Juggling the recent debt crisis in Dubai, reports of a growing asset bubble, the latest unemployment data, and last Thursday’s turkey leftovers can present a formidable task for even the most seasoned of investors.  During times like these, why not sit back, loosen up the belt, and digest an admittedly ‘lite’ version of market commentary?  Jeffrey Saut, Chief Investment Strategist and Managing Director of Equity Research at Raymond James & Associates, as well as Bill Gross, Managing Director at the Pacific Investment Management Company (PIMCO), recently weighed in, releasing their own market thoughts.

Saut’s November 30th commentary is titled, “Don’t Worry About the Dollar!” Citing a previous occurrence during the 1970′s, he believes that stock market investors’ worries about inflation are largely overblown.  Most notably, he predicts that any continued weakness in the US Dollar will be more-than-offset by rising stock prices.  As he explains,

Nevertheless, the dollar’s weakness has clearly been very positive for our “stuff stocks” (precious/base-metals, agriculture, energy, cement, timber, etc.), as well as stocks in general, and we have been bullish. Most recently, we have suggested, “that with credit spreads below their pre-Lehman bankruptcy levels there should be no reason why the equity markets can’t ‘fill up’ the downside vacuum created in the charts by said bankruptcy… That gives the S&P 500 an upside target of 1200 – 1250”…

Saut goes on to support his bullish theory with a myriad of facts.  In particular, he points to recent decreasing jobless claims, dramatic increases in labor productivity, rising corporate profits, and lowering inventories as potential catalysts for an economic rebound.  More specifically, after initially cutting back on labor, he expects that businesses will soon look to reinvest profits, hire new workers, and replenish those declining inventories.  Such a move could reinvigorate consumer demand and jump-start our ailing economy.

Furthermore, he views last week’s Dubai debt crisis as a symptom of the previous real estate bubble, and not a sign of another pending systemic crisis.  Finally, as he has suggested over the previous few months, he is near-term bullish large cap stocks.

Meanwhile, in Bill Gross’s November commentary, titled, “Anything but .01%,” he points out the depressingly anemic returns generated by most of today’s money market accounts.  Indeed, although maintaining low interest rates may be in the economy’s best interests, they are also forcing investors to flee supposedly “riskless” investments in order to chase more attractive returns.  This has sparked a considerable rise in asset prices.

Nonetheless, Gross does not foresee the Fed raising rates any time soon.  As we have seen, the private sector has shown little traction this year, with government spending largely assuming the role of oiling the gears of this economy.  Until GDP picks up considerably, unemployment shows signs of reversing, and private sector demand replaces the need for government stimulus, rates are likely to remain low.  As Gross notes,

The Fed is trying to reflate the U.S. economy.  The process of reflation involves lowering short-term rates to such a painful level that investors are forced or enticed to term out their short-term cash into higher-risk bonds or stocks.  Once your cash has recapitalized and revitalized corporate America and homeowners, well, then the Fed will start to be concerned about inflation-not until.

Looking forward, Gross has a few ideas for skittish investors to consider.  First, long term investors must ready themselves for a “New Normal” economy to take effect.  In essence, they should expect that as companies continue to deleverage, corporate growth slows, and the government’s role in the economy expands, corporate profits will take a hit.  As a result, dividend and interest payments are also likely to suffer; end result, investors may need to lower their expectations when it comes to returns.

According to Gross, part of the reason why Warren Buffett recently invested in the railroads was to simply put his money to work, rather than let it languish in a low-yielding account (I covered this subject in more depth  in my previous blog).  Like Buffett, Gross believes investors would be wise to follow suit.  In this “New Normal” economy, he suggests targeting low-growth, high-yielding companies like utilities.  Although utilities may not excite investors from a return standpoint, they do offer reliable cash flow (dividends), and normally grow in line with the broader economy.

Tags: Bill Gross, debt crisis, Dubai, economy, equity markets, GDP, Inflation, inventories, Jeffrey Saut, jobless, labor productivity, New Normal, PIMCO, precious metals, Raymond James, real estate bubble, U.S. Dollar, utilities, Warren Buffett

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Stock Market Investing: A battle between investment disciplines has developed over the last 3 weeks. As discussed in the Oct. 28th post, numerous warning signs of a technical nature are flashing. However, last week’s news headlines were replete with US$ bearish/equity market bullish fundamental data. Which discipline will ultimately prevail, technical or fundamental? The answer is unclear, for now we remain bullish with a healthy dose of skepticism.

Investment Strategy: Never fight the trend. If the equity markets want to advance we will gladly participate and enjoy the ride. Stay focused on the areas of the market that have the strongest fundamentals for moving higher; namely the commodity space as this rally is pure and simple a vote against the US$. Remain over-weighted in the precious metals. The relative out-performance of this group was significant during the last market sell off which was, I will humbly remind you, anticipated by RCM.

Now, I would like to take you on a journey through some of the key events of last week. My intention is to reduce the noise generated from traditional news outlets and focus your attention on the important issues driving the markets. You will see how these issues have led to the resumption of the US$ breakdown and the mirror image breakout of the equity markets.

We will begin with some excerpts from the FOMC meeting on Nov. 4th. There was an expectation that the Fed may change wording to appear more US$ supportive. In the prior two weeks, the simple possibility of a discussion about an exit strategy for the current liquidity glut was used as an excuse by traders to bolster the US$. However, as you will read below, the Fed has no intention of changing the policy at this time…

ECONX Summary of FOMC policy statement; maintain the target range for the federal funds rate at 0 to 1/4 percent
…Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.

Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. (Is this a boldfaced lie? Surely the Fed knows inflation is a currency event, so why pretend there is no inflation when the US$ is collapsing in value? Simple: the scenario is called “between a rock and a hard place.” If the Fed admits inflation is a problem then easy liquidity policies are more difficult to maintain.)

In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trln of agency mortgage-backed securities and about $175 bln of agency debt…(Logic suggests rates must remain low while the Fed is buying said debt.) In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010….

…And so the US$ began to lose its bid the minute this story broke on Wednesday last week. In response, the price of Gold rallied and the precious metals mining companies ended the week at new highs on major volume. Interestingly, this group has seen a lot of volume accumulation during a time when the rest of the equity markets are seeing volume selling and/or low volume rallies. This is one sure reason for the strong relative price out-performance the group has enjoyed.

Why does the Fed have no intention of changing policy? Because the economy is in trouble, plain and simple…

September Consumer Credit -$14.8 bln vs -$10.0 bln consensus, prior revised to -$9.9 bln from -$12.0 bln

As expected, consumer credit fell for the eighth consecutive month. Credit declined $14.8 billion in September, far worse than the consensus forecast of -$10.0 billion. The consumer credit decline for August was revised up to -$9.9 billion from -$12.0 billion. The reason for the decline in consumer credit has not changed. Consumers continue to believe they too highly leveraged and are working to repay their debts.

At the same time, banks are worried about possible loan defaults, and in return, they have tightened lending conditions and pulled available credit from even the most credit worthy borrowers.

…Without the consumer there will not be a sustained economic recovery. Furthermore, the state of small business in America would suggest consumer credit is not likely to see a recovery any time soon…

Business bankruptcy filings increased 7% in October - WSJ reports business bankruptcy filings jumped in October, reversing two consecutive months of declining commercial filings and indicating that bankruptcies could continue to rise as the economy struggles to stabilize.
…Add to business bankruptcy problems the number of banks going bankrupt themselves and you get a morbid U.S. economic picture demanding Fed leniency…

Nine U.S. banks seized in largest one-day haul – Reuters.com reports U.S. authorities seized nine failed banks, the most in a single day since the financial crisis began and the latest stark sign that substantial parts of the nation’s banking industry are being crippled by bad loans.

Last month, 7,771 businesses filed for bankruptcy protection, compared to 7,271 that sought shelter from creditors in September, according to new data from Automated Access to Court Electronic Records, or AACER. After two months of decline, the 7% rise in commercial filings shows that businesses are still struggling to access financing and are facing weak demand for their products..

Five more banks fail – 120 for the year - CNN Money.com CNN Money.com reports five banks failed late Friday, bringing the 2009 tally to 120. The biggest to fall was United Commercial Bank of San Francisco, which had 63 U.S. branches as well as operations in Hong Kong and Shanghai. The bank held deposits totaling $7.5 billion.

A couple of weeks ago, we warned the “equity markets are trading at these lofty levels because of liquidity not reality and if the Fed-controlled gravy train of easy credit stops, then trouble will ensue.” Well, when you combine recent Fed comments with terrible economic data the result is a gravy train of liquidity that continues to roll and keep equity markets buoyant.

Meanwhile, in this Greek tragedy we are watching unfold, the reciprocal of stronger equity markets is a weak currency. The US$ declines as economic numbers worsen and to add insult to very serious injury, the carry traders are having a field day. I warned “The U.S. $ carry trade will gain steam if European economic recovery/inflation outpaces the U.S. and leads to rate increases”. It seems with every passing week this prophecy gains momentum and the US$ value declines…

Australia raises rates for second straight month - NY Times reports Australia’s central bank on Tuesday raised its benchmark interest rate for the second month in a row, as widely expected, and suggested a gradual withdrawal of stimulus measures amid mounting evidence that the Australian economy is rapidly picking up speed. The increase in its key cash rate, by a quarter-percentage point to 3.5%, makes Australia the only country in the world to have ventured two successive rate increases this year.

Inflationary pressure returns as UK PPI rises - DJ reports U.K. input producer prices rose unexpectedly in October, suggesting that inflationary pressures could be building after remaining muted over the past year, official data released Friday showed. Prices paid by factories for raw materials rose to a 16-month high of 2.6% on the month in October compared with a 0.2% fall in September. On the year input prices rose 0.1%, that was the first annual increase since February, and compares with a steep 6.2% year-on-year decline in September, the Office for National Statistics said. The gains came as a surprise. Economists, on average, were expecting a 0.5% fall on the month and a 6.5% year-on-year drop.

Tags: Bank Failure, bankruptcy, consumer credit, consumers, equity markets, Fed, FOMC, gold, Inflation, interest rates, investment strategy, precious metals, stock market investing, US$

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Stock Market Investing:

Development One: Economic numbers that suggest recovery begin to outpace negative economic news. This leads to the perception — or possibly, the reality — that the Fed will reverse its stance on easy credit.

If you are a new reader I strongly advise the perusal of past post before you begin your protest. Those of you who are familiar with my work will know the well documented relationship between bad economic numbers, easy credit, weak US$ and strong equity markets. As long as the Fed remains committed to easy credit in all its forms the bull market can continue.

However, I have witnessed a disturbing trend over the last few weeks. Good news on the economy leads to selling. This suggests to me a real fear pervades the markets with regard to the continuation of easy credit. The equity markets are trading at these lofty levels because of liquidity not reality and if the Fed controlled gravy train of easy credit stops then trouble will ensue. When the gravy stops dog will eat dog. What the distribution of the last few weeks may be telling us is that the big dogs are smelling trouble and are preparing.

Today’s trading offers a perfect illustration of Development One. First, good earnings numbers out of Microsoft & Amazon were not able to move the markets higher. Instead the excitement was used by the big players to distribute their holding. Second, the following “good” economic report hit the news wires this morning, but the equity markets sold off almost immediately after the release:

Existing Home Sales Exceed Expectations
Existing home sales jumped 9.2% to 5.57 million units in September. The increase followed an unexpected decline (-2.9%) of sales in August. The consensus was expecting sales to rise by a much more modest 5.1% to 5.35 million units.

We obviously don’t have the answer to these questions. However, this very real possibility must be respected. There has always been a high correlation between long rates and the equity markets. I can think of no better example than the crash of 1987. For four months the bond market was collapsing (rates rising) before the equity markets infamously followed.

Of course, in ’87 bonds sold off because the Fed was tightening. If, however, bonds sell off even in the face of Fed easy credit policies then I hate to see the ensuing equity market response.

Record Auctions Announced…euro 1.5001…yen 91.5060 (3.411% -07/32)
Treasury will sell a record batch of bonds next week with $44B 2-yrs Tuesday, $41B 5-yrs Wednesday and $31B 7-yrs Thursday. The record levels show an increase of $1B on the 2-and-5s, and $2B on the 7-yrs. There will also be $7B reopened 5-yr TIPS going off Monday along with $29B 3-mos and $30B 6-mos. The market may get some relief as the news is over, but the high end of expectations had been for closer to $115B versus the $116B announced, so any relief may be brief.

Development Three: The high profile SEC take down of Galleon may cause a ripple effect leading to hedge fund unwinds.

Galleon had over $3 billion and now according to DJ-Galleon winding down all hedge funds.

Last year we all witnessed what happens when hedge funds are forced to unwind. Many of the big funds are often involved in the same trades and one unwind leads to another. There will be many denials along the way but the equity markets will speak the truth.

I will also respectfully submit to you, the readers, that the derivatives crisis is far from over. The individuals that created the credit crisis are still running the show. If you believe this statement is incorrect or feel President Obama promised you change so his cabinet must be full of new thinkers, I suggest you view the PBS Frontline documentary entitled The Warning .

The Warning brings to mind two obvious questions:

1- What will cause the next derivatives crisis? Could it be the take down of a major hedge fund that ignites the next collapse?

2- Why isn’t Brooksley Born a major member of the Obama administration? If he was truly an agent for change wouldn’t she be a must in the cabinet?

Development Two: A funding crisis unfolds.
Will the US$ decline in value to a point where long rates must increase aggressively for our government to continue funding its debt? How long will China and others tolerate the ruse of quantitative easing before demanding higher rates?

Tags: 2nd stimulus, DOW, earnings, economy, equity markets, Fed, galleon, investment strategy, nasd, Not Categorized, obama, sp500, stock market investing, treasury market, US$

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Today’s consumer sentiment numbers offer immediate confirmation that the issues I raised in yesterday’s post are clear and present dangers to the continued recovery of the debt and equity markets.

Clearly, this sentiment data along with the dismal July retail sales data and awful initial jobless claims data paint an altogether more ominous picture. This picture does not bode well for the US$ or the Treasury market.

ECONX Some Sobering Sentiment Data
The preliminary report on consumer sentiment for August from the University of Michigan caught the market by surprise and not in a good way. The index dipped to 63.2 from 66.0 in July. The consensus estimate was 69.0. The current conditions index dropped to 64.9 from 70.5.

The August reading here is unsettling considering it is below the level seen in February when the stock market was much lower and the unemployment rate wasn’t as high. The economic outlook index fell to 62.1 from 63.2. That is the lowest reading since March when this category measured 53.5…

Ultimately, it is income that drives spending, but the weak confidence measure is a sobering reminder of the psychological (and real) effects of a weak labor market that has been accented by a growing mass of workers (1 out of every 3 unemployed) that has been unemployed for 27 weeks or longer. The economic data overall might suggest in the months ahead that the recession is over, but this confidence report goes to show it will feel like a recession for a lot of people a lot longer than some production data says it should.

Tags: consumer sentiment, equity markets, treasury market, university of michigan, US$

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Second quarter earnings can be best characterized as light on revenue but strong on cost cutting, leading to better than expected EPS. The more positive bottom line results have helped fuel the equity market rally over the last couple of months.

Meanwhile, Aug. 13 (Bloomberg) — The Libor-OIS spread narrowed to a level former Federal Reserve Chairman Alan Greenspan said he regarded as “normal,” adding to evidence the freeze in credit markets is thawing. Clearly credit market stabilization has been a major driver of the equity market rally.

While the rally has been a nice reprieve from the bear market the question remains what will compel the markets higher in Q3 and Q4. With credit back to normal that driver is off the table and cost cutting/belt tightening can only work to improve EPS for a short period of time. Revenue must accelerate in the 2nd half of the year for this bear market rally to turn into a bonafide bull market.

With that thought in mind I am publishing the next two stories. If the consumer can’t find a job then spending will not return and revenue will continue to be disappointing. I fear this will result in a resumption of the down trend in the back half of the year.

Of course, these are long term questions and as my Mom always says “you must live the questions; the answers reveal themselves.” “Living the questions” in this case means trading the trend while keeping your eyes open and your mind alert.

ECONX July Retail Sales Disappoint
The July Retail Sales report is a disappointment and yet another reminder, in the midst of a rising stock market, that the consumer isn’t all he/she used to be due to weak wage growth, depressed asset prices, and concerns about job security…

For the month retail sales were down -0.1%. Excluding autos, they were down -0.6%. Both figures were well off the consensus forecasts that called for increases of 0.8% and 0.1%, respectively. The government doesn’t provide any context behind the numbers, but with broad declines in most sales categories, it is clear that consumers weren’t doing a lot of discretionary spending.

There will be a tendency to dismiss the weakness as being the result of consumers delaying purchases to take advantage of tax-free holidays that got pushed into August this year. There will likely be some makeup in August, but there is still no other way to read the July data than to consider it a disappointment. To the latter point, retail sales, excluding autos, gasoline station, and building materials, which is a measurement that flows into GDP estimates, was down for the fifth straight month.

ECONX Initial Claims Still Way Too High

Initial jobless claims for the week ended August 8 increased to 558,000 from a revised 554,000 in the prior week. The current number lifted the 4-week moving average to 565,000 from 556,500. Continuing claims, in contrast, fell 141,000 to 6.202 million. That dropped the 4-week moving average for the series to 6.259 million from 6.287 million. There is cold comfort in the drop in continuing claims since it most likely reflects people losing benefits. To be sure, there isn’t much hiring happening… Separately, while the trend in initial claims has been better of late, a reading north of 500,000 at this point is still downright bad and still well above prior recession levels when the 4-week average for claims was closer to the 400,000-450,000 range. The labor market is weak and these figures aren’t a great portent for consumer spending activity.

Tags: alan greenspan, earnings, economy, equity markets, initial jobless claims, july retail sales

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While the mainstream media is busy rolling “green shoots” and smoking them, I thought I’d compose a post today to help you ‘JUST SAY NO.’

Ben “Helicopter” Bernanke and his side kick Tim “Pinocchio” Geithner (honestly, watch him speak, I swear his nose looks like it grows) have been dealing some pretty potent D.C. “trip shoots.” Of course, they are not alone. A vast network of dealers have combined to create the hallucinogenic state in which the mainstream media floats.

Perhaps the most dastardly dealers in the cartel are those who manipulate the equity markets. They claim to be champions of the free markets and providers of liquidity when they are anything but. They team up with big brokerage firms who love the gravy train of fees and drive up the cost of doing business for the rest of us.

I’m going to take a leap so try and stay with me. If you would like someone to blame for the predicament we are in today look no further than Arthur Levitt. Levitt, an ex-head of the SEC and beloved blatherskite of news outlets everywhere, spearheaded the ruination of Wall Street with the move to decimalization. In his infant wisdom, he believed that the spreads between the bid and ask on equities were too large and therefore hurt the small investor. His stupidity prevented him from realizing that spreads were and are necessary to create real liquidity. As an investor I’d rather see a .25 cent spread on a stock and know I can trade real volume at the price than a .01 cent spread with no volume. In today’s market of decimalization an investor may have to bid a stock (all but the most liquid) up $1 or more to find the real volume that would have been there a 1/2 point lower in a spread environment.

The advent of decimalization murdered a major profit center for the brokers and forced them to find other means of revenue. We all know how that worked out. The profit center of spreads for brokers was not a gift. It was earned by way of creating real liquidity. Decimalization has led to a serious disease of manipulation in the markets today. The blog post below by Joe Saluzzi and the clip from CNBC should further illuminate this argument:

Joe Saluzzi Themis Trading:

Our equity market is being controlled by machines that are nothing more than two bit, SOES bandits. They cloak themselves under the mantra of liquidity providers but they are really just locusts and are feeding off the equity market until it doesn’t suit them anymore. Once their profit margins are squeezed to almost zero, they are likely just to move on to a new market. But what damage would they have done? We will be left with a shell of a market that is used to being led around by computers. Real people and real capital are a scarce resource in today’s market. Read more…

And Here It Is On CNBC: Manipulation

(I’d like to take this moment to commend Rick Santelli whose voice is a true beacon of light on this otherwise wasteland of a network.)

RCM Comment: This California story is not getting much news coverage but should be on the top your watch list. California’s slow sinking into the financial abyss could destabilize the credit markets and in turn the equity markets…

California misses budget deadline, readies “IOUs” – Reuters.com :

Reuters.com reports California’s lawmakers failed to agree on a balanced budget by the start of its new fiscal year on Wednesday morning, clearing the way to suspend payments owed to the state’s vendors and local agencies, who instead will get “IOU” notes promising payment. The notes will mark the first time in 17 years the most populous U.S. state’s government will have to resort to the unusual and dramatic measure. Democrats who control the legislature could not convince Republicans late on Tuesday night to back their plans to tackle a $24.3 billion budget shortfall or a stopgap effort to ward off the IOUs. The two sides agree on the need for spending cuts but are split over whether to raise taxes. Democrats have pushed for new revenues while Republican lawmakers and Governor Arnold Schwarzenegger, also a Republican, have ruled out tax increases. They instead see deep spending cuts as the solution to balancing the budget, but Democrats say that would slash the state’s safety net for the needy to the bone.

Tags: arthur levitt, ben bernanke, california budget deadline, decimalization, equity markets, RCM Editorial, timothy geithner

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