficient.”—Warren Buffett

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