Apr 11, 2010



April 12, 2010

“A good manager is a man who isn’t worried about his own career but rather the careers of those who work for him. Take care of those who work for you and you’ll float to greatness on their achievements.”—H.S.M. Burns, former CEO Shell Oil

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

INDU: 0.64%
SPX: 1.38%
COMPQ: 2.14%
RUT: 2.77%


Complacency is the perfect word to describe the world today. Voters are complacent; otherwise they never would have allowed politicians to create yet another unaffordable entitlement plan. Investors are complacent, with the VIX hitting its lowest level in 24 months. The politicians are complacent in spite of record deficits and all-time low approval ratings. Greece is still on the ropes, but concern over default is being replaced with a complacency that assumes the damage will be contained and well-defined. The Fed is complacent about inflation in spite of a world awash with massive liquidity. Why all the complacency? Because compared to a year ago, with the exception of jobs, things are looking pretty good. CEO surveys are turning positive, hiring plans are weak but improving, and for the time being we aren’t in the grips of economic pandemonium. The negatives still abound, but for now the attitude is “don’t speak about what’s wrong, and maybe it will go away.”

The chart below, courtesy of www.chartoftheday.com, shows how lost this decade has been for investors. Since peaking in 2000 above 5,000, the NASDAQ at its low had lost nearly 90% of its value. Now, still down by half, it’s obvious that we are in the grips of a secular bear market, in spite of the recent gains YTD and since bottoming a year ago March. The moderation of the red resistance line could be an indication the market is running out of steam and may meld once again into a range bound market.

April started out strong, albeit on weak volume due to the recent holidays. Seasonally, April is a strong month for market performance, second only to December (as measured by the S&P 500). A few weeks ago we discussed focusing on mid-cycle stocks, especially consumer stocks. Additionally, energy stocks have been lagging the commodities somewhat as oil has surged over $85, driven by both seasonal factors and increased demand from both China and India. Energy tends to be a leading sector into the summer driving season.


Actual Consensus Prior
ISM Services 55.4 54.0 53.0
Pending Home Sales 8.2% 0.0% -7.8%
Consumer Credit -$11.5bil -$0.7bil $10.6bil
Continuing Claims 4550K 4630K 4681k
Initial Claims 460K 435K 442K
Wholesale Inventories 0.6% 0.4% 0.1%

The ISM Services Index (chart below courtesy briefing.com) came in at a robust 55.4, above expectations of 54.0 and the prior reading of 53.0. This reading is the highest since October 2006. According to the ISM “14 of the 18 industries surveyed reported growth with two reporting a contraction and the comments are mostly positive about business conditions and the direction of the economy.”

March same store sales were up 9% versus horrific comps a year ago, the best comps in over 10 years. Big comps were posted by CATO (CATO, +24%), Kohl’s (KSS, up 22.5%), Aeropostale (ARO, up 19.0%), American Eagle (AEOS, up 15.0%), and Limited (LTD, up 15.0%). JC Penney (JCP) and Abercrombie (ANF) were two of a small handful which missed comps. Warm weather and an early Easter helped the March results.

Pending home sales rose 8.2%, the second largest gain since October 2001. The gain was led by the Midwest region and followed by the South and Northeast. The West saw a drop of 4.8%. Growth may be short lived as expiring tax credit and rising mortgage rates may put a cap on this tentative recovery.

Los Angeles
The city of Los Angeles is running out of cash, fast. The city, a poster child for major cities buried with pension and benefit woes, announced they would run out of cash by early this summer. Mayor Villaraigosa announced closing non-essential services for two days per week in response to the crisis, however, early reports suggest that he doesn’t have the power to follow through on those furloughs. My question is outside of police and fire, what exactly is an essential government service?

Stay tuned, this should get entertaining.

Credit Conditions

An increasing debt burden in the biggest developed economies is becoming a "systemic crisis," said Tim Backshall, chief strategist at Credit Derivatives Research. The company's Government Risk Index rose nearly 40% in the past month. The index is based on credit default swaps on France, Germany, Italy, Japan, Spain, the U.K. and the U.S.

More Hidden Costs in the Health Care Bill

William Blair’s health care team put together an analysis of the recently passed health care bill, and while everyone knows the numbers being bandied about by the Dems are completely made up, Blair’s estimates of the costs are shocking even to me.

First, they note that the Medicare physician fee schedule fix is estimated to cost $280 billion over 10 years and is NOT included in the bill. This cost is roughly twice the amount of the projected $138 billion deficit reduction in the new bill. Further, numerous other timing tricks were played to lower CBOs scoring of the bill. Once fully implemented, the 10-year cost of the bill is estimated at $2.6 trillion. Thus, a cost-containment bill will probably be top priority for whoever is in the White House in 2013.


Earnings Season
Earning reports begin in earnest this week. The numbers should look good compared to last year’s first quarter, but only moderately better on a two year basis. The one year estimated EPS growth for the S&P 500 is 37%.

Tax Week
Taxes are due this week, so I thought I’d provide a few tidbits sure to make your blood boil, or at least 53% of you. It seems that 53% of citizens over 18 pay all the taxes in this country, leaving a whopping 47% who pay zero taxes. This compares to less than 40% non-payers just five years ago. Obviously this is being exacerbated by the increase in unemployment, but that doesn’t account for the entire shift. At this rate of increase, by 2012 the majority of voters won't be tax payers. So much for no taxation without representation!

Other tax facts: The top 5% of wage earners pay 60% of all taxes. The top 10% pays 75% of all taxes. I’d say “the rich” are certainly paying their fair share.

Thanks Jeff.

Banks Just Doing What Banks, and Criminals, Do
According to a recent Wall Street Journal report, data from the Federal Reserve Bank of New York shows that during the past five quarters, big banks in the U.S. cut back their borrowing immediately before it was scheduled to be reported. The Fed found that 18 banks understated their debt used in securities trading by an average of 42%. By timing their borrowing this way, the banks effectively hid debt risk from the public.

Valuing the Market
From Bob Bronson regarding the effectiveness of PE ratios in predicting future stock performance:
“Using future four-quarter earnings, which proxies for perfect forecasts of EPS, did not improve the results. Even if the next four quarter EPS were to be as high as $80, which is extremely unlikely, the current P/E of that future EPS would be down to 14.7, but during the previous 280 previous times, or 17% of the time, that such future-EPS P/E ranged between 15.7 and 13.7, the subsequent median six- and 12-month price-only returns, have been 52% and 104% less, respectively, than the median returns of all those 1,660 monthly periods, which have been +3.0% and 6.2%, respectively. This includes big declines following the periods from mid-1987, late-1972 through early-1973, late-1938, late-1936 and early-1934.

We believe it cannot be reasonably argued that today’s stock market is fairly valued, much less undervalued, based on past or future corporate earnings, or the related P/E ratio, or their relationship to bond yields (interest rates). To the contrary, none of our Supercycle stock market valuation indicators have reached their mean reversion target areas (see the P/E volatility chart below). But even more important, they all show that the stock market is significantly overvalued again.”

Thanks Bob

Mortgage Rates
The Fed has curtailed their $1.25 trillion program targeting the MBS market, and rates on mortgage have begun to rise. A month ago the nationwide median 30 year fixed mortgage was yielding 5.0%. Friday that same mortgage carried a 5.2% rate.

Rising rates will put significant pressure on a struggling housing market.

Every 100 Years?
I know that comparing market performance from various time periods is a poor way to predict future performance, however, sometimes the correlations amaze me. The chart below, courtesy of thechartstore.com, overlays the most recent performance of the Dow (orange line) to that of the 1906-1912 Dow (green line).

If the next few years plays out similar to that older period, it would coincide with our prediction of a flattish market over that time period.

Earnings should grab most of the market headlines this week. Growth year over year should be robust, but make sure to watch the two and three year comparisons to get a better idea of where normalized earnings and revenues actually reside.

Have a great week.


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