Weekly Recap & Outlook – 11.12.10

Tower Private Advisors


  • Lousy week for stocks
  • Marginal economic improvements
  • Big week of releases next week

Capital Markets Recap

It was an ugly week for markets around the world.  These are the first weekly losses in several weeks, but they weren’t unexpected judging by the number of folks calling for a correction before the fourth quarter rally resumes.  Sentiment is stretched on the optimism side, and a shakeout will be healthy for markets.  Sentiment is tough to apply, however.  Here’s a look at respondents to the American Association of Individual Investors weekly survey.  It charts, in the top panel, the bullish respondents as a percentage of those with an opinion (i.e. it excludes the Neutral respondents.)  While it’s at a four-year peak, it would have been a mistake to sell when such levels were reached in the past–or even at far higher levels.

Put option volume versus call option volume did not show investors running for the protection of the former, as the chart below indicates.  The ratio of the two was lower than the five-year average, as well as the 2010 average.

Next week will be a good test for markets.  Ever since the Federal Reserve announced the voyage of QE 2, the markets have displayed a buy-the-dips mentality.  Well, this week marks a dip.  Next week we’ll see if the buyers return.

Top Stories

Quantitative Easing (aka money printing) continues to be a big focus of investment-related news stories.  Here’s a refresher on the subject.

  • A central bank purchases anything it wants to in an effort to boost prices, lower interest rates, spur economic growth, and/or encourage risk taking.  Japan didn’t do this in the ’90s, and the U.S. didn’t do it in the ’30s.
  • Theoretically, the money supply is increased, and if it grows faster than the economy needs the money, the money goes somewhere, likely, financial assets.
  • Primary intent is to prevent deflation.
  • Secondary intent is to stimulate the wealth effect, whereby consumers feel wealthier and become more willing to spend, and also to keep interest rates low
  • Side effects may include nausea, vomiting, diarrhea, inflation, and asset bubbles.

Like E.F. Hutton, when Nassim Nicholas Taleb speaks, people listen–or at least they should.  He popularized the notion of black swans.  Once upon a time naturalists thought that only white swans existed, but that’s because they’d never seen anything but white swans.  But it didn’t matter how many white swans they’d seen, they would never see enough to prove that black swans didn’t exist. 

This week, in an interview he said that, “something needs to be done about Bernanke,” and that, “he doesn’t understand risk.”  He based that latter one on two things:  first, Gentle Ben did not see the financial crisis coming; and second, he reminds Taleb of the folks at Long Term Capital Management.  In short, he should not be trusted now any more than he should have been trusted before crisis.  “He’s like the airplane pilot who thinks only of speed; not safety,” and that Gentle Ben was the pilot of the plane that crashed.

However, of our four key research/strategy services, all four are now bullish toward equities, and at least two of them are that way because of quantitative easing.  Dennis Gartman is another who says it doesn’t pay to go against the flow.  An old time saw is don’t fight the Fed.  In short, don’t fight the Fed’s monetary policy:  easy is bullish for risk assets; tight is bearish.  From all appearances, Quantitative Easing seems to be something you definitely don’t want to fight, but it’s also likely to be a trend that could end very badly.

Cisco Systems is an industry bellwhether.  Dictionary.com says that means it’s, “a leading indicator of future trends.” The word bellwheather–or bellwether–comes from the world of sheep.  A wether is a–gulp–castrated male sheep, who is the leader of the flock.  Since he’s the leader, a bell was hung around his neck; thus, the bellwhether.  Well, this week, the networking industry bellwhether was taken to the woodshed.  While the company beat its Q1 earnings estimate and met the revenue estimate, it said the second quarter (its fiscal year ends in July) would be weak.  The source of the weakness stemmed from lousy public-sector and cable operator orders.  The company said its Q2 revenue would likely be between $10.1-10.3 billion, while the consensus amongst analysts was $11.4 billion.  In the rush to head for the exits, volume totaled 553 million shares, more than 10x the average of the last five years, and more than 2x the highest of any one of those days

On the positive side, the stock stayed about its 8/31 low, but that’s about all one can say.  One analyst went so far as to say that the guidance lowered the long-term value of the company; maybe it’s a matter of what “long-term” means.  We took a little more sanguine view of developments and bought some more shares.  From a theoretical viewpoint, it’s hard to imagine that the value of the company fell by 17% overnight, but that’s what happened.  Shares outstanding multiplied by the stock price equals the market’s valuation of the company, and that fell by 17%, as the chart below shows.

Intel is a bellwhether of a different industry, the semiconductor industry.  It announced it was increasing its dividend by 14% to 18¢ per quarter.  In the Weekly Recap of August 13, I suggested that stock might be worth considering for purchase in light of its 3.24% dividend yield.  It’s up by 12.38% since then, and the dividend yield is still higher–thanks to the increase–at 3.35%.

We’ve come up with our own list of stocks that have had a good history of increasing their dividends.  To avoid stepping on Standard & Poor’s toes, which publishes its Dividend Aristocrats, this list is called the Dividend Blue Bloods, and because laziness is the mother of invention, it only looks at the last ten years, and also screens for some fundamental strength factors.  You can click here to see the list.  Its average yield is 1.77%, and over the last ten years the average increase has been 290%.  While close, I don’t think my income has jumped like that, but yours can if you were to invest in these stocks and the future plays out like the past has.

Asian markets were pounded over night on news that prices in China had risen in October at a 4.4% annualized pace.  Given that a Central Bank’s key mandate is to provide price stability by adjusting monetary policy, it led to fears that the authorities there would raise rates to reign in inflation.  Market partipants gave advance heed to the saw above and decided to not fight the Chinese Fed.  The Chinese have already taken steps to reign in the economy, including a string of hikes in bank reserve requirements, the amount that banks must keep on reserve with the central bank.  For the country’s largest bank, the reserve requirement is 18.5%, meaning that banks must keep 18.5¢ of reserves for each $1.00 of loans; in the U.S., the ratio is 10%.  There’s a reason beyond inflation that China is taking these steps, and it bears remembering:  its economy is growing; as Martha would say, that’s a good thing.

Other stuff

  • Morgan Stanley made more than $100 million in its trading operation only one day in the third quarter.  That’s the lowest count since 2006, and it lost money on ten days of the quarter, compared to just five days in last year’s Q3.
  • AMBAC, which used to insure your municipal bonds, filed for bankruptcy
  • Disney reported earnings which missed analyst estimates, but the market reacted to the earnings before non-operating items, as if they didn’t matter.  The stock was up by 2.6% from yesterday’s opening price or 5.7% from last night’s kneejerk drop.

Multimedia feature

This Week

There wasn’t a lot of economic news this week.  NFIB Small Business Optimism ticked up to 91.7 to approach the May 31 high (92.2).  While it stayed below that peak, it was better than the October level (90) and well above the consensus off 89.  A level of 92.9 would mark a two-year high.  Wholesale Inventories rose more than expected and more than the consensus of economists.  That could become a concern if it signals that businesses have become too enthusiastic about future sales, leading them to cut back on orders.  Initial Jobless Claims (435M) were better than expectations (450M) and better than the upwardly-revised figure from last week (459M).  Continuing Claims (those continuing to claim unemployment insurance benefits) fell to the lowest level in two years, but I fear that’s largely a result of the 52 weeks of insurance ending, as opposed to those folks finding jobs.

Next Week

Key indicators to watch

  • Producer Price Index (Tuesday) – October
  • Consumer Price Index (Wednesday) – October
  • Industrial Production (Tuesday) – October
  • Capacity Utilization (Tuesday) – October
  • Initial Jobless Claims (Thursday) – weekly
  • Leading Economic Indicators (Thursday) – October

Housing indicators

  • NAHB Housing Market Index (Wednesday) – November
  • Housing Starts (Thursday) – October
  • Building Permits (Thursday) – October

Regional Economic reports

  • Empire State Manufacturing (Monday) – November
  • Philadelphia Fed (Thursday) – November

One Response to “Weekly Recap & Outlook – 11.12.10”

  1. wes stouder says:

    As I wipe away the tears of laughter I must admit a bit of sympathy for the Tower crew, unable to enjoy the timeless wonder of Monty Python in this week’s edition. My compliments for wrapping a humorless subject in this cloak of merriment. I found out my Cisco position is vanishing but left the report completely amused…..Thanks! Your diagram of the parallels in this vignette to current events would be equally amusing as we can only surmise what identity you have assigned to the players. Perhaps our own imagination would be entertainment enough……..

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