WEEKLY UPDATE
November 23, 2009
While weakness in the dollar does its best to prop up U.S. stocks today, a protracted decline is likely the future for these stocks. While this decline will cause anxiety for many investors, we are in a good position for such a correction.
As I have mentioned before, we have been seeing signs for months that this rally has been losing steam, but in spite of several attempts to go lower, the stock market has fought off any pullback and worked its way higher. This time might be different, but before this next leg in the market can proceed the dollar will need to bottom out.
The question is how far will a correction take us? Nobody knows for sure. Some have called for a minor correction while others are looking for a drop beneath the March lows. Much of this depends on the economy.
Is the recovery stalling? I think so. The third-quarter GDP was up more than expected, but the figure was a bounce off a terrible drop in the second quarter, and while the stimulus programs were deemed necessary to lessen the blow of the credit crunch, they have not stopped the inevitable slide in real estate prices, credit availability, or job losses. The country seems to be following step-by-step the same trail that Japan traveled after their credit bubble collapsed in 1989. Our country will have to slowly gain strength on our own and grow out of this collapse. Businesses need to start hiring workers, banks need to loosen credit conditions to consumers and small businesses, and citizens will need to become more confident about the future. History tells us that this takes more than a handful of months to occur and that is why FED Chief Ben Bernanke is telling the country that the recovery will be "bumpy."
As stocks decline, government bonds rally. The chart below shows the yield of the 2-year U.S. Treasury Bond. As talk of green shoots was bandied about this past spring, bond yields peaked and bond prices bottomed out. Since June, yields have trended lower and prices have continued to climb (since bond prices and yields move in opposite directions). This trend has accelerated in recent weeks pushing yields down to levels we have not seen since the worst of the credit crisis last year. We are generally over-weighted in this asset class to take advantage of this move in prices and to earn a relatively high yield for our portfolios. Because this is currently an important part of our portfolio, we are closely monitoring bond yield trends.
Bottom line: Normally Thanksgiving week is a quiet one on Wall Street, but with several economic reports due out the markets will be jumpy. Depending on the varying needs and risk tolerances of each of our clients, we are positioned for these trends to develop further. If material changes in the strength of the economy or the markets develop, we will adjust our course accordingly.
Happy Thanksgiving!
Greg
November 14, 2009
Computers Rule on Friday the 13th: Ever since computers were invented, Hollywood has been producing movies about the "computerized monster" taking over our lives. I remember how fascinated I was by the 1968 science-fiction film "2001: A Space Odyssey." This film dealt with elements of human evolution, computer technology, and artificial intelligence. In the film our dependence on computers brings us into space, but it then turns on us when computer "HAL" takes over the lives of the humans it was designed to serve…It appears that Friday's market behavior was significantly influenced by computerized trading.
An interesting trading pattern emerged this Friday. The chart below illustrates what we discovered. This chart traces a minute-by-minute recap of trading on Friday for the DOW and compares it with the U.S. Dollar Index. The scale on the bottom of the chart is the time of day (EST).
Curiously at exactly 10:00 AM stocks reversed early weakness and started to climb, but sixty minutes later at the stroke of 11:00 the market went into sell mode. Then precisely at 12:00 buying came back into the market and it started climbing back again. It reversed direction at 2:00 and fell back down. One hour later (at the stroke of 3:00) buyers returned.
I believe that this eerie trading pattern is an indication of our late-stage position in this bear-market rally. Just as a receding tide reveals sea shells on a beach, receding trading volume and lack of breadth in stocks traded reveals the impact of computerized trading on the top of each hour.
While we cannot know exactly when this bear market rally will end, we do know that two important measures of a healthy bull market are strong market breadth and strong trading volume - both of these measures peaked on August 13 and have been declining ever since. This means that fewer and fewer individual stocks are causing the major indexes to go higher. For example in 2007, these measures topped and started to decline in April, three months ahead of the July 2007 peak.
Bottom line: The recent rally in the stock market continues to be fueled by a weaker dollar, but the dollar has been showing signs of laying down a floor. Knowing exactly when the dollar will bounce back (and when stocks will decline accordingly) is virtually impossible. Still, the stock market has lost steam over the past few weeks and is trading in a pattern that is typical for the end of a bear market rally.
Consumer Sentiment Falls, Treasury Prices Rally: U.S. consumer sentiment fell in early November to the weakest level in three months amid grim expectations for job and income prospects, a Reuters/University of Michigan survey reported on Friday. The survey said its preliminary index of sentiment for November fell to a reading of 66.0. Economists' expected a reading of 71.0 and were surprised by the lower results.
Treasury prices ended the week stronger on the news that consumers are still concerned about their future. Given that 65% of our economy is based on consumer spending, these results appear to be yet another sign that the economy is vulnerable to a setback.
Take care,
Greg
November 12, 2009
In my last update posted this weekend, I noted that stocks remained below trend-line support and prices were likely to go lower. My view that we are overdue for a correction in stock prices has not changed, but Sunday evening's announcement from the Group of 20 (G-20) meeting did cause a short rally in the stock prices Monday morning.
Economic fundamentals and recent announcements from retailers (particularly Macy's & Wal-Mart) point to more weakness ahead for U.S. consumers. As mortgage rates eased last week, refinancing activity picked up, but home sales are falling lower. Our view that we are due for a double-dip recession still holds.
After Monday's rally, stocks have been essentially flat. One of my research services noted that 70% of the Dow 30 stocks are still below their recovery high (set on October 21), and many other internal indicators are weaker as well. The stock market looks toppy and will need some surprising, positive news to push it higher.
Treasury bond prices have held up very well this week. On Monday, Treasuries rallied strongly and held that strength as they proceeded through auction week. This matters a lot to us because we are still advising over-weighting in treasury and government-backed bond funds and under-weighting in U.S. stocks.
Take care,
Greg
November 8, 2009
Stocks rebound: In what could otherwise have been a terrible week for stocks, the markets proved somewhat resilient to several disappointing economic reports. A week earlier, U.S. stocks fell below their March/July trend-line to signal that this rally might be finally coming to an end. This week the markets were able to buck that trend by coming up to test the lower trend-line that they violated the week earlier, but this counter-trend bounce was very weak. The internal measures of upside momentum weakened all last week, and while the stock market closed up for five straight days the volume on the NYSE contracted on each of those five days. This suggests that this bounce is losing steam. The bottom line is that in spite of last week's gain, the U.S. market's trend remains down.
FED comments boost Treasury prices: The FED concluded their two day FOMC meeting this past Wednesday. Following that meeting the FED released a statement saying they see no reason to raise interest rates anytime soon. The FED sees no sign of inflation on the U.S. Consumer's horizon and sees so much excess capacity in our nation's employers that they see no reason to pull back on the stimulus afforded to our economy. Treasuries prices remained strong for the rest of the week and extended an upward trend that has gone on since May.
Unemployment is getting worse. After a year of unprecedented fiscal and monetary stimulus, Friday's payroll data (unemployment above 10%) confirms the depth of the "credit hangover" our economy is still suffering from.
On Wednesday we learned that first-time unemployment claims exceeded 500,000. This is the 51st straight week that we have had more than 500,000 people make first-time claims for unemployment benefits. This is a terrible statistic! On Friday we learned from the Commerce Department that the unemployment rate grew from 9.8% in September to 10.2% in October. Nearly 7 million people have lost their jobs since the recession began, making this one of the worst economic climates since the Great Depression. Friday's report was especially disheartening because it showed that broad-based job losses continue to mount in the auto, construction and service sectors of our economy.
Housing continues to suffer: Many analysts don't see a rebound in housing for another year. We here in Modesto have seen a rebound in the lower-priced sector of our market, but we still remain somewhat stagnant in average-to-higher-priced homes. Nationally, the trend remains downward.
Fannie Mae asked for a fourth handout from the taxpayers this week when it reported a $19 billion loss for the months of July through September. Fannie Mae is asking for an additional $15 billion bailout now and is warning that they will likely need more money later on if the economy doesn't bounce back soon. In an effort to soften the blow of foreclosed homes to the market, Fannie Mae has begun to offer one-year leases to folks to whom they have foreclosed their home; this will make Fannie Mae (i.e. the U.S. government) the largest residential landlord in the country.
FHA is still offering No-Money-Down Home Loans: The FHA continues to aggressively promote its 3.5% down payment loan program to first-time home buyers and is going so far as to urge them to use their first-time home buyers credit to make the down payment. Many critics of the program remind FHA that these types of no-money-down loans created the housing bubble that started this whole mess.
Commercial real estate is hurting. Investor Wilbur Ross of WL Ross & Company says that we're on the brink of a huge commercial real estate crash: "All the components of real estate value are going in the wrong direction simultaneously," he told Bloomberg this week. Ross is one of nine money managers participating in a government program to remove toxic assets from bank balance sheets. He advocates using "extreme caution" before putting money into commercial real estate. Meanwhile Treasury Secretary Timothy Geithner says that the sagging commercial real estate sector will not lead to another banking crisis. "That's a problem the economy can manage through even though it's going to be still exceptionally difficult," Geithner said according to Bloomberg.
About $500 billion in commercial real estate loans are expected to come due annually over the next few years, making it one of the largest sectors of the real estate bubble yet to fully pop.
Meanwhile, more talk on bubbles: Market guru Gary Shilling believes that the stock market's recent jump from the March lows represents a bubble created by loose lending to the nation's top banks. Shilling believes that the economy is poised for a double-dip in the fourth quarter; because consumers are still very cautious and credit continues to contract on both a consumer and business level, Shilling believes that the market is poised to drop 35% from current levels. (I agree)
Conclusion: This past January I said that I expect to see a sustainable recovery in the stock market emerge some six months before the economy starts to get back on track. Unfortunately I also said that the government's stimulus measures would likely create a W shape recovery as well as a bear-market rally in stocks. While it may be too soon to call for a dip in the economy in the fourth quarter, it is clear that stimulus programs created a bubble in stocks and a unsustainable bounce in automobile and home sales. All three of these sectors are now showing signs of slowing down. This week's unemployment rate (10.2%), the first-time unemployment claims figures (+500,000), and the FED's decision to keep interest rates indefinitely low all lead me to remain cautious about risky investments. For the second straight week stocks remain below their bear-market-rally trend-line signaling a growing possibility of lower prices. I caution others to remain under-allocated in equities and over-allocated in bonds.
In my next report I will talk about how for the first time the U.S. Economy will not lead the world out of this Great Recession, rather we will be depending on other countries like China, India and Brazil to take the economic lead and how deflation (not inflation) is the FED's primary concern.
Take Care,
Greg
November 1, 2009
U.S. Markets Fall Broadly: The markets fell broadly on Friday continuing a trend that has been building for weeks. The drop in Friday's stock market has been widely attributed to a comeback in the dollar, but many other factors contributed to the selloff:
- A closer look at Thursday's GDP report revealed that the primary source of third-quarter growth came mainly from the federal government (while the private sector shrank).
- Consumer sentiment continued to decline in September.
- Consumer spending fell 0.5% in September.
- The unemployment rate reached 9.8%.
- Personal income fell in September.
- Stimulus programs are winding down.
- Credit remains tight.
- On a historic basis, stock prices are over-valued.
The combination of several factors strongly suggests that the trend for stocks remains decidedly down. Selling volume, downside momentum and the failure of the major indexes to hold above trend-line support are just three key factors suggesting weaker prices are likely ahead. After such a crushing loss on Friday, the stock market might rise briefly next week, but the trend is still toward lower prices.
Next Week: The FED meets next week for a decision on interest rates and a statement due out late Wednesday morning. Based on recent volatility, the markets could take any action by the FED out of context.
Treasuries Rally: As the stock market declined, treasury prices rallied higher. I have been recently concerned that a weaker dollar could result in weaker treasury prices, but that has not been the case. Stocks have been drifting higher whenever the dollar falls, but as soon as the over-sold dollar rallied, stocks fell. Our concern was that treasury bonds would fall for the same reason, but treasuries instead were a safe-haven as stock investors took a loss.
Defense Counts: In spite of terrible economic conditions, the stock market strongly rallied off their lows six months ago in very much the same way they did in other severe bear markets (for example, 1930). There are many psychological reasons for this, but when stimulus was added to the mix, the conditions were ripe for a bear-market rally. On a risk-adjusted basis, fully-allocated stock positions hardly make sense. Recent market behavior suggests that risk-averse investors should beware. I continually review our clients' positions with these factors in mind.
Take care,
Greg
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