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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Tea Leaves; in the last couple of days there have been a lot of them, so let’s start reading:The tangible parts of GS’s earnings were suspect (Investment Banking -38%, Asset Management -6%, Trading and Principal Investments -7%) while the FICC unit (Fixed Income, Currency, Commodities) showed all the gain. “Net revenues in FICC were $5.99 billion, significantly higher than the third quarter of 2008. These results reflected strong performances in credit products and mortgages, which were significantly higher compared with a difficult third quarter of 2008.” In other words, last quarter this division had mark downs and this quarter the assets were marked up. Is that a sign of a strong business or clever accounting? ECONX Industrial Production Surges
Industrial production rallied for the third consecutive month as production increased 0.7% in September. The consensus expected a much more moderate increase of only 0.2%. The jump in production was expected to be driven by the auto industry, and the sector didn’t disappoint as motor vehicle production rose 8.1% as assemblies of autos and light trucks increased 13.0% to 7.15 million vehicles.What has been the Fed’s response to all these tea leaves? Read on…

Fed’s Fisher says keep rates low, inflation not a risk - Reuters.com
Reuters.com reports the U.S. economy is recovering but the upturn will be slow and it makes no sense to raise interest rates in this climate since inflation is not a risk, a top Federal Reserve official said.(I humbly suggest someone clue in Fisher to the reality that (all together now) Inflation is a currency event, not an economic event.)

Earnings from the technology space, Intel & Google to name a couple, have been well above expectation. This could be a positive development, but of course expectations are a joke. Analysts constantly get it wrong so let’s dispense with the “better than expectations” farce. A note a caution on the Intel number and others on that end of the food chain; an inventory rebuild is occurring at an aggressive pace. This rebuild is only a good thing if consumers spend. I would be more apt to cheer a good earning number out of, say Best Buy, as that would show end user demand. Inventory build without end user demand spells trouble for the economy in Q1 of 2010.

I am loath to discuss the earning of the banks. JP Morgan and Goldman Sachs showed strong results. However, when we parse the numbers it appears that earning were again created with clever accounting.

 JP Morgan’s results were similar to GS. Should we cheer or should we be concerned with this ugly little fact buried in the announcement: “JPMorgan’s loss provision to cover current and future home loan defaults rose to $3.99 billion, while its provision for credit card losses surged to $4.97 billion”

We will choose to be concerned. However, the share prices of the financial group remain in an uptrend and while it may be stupid to believe the earning “surprises” it may be equally stupid to fight the trend of higher share prices. I would suggest you keep the above discussion in the back of your mind so when prices begin to falter you will not be the proverbial “deer in the head lights.”

A review of our investment strategy may be in order before we begin the reading of economic tea leaves. I have established over the last few months that the inflation trade is under way. Assets are inflating, both the commodity and equity markets, because of increasing U.S.$ weakness. Hence, weak economic numbers are actually positive for the aforementioned markets because the Fed can not raise rates and defend the U.S.$ while the economy is still in trouble.

So, how is the economy looking?

 The numbers were even better than the headline suggested as total manufacturing excluding motor vehicle production rose a healthy 0.5%. This includes strong growth in consumer goods excluding motor vehicles, which jumped 0.3%.

There is a drawback to the strong production numbers. We have not seen orders for manufactured goods pick up. If orders stay low we could end up with a big increase in manufacturer inventories. This would cause manufacturers to pull back on their production. If this scenario occurs, manufacturing production will see a “double-dip” as production rises today and quickly falls back in a few months.

Ok, we know from the recent spat of “good” earnings that production is up, but as we discussed this will be negative down the road if consumers don’t wake up.

How is the consumer doing…? Briefing: October University of Michigan Sentiment-prelim 69.4 vs 73.3 consensus. This was a bad miss and could spell trouble. Again I will say, this is good for stock market investing.

One reason for this bad Michigan number may be related to the on going problems in real estate as evidenced by this Fitch story…

Fitch Sees 60% of Current RMBS Borrowers Underwater

“The majority — 60% — of remaining performing borrowers within ‘06- and ‘07-vintage residential mortgage-backed securities (RMBS) bear negative home equity, meaning they are underwater on their mortgages and owe more than their houses are worth.The rating agency noted the number of non-agency borrowers 90 plus days delinquent reached 1.66m in September — the highest level on record. The rating agency expects US unemployment to peak at 10.3% in the middle of next year, further pressuring current borrowers. House prices will ultimately decline another 10% over the next year.”

“I am worried about unemployment and I see an enormous amount of slack. I hear it everywhere,” Federal Reserve Bank of Dallas President Richard Fisher told Reuters in an interview. “I am super-hawkish on inflation. I don’t think that is where the risks are right now,” Fisher said.

His comments will reinforce the impression that the U.S. central bank is in no hurry to raise interest rates,despite guarded optimism that the U.S. economy is healing. Fisher, who takes pride in a reputation as an anti- inflation policy hawk, said the U.S. central bank would not lose sight of its long-term obligation to keep price pressures at bay. But he stressed that this was not the current issue. “Right now that is not the risk. The risk is a disinflationary/deflationary risk,” he said…

Fisher, who is not a voting member of the Fed’s policy-setting committee this year, said it would take “a while” to work off excess capacity in the economy. “I don’t see a ‘V’-shaped recovery. I see a couple of quarters of growth and then the question is where do we go from there. That is the real key question in 2010 and 2011.”

Tags: central bankers, Fed, Fisher, Goldman Sachs, Google, Inflation, intel, interest rates, investment strategy, JP Morgan, new global currency, stock market investing, US$

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• UUP = US$ -> The US$ broke down against a basket of currencies last week and in doing so took out major long-term support. The weakening US$ trend has been going on for a while as the Fed continues to print currency out of thin air in an attempt to stimulate the economy. The latest magic trick and perhaps the last straw has been the monetization of treasury debt. The Fed’s buying of government debt at a time when the Obama administration continues to inflate the deficit has led to a loss of confidence in the US$ as the reserve currency of the world. This corrosion of confidence and abuse of Fed powers is the leading cause of the hyper-inflation trend. Remember, inflation is a currency event not an economic event.
  
• TLT = Treasury bonds -> T-bond prices were down last week which of course results in higher yields. This rate creep up is in its infancy. However, if rates continue to rise, eventhough the Fed is supporting the market, this will be a clear indication that inflation fears are beginning to dominate.
  
• CRB = Commodities -> The commodity complex as a whole sold off last week. Basic materials such as energy suffered declines indicating that an economic recovery is not in the offing. I would not typically read too much into any one week but with the US$ off so much last week one would have expected to see the whole commodity complex higher. Instead, we witnessed a bifurcated commodity complex that screams of stagflation; economically sensitive commodities suffered as inflation sensitive commodities rallied.
  
• GLD = Gold -> The key inflation sensitive commodity rallied strong last week as did the price of silver. Tuesday the 1st was perhaps the most telltale day when the inflation sensitive precious metals complex closed higher in the face of a stronger US$.

The developments of last week could be viewed as troubling if you are not prepared. However, if you are a member of the Rosenthal Capital Management family, then you are all smiles this week. You know we are prepared for this development and in fact welcome the trend.

I feel at this time we are compelled to clear up a little misunderstanding. We should give credit where credit is due. Yes, Ben Bernanke has been able to create “shoots” in the economy. We stand corrected and beg for Ben’s forgiveness for our ever doubting his ability to create “shoots”. We would however, respectfully request he visit his ophthalmologist or perhaps a neurologist to discuss his confusion recognizing colors. The “shoots” that he sees are real but they are GOLDEN not green.

Tags: ben bernanke, commodities, crb, Fed, gold, green shoots, interest rates, precious metals, silver, T-bonds, US Treasury, US$

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President Obama says US may be seeing beginning of end of recession -DJ
Sure, and the emperor was wearing clothes…

ECONX Summary of Fed’s Beige Book Reports suggest that economic activity continued to be weak going into the summer, but most Districts indicated that the pace of decline has moderated since the last report or that activity has begun to stabilize, albeit at a low level….

Amidst all the positive recession-ending talk looms the dark clouds of a weakening Treasury bond market. As the Beige Book illustrates, the pace of economic decline has slowed but not stopped; in order for any recovery to actually gain traction interest rates must remain low.

The Obama administration’s economic policies may be the undoing of his proclamation that the recession end is near. Allow me to explain. Apparently the Administration is employing a very scientific two-pronged approach for economic salvation: 1) If you close your eyes and say ‘the recession is ending’ enough times it will come true. We will call this the Oz method. 2) With your eyes closed, spend like a drunken sailor.

The problem with this brilliant technique is first, closing your eyes and wishing only works for little girls with pigtails and second, excessive spending leads to a rise in interest rates. The conundrum: spend to get out of the recession but spending leads to Treasury bond weakness/rate increases. The real estate situation in this country remains dire and an increase in mortgage rates will re-accelerate the economic decline.

Our job as investors remains precarious as this equity rally continues to pick up steam. We must monitor the conundrum by paying close attention to Treasury bond auctions. Weakness in these auctions creating interest rate creep will be telling signs of trouble to come.

To that end, I will be periodically posting data from various auctions of government debt. Keep a close eye and look for troubling trends.

And then Wednesday…

Briefing: ECONX 5-year Note Auction Results: High Yield 2.689% (2.635% expected); Bid/Cover 1.92x (2009 Avg 2.22x); Indirect Bidders 36.7% (2009 Avg 41.9%)

Previous offering saw $37B, 2.7% yield, with a bid-to-cover of 2.58x and an indirect bidder participation rate of 62.8%.

Tags: bond auctions, interest rates, obama, U.S. Dollar, US Treasury

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