New Avid Trader Home

All articles have been moved to www.avidtrader.com. We have a whole new look!  We hope you enjoy all the new infomation on Avid Trader!

No Time To Be An Ostrich?

by Avid Investor Group

 

A couple of weeks ago we gave what we believe to be the good and not-so-good factors currently impacting the stock market. Our conclusion was that the financial health of our public companies and the opportunity for Washington to leverage that health would bring decent economic data in the coming quarters and provide a spring board for stock prices. The news and stock market action, especially in Europe, for the last week has left that analysis on increasingly shaky ground.

A key data point to us was the market’s reaction to the President’s speech Friday, we felt he said the things that stocks would want to hear, yet the market dropped 2 to 3% across the board. We have noticed that most of the time when the President speaks the market tends to move higher. Some claim the Plunge Protection Team is responsible for goosing the market so as to appear that it supports the administration’s policies and promotes investor/consumer confidence.

Most domestic indices and sectors are clearly sitting on a precipice as depicted by the S&P 500 daily chart here.

The low in early August held for the fourth time on Monday this week. Consolidation patterns like this often continue in the current direction of the market and this chart appears to be headed lower. Most European indices have broken well through their August lows. There are some data points indicating this area may hold, but with the drama attached to the overnight headlines anything can happen. The situation calls for vigilance and flexibility, ostriches may be at risk in a market environment like this.

The recent two year stock market rally (up over 100% bottom to top for the S&P 500) even higher numbers. Is this the start of a Secular (long term) Bull Market? Or have the credit excesses of the last couple of decades left us stuck in a trading range that started fifteen years ago? The last Secular Bull started in 1982 and factors like inflation, interest rates, and taxes all were headed lower. The current environment appears that these components may now be headed higher.

Healthcare Sector

As the baby boomers age it appears they are creating the Right to Work Act for healthcare practitioners. As of July 2009 there were 39 million Americans over the age of 65. About 65 years ago the first baby boomers were born and that 39 million is projected to be 72 million by 2030. That would comprise approximately 19% of the total US population. A recent study revealed that 80% of seniors have at least one chronic health condition requiring ongoing care and 50 percent have at least two. The study predicts that by 2030 six out of ten boomers will be managing more than one chronic condition. What makes these stats even more compelling is that life expectancy from 1950-2004 increased nearly 50%. It may not continue at that clip, but will probably continue to get older. The study and stats above are all provided by the US Census Bureau.

According to the US Department of Health dollars spent on healthcare nationally have been increasing steadily every year. They first topped $1 trillion dollars in 1995 and exceeded $2 trillion ten years later. By 2019 they are expected to reach $4.5 trillion. The youngest and oldest age groups have the highest office visits. The 65 and over age group has shown a dramatic increase in number of office visits.

A decided factor in that increase is due to the number of new therapies coming out of the life sciences sector. In the fourth quarter of 2010 venture capital spending in the categories of biotechnology, medical devices, and equipment represented 23 percent of all venture capital spending, according to Price Waterhouse Coopers. Obviously this data supports the lengthening of our life expectancies. When you look at the growth in chronic diseases like diabetes and obesity the amount of healthcare expenditures could even be higher than are projected.

We find the data above to be very compelling and worth exploring how profits may be made in this sector. Many consider healthcare to be a relatively recession proof industry. It is one of the few sectors to have job growth every year during the recent recession.

Let’s keep our fingers crossed the market can hold the August lows, with our leaders in Washington making some strong, far reaching decisions getting more people back to work and much of the stress and pessimism of the last few months eases. We could sure use a good night’s sleep!

Did You Know

Stock Market Stats - In the last 20 years (1991-2010), the S&P 500 stock index has gained more on a total return basis during the 4th quarter (i.e., October-November-December) than it has during the other 3 quarters combined. The final 3 months of the year have gained +150.9% (total return) vs. a gain of +129.2% for the first 9 months of the year over the last 2 decades. The best monthly performance on a total return basis for the S&P 500 over the last decade (2001-2010) has occurred in April, October or November in 9 of the 10 years. The only year that 1 of these 3 months did not lead the way was in calendar year 2010 when September was the best month. With still 4 months to go in 2011, February’s +3.4% gain is the frontrunner month YTD (source: BTN Research).

Final Thought

“We never really grow up, we only learn how to act in public” – Anonymous

Can You Say QE3?

A couple of weeks ago we wrote that a bottom appeared to be forming in the stock market and a rally was near. We did not expect most of the major indices to rally 7%+ in eight trading days. We went on to say that the earnings season beginning in mid-July would dictate the extent of the rally. This past weekend sovereign debt issues out of Italy dominated the headlines and overshadowing a dismal jobs number on Friday. Our portfolio mantra of vigilance and flexibility is welling up when we look at the current status of several intermediate term charts.

We believe this is one of those times to ask tough questions of your advisor regarding capital preservation strategies. The current news backdrop is not that negative, but the current chart formations are of concern to me. Remember the stock market tends to be a leading indicator that that is often 6-9 months ahead of the good or bad news in the system. What we am seeing right now suggests that at best a consolidation period is ahead and at worst a steep correction. we are going to get a little deeper into the weeds using technical analysis more than we usually do, but feel this is the type of information that can help you make more informed investment decisions. We’ll try not to be too confusing.

The signals we commented upon a couple of weeks ago were from daily charts. The signals we are currently responding to are from weekly charts and they look eerily similar to patterns occurring in late 2007 and early 2008. We’ve written about the MACD before as one of the indicators we use in our work. In the weekly chart of the S&P 500 below, the rally of the last couple of weeks back near to May’s high (some indices did make new highs) while the MACD barely budged higher (red arrows). This is known as a negative divergence and often, not always, leads to a correction. A similar pattern occurred in 2007 that denoted the ultimate top. The negative divergences were combined with head and shoulders patterns, which are also considered to be negative.

If you look closely you can see the right shoulder that formed in late 2007 led to a quick 15% correction. The market tried to rally midyear 2008, but we all know the failure that followed. The similarities in these patterns are clear and I believe caution is key here. Moving to a more conservative position and/or raising cash could be a constructive strategy. A couple of key points to consider; if we take out last week’s highs (S&P 500 1360 area), the rally will probably continue; if we take out the June lows (1250 area) the probabilities of a steep correction expand. Nothing is sure in technical analysis, but preventing a significant loss in a portfolio is always a good thing.

  

The chart of the US dollar is also flashing a warning with our work. Since the stock market bottomed in March of 2009 the dollar has had a fairly strong inverse relationship to the stock market. Most believe the reason for this is that when the dollar falls it helps our large multinational firms export more products at lower prices due to the weaker dollar. The chart below shows the Dollar Index broke a thirteen month downtrend this week. That combined with a positive divergence on the MACD suggests that the dollar could rise for the next several weeks to a few months. If the inverse relationship continues this move would confirm the negative divergence and sell signal that stocks are currently flashing. Looking back to late 2009 the dollar broke a similar downtrend and rose almost 20% in six months. Stocks were down while the dollar rose during that period. 

As we mentioned previously these signals indicate probabilities/possibilities as they do not always play out. In our minds what increases the probabilities are the collective nature of this signal. Most domestic indices, sectors, leading stocks, and foreign indices have similar patterns. The chart below is of the German DAX, which is clearly a leader in Europe economically and from a stock performance standpoint. Because the chart is only a couple of years long (the S&P 500 above is five years) the head and shoulders and negative divergences are easier to see. Strong support for this index is at the break out point last November (green line) and that is about a 12% haircut from current levels. Several European indices have already broken through their June lows. 

Our take from these charts is that there is bad news coming and stocks are warning us about it. We started earnings season Monday and for the next couple of months, several key stocks on a daily basis will report their second quarter earnings. Our guess is those will be okay, but the outlook for the second half of the year will be more challenging than previously anticipated. That would dovetail with the mostly poor economic numbers that have made headlines the last two months. Maybe the issues in Italy and Greece become a domino contagion situation, compromising the large money center banks of Europe and pushing the region into another recession? Maybe it is something that is not on the radar currently? In the fall of 2007 we did not know what sub-prime was. We don’t believe we were alone there.

We have no interest in being a Chicken Little here and this analysis may prove wrong. Again if the S&P 500 breaks through the 1360 level as other indices make new highs we will jump back on the bullish bandwagon Fed head Bernanke and other policymakers want us riding. Until then we are looking out below.

Did You Know

CAN THEY TAKE ALL OF IT? - To rank in the top 2% of all US taxpayers required an adjusted gross income (AGI) level of at least $253,197 for the 2008 tax year (i.e., the last year that tax data is available). This high-income group paid 46% of all federal income tax paid by individual taxpayers in 2008. If every individual taxpayer in this group paid federal income taxes equal to 100% of his/her AGI, an additional $1.633 trillion of federal income tax would have been raised. The Treasury Department estimates a $1.645 trillion budget deficit for fiscal year 2011, i.e., the 12 months ending 9/30/11. Russia implemented a 13% flat income tax rate for individual taxpayers in 2001, why not us? (source: Internal Revenue Service, Treasury Department).

Final Thought

“A man is never more truthful than when he acknowledges himself a liar”

- Mark Twain (probably for politicians)

Economy and Markets Resemble Witch’s Brew?

We work with several interns from local colleges and attempt to help them understand the financial services industry from a number of angles. The business itself, the variety of career opportunities, the economy, investments, politics, and the financial markets are a few of the topics we attempt to share real world information with them. Remembering my own transition from academia to a career and its challenges, we try to give them as much real world experience as we can. We remind them that this tough job market could last a few years and at this point there is probably no such thing as too much preparation.

When we talk about the economy we impress upon them the unprecedented events, factors, and strategies occurring right now. Bailouts, quantitative easing, negative real interest rates, sovereign insolvencies, and burgeoning deficits are some of the dynamics currently colliding. We explain to them that if they can understand how unusual these times are then it might be easier to grasp what a more typical economic/market environment would be like. We have found it can be simpler to understand the playing field by studying the exceptions rather than the rules as many times the exceptions define the rules.

The point of today’s missive is to depict how two important landscapes, our economy and financial markets, are experiencing numerous unprecedented situations and there is a possibility that no one truly knows what the potential outcomes are? We can understand preparing for one or two of them, but when you have several and some of them never unfolding before (QE2), it can shift how portfolios are managed. We have come to the conclusion flexibility and vigilance are the two key components in investing in these curious times.

Let’s start with the economy, just last week our policymakers played a card never dealt before. The International Energy Association (IEA) holds strategic petroleum reserves (SPR) to use in case a crisis unfolds. Only twice in the past have reserves been used, Katrina and the 1991 Persian Gulf War. It does not appear we are currently in crisis mode? With the price of gasoline above $4 earlier this year, it appears a concerted effort to bring the ppg down so consumers have more discretionary income. Another possible intent may have been to send a message to speculators who have been accused of propping energy prices for personal gain. Using energy reserves in this manner is unprecedented.

Most of the feedback on the controversial Fed strategy, Quantitative Easing 2, has been negative as the unemployment rate is stubbornly high and recent GDP numbers were anemic. What most don’t ask is where would we be if they did not do it? QE2 comes to an end this week and we imagine there will be some continuing “below the radar” stimulus from the likes of the Plunge Protection Team, after all the campaigning has clearly started and we are sensing this administration is starting to play economic catch up. Other strategies that we believe you will see in the coming weeks include raising the debt ceiling (pretty much a no brainer), waiving the taxes on funds stuck overseas of our multinationals (Bush did the same thing), possibly drilling in Alaska, and extending the payroll tax holiday. We have to admit that they may have a few more bullets left, too bad they are driven more by the election cycle than our needs.

Here’s a good one, in 2002 Goldman Sachs assisted Greek government officials in developing securities that would hide the true picture of their flailing balance sheet? This was to pass muster with the European Union so Greece could continue to receive loans. Apparently without this help Greece would have had to fess up earlier and bankers may have stopped throwing good money after bad sooner. GS purportedly made $300 million for that piece of advice. Ireland, Italy, Portugal, and Spain look on from a standpoint of where they may begin their negotiations with these European banks. John Stewart did a funny bit on this transaction and caution as usual with him bleeped profanity is involved.

Moving from the economic landscape to the financial markets brings about some similar dynamics. Here there are a few new marbles rolling around in the jar also. High Frequency Trading (HFT), computers trading for pennies and within seconds, supposedly accounts for 60-80% of the daily volume. Another couple of factors that have been around for a bit, but may be pushing their own envelope are naked short selling and the synthetic structure of many ETF’s. Click on the links and they will explain these topics more fully. The point is that these factors, among others, were looked at closely concerning previous market dislocations, especially last year’s Flash Crash. We are still concerned that the regulators have not fully safeguarded the markets against another potentially severe dislocation.

With both the economic backdrop and financial markets experiencing a variety of relatively new phenomena you probably can see the need for vigilance and flexibility. Up until a few years ago most investors owned “good” stocks and mutual funds for the long haul. Few financial advisors shared with them the no progress 1930’s and 1970’s. There are good arguments that we have seen the bottom and are now in a new Secular Bull Market and just as substantive data points that could lead to new lows.

Remember the purpose of this article is to help you make informed decisions, if you are not factoring these issues into your investing strategy you could be making a mistake.

Chart Spotlight

Well that was a little gloomy. As a matter of fact stocks appear to have put in a bottom last week! We avoid using too much jargon in this space, but this signal is so clear we are going to take a shot. Below is chart of the Dow Industrials and indicator we use regularly, the Moving Average Convergence Divergence (MACD don’t ask). As you can see the world’s most famous stock index made a low a couple of weeks ago, rallied for four days and then retested the previous low (green arc). The low last week was not confirmed by the MACD as it held steady (green arrow). This is known as a positive divergence and often depicts a point where the selling becomes exhausted. A rally often unfolds after a pattern like this. What encourages us is that several of the leading indices and sectors have similar patterns and makes for a stronger signal. We believe we rally into the middle of July when 2nd quarter earnings results and forward looking forecasts will dictate the next move. If they are constructive we believe we could go to new highs for the year. 

Did You Know

Women’s Dress Indicator - While watching CNBC last week Todd Schoenberger, Managing Director of Landcolt Trading was interviewed. He has come up with an interesting economic indicator, women’s dresses (and not their length). He claims for the last 25 years sales of women’s dresses has been an accurate economic barometer, when they are strong the economy is good, when they’re weak it is recessionary. His theory is that the mom’s of the household will buy the kids clothing first and only when she feels good about discretionary cash flow will she spend money on herself. He says women’s dress sales are currently strong.

Final Thought

“The only function of economic forecasting is to make astrology look respectable”

-John Maynard Keynes

Plunge Protection Team To The Rescue?

The two issues we penned in May revolved around the vulnerability the equities market was finally showing. An oft quoted Wall Street axiom is ”the stock market climbs a wall of worry.” We cannot remember in the twenty plus years we have followed the market that there were so many things to angst about, and yet nothing seemed to faze the charging bull. North Korea attacking South Korea, a devastating earthquake, tsunami, and nuclear crisis in Japan, the apparent insolvencies of several European countries as well as our states and municipalities, nagging unemployment, Mideast unrest, $4+ a gallon gas, a non-existent real estate/construction recovery and other less than desirable data points were unable to distract the Dow from gaining 2,750 points from September 1st to May 1st.

The fundamental catalyst for the run appears to be growing corporate profits and the cash build up generated from them. Much of the profits were from strong gains in productivity combined with expense reductions, mostly in the form of layoffs. The earnings of the S&P are estimated to surpass the record made in 2006 of $87.72, with most estimates hovering near a $100. What could go wrong?

May was a challenging month for stocks, but the resiliency continued to be evident. The last four days brought another one of those rallies that had me thinking here we go again, as the major indices cut their losses. The S&P 500 lost just a shade over 1% for the month, no big deal. But the first four trading days of June has been a little different story as the S&P 500 has lost over 4% and key support levels have been sliced through like buttah. There is a legitimate concern for a deeper correction as much of the recent economic news might be hinting those earnings estimates might be a little too rosy.

This calls for the work of the Fed’s not so secret Plunge Protection Team. We are surprised that many investors are unaware of this entity and its interesting history. It was created in the aftermath of the 1987 Crash; you know when the Dow dropped over 20%…in a day! The Working Group on the Financial Markets was created by executive order by President Reagan. Members include the Treasury Secretary, Fed Chairman, and the Chairman’s of the SEC and Commodity Futures Trading Commission. The intent was to prevent and repair significant market dislocations.

It appeared the team earned their keep in 1998 when the hedge fund Long Term Capital threatened to bring down the bond market. The story goes that Alan Greenspan was able to convince several large banks to work together to avert a possible financial system meltdown. The strategy worked and we still remember the very scary correction bottoming on October 8th, and the dotcom bubble recommencing its epic run. Greenspan earned the moniker “Maestro” for his efforts, which was also the title of a revealing book written by Bob Woodward of “All The President’s Men” fame.

Many have postulated that the last dozen or so years the PPT has become a tool in the Fed’s arsenal to prop up the stock market at key times by purchasing index futures. The purported intent is to keep investor confidence high which should have a residual effect on consumer confidence. We first came to know of the PPT around the turn of the century and viewed this rumor with some skepticism.

We did start to notice often when the market appeared to be sitting on a precipice or just falling off it, a robust rally would begin and technical support levels would hold and even strengthen. It happened so often that we did a flip flop and become a conspiracist. As the last decade unfolded new reports of the PPT increased and the existence of the group became “sort of” well documented. Former Fed Governor said in the WSJ that it would be more effective to buy futures than flood the system with liquidity and potential spark inflation. We believe there is your smoking gun.

Our guess is that the next few weeks might bring the Invisible Hand of the PPT into the market and a prevention of too steep a correction. Just the fear of the PPT coming into the market can keep the short sellers nervous, off balance, and even out of the picture. We believe the team may actually use the short sellers to their benefit in the following manner; the market is sitting on an important support level and falls through, this will often have the short sellers increase their bets pushing the market down further, the PPT will let this unfold and then begin their purchases pushing the market back above the support level, forcing the shorts to extend the move when they cover, and this strengthens that support level. Hope you were able to follow that. It certainly is no fun being a short seller in that scenario.

The next key data points to focus on are second earnings results due to begin the second week of July. The recent weak economic numbers will probably have little impact on those releases, but the forward look to the third and fourth quarter might be impacted. Couple that with QE2 ending and the PPT may have their hands full this summer. QE3 may become a very hotly debated topic if it coincides with the debt ceiling drop dead date in August and the ramping of the 2012 campaigns.

We sure hope this grand strategy the policymakers are experimenting with has a productive outcome. It seems to me the more they fool with Mother Nature (Mother Market in this case) the more challenging the end result might become. If ever there was a time for bi-partisan leadership from our politicos, this is it (twittering your underwear does not count). Secondly let’s hope the growing middle classes of these developing countries around the globe become mini me American consumers and help us grow our way out of this predicament. It could happen? 

Chart Spotlight 

Below are two leading indices, the S&P 400 Mid Cap and the Russell 2000 small cap index. Both indices have been leaders of the rally the last two years and both made new all time highs earlier this year. As you can see the first week of June took both indices below key support levels as indicated by the green lines. Often times when support levels like this our broken they become resistance levels to attempted rallies. Several other sectors and indices have broken similar support levels intimating that a correction may last the entire summer. A similar pattern unfolded last year and as that 15%+ correction persisted QE2 was hatched. No dull moments here.

Did You Know

Summer Stock Market Data - The 3 summer months (June-July-August) have produced an average loss of 0.6% (total return) for the S&P 500 stock index over the last 21 years (1990-2010). The stock index was up +11.7% during the 3 summer months in 2009 but was down 3.2% during the summer of 2010. Through the end of May 2011, the S&P 500 was up +7.8% YTD on a total return basis. June is ranked 11th out of the 12 months in average performance for the S&P 500 since 1990. Only August (ranked 12th out of the 12 months) has a poorer average stock performance than June. The best “June-to-December” total return performance for the S&P 500 in the last decade (i.e., 2001-10) took place in 2009 when the stock index gained +22.8% over the final 7 months of the year. The worst “June-to-December” result took place in 2008 when a loss of 34.5% occurred (source: BTN Research).

Final Thought

“A fanatic is one who can't change his mind and won't change the subject” - Winston Churchill

Evening Market Update

Stocks Sour on Weak Data, European Debt Anxiety

US equities finished lower to start the trading week as festering eurozone debt concerns and some disappointing economic and earnings reports out of the US hampered sentiment. Technology issues led the decline, along with weakness in commodity prices. A gauge of manufacturing activity in the New York region fell well below what economists were expecting, while homebuilder sentiment remained unchanged at a depressed level. On the equity front, J.C. Penney Co. posted profits that beat analysts’ forecasts, but revenues missed, while Lowes Companies fell short of both earnings and revenue forecasts. In M&A news, Nasdaq OMX Group and IntercontinentalExchange said that they will withdraw their joint proposal to acquire NYSE Euronext, while a consortium of banks and pension funds in Canada announced that they are launching a rival bid for Toronto securities exchange operator TMX Group Inc. Treasuries finished higher.

The Dow Jones Industrial Average fell 47 points (0.4%) to 12,548, the S&P 500 Index lost 8 points (0.6%) to 1,329, and the Nasdaq Composite declined 46 points (1.7%) to 2,782. In moderate volume, 907 million shares were traded on the NYSE and 2.1 billion shares changed hands on the Nasdaq. WTI crude oil closed $2.28 lower at $97.37 per barrel, wholesale gasoline tumbled $0.14 to $2.93 per gallon, while the Bloomberg gold spot price fell $2.10 to $1,491.50 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—fell 0.3% to 75.51.

J.C. Penney Co. Inc. (JCP $37) reported 1Q earnings of $0.28 per share, above the $0.25 consensus estimate of analysts surveyed by Reuters, with revenues rising 0.4% year-over-year (y/y) to $3.9 billion, compared to the $4.0 billion that the Street was looking for. Also, the department store said 1Q same-store sales—sales at stores open at least a year—rose 3.8% y/y, on strong gains in both men’s and women’s apparel businesses, while the steps to manage expenses also aided bottom-line results. JCP raised its full-year EPS outlook. Shares gave up an early gain and finished lower, possibly on concerns that the recent surge in food and energy prices could hurt future profitability.

Lowes Companies Inc. (LOW $25) announced 1Q EPS of $0.34, two cents short of analysts’ forecasts, with revenues decreasing 1.6% y/y to $12.2 billion, below the $12.5 billion that the Street expected. 1Q same-store sales at the world’s second-largest home improvement retailer declined 3.3% y/y. The company said its sales were lower than expected as it faced ongoing economic pressures, unfavorable weather conditions and tough comparisons to last year’s government stimulus programs. LOW lowered its full-year guidance to a level that was below analysts’ estimates. LOW traded lower.

In M&A news, Nasdaq OMX Group Inc. (NDAQ $26) and IntercontinentalExchange Inc. (ICE $2 announced that they are withdrawing their joint proposal to acquire NYSE Euronext (NYX $36), following discussions with the Antitrust Division of the US Department of Justice. NDAQ said the decision to withdraw the offer came as it “became clear that we would not be successful in securing regulatory approval.” Shares of Deutsche Boerse (DBOEF $80) finished nicely higher in Europe following the announcement as the German exchange has already agreed to a merger with NYX. Shares of NDAQ lost ground and NYX was sharply lower, while ICE finished solidly higher.

Elsewhere, a consortium of banks and pension funds in Canada announced that they are launching a rival bid of C$3.6 billion ($3.7 billion) for Toronto securities exchange TMX Group Inc. (TMXGF $45), in an attempt to stymie a previous merger agreement between the Canadian exchange and London Stock Exchange Group Plc (LDNXF $14). The Canadian group said its deal will “secure the future growth and ongoing integrity of the Canadian capital markets.” LDNXF said it remains committed to its bid for TMXGF, which said it will evaluate the new offer, but it will continue to pursue the approval for its merger with LDNXF, per the Wall Street Journal. Both companies finished in the green.

New York manufacturing activity decelerates, homebuilder sentiment unchanged

The Empire Manufacturing Index, a measure of manufacturing in the New York region, slowed in May to a level of 11.90, compared to the estimates of economists surveyed by Bloomberg, which expected a decrease to 19.55, from the previous month’s level of 21.70. The larger-than-forecasted decline came as new orders and shipments slowed, offsetting gains in employment, inventories, and unfilled orders. However, the index remains in expansionary territory depicted by a reading above zero. Also, the report showed the prices paid component rose by more than 12 points to 69.89, exacerbating concerns about inflation. The report is the first major piece of data looking at manufacturing conditions in May, and Thursday gives us a look at activity in the Mid-Atlantic region in the form of the Philadelphia Fed Manufacturing Index, forecasted to improve from 18.5 in April to 20.0 in May.

Meanwhile, the  NAHB Housing Market Index, a gauge of homebuilder sentiment, remained unchanged at 16 in May—the sixth month out of the last seven that it has posted this level—with any reading below 50 indicating more respondents feel conditions are poor. The index remained unchanged as the future sales component declined to offset improvements in present sales and prospective buyers’ traffic components of the report.

Treasuries ended modestly higher following the data. The yield on the 2-year note was down 1 bp to 0.53%, the yield on the 10-year note lost 3 bp to 3.15%, and the 30-year bond yield was 3 bps lower at 4.28%.

European debt leaders approve Portugal bailout

Festering debt uneasiness hampered sentiment overseas as European leaders began meetings to discuss how to handle the fiscal problems facing the recently bailed out peripheral nations of Greece, Ireland, and Portugal. During the meetings, and after the close of European markets, the finance ministers approved Portugal’s 78 billion euro ($110.8 billion) rescue package in a unanimous vote. The two bailout funds, the European Financial Stability Facility (EFSF) and the European Financial Stabilization Mechanism (EFSM) will each front one-third of the package, with the International Monetary Fund (IMF) covering the remaining part. The finance officials dubbed Portugal’s austerity measures as “ambitious but credible.” However the gathering was clouded by news of the weekend arrest of IMF Managing Director Dominique Strauss-Kahn on charges of attempted rape. Strauss-Kahn, who was expected to be a leading candidate for the presidency of France, was arraigned today and was denied bail.

In economic news across the pond, eurozone core consumer prices—excluding food and energy—came in hotter than expected in April, while the eurozone trade balance swung back to a surplus. Elsewhere, a read on UK home prices rose for May.

In Asia, the anxiety toward the euro-area debt crisis also soured sentiment, along with uncertainty regarding the health of the global economy. Australia reported that home loans in the nation unexpectedly fell in March, while Goldman Sachs downgraded its outlook on stocks in the Asian nations of Japan and South Korea. As well, monetary policy tightening concerns were exacerbated by Hong Kong raising its inflation and economic growth forecast following Friday’s stronger-than-expected 1Q GDP report out of the nation. On the plus side, Japanese machine orders rose 2.9% m/m in March, compared to the 10% drop that economists forecasted.

In economic news out of the US’ neighbor to the north, Canada reported a 1.9% m/m increase in manufacturing shipments during March, above economists’ forecasts of a 1.7% rise and following a revised 1.8% decline in February.

Readings on housing and industrial production out tomorrow

Tomorrow’s US economic calendar begins with housing starts, expected to rise 3.6% m/m in April to an annual rate of 569,000 units after rising 7.2% in March, while building permits, one of the leading indicators tracked by the Conference Board as it is a gauge of future construction, are forecasted to increase 0.9% m/m to 590,000 units after jumping 11.2% in March.

Later, just before the market open, the industrial production report will be released, expected to show production gained 0.4% m/m in April after rising 0.8% in March, while capacity utilization is forecasted to increase to 77.6% from 77.4%.

International releases include Japan’s machine tool orders, UK CPI and retail price index, the German Zew Economic Sentiment Survey, Chinese foreign direct investment, and the Reserve Bank of Australia releases the minutes from its last monetary policy meeting.

Morning Market Update

Stocks Climb Amid China Data and Eased Euro Debt Concerns

The US equity markets are moving higher in early action, aided by a better-than-forecasted Chinese trade report, along with some relatively eased worries regarding the threat of a restructuring of Greece’s debt. Treasuries are modestly lower amid the advance in stocks, and after reports that showed import prices were hotter-than-forecasted and small business optimism deteriorated by a larger amount than expected, ahead of the release of wholesale inventories. Meanwhile, M&A news is helping boost optimism, highlighted by the announcement that Dow member Microsoft Corp reached an agreement to acquire Skype Technologies SA for $8.5 billion in cash. On the earnings front, Activision Blizzard Inc reported stronger-than-estimated earnings and revenues, while Dean Foods Co topped the Street’s profit expectations despite higher dairy commodity costs. Overseas, Asia was mixed following the Chinese data, while Europe is nicely higher as earnings are helping support sentiment.

As of 8:48 a.m. ET, the June S&P 500 Index Globex future is 5 points above fair value, the Nasdaq 100 Index is 10 points above fair value, and the DJIA is 35 points above fair value. WTI crude oil is $0.57 lower at $101.98 per barrel, and the Bloomberg gold spot price is down $1.68 at $1,512.05 per ounce. Elsewhere, the Dollar Index—a comparison of the US dollar to six major world currencies—is down 0.1% to 74.59.

In M&A news, Dow member Microsoft Corp. (MSFT $26) announced that it has reached an agreement to acquire internet phone company Skype Technologies SA for $8.5 billion in cash, including debt. MSFT said Skype will support its devices like Xbox and Kinect, Windows Phone and other Windows devices, while Skype users will be connected to Lync, Outlook, Xbox Live and other communities.

Activision Blizzard Inc. (ATVI $12) reported 1Q earnings ex-items of $0.13 per share, above the $0.08 that analysts surveyed by Reuters had expected, with revenues increasing 5.7% year-over-year (y/y) to $755 million, versus the $668 million that the Street had expected. The video game publisher said its results were driven by digital sales and the continued strength of its Call of Duty and World of Warcraft franchises. ATVI increased its full-year guidance.

Dean Foods Co. (DF $11) announced 1Q EPS of $0.14, compared to the $0.06 that analysts had estimated, as revenues rose 3% y/y to $3.05 billion, versus the $3.07 billion that the Street had anticipated. The company said revenues were aided by strong sales growth at its WhiteWave-Alpro segment and the pass-through of higher overall dairy commodity costs that were partially offset by soft volumes at its Fresh Dairy Direct-Morningstar business. Looking ahead, DF said volumes across the conventional milk industry are expected to “remain soft” over the coming quarters and it has stepped up its agenda to reduce costs. Also, it is focused on pricing to offset inflation through efficient pricing mechanisms.

Import prices rise, small business optimism declines, wholesale inventories due out later

The Import Price Index rose 2.2% month-over-month (m/m) for April, compared to the expectation of economists surveyed by Bloomberg, which called for the index to increase by 1.8%. Year-over-year, import prices are higher by 11.1%, versus the 10.4% forecast of economists.

In other economic news, the NFIB Small Business Optimism Index declined by a larger amount than expected, decreasing from 91.9 in March to 91.2 in April, compared to the expectation of economists, which called for the index to decline to 91.8. The decrease came as the number of firms reporting expectations of higher sales dipped, along with plans to increase capital spending, while those planning to increase inventory declined into the red and expectations of a better economy fell further into negative territory. The declines in the above components offset a gain in expectations of higher selling prices, while plans to hire remained unchanged.

Treasuries are lower in morning action following the data, with the yields on the 2-year and 10-year notes, along with the 30-year bond increasing 1 bp to 0.56%, 3.17%, and 4.32%, respectively.

Later this morning, the US economic calendar will bring the release of wholesale inventories, forecasted to increase 1.0% m/m in March, after rising by the same amount in February.

Europe rebounds on earnings and China data

Stocks in Europe are nicely higher in afternoon action, led by basic materials and industrials, following some favorable earnings reports and some stronger-than-expected trade data out of China. Shares of InterContinental Hotels Group Plc. (IHG $21) are solidly higher after the parent of Holiday Inn reported a sharp increase in earnings, aided by a rebound in travel in the Americas. Moreover, Deutsche Post (DPSTF $19) is moving nicely to the upside after the air and sea freight carrier posted better-than-expected profits, while shares of Solvay (SVYSF $115) are sharply higher after the chemical and plastics maker reported earnings that topped forecasts and it issued a favorable outlook. Meanwhile, financials are higher to aid the advance in the region as fears of a debt restructuring in Greece are easing, though the debt-laden nation is expected to conduct a public debt auction later today.

The advance across the pond comes even amid some disappointing manufacturing data in the region, with France reporting that its manufacturing and industrial production unexpectedly fell in March, while growth in Italian industrial production rose at a smaller-than-estimated pace. However, a read on UK home prices unexpectedly improved.

The UK FTSE 100 Index is gaining 1.3%, France’s CAC-40 Index, Germany’s DAX Index, and Italy’s FTSE MIB Index are increasing 1.4%, while Greece’s Athex Composite Index is trading 1.5% to the upside.

Asia mixed following China trade data

The equity markets in Asia finished mixed, with the Shanghai Composite Index rising 0.6% following a report that showed China’s trade surplus widened by a much larger-than-estimated amount, fueled by the nation’s exports outpacing imports in April. The report precedes tomorrow’s data on inflation, industrial production, and retail sales. Volume was lighter than usual in today’s trading session, with markets in Hong Kong and South Korea closed for holidays. Elsewhere, Japan’s Nikkei 225 Index rose 0.3%, helped by a solid gain in shares of Toshiba Corp. (TOSBF $5) after the chipmaker forecasted a steep increase in full-year profits. However, Australia’s S&P/ASX 200 Index declined 0.7% despite the data out of China and a separate report that showed the nation’s trade balance swung to a surplus in March, and India’s BSE Sensex 30 Index declined 0.1%.

Is The Market Fooling The Masses Again?

Several years ago we discovered I had a tendency of not wanting to admit we were wrong and found it stood in the way of understanding the situation we were engaged in. We spent more time defending and spinning our initial conclusion rather than quickly admitting our miss take. The stock market had something to do with the lesson as we found arguing with the market was hazardous to our wealth. The phrase “It is okay to be wrong, it is not okay to stay wrong” has made an impact on our learning curve personally as well.

We found the reason we were resistant to admitting we were wrong was that we thought others would think lesser of us, our critical thinking skills, and our credibility. After further review we found that the quicker we admitted a mistake the quicker the more relevant data was revealed. So the irony of the situation was that our critical thinking skills were actually being impaired because of our resistance to admitting we were wrong. The ego can play some interesting games and weave tangled webs, often below the radar.

Late last summer found the markets struggling and some less than stellar economic numbers being released. We were fairly convinced that the stock market would at best struggle as the headwinds of unemployment, state/federal/consumer/European budget deficits, and a host of other dynamics would thwart any decent rally. Wrong! Stocks took on the look of the Pamplona bulls, running through obstacles (negative news) with little respite. Outside of a short trough break in November the left to right 45 degree angle was nothing short of impressive.

Many, including ourselves, thought that the resiliency was due to the Fed’s QE2 strategy (providing a fire hose of liquidity) and soon that would end along with the rally. It is still a possibility, but in our estimation the constructive/productive nature of this equity rally has forced the question “Is this the start of a Secular Bull Market?” The last Secular Bull Market started in the summer of 1982 and most believe ended in the spring of 2000. The rally that started with the Iraq war in 2003 and ended with the Sub-Prime debacle in 2008 was considered a Cyclical Bull Market. Many still consider the current two year rally a Cyclical Bull and there will be another shoe to drop before we fully exhume the excesses of the past few decades.

We touched on this subject a while back and provided a table which showed the distinctions in several financial/economic factors that were in place in 1982 and recently. The few that stand out most notably to us are first interest rates, back in 1982 mortgage rates were above 15% and now they are below 5%, Treasury yields have similar spreads. Next was inflation; the seventies produced inflation rates that maxed out in the high teens, current inflation rates are less than 2%. Tax rates were significantly higher when Reagan took office, with the highest bracket near 70% on a marginal basis, and his administration reduced them considerably (and subsequently took back about half of them). Rates are currently averaging in the mid-thirties and we are not sure you can find anyone who thinks they are headed lower. These do not appear to be the dynamics that are the seeds of a Secular Bull Market. So what factors could be the impetus of a new Secular Bull?

Before we address that question we will say that there is a decided larger group that believes the economy and the markets face severe headwinds as compared to in 2007. Back then the worrywarts were dismissed summarily as being sour grape-ish because they missed the real estate boom. With only anecdotal evidence it appears to us now that the numbers have been reversed with more worrywarts than those with a constructive outlook. Remember the market’s tendency to make the majority wrong.

So if this is the early stage of a Secular Bull Market what might be the economic drivers? The most compelling demographic group we see in the current landscape is the growing middle class of the dozens of developing countries around the world. They are certainly attracted to the western style of life, which has been largely shaped by democracy and capitalism. Most economists will tell you that growing middle classes are economic engines. The decided advantage that this group has versus the growing US middle class in the latter half of last century is the access to incredible new technologies. The technology dynamic might be our economic savior as we provide the goods and services that help propel the economies of the developing nations. Could this overcome our interest rate, tax, and inflation issues?

Clearly quite a bit of conjecture here, but recent market action challenges us to step outside our cautious box. We subscribe to a fairly well known newsletter writer who has been more cautious than me the last several months. His latest missive continues to point to the headwinds and how a deep correction and possible crash will eventually occur. Unfortunately he gives no explanation for how and why he has been wrong for the past year. He may eventually be right (although we cannot imagine anything alarming occurring in the 3rd or 4th year of the Presidential Election Cycle), but we think he could benefit immensely if he would explain to his readers why he has been inaccurate.

If you have been cautious about investing in the stock market of late it is completely understandable considering the past decade. With the recent action this might be a decent time to re-evaluate your portfolio and determine if your cautiousness has created some lost opportunities? Certainly in the short term the information below probably points to higher prices, but then again we could be wrong.

Chart Spotlight

We mentioned above that several foreign markets have constructive chart patterns similar to the US indices. Below left is the chart of an Exchange Trade Fund representing an index of emerging growth countries (EEM).Last week the ETF broke cleanly above a six month base, a often very bullish pattern. The chart below is one that goes a little deeper in the weeds technically than we normally like to go in this space. It is of the New York Stock Exchange Summation Index Stochastic indicator (red/black double line) with the S&P 500 behind it. We do not want to get too much into details but what we are interested in showing is the relationship of the NYSI Stochastic to the S&P 500. As you can see each time the double line bottomed and turned around (green arrows), it was the start of a multi-week rally for the S&P 500. This indicator bottomed and turned up last week. The indicator does not work all the time, but since stocks bottomed in March of 2009 it has been a relatively reliable data point.

Did You Know

AND BORROW WE DO - The yield on the 10-year Treasury note was 3.29% on 12/31/10. The yield on the 10-year Treasury note was 5.12% on 12/31/00. Thus, for the same annual cost of money that our government would have paid a decade ago, we can borrow +56% more money today than we did 10 years ago. The US government paid $1 billion of interest expense on its Treasury debt every 31 hours during the month of February 2011. Total consumer credit nationwide (i.e., consumer debts excluding home mortgages and home equity loans) was $2.412 trillion as of 1/31/11, $35 billion less than the national total of $2.447 trillion as of 1/31/10. Although the $35 billion reduction sounds significant, it is equal to only $311 of debt reduction for each of the 112.5 million households in the country today. (source: BTN Research).

Final Thought

“Sometimes the questions are complicated and the answers are simple” – Dr. Seuss

Cyclical Or Secular: The Bull-Bear Debate?

In our last issue we wrote that the constructive action in the US equity market, as well as several other foreign bourses, appeared to possibly be the beginning of a new secular bull market. Secular in this case means long term although the market does appear to have religious implications at times.

Some of the dynamics have changed since the end of 2009, but the gist of the comparison is still valid. One of the more glaring factors is interest rates. The reason for hat outsized mortgage rate was Ronald Reagan’s request of then Fed head Paul Volcker to raise the fed funds rate to 20% (it now lies at 0.25%) to whip the double digit inflation that began in the seventies.

Often times it is not where rates are, but where they are headed that creates business activity. As those high rates began to fall they became economic fuel for the baby boomer generation. Below is a long term chart of the 30 Year Treasury Yield which you can see dropped from 14% in 1982 to a low of near 2.5% at the end of 2009. As interest rates fall bonds rise and this has clearly been a 30 year bull market for bonds. There is much talk currently that the blue trend line is about to be broken and the bond bull market will end. We tend to disagree as we feel at some point the Fed will redirect its energy from inflating assets to keeping rates low, as Japan did in the 90’s in an attempt to spark a struggling economy. Did you know that the Nikkei 225 is at the same level it was in the mid 80’s? No progress for 25 years! Now that is a secular bear market.

 

Reagan also instituted tax cuts for individual and businesses with the top bracket dropping from 70% to 50%. With the budget issues of the federal and state governments tax cuts do not appear to be on the horizon. Look at the divisive nature keeping the Bush tax cuts created for Congress and the country late last year. Reagan also reduced government spending and government regulation during his tenure. As I entered the investment world later in the eighties the outstanding federal debt was a constant concern for investors at 40-50% of GDP. Today our outstanding debt nearly matches the annual GDP of the nation.

Another hurdle for the secular bull to overcome is the aging of the baby boomers. This group born in the fifteen or so years following WWII has been the most dominant demographic group in our country's short history, maybe in world history. As they entered the workforce the role women played as homemakers gave way to two-income households. The middle to upper middle class grew extensively in numbers and productive employment years to a period where they stop accumulating assets and begin taking distributions from them. Generations X and Y are smaller in size and create the concern that their contributions to Social Security will not cover the benefits the Boomers are penciled in to receive.

So the table argues that this is a cyclical bull market within the confines of a secular bear market. As we have mentioned consistently in the past the last thing you want to do is tell the market what it is going to do. It is okay to converse/write about possibilities, but absolutes tend to get you in trouble. If this is the beginning of a new secular bull what dynamics will replace a productive baby boomer generation, falling interest rates, and tax cuts?

Three things jump out at us 1) is the growing number of developing nations in the world and their growing middle classes. The ability for them to mimic the learning curve we developed and refined over the last couple of hundred years around technology, infrastructure, policy making, resource utilization, etc. and actually improve upon them could bring a world where they eventually out consume us. This group could be the buyers of our goods and services that replace our falling domestic consumption. 2) The financial crisis and attendant recession forced corporations into an increased efficiency mode which involved fewer people doing more work. This is a key factor in analysts estimating all time record S&P 500 earnings for 2011. If this productivity boom is a new paradigm it could impact profit margins and the bottom line for several years. 3) An innovation boom involving the internet, wireless, and other technology could leverage the previous two factors, maybe exponentially. Hard to tell the impact hundreds of millions of people becoming technology literate will do to the world economy. We do not remember many experts predicting the dotcom boom and maybe there is another “under the radar” technology explosion in the wings. Just hope it ends better than the dotcom thing did.

We believe that at some point this year or early next the secular bull market question will be answered. With the events in Egypt this past week the financial crisis hangover appears to be lingering if not intensifying. We know one thing for sure is that the world’s financial and economic policymakers/leaders have their work cut out for them. It does appear to be one grand experiment with few dull moments.

Chart Spotlight

We have written regularly for the past decade about manipulation that occurs in our markets. Early last decade much of what we and others wrote about this topic was summarily dismissed as typical conspiracy conversation. The last few years have pulled a few of the layers back from the onion revealing some of the funny business that appears to have gone on, a good crisis has a tendency to do that. Last Tuesday a relatively odd thing took place in the stock of IBM (dark line on chart). About an hour before the close with the stock trading in the $161 area, it all of a sudden traded above $164 (thin line in oval) for no apparent reason. Is it possible that move was enough to spark a computer generated program trade in the S&P 500 futures driving them up several points in short order? There has been no hard evidence that the IBM trade ignited the S&P rally, but it sure appears fishy. This may seem inconsequential, but adds to the growing evidence in our minds that the market is not always a level playing field. Last May a few days after a very constructive multi-month rally (not unlike the last few months) the Flash Crash (a thousand point intraday Dow drop) occurred. It is situations like this that lead us to believe that the regulators may not be able to prevent another one of these anomalies from occurring. Hope we are wrong.

  

Did You Know

Housing Numbers - $23 billion of adjustable rate mortgages (ARMs) are expected to be reset from their initial interest rate in January 2011, the smallest monthly total that will be reset nationwide in 2011. The peak amount of resets this year will occur in August 2011 when $40 billion of ARMs will end their initial rate period, i.e., the length of time that the original ARM interest rate remains unchanged. 50% of the 75 million homeowners in the USA either have an outstanding mortgage balance on their primary residence that is less than 50% of their home’s current fair market value (e.g., mortgage debt of less than $100,000 on a $200,000 home) or they have no outstanding mortgage debt at all. 1,046,762 homes were seized by lenders in calendar year 2010 as a result of foreclosure, an average of 2,868 per day. There are 75 million homeowners in the USA, 24 million of which do not have any mortgage debt on their homes (source: RealtyTrac, Census Bureau).

Final Thought

“It is amazing what can be accomplished when no one specifically gets the credit” –

John Wooden…probably speaking to Congress