3/14 Kelly Letter Topics
Weekly market review
Fed oversees banks
EU bails out Greece
China likes Treasurys
Consumers still down
CT suing Moody's, S&P
US AAA rating at risk
Strong retail sales
Topping oil prices
Index chart patterns
Households suffering
Market at 1150
What range top means
FMD shooting higher
Bluefin tuna ban
2010 EDITION
Much has changed; good investing has not
The Neatest Little Guide to Stock Market Investing, 2010 Edition
Today's reading is a collection of excerpts suggesting caution.
Doug Kass:
Despite the strong share price momentum and the aforementioned emerging optimistic economic/profit consensus, I continue to hold on to the variant view that the markets have likely peaked for the year based on the existence of nontraditional headwinds, an end to decades of aggressive credit expansion and financial inventiveness, a still-vulnerable housing recovery (in the form of outsized phantom inventory challenges) and a still-fragile consumer -- among other factors.
If you look at the sheer scale of global stimulus this year, what shocks is how little has been achieved. China's exports were down 23pc in August; Japan's were down 36pc; industrial production has dropped by 23pc in Japan, 18pc in Italy, 17pc in Germany, 13pc in France and Russia and 11pc in the US. Call this a "V-shaped" recovery if you want. Markets are pricing in economic growth that is not occurring.
Banks round the world have still to reveal about half of their likely losses resulting from the financial and economic crisis, the International Monetary Fund said on Wednesday, warning that there was still a "significant" risk of another downward lurch in the global recession.
The IMF described credit risks as remaining "elevated" even though financial conditions have improved significantly since spring.
It said these risks, alongside weakened banks, were likely to depress the availability of new credit and damp the global economic recovery unless significant additional capital was raised to improve the health and lending capability of banking systems.
The biggest risk of higher oil prices looks to be the latest storm brewing in the Middle East. Our contention has been that oil prices are destined to slip back to their pre-stock-bounce range once economic reality sets in and demand remains persistently low. To that end, we own a hedge against falling oil prices.
However, the likelihood of military action against Iran by either the US, Israel, or both is growing, and such action would cause oil prices to spike. Let's look at the situation and chance of an attack, and why it would put upward pressure on oil prices.
In April, the Obama administration granted Iran until Sept. 24 to open talks with the five members of the UN Security Council plus Germany, a group referred to as P-5+1. The consequence of not doing so was to be harsh sanctions. Since then, Obama extended a fig leaf to the Islamic world with his friendly speech in Cairo, the appointments of special envoys George Mitchell for Israel/Palestine and Richard Holbrooke for Afghanistan/Pakistan, and soft-edged diplomacy intended to reverse harsh feelings left over from the Bush years.
The result of the fig leaf has been impressive when judged by the content of warm speeches all around, but not so great when judged by the list of concrete steps to improve upon America's interests in the region. Terrorist activity has not declined, Mitchell was unable to change the situation between Israel and the Palestinians on the settlement issue, Holbrooke hasn't improved the Afghanistan War situation at all, and, most vital to our discussion, Iran hasn't budged in its nuclear ambitions or even attitude toward the US and the P-5+1. It's now past the Sept. 24 deadline, and the situation technically calls for sanctions to be applied. Will they be?
Apparently not right away, because the talks have been rescheduled to start this Thursday, October 1. Few are holding their breath for the talks to mean anything, anyway, so attention is already turning to what will happen when Iran changes nothing.
If the sanctions are applied, they need the cooperation of China and Russia in order to work. Either country could supply Iran with all the fuel it needs, and both countries have expressed their disapproval of the sanctions. So, the sanctions are looking like a joke.
That leaves an attack as the most probable way of thwarting Iran's nuclear plans. It would likely involve both the US and Israel, because either country's initial entry into a fight with Iran would draw the other in. Israel can't go it alone against Iran and the US won't let Israel come out of a conflict worse off.
Besides, the first thing Iran would do in case of being attacked is close the Strait of Hormuz, which would bring the US immediately into the fight. In July, Iran's oil minister issued the threat and received the US response, as reported by Fox:
The US Navy and its Gulf allies will not allow Iran to seal off the strategic Strait of Hormuz if the country is attacked, the commander of US naval forces in the Gulf said Wednesday.
The warning comes as Iran's oil minister vows that any attack on his country by the United States or Israel would provoke an unimaginably fierce response.
The announcement by Vice Adm. Kevin Cosgriff, commander of the 5th Fleet, came as he was holding talks with naval commanders of Gulf countries at a conference in the United Arab Emirates capital of Abu Dhabi. The one-day meeting was to focus on the region's maritime and trade-route security and the threat of terrorism.
The 5th Fleet is based in Bahrain, across the Gulf from Iran. Cosgriff said that if Iran choked off the Strait of Hormuz, it would be "saying to the world that 40% of oil is now held hostage by a single country."
"We will not allow Iran to close it," he told reporters.
Cosgriff's comments follow Iranian threats that it could seal off the key passageway in case of a Western attack on Tehran. But Cosgriff said that if Iran moved to choke off Hormuz, the "international community would find its voice rapidly" against Iran.
Here, we run up against the risk of an oil price spike. Whenever 40% of the world's oil supply is perceived to be held hostage, prices will spike.
That's where we may be heading. Yesterday, Iran test-fired missiles that it claims can hit any regional target. That came on the heels of the US and its allies expressing concern that not only has Iran not slowed down its nuclear ambitions, but has in fact grown them by building a second uranium enrichment facility.
There is always the option of doing nothing, but that would make the US look unbelievably weak to sit by idly while Iran makes nuclear weapons. It would also force Israel to go it alone, which would cause Iran to close the Strait of Hormuz, which would draw the US into the fight anyway. Doing nothing would be about the worst option because the US would look weak and still end up in another military action.
Thus, as Iran moves ahead, the options before the US are sanctions that won't work, a military strike that will result in the Strait of Hormuz closing for a brief period, or doing nothing until forced into joining an Israeli military strike that causes the closing of the Strait of Hormuz for a while.
As you can see, the odds are pretty good that we'll see the Strait of Hormuz close in the near future, which will send oil prices higher. That's why we're watching this issue carefully, and may need to sell our oil hedge soon.
Disclosure: Long PowerShares DB Crude Oil Double Short (DTO)
Today's article comes courtesy of frequent contributor Dave Van Knapp. His site, SensibleStocks.com, is chock full of clear-headed ways to pick stocks and explains the oft-unappreciated role of dividends. You may find it useful to compare his market ideas in today's article with those he shared here on September 1, in Why The Rally Has Been Sustained.
As the market was plunging from October 2007 until March 2009, I ran occasional articles, usually titled Are We There Yet? The question, of course, was whether the bear market was over -- was it safe to come out of the woods and invest cash in the stock market again? A couple of these articles correctly identified false starts late last year as failing to demonstrate the end of the bear market. Finally, the bear market ended on March 9, 2009, replaced by a direct reversal and a strong bull market.
Now that bull market has lasted for more than six months and raised the S&P 500 by more than 50%. Some people are getting nervous about it. Is it sustainable? Therefore, I am going to write occasional articles asking the old question in reverse: Has the market topped out? Is it time to take some profits off the table, or to go completely back into the woods where the bears hang out? This is the first of those articles.
Frequent readers know that I already have my exit strategy in place for my public Capital Appreciation Portfolio. There are three holdings there: SPY (the ETF that tracks the S&P 500); QQQQ (the ETF that tracks the NASDAQ); and IBM, the only individual company. The first two holdings -- SPY and QQQQ -- are protected by 8% trailing sell-stops. I update the stops each weekend, sometimes in the middle of the week if the market makes a significant one-day jump. I have a 10% trailing sell-stop under IBM.
That's my approach to controlling risk. Others may be protecting their profits with hedging strategies, or by using sell-stops placed at different values...5%, 10%, the 20-day simple moving average (SMA), the 50-day SMA, or "support" lines they have drawn on a chart. There are an infinite number of ways to select the level of a sell-stop.
However you are protecting your profits, these occasional Topped Out? articles will be asking a different question: Are we back in a bear market? I will let that term be vaguely defined for now. Let's just say that I am asking whether we have entered a period where the market is likely to decline by 20% or more. That matches the rule-of-thumb definition of a bear market.
Of course, by definition, no one knows the future. So these articles will necessarily consist of conjecture. But I will base my conjecture on facts and sound reasoning to the best of my ability.
I have stated many times that this has been a sentiment-driven bull market. While it has been more powerful than most, in many ways it is a garden-variety recession bull. Of the previous nine recessions before the current one, the stock market has bottomed out and started back up several months in advance of the end of the recession. That's what has happened here since March. Why does that happen? Stock investors look forward -- the stock market is a leading indicator of the economy. So it often starts back up while the economy is still mired in recession, indeed while many elements of the recession are still getting worse.
But the market does not do that based on simple hope. I have coined the term "net news flow" to explain what positive-minded stock buyers have been reacting to during this bull market. They have been reacting to the so-called "green shoots"...signs that the economy might be pulling out of the recession. Early on (say, last March), most any sign that could be interpreted positively was a data point that was simply "less bad" than before. The perceived meaning of this was that the downward cycle of various indicators was slowing down and bottoming out -- a necessary precondition to the indicators actually turning back upward.
Currently, most indicators have slowed their descent significantly, some have clearly reached a trough, and some have turned upwards. For example the Conference Board's Index of Leading Economic Indicators has risen for four straight months. I track a few important indicators in my bi-weekly Timing Outlook reports.
One specific topic to end with: In the last earnings season, a majority of companies reported earnings that were "positive surprises," meaning they exceeded the consensus expectations of stock analysts. All of these positive surprises contributed greatly to the positive net news flow that helped the market along. In most cases, the quarterly reports did not reflect growing revenue or earnings compared to a year ago. They simply reflected better-than-expected earnings, which in most cases were well down from a year before. Most of those positive surprises were based on companies' fast cost-cutting, which meant layoffs and hiring freezes. That's why we have the high unemployment rate that we do right now.
However, it did not go unnoticed that, while earnings surprised positively, revenue often did not. Not only that, many companies' projections for revenue going forward were not encouraging. So here's my thought: Last earnings season was a "free pass" on the revenue front in terms of how forgiving the stock market was in interpreting the news. The market forgave revenue misses and rewarded earnings hits.
We have a new earnings season coming up in a couple of weeks. If many companies do not show sequential revenue jumps (that is, quarter-over-quarter), and/or do not project positive revenue expectations going forward, then positive earnings surprises will not be enough to count as "good news" this time around. This will not help the net news flow, will not add to positive investor sentiment, and may herald a new bear market.
It's possible that stocks will not be worth their trouble for another many years. We could already be in a range that holds for so long that people simply move beyond stocks as a place they consider storing their money. The stock market could become a distant report for specialists only, much the way most people view esoteric investments like cattle futures. How much does the cattle report factor into the lives of most people you know?
It's already like that here in Japan. For the first five years of the lost decade of the 1990s, individual Japanese investors tried scooping up bargains on every minor bottom. The more nimble among them probably made a few yen in the bounces of 15% in autumn 1990, 40% from summer 1992 to summer 1993, 48% from summer 1995 to summer 1996, and so on. Each was heralded as the start of a new bull market, all proved false. The three bounces just mentioned were followed by respective drops of 45%, 21% then a spike followed by another 32%, and 43%. After eight years of fighting it out in the trenches, most stock investors saw their accounts worth less than half what they had been at the end of the initial drop.
Small wonder, then, that people gradually packed up and left. That was 11 years ago, and the Japanese stock market trades today at a level 20% lower than it did at the end of that example. When the news of plunging markets covered papers, magazines, and websites last year, few in Japan cared. Why would they? They hadn't had money in stocks for more than a decade and don't plan to ever put any in again. If anything, last year's headlines just confirmed that they'd made the right decision. "Gambling is fun," one engineer told me, "but it's not the right way to plan for the future."
Such a sentiment could take hold in America, too. The same factors that killed Japan's equity market are present. Banks blew up, government screwed citizens to bail out banks but didn't bail them out enough to actually get things moving again, the unresolved bank debt was moved from banks to the country's balance sheet and an increasing portion of tax revenue was siphoned off to service that debt, so a new normal took hold with a lower rate of growth and a much less enthusiastic population, most of whom never really understood what the hell happened. How did life go from golden bathtubs to goldfish for dinner because of some banker's mistake? It did, though, and it's happening in America, too.
During the savings and loan scandal of the late 1980s, a regulator named William K. Black exposed government connections to bank fraud when he accused then-house speaker Jim Wright and five US senators, including John Glenn and John McCain, of doing favors for the S&Ls in exchange for political contributions. Black wrote a book about the experience, aptly titled "The Best Way to Rob a Bank Is to Own One." Last April, he appeared on Bill Moyers Journal to discuss the subprime mortgage crisis. Among his many excellent observations, the following comment caught my attention:
In the savings and loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the savings and loan crisis -- didn't matter which party was in power -- the US Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the savings and loan crisis, because it worked really well. Instead you're covering up the bank losses because, you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." The Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets.
Yes, the bad assets are still there. The citizens of the United States unwillingly ponied up a national fortune via government's big bank connections such as former Goldmanoid Hank Paulson serving as Bush's Treasury Secretary. The Obama administration has employed many of the same people with banking industry connections, so the only thing that has changed is the name on the White House -- which matters little because it changes every four or eight years but the industry interests that control Washington never change. We have made a permanent growth impediment out of the ungodly sum of debt created by bank fraud. It is hanging over the United States the same way it has hung over Japan for two decades. The difference is, we're less than a year into our overhang.
This is treated as last year's story, but it's not. It's this year's story and, I'm afraid, next year's and the year's after that and so on possibly for a long enough time to remove stocks from the list of financial options in the mind of most individual investors. The problem is that few people ever grasped what had happened even when it was the hot news of the day. Now that it's already labelled history, fewer still will keep track of the long-term effects or why things just aren't quite as good as they used to be. As they say in Japan, "How long does a recession have to last before we stop calling it a recession and just call it the economy?"
Japan, too, had its periods of improvement over the last two decades. There were moments of good-times-are-here-again hope with this economic data growing more than expected, this company beating estimates, that bank getting squeaky clean, and so on. Overall, though, it's been a down trend across the board. The good news is that people adjusted. What else can you do when the new normal isn't just a slogan but is actually the new normal? If it's normal, you'd better get used to it, so that's what people did. People will do so in the US, too, but that doesn't necessarily mean good things for stocks.
You have every right to be angry. This is the biggest failure of American leadership we've seen in our lifetimes, though few see it that way yet. This is the culmination of a growing corporate ownership of America that began after World War II and spun out of control. About one-third of US tax revenues go toward a defense establishment strong enough to wipe out the Third Reich, but impotent against a bunch of box-cutter-carrying terrorists from our oil ally, Saudi Arabia. Our response? Launch an unrelated war in Iraq that's slated to cost $3 trillion before it winds down -- and it won't wind down until the new war in Afghanistan ramps up.
Even Robert Gates, Director of Central Intelligence under the first President Bush and Secretary of Defense under both the second President Bush and President Obama, pointed out the need for a more reasonable defense budget when he wrote last January, "As much as the US Navy has shrunk since the end of the Cold War, for example, in terms of tonnage, its battle fleet is still larger than the next 13 navies combined -- and 11 of those 13 navies are US allies or partners."
This is not a political discussion, it's an economic discussion. Notice how much of the opposition to health care reform has centered around the inability of the country to afford it. Why is there never such consideration for military expenditures? It's the same Treasury paying, and the same Treasury paying off banksters, too. There's an endless supply of money for meaningless wars and bank heists, but not enough for health care. You know how much the proposed health care reform would cost? About $100 billion per year for ten years. You know how much Paulson's Troubled Asset Relief Program (TARP) cost? $700 billion. Poof! Just like that, the banks got the dough. For health care's smaller cost, angry mobs turned up at town hall meetings to scream "socialism" at the very idea.
Is the country heading for bankruptcy? It sure looks that way. Is it because of social spending? No. It's not really because of military spending per se, either. The country is heading for bankruptcy because corporations control government and the nation's treasure is redirected to where it most benefits corporations, not citizens. Government military spending helps corporations because they want to sell the most expensive weapons systems to government. Government health care spending hurts corporations because it reduces profits at private insurers and lowers the price people pay for medicine and equipment. Lobbying by corporate interests in both cases has garnered more government military spending and less government health care spending. In these and other cases, corporations win and citizens lose.
This is not a discussion about the military or health care, though. It's a discussion about America's culture of corporate control. The same way government is manipulated to benefit corporations in those two sectors, it is also manipulated in the banking sector. There, the culture of corporate control has finally gone too far and made public the private debt disaster that bankers created. That overhang will crimp stocks for years.
Coming back to Japan, one reason people got tired of stocks is that none of the usual ways of analyzing them made sense anymore. It became a guessing game of what stimulus would come from government next, when it would peter out, what new shenanigan banks would try to prop up their balance sheets and how many people it would fool, when that would peter out, and so on. Gambling, indeed. Fundamentals? Please. Cash from government to banks to pour into the stocks they own to drive up those prices so the stocks could be dumped at a profit looks to the casual observer like a rigged game. Once the public sees the stock game as being rigged, it starts to pull out and leave the game to the big guys with government connections. Stock markets began as a way for companies to get financing to grow their business ideas. That's not what they are anymore. They're a competition of connections. If you have as many family members working at the Treasury as Goldman Sachs has, then you might just stand a fighting chance. If not, maybe other assets will prove better for you.
Are we there yet? No, and there's a chance the US will pull out of this funk the way it pulled out of the 1970s. For that, though, it took the vision and strength of Ronald Reagan. As popular as Obama may be, he's no Reagan. His first half-year in office has proved that, and his dropping poll numbers betray that even the political babes who fell for the hope gambit have realized that nothing's any different. Those who've been around longer knew from the get-go that the same people who ran things at the beginning of January would still be in charge at the end of January, and so it was. Having a Sunday morning celebrity for a president is good fun, but doesn't get much done.
Edward Lucas wrote in the Telegraph last Sunday:
Mr. Obama has tactics a plenty -- calm and patient engagement with unpleasant regimes, finding common interests, appealing to shared values -- but where is the strategy? What, exactly, did 'Change you can believe in' -- the hallmark slogan of his campaign -- actually mean? The President's domestic critics who accuse him of being the sinister wielder of a socialist master-plan are wide of the mark. The man who has run nothing more demanding than the Harvard Law Review is beginning to look out of his depth in the world's top job. His credibility is seeping away, and it will require concrete achievements rather than more soaring oratory to recover it.
Cash is worthless with rates near zero, and there's a lot of cash out there needing somewhere to go after the many bailouts and injections into the banking system that have not been converted into new lending. Lots of money into the banks with none coming out indicates that banks have taken their free taxpayer money and put it into stocks, creating a self-fulfilling balance sheet improvement tactic. Toxicity on the accounting ledger has come down as stocks have gone up.
That's one way of saying that liquidity is driving the current market, lots of government liquidity. Gluskin Sheff's David Rosenberg, however, wrote on Friday that such talk "is usually a catch-all phrase for 'we have no clue' but it sounds good."
Apparently quite a few of us think it sounds good. For instance, Kopin Tan wrote in this weekend's Barron's, "Because the current rally is fueled not just by economic recovery but by the government-induced reflation of balance sheets, Michael Hartnett, Merrill Lynch's chief global equity strategist, thinks the risk of correction lies not with the widely feared double-dip recession, but with the withdrawal of monetary easing."
Add to that the following from Steven Pearlstein's column yesterday in The Washington Post:
So who is borrowing [all the money printed by the Fed]? By and large, it's not households and businesses, which are reluctant to borrow during a recession. Rather, it's hedge funds and other investors, who have been using the money to buy stocks, corporate bonds and commodities, driving prices to levels unsupported by the business and economic fundamentals.
The excess liquidity is even being used to finance a new "carry trade" in which global investors borrow at U.S. rates and buy government bonds in places like Australia, where prevailing rates are higher. Because the carry trade involves exchanging dollars for foreign currencies, it has been a major contributor to the recent decline in the dollar.
Naturally, this has been a blessing for Wall Street's biggest banks, whose trading desks have not only made big money executing and financing the investment strategies of others, but have also been trading actively for their own accounts. And with bubble profits come bubble bonuses.
Back at the Fed, the attitude has been to welcome anything that strengthens the balance sheets of banks, particularly while they continue to write off billions of dollars in soured loans each quarter. Nor is the central bank in any rush to begin pulling back from its current policies. Citing the mistakes made by their predecessors during the Great Depression and by the Bank of Japan during the "lost decade" of the 1990s, Fed officials are determined not to snuff out the economic recovery by moving too early to raise interest rates and reduce liquidity.
Gluskin Sheff's David Rosenberg on the market's overvaluation, sent to clients last Friday:
On one-year forward (operating) earning estimates, the P/E ratio is now 15.7x, the highest it has been in nearly five years. At the peak of the S&P 500 in the last cycle -- October 2007 -- the forward P/E was 14.3x, and the highest it ever got in the last cycle was 15.4x. So hello? In just six short months, we have managed to take the multiple above the peak of the last cycle when the economic expansion was five years old, not five weeks old (and we may be a tad charitable on that assessment).
As an aside, the forward multiple on the eve of the 1987 stock market collapse was 14x and one of the explanations for the steep correction was that equities were so overvalued and overbought that it was vulnerable to any shock (in that case, it came out of the US dollar market). It certainly was not the economy because that sharp 30% slide took place even with an economy that was humming along at a 4.5% clip.
In other words, valuation may not be the best timing device, but it still matters. If the S&P 500 was in a 700-750 range, de facto pricing in zero to 1% real GDP growth, we would certainly be interested in boosting our allocations towards equities. But at 1,060 and over 4.0% GDP growth effectively being discounted, we will be spectators as opposed to participants, understanding that the key to success is to NOT buy at the peaks.
So the strategy is to sit on the sidelines, be selective in our equity choices, and wait for the correction to come or for the fundamentals to catch up with this overvalued, overbought, overextended market. Remember, the reason why the tortoise won the race was because the hare got tired.
How about some news from the front lines of Japan's economic slump?
A new, young face recently showed up at one of my favorite restaurants in Sano, where I live. She waited on me a few times and the last time I asked her name and if she was a student. "Yes," she replied. "I'm 15, a high school student." That made sense, as I'd seen her only in the evening at the restaurant, never during lunch time.
"What clubs or teams are you on?" I asked.
"None."
That's unusual. Most students in Japan can't find enough hours in the day for their studying and many club and team memberships. "Why's that?" I asked.
"Because I'm working this job at night. I come here right after school."
"Are you saving to buy something?"
"No. I'm helping my family."
Her father lost his factory job and spends his days down at the government employment office, in line with former co-workers. The rest of the family members are doing what they can to help keep the lights on and the water running. For the first time in a long time, I wished the culture would allow me to tip somebody. Instead I told her she was a fine daughter, which made her smile.
TCW Group Chief Investment Officer Jeffrey Gundlach said at a June 2007 Morningstar conference, "The subprime market is a total unmitigated disaster and it's going to get worse. The delinquency rate is still climbing. At the same time, the ability of people to refinance is also going down. It's just not a very attractive situation." The S&P 500 traded at 1,500 back then.
On Wednesday, in a conference call titled Too Good to Be True, Gundlach said of the current market that it was about to lose momentum, and advised selling on strength when the S&P 500 is over 1,000.
"You've made 90% of the money you're gonna make in this rally," he said. He thinks much of the economic data that people are calling green shoots is just the temporary result of unsustainable government spending. "We're basically borrowing money and calling it economic growth. It's not real economic activity."
About the much-praised Cash-for-Clunkers program, he said, "Deflation is so strong that you can't even sell cars unless you slash prices 20% through government subsidies." He also thinks commodity deflation lies dead ahead, saying that "a turning point is close at hand in these markets."
He's also worried about debt defaults: "We're standing on the edge of a major default wave. Defaults are the elimination of dollars. You could eliminate so much actual wealth that this could be the source of a strong dollar rally."
To see the slides of his presentation in PDF format, click here.
It was always said that come what may, you can count on U.S. consumers. Not these days. For nearly 20 years, consumer spending has outpaced income growth in America. Credit everywhere they turned, the wealth effect of the dot com stock market, and then the ATM-like appeal of rising house prices was enough to make the word "budget" foreign to most Americans. Shop 'til you drop was the rallying cry from coast to coast.
Too bad they did just that. We haven't seen this many dropped consumer corpses in the aisles since John Steinbeck was the contemporary chronicler of American culture.
The current financial crisis and attendant economy that grows nothing but joblessness has kicked consumers in the teeth. Finally giving up on government to limit the gimmicks of financial firms, households have ignored Washington's efforts to get the binge going again. Instead, Joe Sixpack and his wife are giving the finger to Goldman Sachs, the Treasury, and the Fed and taking care of some toxic assets closer to home. Yes, household balance sheets are getting fixed. People are buying less and saving more, which is catastrophic to the debt-based economy built by government, banks, and big business over the past fifty years or so. A full 70% of the economy depends on Joe buying trifles he doesn't need to keep trifle manufacturers in business so they can contribute to campaigns and lobbying efforts.
What's good for Joe, then, ain't good for the economy. At least not the fraud that the modern economy has become. Wall Street profits come from selling a lot of trifles, and if Joe ain't buying, earnings won't grow. The question then becomes: Is Joe buying?
Nope.
Consumer credit fell at an annual rate of 10.4% in July, erasing a record $21.5 billion. Revolving debt like that on credit cards dropped 8%, while non-revolving debt like auto loans dropped 11.7%. Those came to dollar amounts of $6.1 billion and $15.4 billion respectively. As of July, consumer credit has been shrinking for six months in a row.
Good for you, Joe! Keep up the good work. Cut up those credit cards and start paying cash. Read fine print. Don't borrow. Save. Send the government, bank, and big business scum back to the drawing board to figure out some new way to suck cash out of a different generation of suckers.
As for the economy, don't worry. Green shoots, remember? We'll do just fine on 30% firepower. Hey, it's better than nothing and in these new happy times, better than nothing is the same as fantastic.
It's time to recognize that things have changed and that they will continue to change for the next -- yes, the next 10 years and maybe even the next 20 years. We are heading into what we call the New Normal, which is a period of time in which economies grow very slowly as opposed to growing like weeds, the way children do; in which profits are relatively static; in which the government plays a significant role in terms of deficits and reregulation and control of the economy; in which the consumer stops shopping until he drops and begins, as they do in Japan (to be a little ghoulish), starts saving to the grave.
I could go on, reintroducing the negatives of an aging boomer society not just in the US, but worldwide. Increased health care may be GDP positive, but it's only a plus from a "broken window" point of view. Far better to have a younger, healthier society than to spend trillions fixing up an aging, increasingly overweight and diabetic one. . . . Our world, and the world's world, is changing significantly, leading to slower growth accompanied by a redefined public/private partnership.
Here's Megan McArdle at The Atlantic responding to an interview up with Nick Gillespie of Reason on the proposed Consumer Financial Protection Agency:
A consumer financial protection agency is not going to do much to help consumers. It is true that people don't always understand all the terms in their credit card contracts or mortgages.
The problem is, it is almost never the tricky hidden terms of those loans that get people into trouble. People get into trouble because hyperbolic discounting, or an insurmountable crisis, leads them to borrow more money than they can reasonably pay back. By the time a 5% increase in your credit card interest rate spells financial ruin, you've been in deep trouble for several years.
So if the CFPA confines itself to ensuring full disclosure, this will not much help consumers, because the terms that matter are already disclosed, i.e. that you are borrowing money and will have to pay it back with a high rate of interest.
Too many people look for somebody to blame for their inability to control their own spending. Yes, credit cards and banks maintain usurious policies to snag the unsuspecting. So, don't be unsuspecting. Get a no-fee card, limit your spending, and pay the full balance each month. If you do that, you get an interest-free loan each billing cycle, and the joke's on the bank.
I wrote here a month ago that Japanese were wondering where talk of recovery was coming from. Japan had just reported its highest unemployment rate in six years at 5.4%, and its total number of jobless at 3.5 million. Credit Suisse Japan chief economist Hiromichi Shirakawa said, "Employment conditions are taking a turn for the worse."
A month later, they still are.
The unemployment rate reported last week rose to 5.7%, well above the 5.5% expected and, more to the point, the highest it's ever been. The total number of jobless is now 3.6 million. The ratio of job offers to job seekers fell to an all-time low of 0.42 in July, meaning every 100 job seekers must fight over just 42 offers. Fear of deflation persists, as consumer prices slipped 2.2% in July from the year prior, on top of a 1.7% dip in June. As in the US, Japan's families are cutting back. Average household spending in July declined 2% from a year earlier.
Toyota is slashing production capacity, and Japan Airlines is laying off 10% of its workforce. Companies in every sector are reducing hours worked per week, forcing many employees to find part-time jobs to support their families.
Unfortunately, forecasts for Japan's unemployment rate call for it to keep rising for some time yet. Barclays Capital in Tokyo, for instance, sees it reaching 5.9% in the first half of 2010.
The situation is eerily familiar to older Japanese. These conditions, particularly deflation, are what crippled the Japanese economy during the "lost decade" of the 1990s. As we close in on Japan having been in recession for 20 years, talk on the street is that it's silly to call it a recession anymore. It's just the way the economy is. The aberration isn't what people are calling bad times; the aberration was what they called good times.
"We see consumption as a major concern for the Japanese economy," said Chiwoong Lee, an economist at Goldman Sachs in Tokyo. "[Friday]'s labor market release revealed worse unemployment ... than the market expected ... and wages remain on a downtrend."
Daisuke Uno, chief strategist in Tokyo at Sumitomo Mitsui Banking Corp., isn't optimistic, either. "Jobs data and prices continue to deteriorate, indicating the economy has yet to hit the bottom," he said.
That's one reason Japan made a rare show of unity in "throwing the bums out" of political office last week. Almost 70% voter turnout -- the highest since the current electoral process took effect in 1996 -- put 308 of the Lower House's 480 seats under members of the Democratic Party of Japan (DPJ). Only 241 were needed for a simple majority, obviously, making this a notable landslide. It marks the first time since 1955 that the Liberal Democratic Party (LDP) has not controlled Tokyo.
The DPJ plans to work quickly with its army of new and young faces to restructure the government's economic stimulus package, and create a new policy writing board called the National Strategy Office to go through Japan's budget and re-set policies.
I like to consult with older people to see what to expect. The ones I spoke with said, "Not much." To them it looks like just another way of saying that change is coming, which has been said dozens of times over the past few decades, but nobody in office has any real power.
The last time Japan was this excited about its government was when Junichiro Koizumi became prime minister in 2001. His flowing hair and maverick ways were sure to shake up the system, went the refrain. Then, in 2005, he led his LDP party to one of the biggest majorities in recent Japanese history. Great! So, what came of it all?
A change in uniforms at the post office. Really.
The privatization of the nation's post office and its huge postal savings system was supposed to inject $3 trillion of private capital into the economy and get things moving again. To see how that went, re-read the first part of this article. Stamps cost the same, the post offices are all in the same places, the same people work at them, letters arrive as before, but instead of being called Japan Post it's now called Japan Post Holdings and abbreviated JP on signs and uniforms. Oh, and customers can now transfer assets from the post office to private banks at the ATM. Other than that, life goes on as before.
Just as in America, corporate interests are the real leaders. Elections and politicians are mainly for show so the electorate can get riled up over something, but those who fund politicians and pull their strings don't care who's name is on the door as long as he or she can vote, sign, and stamp as needed. As with Obama's enthusiastic base of six months ago that's already abandoned him once he turned out to be like his predecessors, so it will go with this supposedly significant election in Japan.
What do the old people here say about that? Something along the lines of, "Oh well, it's just about time for our lovely autumn colors. Where shall we view them this year?"
Figuring that out is a much better use of time than projecting what difference the DPJ will make.
Today's article comes courtesy of frequent contributor Dave Van Knapp. His site, SensibleStocks.com, is chock full of clear-headed ways to pick stocks and explains the oft-unappreciated role of dividends.
This article is a follow-up to my article, This Rally Is Sustainable, published in Jason's column on June 2, 2009. At that time, the market rally was almost three months old and the S&P 500 had risen from its March 9 closing low of 677 to 943, or 39%. It is fair to say that most commentators thought the rally was unjustified -- claiming it had no fundamentals to support it -- and that a backwards slide, or even a crash ("retest of the March lows") was both inevitable and probably imminent.
That's not what happened. Almost three more months have passed, and the index stands at 1029, or 9% higher, for a total gain of 52%. The rate of ascent has slowed, but overall the rally has been remarkably consistent: +9% in March, +9% in April, +5% in May, flat in June, +8% in July, and +4% in August. If you define "correction" as a 10% pullback, there has been no correction along the way.
The case I made for the sustainability of the rally has held up. Basically, I suggested that, (1) the stock market tends to rally significantly a few months before the ends of recessions, and, (2) various news items and data points could be interpreted by reasonable people as demonstrating that the recession was ending.
I'd like specifically to address those who say the rally is unsupported by fundamentals. I believe that this rally has been fully supported by fundamentals, although I suspect many will disagree with how I define "fundamentals." Here is my reasoning in three easy steps:
First, too many investors, while recognizing that both the stock market and the economy run in cycles, believe that the cycles are concurrent. That is, they think that the stock market's value and economic fundamental values are always directly proportionate. They are not. There are often stretches when the market's cycle and the economic cycle are out of phase. That has been consistently true in recessions. In eight of the last nine recessions, the stock market has anticipated the end of the recession by an average of about six months. The market displays its anticipation by going up. I simply postulated that this time it would happen again. It has, making it now nine out of the last ten recessions that the market has made a significant increase during the recession.
Second, then it is reasonable to define fundamental economic metrics as "improving" if they are getting worse at a slowing rate. Such fundamental economic measures as the GDP, employment rate, consumer confidence, the Conference Board's LEI (Index of Leading Economic Indicators), reports from ISM (Institute for Supply Management), housing prices, credit availability, and the like, do not have to be actually going up to be "improving." They may still be dropping toward their eventual trough -- the economy may still be contracting -- but the important observation is that the rate of contraction is slowing. If that is happening, then you can reasonably infer that the recession is in fact reaching its late stages. By definition from the National Bureau of Economic (NBER), which has quasi-official status in such matters, a recession ends when the economy stops contracting.
Third, what I call the "net news flow" has been kicking out many data points for months now that economic fundamentals were in fact getting worse at a slowing rate. In the past couple of months, a few of the fundamental economic measures have reached individual inflection points and actually started to rise. For example, the LEI have been going up for four months. More recently, housing prices (as measured by the Case-Shiller Index) have stopped falling and are rising in some metropolitan areas. Of course, the news is often lumpy and seemingly contradictory. That's life and is why I call it "net news flow." The point is that the "average" of all the economic news, taken as a whole, has been going in the right direction since this rally started.
That is why I believe that this rally has been fully supported by economic fundamentals. As you can guess, I disagree with the critics of "green shoots." The market runs on investor sentiment. It is the green shoots that have fueled this rally, giving hope to investors who have bid up stock prices in the belief that the economy first pulled back from the abyss and will begin getting better soon.
I invested based on this reasoning. I maintain a publicly published Capital Gains Portfolio, a demonstration portfolio for purchasers of my book, Sensible Stock Investing, that is also available for free viewing by the curious. The portfolio was entirely in cash for many months before this rally began. But in April, I began cautiously purchasing into the rally, mostly through a series of purchases of SPY (SPDRS, an ETF that tracks the S&P 500). At the time of the earlier article in June, the portfolio was 52% invested. Last week, I made my final purchase. The portfolio is now 100% invested.
In addition to the cautious, gradual re-entry into the market, I've helped manage risk by using tight 8% trailing sell-stops. None of the stops has been hit. All positions are in positive territory. Because of the gradual investments, the portfolio's performance this year is a bit behind the S&P 500's. That's OK. Because the portfolio was in cash for so long, it did not suffer from much of the crash that preceded the rally, so overall the portfolio is way ahead of the S&P 500 benchmark index since its inception. Risk management is very important; it helps you avoid "sucker's rallies," "dead-cat bounces," and just plain being wrong.
Where is the market going from here? I haven't given that much thought, to be honest. Now that I am fully invested (no new money goes into the portfolio other than dividends it generates), I have no more decisions to make for a while. My exit strategy is already in place via the sell-stops. Sure, I may play with the stops (tighten them, loosen them, or use a moving average rather than a flat percentage to set them), but I do not need to anticipate the market's next major move. Past readers of my articles may recall that I believe in "waiting for the turn" anyway.
That said, I think that strong arguments can be made for at least three scenarios:
The market will make a correction (that is, contract by more than 10%), then resume its expansion if the news warrants it.
The rally will continue for some more time, without a correction, anywhere from a few weeks to many months, depending on the news flow.
The rally will end and the market will reverse and begin to contract. This is what I think will happen if/when the net news flow turns negative. So if, as many believe, we are in for a double-dip recession, signs of that will show up in the news flow, and the market (again leading the economy) will anticipate that and go backwards.
