Weekly Recap & Outlook – 07.17.09

Tower Private Advisors

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  • Super strong stocks
  • Earnings season gearing up
  • Economy as an alphabet

Capital Markets Recap

wro1As the accompanying chart shows, markets were exceedingly strong this week.  Better-than-expected earnings from most (80%) companies were supported, in part, by a big drop in first-time jobless claims and other less-bad-than-expected (see below.)

Does all of this just not make sense to you?  No, I’m not talking about you having trouble with the highly-technical language herein–that last word being an example.  Instead, does it not make sense to you that stock prices are up by 39% since the beginning of March, or that prices were up by 7% or more in this week, alone, or that inflation is subdued? After all, the President, aided and abetted and Congress, is spending money faster than the proverbial intoxicated seaman, your neighbor is out of work, and so much else seems wrong with the world, not to mention here at home.  What’s more, you’re struggling with the notion that eventually the dollar might be replaced as the world’s standard of exchange, and we might take second place in the global pecking order behind China.  Something’s wrong here.

You’re right, and it just might be you.

There is rhyme and reason. Consider March 6, Armageddon Day, when it didn’t seem like things could get any worse.  You wanted to never see another stock/fund.  Lots of folks sold theirs that day.  That produced a situation where a spring was pushed down to the point where a lack of further sellers and the slightest glimmer of good news produced a bounce in stocks.  Since then, we’ve seen further improvement in–if in no other way than in being less bad–folks’ gloomy outlooks for companies, sectors, and the economy.  An economy, which could be idealized as an “S” laid on its side, goes through cycles, booms and busts, growth and contraction.  Always, the change between those phases of the cycle include a perfectly flat line, and until then the line declines but at an increasingly more modest rate.  We’re beginning to see that with many indicators, some of which are mentioned below; the flatness is visible.  Oh, and did I mention that investors are under invested.  Mutual fund managers and other folks raised cash late in the Armageddon phase and were reluctant to jump back in, only to look stupid, again.  As a consequence, every glimmer of hope brings a bit more of that cash back into stocks.

My guess is that if you’re overly pessimistic on the outlook for the economy and stocks for the next month and a half, you’re being too pessimistic.  Recent dispatches of this missive warned of impending weakness, and stocks declined, reaching the levels of May 1, which was the date when we entered a new range of trading.

Something’s wrong here, and it just might be your timing.

We are not enthusiastic on the outlook for stocks and the U.S. economy beyond the short term.  The U.S. is building up more of the same imbalances that got us into the housing problem, the credit crunch, and this recession.  The only difference now is that while the consumer has hunkered down, saved more, and paid off debt, Uncle Sam has piled on the debt, and is doing so rapidly.  There will be a day of reckoning, and I reckon it’ll manifest itself in one or more of the following developments:  1.) high to very high inflation; 2.) high to very high taxes; and 3.) a devaluation of the dollar.  But, those developments are not likely to emerge for some time yet, as in next year and beyond.  It will be critical to be prepared for that time, but until then it’s a function of expectations, sentiment toward stocks, and a largely-underinvested public, especially money managers who are measured against a broad but imperfect market index or two.

Top Stories

The story of the week is earnings, as we enter the second week of the second-quarter earnings reporting season.  This week, 34 of the 500 companies in the S & P 500 reported Q2 earnings.  All told, the average year-over-year growth for the 34 companies was -24.63%, with Industrials (-46.44%) and Financials (-45.23%) having the worst showing.  79% of the companies reporting showed results that were better than expected; these are called positive surprises.  Seven of the 34 produced worse-than-expected results.  Materials (2 companies reporting) had only positive surprises, as did Consumer Discretionary (6) and Health Care companies.

Because the market has a tendency to adopt a what-have-you-done-for-me-lately attitude, there is not a very strong correlation between surprises and performance, as the chart below indicates.  In it, I’ve taken the 34 companies that reported this week–minus two outliers whose earnings were negligible, and plotted their price changes for the week against their surprise percentage.  This is a faulty measure in that the companies reported throughout the week.  That may account for part of the reason that the R-squared, the portion of the return explained by the surprise, is so low, at 3.76%.


Regardless, as a whole, the market liked the earnings action, judging by the results at the top of this page.

At the sector level, performance this week was largely in line with Beta (β)–or at least perceived Beta–as the table below shows.


In company specific news, the following caught my eye from a look back at the week.  YUM Brands, which is basically KFC, Taco Bell, and Pizza Hut, said that its same-store sales might come up short.  In a case of what-have-you-done-for-me-lately, the company beat its estimates by 15.21%, but saw its shares fall by 5.41%.  YUM is a classic China-growth story, as we’re told that KFC is the hottest thing there since fried chicken.  Goldman Sachs, not terribly concerned about raising the ire of Congress and Barney Frank, reported Q2 earnings of $2.9 billion.  Most other banks did similarly well, including JPMorgan Chase ($0.28/share v. $0.046/share expected) and Bank of America ($0.75/share v. $0.183/share expected).  Citigroup was the worst of the too-big-to-fail group (-$0.61/share v. $-0.332/share).

General Electric disappointed investors with poor results in its industrial divisions, although GE Capital did better than expected.  Googlereported a slowing in internet advertising.  On the other hand, IBM beat its estimates by 15% and saw its shares increase by 10.9%.

Earnings season is just beginning.  Next week we’ll see the results of 147 companies of the 500 in the S & P 500.  They’ll represent a broader swath of the economy and give us a better idea of how the rest of the year might shape up.

There was a reminder this week that we’re not out of the credit crunch woods.  CIT Groupis a lender to consumers and businesses.  It receive a couple of billion dollars worth of government largess in the throes of the credit crisis.  It appears, however, that the company is not too big to fail, as the FDIC has refused to insure its debt and the company is scrambling to find capital.  Meanwhile, the vultures are circling; for example, JPMorgan Chase is apparently purchasing the company’s factoring arm at, one would assume, a good price.  As of yesterday, Credit Default Swaps, which could be used to insure against default on the company’s debt, were selling at 50% of face value.  In other words, it would cost $500,000 to insure against $1 million of debt.  While a default by CIT would send countless small businesses scrambling for other forms of financing, the markets seemed to shrug off the possibility of serious consequences.

Nouriel Roubini, along with folks like Robert Shiller, is one of a big handful of commentators who have been, for some time, raising alarms about credit, housing, stocks, the economy, and the fate of the goggly-eyed merganser pigeon.  The news outlets have, therefore, been quick to pick up on anything that might be seen as positiveusing the logic that when the uber-bears turn bullish it’ll truly be bullish.  Thus, the Bloomberg headline yesterday:  “Roubini Says U.S. May Recover This Year, Need Additional Stimulus in 2010.”  Mr. Roubini, who is a professor at the Stern School of Business at NYU, fired back with a 5:07 PM missive, in which he said (mine is the orange highlighting; links should work):

“It has been widely reported today that I have stated that the recession will be over “this year” and that I have “improved” my economic outlook. Despite those reports – however – my views expressed today are no different than the views I have expressed previously. If anything my views were taken out of context.

“I have said on numerous occasions that the recession would last roughly 24 months. Therefore, we are 19 months into that recession. If as I predicted the recession is over by year end, it will have lasted 24 months with a recovery only beginning in 2010. Simply put I am not forecasting economic growth before year’s end.

“So, yes there is light at the end of the tunnel for the US and the global economy; but as I have consistently argued the recession will continue through the end of the year, and the recovery will be weak and at risk of a double dip, as the challenge of getting right the timing and size of the exit strategy for monetary and fiscal policy easing will be daunting.

Alan Blinderis a former Fed Governor and is now a professor of the dismal scientist, and judging by a headline on the Bloomberg is displaying an eponymous lack of understanding when he says “Blinder Says Fed May Raise Rates in First Half of 2010 as Economy Recovers.”  Now, we do a lot of reading of some really smart folks and firms and have yet to see a robust enough estimate of 2010 growth to call for Fed tightening.  Unless the Fed needs to pull a Paul Volcker like screw tightening on inflation,  there will be no reason for tightening up any monetary policy.

Lastly, if you wonder whither oil, you might want to consider the viewpoint of a Canadian professor who says that the black gold could be headed for $20/bbl, which would be an elixir to the global economy and consumer balance sheets.  His reasoning is that with 1) two million more barrels of oil produced today than are needed to clear global demand; 2) the excess having gone into storage (e.g. floating tankers, salt domes, etc.); and 3) slack demand for fuels, producers will soon tire of paying storage costs and will bring the oil to market regardless of price.  At the height of, and on the way to $140+/bbl. there was a lot of talk about peak oil, which is, technically, not a running out of oil, but a decline in the global production rate.  Now, it seems, we’re looking at a situation of peak storage.  You can find the easy-to-read story by clicking here.

This Week

Producer Price Index data wasn’t kind to the dismal scientists.  Instead of a +0.9% pop in headline rate, it was +1.8%; at the core level (excluding food and energy) economists expected +0.1%, while the actual figure was +0.5%.  On a year-over-year basis, wholesale prices are down by (-)4.6% at the headline level, and, revealing that the deflation has been of the food and energy sort, 3.3% at the core level.  Consumer Price Index data were much kinder to economists, with most of their guesstimates close to right on.  Headline prices down by (-)1.4% over the last year, while if you’re one that doesn’t need food or energy, prices are up by 1.7% over the past year.  The takeaway from these series is that inflation is not yet rearing its ugly head, although it’s all but inevitable over the next several years.

There were some surprises in the week’s economic releases.  The Empire State Manufacturing survey from the New York Fed improved from a reading of -9.41 to -0.55, whereas economists expected -5.00.  That puts the year-over-year change in positive territory for the first time since 2007.  Industrial Production contracted less than expected (-0.4% v. -1.1%), and Capacity Utilization fell less than expected.  Capacity Utilization is at an all-time (post 1967) low, although a graph of it looks like a roller coaster which is beginning–only just–to flatten out.  The good news is that there haven’t been many false starts in the past.  When the graph turns up, the worst has usually been in the rearview mirror, and speaking of that market wiseguy, Dennis Gartman, announced yesterday that the recession is over because of the downward spike in Initial Jobless Claims, which fell by 43,000 to 522,000.  (Last week’s figure, however, was revised upward by 4,000).  That flummoxed economists who looked for 553,000.  It didn’t faze us one bit.  Our complex econometric model predicted 519,000, which isn’t a shabby showing.  Here’s the comment from last week.

We, here at Obvious Insights, are much more cool headed, if considerably lower paid, yet as much as we’d like to call that a one-timer, our model dictates that we follow it, so we forecast a sizzling 519,000, for a staggering drop of 46,000.  Probably explains some of the lower-paid stuff.

From a high of 674,000 at the end of March the series has fallen by 22.6%.  Our Ned Davis Research service says that “adjustment factors around annual auto-industry layoffs are at play.”  Continuing Claims, which measures the number of folks continuing to claim unemployment insurance benefits, fell by 9.3%, although because unemployment insurance expires, it’s impossible to determine from the number alone whether it’s a result of people finding jobs or losing benefits.

Housing data was largely positive this week.  Mortgage Applications crept up a bit (by 4.3%), but homebuilders surveyed in the monthly NAHB Housing Market index were a bit more enthusiastic than they were in June.  That strength was based on Current  Single Family Home Sales and Prospective Buyer Traffic but was tempered by lower Expected Single Family Home Sales. Released today, Housing Starts(582,000) were up by 9.8% over economist estimates and by 9.4% over May data.  Before sounding the all clear, it’s important to put the data into the context of a longer time-frame, and, accordingly, new home starts are 46% below the level of a year ago.  It will likely be at least November when we can look forward to a positive year-over-year comparison.  Building Permits (563,000) rose by 8.7% from May and 7.4% over what economists had expected.  The downside of this happiness is that it will cause home inventories to rise absent an increase in demand for new homes.  At the end of May, new home inventories stood at 10.2 months’ worth.  Economists expect that, on July 27, New Home Sales for June should tally 350,000.

On Wednesday, the minutes of the Federal Open Markets Committee’s June 24 meeting were released.  Here’s a Wordle picture of the official statement.


Next Week

Not much this week.

MondayLeading Economic Indicators are announced.  This index is comprised of a number of indicators, which are categorized as Leading, Coincident, and Lagging, based on their historic correlation with economic activity.  Further, they can be viewed as engineered (e.g. money supply) or non-engineered (jobless claims).  Naturally, the Leading variety gets the majority of the attention, but economists and other like-minded folks also look at the ratio of Coincident:Lagging indicators, the so-called Co/Lag ratio; it also has good predictive ability.  What’s more, it appears to have turned up, with few instances of false starts.  According to Ned Davis Research, the median lead time, from trough to end of recession, has been three months.  To allow for the extraordinary nature of this downturn, and marking time from this observation–assuming that Monday’s release doesn’t turn the indicator back down–it’s probably safe to say the economy exits recession in the fourth quarter.

Recession means the process of receding, so the recession ending means that output ceases to recede, or decline.  It doesn’t mean the economy begins to recover in a robust fashion.  If you haven’t noticed, there are a lot of letters tossed around, as in “V” or “L” or “W”, to describe the shape of the economy. A V-shaped recovery would be rapid and commencing immediately; L-shaped describes a plunging economy that doesn’t recovery; and so on.  If forced to choose a letter of the alphabet, common sense ruling out such incomprehensible recovery patterns offered by “K” and “R” and the like, I’d go with U-shaped, wherein the economy plunges, bottoms out (we’re seeing this now with the improvement in the second derivative, or green shoots–take your pick), and then picks up after perhaps a prolonged period of sideways, very modest growth.

Wednesday – the broadest measure of U.S. home prices, the Home Price Index, from the Federal Housing Finance Agency, is released.  It is expected to have declined  by (-)0.2% in May.  As usual, it will present pockets of weakness and strength, broken down as it is into nine categories–bound to be some strength somewhere.  This will be the quarterly report, which will also include monthly data.

Thursday - Initial Jobless Claims are announced.  Economists expect claims to have stayed unchanged–their estimates that is–at 555,000.  We’ll look for 483,000, which is nearly implausible, but that’s not stopping us.

Friday – we get Existing Home Sales for the month of June.  Economists expect them to have been running at an annual clip of 4.80 million units, up from 4.77 in May.  That was just (-)3.22% below the year-ago level, but a big (-)33.9% below the peak in 2005.  Lastly, University of Michigan Consumer Confidence is released, and economists expect the final July reading to have remained largely unchanged from the mid-month reading.


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