Leading Index Dives

The Conference Board’s Index of Leading Economic Indicators fell by 0.4% in November, while the closely watched six-month rate of decline was 2.8% — the steepest decline since 1991. The largest contributors to the drop were building permits, stock prices and average weekly initial claims. Only four of the 10 indicators in the LEI registered gains, including new orders for consumer goods, the interest rate spread, money supply and new orders for non-defense capital goods. Meanwhile the coincident index fell for the sixth time in seven months. There’s no doubt that the economy is mired in one of its deepest recessions in decades. Conditions will probably not improve until the new administration takes office in late January. But we remain hopeful for a mid-to-late-year recovery, largely because of the structures-related, jobs-creating fiscal impulse expected to be enacted in late January.

source Argus Research Market Watch, December 23, 2008

Potential Fuel for the Fire

The percentage of Household Financial Assets allocated to cash has risen back to levels last seen in the Bear Market of 2000-2002. According to our calculations, households now have 21% of their total financial assets in either checkable deposits, currency, time and savings deposits or money market fund shares. During the bull market of 2003-2006, the percentage dropped to 19%, as household funds were diverted into corporate equities and mutual fund shares. On a dollar basis, the funds on the sideline for the Household sector now total $8.4 trillion, out of total household financial assets of $39.8 trillion. Were investors to move back into the market as they did in 2003, as much as $1 trillion could be deployed into stocks. This move could have a major impact on the market, as the capitalization of the S&P 500 is now $7.9 trillion.


source: Argus Research Market Watch, December 18, 2008

Tobin’s ‘q’ at 0.76 in QIII

The Federal Reserve recently released its quarterly Flow of Funds data for the third quarter, which permits us to estimate a back-of-the-envelope value of Tobin’s ‘q’ — a measure of market valuation. Investors will recall that ‘q’ is defined as the ratio of the market value of a firm to the replacement cost of its assets – in this case, we are estimating figures for the entire industry. According to Nobel Laureate James Tobin, the ratio of total stock market value to the stock market’s net worth (corporate net worth) is a reliable indicator of market valuation. When the stock market trades at a ‘discount’ to the replacement cost of its assets, the market is inexpensive, or cheaper to buy than build. This discount possesses ‘q’ ratios that are less than 1.0. Conversely, when “q” exceeds 1.0, the market trades at a premium to its replacement cost. The runup from 1996-2000 had ‘q’ approaching the unthinkable value of 2.0. Encouragingly, the most recent level of 0.76 is the lowest since 1965 – quite discounted. The longterm average for Tobin’s ‘q’ is 0.76.


source: Argus Research Market Watch, December 17, 2008

Fed Meets Today

The Federal Reserve is scheduled to meet today to discuss the state of economic affairs. We anticipate a 50-basis-point cut today, and another 50- basis-point reduction on January 28. The Fed Funds rate currently stands at 1.0%, and Street expectations are varied. Of 82 economist polled by Bloomberg, 55 look for a 50 bps cut, 16 for no change, six for a 25 bps cut, four anticipate a 75 bps cut, and one sees the Fed slashing by a full point. A 50 bps rate would be the lowest since 1954, when the Fed first reported the data. Over the last few weeks, the effective Fed Funds rate has been trading at 48 basis points, which suggests a 50 bps cut would probably not impact the financial markets. Also, changes in the funds rate usually influence the economy 12-to-18 months down the road — so there’s really no near-term economic reason to reduce rates.

source: Argus Research Market Watch, December 16, 2008

Market Review After Fed's Bold Steps

FOMC’s decision to go the market one better and reduce its target rate to a range of 0%-0.25%. The Fed also provided a list of potential actions to further prop up the financial system. The market managed to add to gains into the close of trading. Other
economic data released during the session included the consumer price index, which came in below expectations at minus 1.7%,and housing starts and permits for November, which were well below projections. The DJIA closed up 359.61 points at 8,924.14, the S&P 500 added 44.61 points to close at 913.18, and the Nasdaq Composite finished regular trading up 81.55 points at 1,589.89. Bonds rallied strongly following the Fed’s action, and the dollar lost ground against most major currencies. As selling pressure has tapered off in recent sessions and the market has regained a measure of optimism over stimulus actions, recent economic data has been even more negative than many had been expecting. The economy – and corporate profits – may be in for a long slog before again reaching positive postings, but the market is already showing signs of anticipation of the upturn. This is likely to be balanced by further spates of negative turns and outright fear in the markets in the near term, suggesting that while volatility has cooled a bit recently it could remain at elevated levels for some time yet. (author: Kevin Calabrese, Market Digest, Argus Research 12-17-2008)

Profit Outlook is Murky

Earnings estimates are falling on the Street, but there is a wide range of variability in the outlooks. For example, on the S&P website, the bottom-up view of the official index arbiter calls for S&P 500 EPS in the mid-80s next year. Some strategists, however, are as low as 53. Our outlook is for 56, down from an estimated 65 in 2008 and an EPS peak of 91 in 2Q07. Our estimate thus implies a peak-to-trough decline in profits of approximately 40%, which is not far from the peak-to-trough slide in the S&P 500. Why the variability on the Street? For one thing, transparency is lacking in most industries, as demand has shriveled. In addition, the S&P 500 Index has undergone substantial changes this year. Major earners such as Fannie Mae and Lehman Brothers are out, replaced by smaller firms with fewer profits. It may take a few more weeks — and more volatility — until analysts and strategists come closer together with their outlooks for earnings.

source: Argus Research Market Watch, December 11, 2008

Breaking the $10 Barrier

When stocks fall below $10, many investors initially think the bargain shopping has begun. But studies have shown that in most cases, single-digit stock prices don’t climb back to double-digits in short order, if at all. A Merrill Lynch study of Tech stocks in 2001 concluded that only 3.4% that fell below $10 between 1985-2001 rebounded to $15 or higher within the next year. The current bear market has pushed hundreds of stocks below the $10 level during the past year. According to S&P, 101 stocks in the S&P 500 are in single digits — the most in 28 years. At Argus, 249 out of the 708 we cover are below $10. Our chart shows that, once again, many of these companies are in the Tech sector, as well as in the Consumer Discretionary and Financial groups. We do see some attractive sub-$10 stocks, though, including Saks Inc., Nova Chemicals, Genco Shipping & Trading, Och Ziff Capital Management and Mylan Labs.

Source: Argus Research Market Watch, December 4, 2008

From today's reading ...

From SeekingAlpha.com

Bull/Bear Ratio Is a Contrarian Indicator | Walid Nasserdeen | December 1, 2008

The Bull/Bear ratio, a market indicator popular with insiders, is a poll of investment professionals that gauges whether they are bullish, bearish, or neutral on the stock market. The weekly publication by Investor's Intelligence is considered the most relevant measure of market sentiment as participants have daily dealings within the financial markets. The ratio shows the relationship between bullish and bearish advisers and is interpreted to be a contrarian indicator, since extremes in either direction are signals of a reversing market trend. ...

Click here to read the rest.

A Mean One

The current Bear Market settled quickly on Wall Street, and has done extreme damage compared to other Bear Markets since 1900. There have been 12 other periods over this time frame in which the markets have fallen at least 20%. The average decline during those Bears has been 36%. The peak-to-trough decline in the current bear market has been 52% on a closing-price basis, and 53% in terms of intra-day trading. Typically, Bear Markets have taken 16 months to reach the bottom; the current bear is only 13 months old. On the way back up – and there has always been a way back up – investors have waited on average 33 months for the markets to recover. The shortest period was nine months, in 1970. The longest was 151 months, during the Great Depression in 1929-1933.


Source: Argus Research Market Watch, December 1, 2008

Housing Liquity - from seekingalpha.com

The following post is from seekingalpha.com
James Eckler author

The baby boomers are reaching the age where they need to decide between asset ownership and liquidity. A growing percentage of this group will use up their savings “between jobs” after age 50 and before retirement. They will go through the process of liquidating their assets at prices that are much lower than a few years ago in order to add to future monthly income.

With over 75 million baby boomers looking ahead at uncertainty, more job shortages for older people, and a largely unfunded Social Security and Medicare system (especially Medicare), they will begin to consider how to get liquidity from their hardest to liquidate assets – their houses. Social Security checks now average about $1100, and for a large percentage of these people this is what they will have to live on.

Sustainability of the existing financial lifestyle among the boomer group will probably be restricted to about 10-20% of the overall group. The rest will need to liquidate assets, especially aging houses, to pay monthly expenses and cover rising healthcare premiums.

The biggest decision for most will be WHEN they sell their houses if they are homeowners. This could easily lead to a large increase in the number of listed homes over the next decade where, unlike before, the seller is not the buyer of another home. It could also lead to many who do have assets (the top 20% probably have around $800,000 in assets) selling second homes and not replacing these homes.

The impact of these changes in homeownership and income will be a big increase in demand for low cost rental housing (under $600 per month with utilities and taxes), a portion of the market that is largely unavailable today.

Since 2000, according to reports created by the former Comptroller of the United States, David Walker, the total liabilities of the U.S. have grown from $20 trillion to $53 trillion by 2007. This number can’t be paid, so the issue that faces the investment community in the U.S. is how to react to what amounts to undisclosed future cuts that will have to be made in programs. Most of these liabilities are for unfunded Social Security and Medicare (especially Medicare). Medicare reached “Warning Status” recently, which requires the new President to make changes to make the program solvent in 2009.

If taxes are raised, it will slow the economy. If benefits are cut, a large portion of the population will have to raise their savings rate, sell assets, and cut spending. Which will be chosen, or will it be a combination?

The Peterson G. Peterson Foundation web site, where David Walker is now CEO, has a great citizens guide for those readers who really understand the scope of the debt issues confronting the U.S. and its financial markets.

The way this issue is resolved will have a big impact on the housing business for the next decade, and on our economy for an even longer period.

Valuations Falling

The deep sell-off in stocks in 2008, as well as the rally in bonds, has resulted in historically low valuations in such metrics as the Fed model. Other valuation measures are more mixed. For example, the S&P 500 P/E ratio could be a low 11 or a more normal 13, depending on which EPS forecast is being used. On a trailing P/E basis, the ratio is higher, at 17. The price/sales ratio is signaling value – but far from a historical low. To calculate this ratio, we use Corporate Equity market values from the Fed’s Flow of Funds report and Real GDP. In the post-WWII period, the ratio has ranged from a low of 0.40, in the early 1970s, to 1.9 during the peak of the tech bull market. Last year, the ratio was high at 1.44. The onset of the bear market in 2008 has pushed the current ratio to 0.68, below the historical average of 0.80 but not at the depths we recorded in the bear markets of the early 1970s and 1980s.


source: Argus Research Market Watch, November 24, 2008

Headline Financial News

Paulson flip-flops on TARP reserve. As recently as last week, Treasury's Henry Paulson said he wouldn't use the $410B of remaining TARP funds, preferring to save the money for unforeseen emergencies and to allow the new administration flexibility. Apparently, things have changed since then, as Paulson is now considering a more active role for his final weeks in office and may use the second half of the TARP funds to roll out new programs after all. Sources say that as market conditions deteriorate, Paulson is looking for ways to stem foreclosures and to make it easier for households to borrow money. A Treasury spokesman confirmed "we're looking at a variety of programs to support the market and we'll implement them as soon as they're ready," and said Paulson had never ruled out tapping the remaining funds. The Treasury is also considering another capital-injection program aimed at financial institutions beyond banks.

Obama's oh-so-big stimulus plan. President-elect Obama is crafting an aggressive economic stimulus plan that could see $500B-$700B in federal spending and tax cuts over the next two years, according to several of his senior aides. Lawrence Summers, a recent addition to Obama's economic team, indicated a stimulus of that magnitude was indeed possible, adding any stimulus will need to be "speedy, substantial, and sustained." He also warned that "we're going to need impetus for the economy for two to three years." Democrats are hoping to rush a stimulus bill through Congress after New Year's so Obama can sign the bill immediately after his January 20 inauguration. Obama is expected to release more details of his plan during a press conference later today to introduce Tim Geithner as his choice for Treasury Secretary.

Builders ask for billions. Automakers struck out, but that hasn't deterred home builders from trying to get government rescue money. The builders' lobby is pushing for a $250B stimulus package it calls "Fix Housing First," arguing financial markets won't recover until housing markets stabilize. The package includes tax credits for home purchases and a federal subsidy on mortgage rates. Critics say the proposal is too expensive and overemphasizes home purchases vs. loan modifications, and warn that any government intervention will have to find a way to stimulate housing demand without artificially propping up property values.

Baltic Dry Index Collapses

Unprecedented demand for commodities, heavily congested ports and the aftereffects of the Chinese earthquake sent shipping costs through the roof this past summer. Over the last eight years, the Baltic Dry Index had jumped ten-fold, and at its peak this summer was more than 150% higher than in January 2007. The surge was driven by demand for coal, grains and iron ore. Global demand — especially in and out of China ahead of the Olympics – for agricultural products like grains and metals also boosted shipping costs of dry bulk commodities. This placed a greater pressure on the general price level. The Baltic Dry Index, the benchmark of dry bulk shipping costs and a fairly accurate gauge of global economic health, has since tumbled below 1,000 for the first time in six years amid global economic uncertainty. It is just another in a series of indicators signaling recession.

source: Argus Research Market Watch, November 19, 2008

Market Factors

The market remains starved for leadership. The number of stocks making new lows currently holds a 50-to-1 advantage over the number of stocks making new 52-week
highs. Declining stocks continue to swamp advancing issues. On the rare rally days, volume is thin. The 10-day trend in market volumes on the NYSE and the Nasdaq has
been ascending during the market’s recent struggles.

In the absence of leadership, the percentage of stocks trading above their 200-day moving averages is stuck in single digits. In fact, the percentage of stocks trading above their 200-day moving averages has been below 10% since October 7. The 10-day average in this series is under 5%; and the current absolute level is 3%.

In desperate need of silver linings, some investors are pointing to the last time this index tracked at meaningfully low levels. That was a quick touch-down to the low teens in July 2002, followed by a month-long trade in the low teens in December 2002. Within three months, of course, the market embarked on the great 2003 rally, rising 30% in about eight months.

The greater danger is that the market makes a lower high, then follows with a lower low – perhaps below the mid-October intra-day low of 819.

Argus Research

Import Prices Tumble

Blame it on slower global economic growth, the skyrocketing value for the U.S. dollar, or the free-fall in the price of crude oil — but the value of U.S. imports has fallen precipitously in recent months. In October, total import prices fell 6.7% — the biggest monthly decline since 1988 when the indicator was first calculated. The 12-month pace of import inflation stands at 6.7%. Import prices of petroleum products plunged 16.7% in October, which followed equally steep declines of 10.2% in September and 9.7% in August. Meanwhile, non-petroleum import prices fell 0.9% last month, bringing the annual pace of core import inflation to 5.0%. Agricultural export prices fell 8.7% in October amid an outright collapse in commodity prices. We expect this downward trend to continue as oil and commodity prices slide lower over the next few months.

source: Argus Research Market Watch, November 18, 2008

G 20 Statement

G20 statement: Against this background of deteriorating economic conditions worldwide, ... a broader policy response is needed, based on closer macroeconomic cooperation, to restore growth, avoid negative spillovers and support emerging market economies and developing countries. --> Further policy steps to include Monetary policy support as appropriate for domestic conditions, fiscal measures to stimulate domestic demand, while maintaining a policy framework conducive to fiscal sustainability. Increased transparency of financial sector, regulation of rating agencies, avoiding pro-cyclical regulation, increased information sharing between national authorities, expanding the FSF to include emerging economies and ensuring that IMF and other multilateral institutions to have sufficient resources to support emerging economies capital needs

IPO INVESTORS DISAPPEAR

In another sign that the capital markets have dried up, initial public offering activity on a monthly basis has dwindled to zero since Labor Day. Meanwhile, companies appear all-too-eager to withdraw previous applications to go public. According to Renaissance Capital, the market may stir a bit next week if Grand Canyon Education, which is seeking to raise $175 million, goes through with its planned launch. Though the timing may not be right for IPOs, Argus Analyst Jackson Turner has argued that the economic and market problems are driving students back to school, including to for-profit programs. More broadly, we look for the IPO market to rebound at the same time longterm corporate yields fall from their double-digit perch. With Ford and GM teetering on the brink of bankruptcy, this turnaround may be a mid-2009 event at best.


Source: Argus Research Market Watch, November 12, 2008

STILL TOO HIGH
Analysts remain too optimistic about corporate earnings growth into 2009, and upcoming downward revisions will likely cap near-term rallies even more so than economic reports. According to Standard & Poor’s, S&P 500 earnings are expected to climb 29% next year to more than $93. That compares to our forecast of an 11% decline to $70. Drilling down to sectors, we think forecasts for double-digit gains in Technology, Telecom and Utilities, in particular, will be reduced. The wild card is Financial Services. The enormous write-offs through 2H07 and 2008 have made comparisons in the group meaningless. If the government’s programs — ranging from increased deposit insurance to the second phase of TARP — take hold into next year, Financial Services could get back on track and deliver an upside surprise. This potential boost could turn around the negative corporate EPS profit trend that has triggered the Bear Market since 3Q07.

Source: Argus Research Market Watch, November 10, 2008

Economy Sheds 240,000 Jobs

The surge of job cuts came a month earlier than we had anticipated. The U.S. economy eliminated 240,000 nonfarm payroll jobs last month, which followed a downwardly revised 284,000 lost jobs in September. There have been 10 consecutive monthly declines in nonfarm payrolls, totaling 1.2 million workers this year. In no big surprise, the biggest losses came from manufacturing (90,000), construction (49,000) and business services (45,000). We suspect that this weakness is consistent with our expectation of a fourthquarter recession, and a profound 2.6% decline in the overall pace of economic activity. Another equally disturbing statistic was the unemployment rate — which climbed to 6.5% in October from 6.1% in September. Unemployment now stands at the highest level in 14 years. We suspect labor market conditions will worsen before they get better, with unemployment peaking in the second quarter of 2009 somewhere around 7.25%.


source: Argus Research Market Watch, November 7, 2008

Market News

Some investors view the post-election-day market
decline as a warning about trends related to the new
administration. But perhaps it is plain and simple profit
taking, borne of the pre-election run-up. Consider that the
S&P 500 rallied by 18.5% from its close on October 27
through the close on November 4. That said, the S&P also
lost momentum right after it broke above the 1000 mark
(closing at 1005.75 on election day).

Headline Financial News

How low can it go? The Fed will likely shave its key fed funds target rate to just 1% today, and signal further reductions to levels unseen since Dwight Eisenhower was president. "Inflation risks are off the table," economist Mark Gertler says, which is why it can afford to be 'very aggressive' in stimulating the anemic U.S. economy. "If the economy shows additional signs of a deepening recession, I think the Fed will decide that the floor is not 1 percent," former Fed governor Lyle Gramley said. "Zero is a possibility."

Consumer confidence plunges to record low. The Conference Board's Consumer Confidence Index plummeted to an all-time low of 38, down from 61.4 in Sept., falling way short of consensus estimates of 52. "The impact of the financial crisis over the last several weeks has clearly taken a toll on consumers' confidence," it said. "In assessing current conditions, consumers rated the labor market and business conditions much less favorably, suggesting that the fourth quarter is off to a weaker start than the third quarter. Looking ahead, consumers are extremely pessimistic." Ian Shepherdson of High Frequency Economics called the data extraordinarily awful, and noted the lower-than-expected expectations index indicates real consumer spending could fall at an annualized rate of about 3.5%, even worse than the 3% he previously expected.

Home prices drop, again. Home prices fell 16.6% in August from a year ago, in-line with forecasts, after a 16.3% decrease in July. It's the 20th straight monthly drop in the S&P/Case-Shiller index. "The downturn in residential real estate prices continued, with very few bright spots in the data," S&P's David Blitzer said. Sales of distressed properties accounted for 35-40% of the month's total. "House prices will remain on a downward trend for some time and until they are low enough to stimulate sufficient demand to clear the market," economist Joshua Shapiro said.

source: seekingalpha.com

Quote of the Day

The shoe that fits one person pinches another; there is no recipe for living that suits all cases.
-- Carl Jung

Unemployment & Stock Returns

The stock market anticipated the 1990-1991 recession as early as September 1989, and started to decline. But the unemployment rate didn’t start to rise until June 1990. By the time the unemployment rate peaked at 7.8% in June 1992, stocks were back to delivering positive 12-month returns. The same pattern held up in the 2001 recession. Stocks started predicting a recession the spring of 2000. The unemployment rate didn’t start to rise until June 2001. This time around, the markets started weakening in the summer of 2007 and unemployment readings began heading up earlier this year. To be sure, unemployment seems likely to increase further. So we can’t see a peak in that number yet. But businesses are aggressively cutting costs and the plunge in commodity costs should begin to help margins. With stocks already down nearly 50% from their peak, weak earnings may already be largely priced in.

source: Argus Research Market Watch, October 27, 2008

5 Ways the Global Economy is Rebounding

By Jim Wiandt, IndexUniverse.com

Despite the latest plunge, the market feels like it may be finding its legs now. Here are the early signs.

The last month to me feels like the way you feel when you are just knocked out by a flu or with a debilitatingly sore back. You realize how fragile everything is and how mortal we are. And then when you come through to the other side, you get a renewed perspective. The colors seem a little brighter, you savor your morning coffee a bit more, maybe take a few days off with the family.

That is how I feel about the market. Essentially we've gotten quite a crisp view of the market's mortality and have been able to understand, in a very visceral way, how the global economy could fall to pieces, practically overnight. And looking at continuing market action, we're certainly not out of the woods yet, and all signs point to a protracted economic slump. But it's not going to be the Second World Depression (a la the Great War being renamed the First World War). Here's why:

1. Credit spreads are coming in. As Matt Hougan details in his blog (which rehashed my blog of the day before which apparently Mr. Hougan hadn't read), LIBOR rates are coming down quickly and the TED spread is beginning to seriously come in. This is the fundamental constipation in our financial system that must heal before the economy recovers. And it is. Billions of dollars of government intervention appears to be doing the trick. Look at that TED Spread chart from today—it's dropped off a cliff.
2. The dollar is seriously on the rebound. The U.S. dollar has been stuck in prolonged doldrums as the current account and trade deficits for the U.S. soared. It's clear that the U.S. must lead the fight out of the recession, and the dollar's surge indicates that the market thinks it will, as it continues to see the U.S. as a safe haven.
3. Commodities continue to stall. While you can argue that the falling of commodity prices are a reflection of the coming recession (and probably be right), lower energy and commodity prices ultimately will also lead to a recovery and some balance on supply and demand, which felt badly out of whack. Gold's stalling despite the economic downturn is odd, and feels like it indicates that the world does not believe we're heading for depression, but is in value-seeking mode for equities and other hard-hit asset classes.
4. Real estate is finding reality, while other asset classes are catching up with the bottom real estate has set. A dynamic of hard falling prices is necessary and healthy to get the economy back in line with its actual productivity. Prices coming down on real estate, and credit becoming first impossible to receive and then more realistically tied to the prospects of payback, are good trends for economic stability.
5. There is a ton of money looking for a place to go. Ultimately, the overall financial system is juiced to the gills with potential as money is looking for a place to find bargains, and it will pour into the system once it's clear that a bottom has been established.

I think that even while the wild volatility continues, the market is gradually moving from panic to resignation that we're entering a time more based in the reality of our actual economic productivity than a giddy fantasy greedfest, where it feels like money is growing on trees. Ultimately this is healthy for our economic stability and for the prospects of grounded future growth.

Great Quote

Courage is the first of human qualities because it is the quality which guarantees all others.
-- Winston Churchill

More from today's readings ...

Valuations Need To Fall Further for a Sustainable Rally
October 20, 2008 | Matt Blackman | Seeking Alpha

Last week we discussed Robert Shiller’s S&P 500 trailing 10-year price earnings ratio that has averaged 16.3 since 1881 and the fact that it had dropped to 15 as of October 10th. While we saw prices increase last week and a rise in P/Es, what does the longer-term future hold?

In our next chart, we show annual trailing 10-year P/Es from 1920 to August 2008 using Dr. Shiller’s data. As we see from this chart, every major recession has resulted in P/Es falling below 10 for an extended period of time - lasting decades, not years - typical of secular bear markets.

At 15 last week, the P/E was back to just below the long-term average, but this was a daily drop, not an annual P/E. It will take many more months (possibly a year or more) to get back below 15 on an annual basis, meaning we probably won’t see this occurring till 2009 or even 2010.

After that, it could take a few more years to get back to single digits like we had during the last major recession in 1981-1982. In other words, markets and economies will need a long rest with P/Es below 10 before they will be able to mount the next sustainable bull market. A similar situation occurred during the Great Depression into the early 1950s, as we see from the chart above.

Could we get another cyclical bull market rally lasting a few weeks, months or even years as we saw between 2003 and 2007? Very possibly, but as we learned, more often such rallies are short-term and often end abruptly and rather unexpectedly. There are also the raft of fundamental financial challenges facing a sustained U.S. economic recovery like the crushing levels of debt, rapidly deflating derivatives and housing bubbles, falling Treasury sales and mounting government deficit as a result of more than $2 trillion in bailouts so far.

But that doesn’t mean you can’t make money trading the powerful reactive rallies embedded in every secular bear market. This is a trader’s market where it's important to set tight stops and take profits off the table regularly, not a time to buy and hold for the long-term, as the so-called pundits would have us believe, if we are in a true secular bear market.

From this morning's reading ...

The Credit Crunch Is the Solution, Not the Problem
October 20, 2008 | Jason LaValley | Seeking Alpha

Since roughly October 2007, the world’s financial institutions have trembled, credit markets have seized, and as the government bailouts arrive, a consensus view has developed that the root cause of our recent misery is the greed of over-levered, under-regulated financial institutions, helpless in the face of overwhelming losses caused by indefensible gambles on sub-prime mortgage loans for over-valued residential housing.

While reasonable conversations can take place regarding the root cause of mortgage lending standards (e.g. the Community Reinvestment Act in the Carter era), the simple truth is that the true nature of the economic crisis has been obfuscated. Most Americans believe they are in for a severe recession caused by the unwise decisions of bankers. They may not understand they are coming out of a severe recession facilitated by the very government now coming to the rescue.

Theme I: We’ve experienced a much more severe inflation shock than reported.

Let’s keep it simple. When we greatly expand the number of dollars that exist, each of them will be worth less (i.e. prices will rise). The facts are clear:

- Most official measures of the U.S. Dollar money supply show a recent record of minor, very stable growth – all the hallmarks of a concerned steward of stable prices. In fact, in March 2006 the US government stopped reporting “M3” a critical component of the money supply which helps indicate how much money supply growth is attributed to commercial bank lending via institutional deposits, money funds, and Euro dollars, etc. While official monthly money supply measures (M2) show the supply of US Dollars growing in a 4-6% range since 2003/04, private individuals who have continued estimating M3 growth show that the world’s commercial banks have increased the growth rate of dollars by up to 16%.

- That’s OK, you say. The government carefully measures inflation, ensuring that swift and prudent action is taken the minute money supply growth impacts the stability of the prices for this we must buy as part of our daily lives. Now I ask, does that sound like the U.S. federal government to you? The government does continue to measure price inflation, but they have made two significant changes since our last inflation shock in 1980 when Paul Volker killed inflation by raising interest rates. Back then, the rampant, unacceptable inflation rate touched 15% . Of course, this time in the worst of it (2008) we only touched 5 ½ %... except that we changed how we measure it. If you still measured inflation the way we did in 1990, before the Clinton-era changes, we experienced 9% inflation in 2008. If we measure it the way we did in 1980, we touched 13% - almost to the Volker era highs. You weren’t crazy. Did you get a 13% annual pay raise?

- And the markets weren’t fooled for a minute. Gold (priced in dollars) rose 235% from 2005 through 2008. Oil by 247%. Now, U.S. GDP only rose 11% from 2005-2007, Adjust for the ‘new’ inflation numbers and you find the line you hear in the media. “We’re not quite in a recession yet”. Adjust GDP for something approximating the way we measured inflation in recent history and you see that we’ve been in a rather severe recession for some time now. Ask yourself – hasn’t it felt that way?

- And, as it always does, capital flowed to more hospitable places. It doesn’t matter if you looked at U.S. investment in anything overseas (especially emerging markets), anything not priced in dollars, or if you just flat out look at the currency. The US dollar dropped in value (against a basket of other currencies) by more that 40% from its peak in 2002 to trough in 2007.

Theme II: This time we didn’t need to raise interest rates

In 1980, the Volker fed needed to raise interest rates to extremely high rates to break the back of inflation. I’m sure we can all agree we’d prefer not to incur borrowing costs in excess of 15% - so why do we get to avoid that pain?

In this case, the cause of the problem (the rampant creation of too many dollars by the commercial banking system) seems to have been corrected by the market itself. After peaks in 2008:

- The U.S. Dollar has risen 14% in 2008 from its lows.
- Gold has declined 21% from its highs
- Oil has declined 34% from its highs
- Credit creation by commercial banks has declined from 18% to 2%.

In other words, the current “credit crisis” is in fact the source (commercial banks) of the problem (inflation caused by M3 supply growth) correcting itself (reversing through the refusal to extend credit) through market forces (which question the real value of the collateral e.g. houses) for the loans.

Theme III: The Return of America

So how do we interpret the current state of our economy? The majority of media outlets repeat the standard line that the lack of available credit will negatively impact the earnings potential of U.S. equities. They claim that the best expectations for growth continue to lie in emerging markets - and that we are still in for a ‘deep’ recession, not coming out of one.

Phoey! The run up in energy and commodity prices was largely due to these commodities being priced in the free-falling dollar (doubt me? check a chart of oil priced in Euros or gold compared to dollars) . The strengthening in the dollar caused by the fact that commercial financial institutions no longer have the capital to debase the currency represents a massive tax cut for productive US industry. US industry, whose consumers have already seen the worst of a very deep economic recession.

- In terms of momentum there is no better currency in the world.
- There is a flight to the quality of the US, both in terms of currency and equity of commercial and real assets that will be levered for foreign investors by the continuing strength of the dollar.
- For the undervalued US Equities, expect a new era of “going private” and/or the ‘new conglomerates’ as balance sheet cash and real dollar profits are put to work buying over-levered or foreign assets.

As markets adjust from the paradigm of a weak dollar we are:

- Long Volatility (VIX)
- Long US Dollar (USDX)
- Long US Equities (SPY)

- Short World Equities Ex-US (especially the Euro zone) (VGTSX)
- Short Commodities priced in dollars (DBC)
- Short the US Government, not a having truly independent measurement of monetary statistics.

From the desk of Louis Navellier

Dow Plunges 733 Points
Rapidly Declining Retail Sales and Gloomy Beige Book Sink Stocks

Reno, NV (Marketmail) - October 15, 2008

Stocks suffered another major setback today after dreary economic data essentially confirmed that the U.S. economy is in recession.

September retail sales dropped 1.2%, significantly more than the -0.7% consensus and the largest decline in three years. Sales ex-autos fell 0.6%, tripling the -0.2% consensus.

Sales fell on a year-ago basis for the first time since 2002 and only the third time since 1991, according to Economy.com.

"Core sales, which we define as total sales ex- autos, gas, and food, fell 0.8% for the second straight month, pushing the three-month annualized rate down to -5.7%, the worst since the current dataset began in 1992. Another sharp drop in consumption is assured for October, and there can be no doubt now that the economy is in recession. It will be there for a while," said Ian Shepherdson, Chief U.S. Economist at High Frequency Economics.

The October Beige Book report, a survey of labor market conditions, retail sales, consumer spending, construction and real estate, manufacturing, banking and finance, agriculture, energy, and natural resources, indicated widespread weaknesses across all 12 Federal Reserve districts in the U.S.

San Francisco Federal Reserve President Janet Yellen said, "Indeed, the U.S. economy appears to be in a recession."

Marisa DiNatale at the Dismal Scientist said the Beige Book "is the first glimpse at how regional economies have reacted to the credit crisis."

The bleak news hammered the Dow with a 733 point loss, the S&P 500 with a 90 point loss, and the Nasdaq with a 150 point loss. Moreover, cumulative losses from yesterday and today wiped out the majority of Monday's record rebound, when the Dow exploded 936 points higher.

Conclusion

We're not surprised that most of Monday's rebound has evaporated. We regained too much ground too quickly. Since volatility is at exceedingly high levels, and markets often overshoot on the downside and upside, we expected some 'back and filling' to occur after the big rebound, but we must admit we didn't expect it to happen by this magnitude, this suddenly.

With the VIX Index, a measure of market volatility, above 55, we can expect significant volatility to continue in the coming weeks. As such, several 500+ point rallies and sell-offs could be in our future. It's part of the bottoming process in bear markets.

We could have a retest of the lows tomorrow or Friday. Hang in there.
...

From this morning's reading ...

Historical Sector Weights of the S&P 500
Bespoke Investment Group
Seeking Alpha, October 15, 2008

With the extreme action in the markets lately, we thought it would be good to update our charts on historical S&P 500 sector weightings. In the first table below, we highlight each sector's representation in the S&P 500 (in percentage terms) since 1990. For each year, weightings are color coded from red (smallest) to green (largest), with the biggest sector highlighted in white font. For 2008, we provide weightings as they stood on July 15th (a short-term market bottom and the top in commodities), September 19th (the temporary peak following the initial TARP announcement and "No Short" rule), and yesterday.

As we've noted in the past, sector weightings go through cycles, and looking at where representation stands versus its historical average can offer insight into the long-term overbought and oversold levels of a sector. It also offers a good glimpse of the economic trends of the country.

As you'll see in the table below, the consumer sectors and industrials made up the majority of the market in the early 90s, while financials and technology were two of the smallest sectors. That changed quickly in the mid-90s, and financials and technology have been either the first or second largest sectors since 1996.

Unsurprisingly, the energy sector rose significantly over the last few years, and for a brief period this year, it was the second biggest behind technology. The doubling of its weight from '04 to '08 and the big movement above its historical average were clear signs that the energy sector had become overheated. Since July, the energy sector's weight has fallen from 15.3% down to 12.8%, and it now ranks behind financials, technology, and health care.

The trend this year for the financial sector's weighting has also been interesting. Back in July, the problems in the equity market were still largely contained to financials, and its sector weighting fell sharply from 17.6% at the end of '07 to 12.9% on 7/15. Since 7/15, however, the credit crisis has hit every sector hard, and financials have outperformed many of them. This has resulted in the financial sector's weighting actually increasing back up to 16%, once again making it the biggest sector in the S&P 500.

As our economy changes over the next few years due to everything that has happened this year, it will be interesting to see how sector weightings change. Will the consumer sectors and industrials stage a comeback? Will technology move into first place and widen the gap again like it did in the late 90s? Will financials no longer be the largest sector of our economy?


Below we highlight individual sector weighting charts over time. The red line represents the average weighting for each sector since 1990.

As shown, financials and technology are currently resting just above their long-term averages, while industrials and utilities are resting just below. Health care has recently moved quite a bit above its average, and energy remains well above its average but continues to head lower. The materials sector has tried to move back up towards its long-term average over the last few years, but the recent selloff in the sector has halted the trend. And consumer staples has moved above its long-term average this year, while consumer discretionary is at its lowest weighting since 1990. The consumer discretionary sector probably stands out the most as the one due for a big rally.

From Our Reading This Morning...

The Dangers of Timing the Market
Seeking Alpha, October 14, 2008, David I. Templeton

Today's sharp move higher in the stock market sheds light on the dangers of an investor trying to time the market. I wrote a post earlier this year, Focus on the the Long-Term, in which it was noted missing just a handful of the market's best days in a given year can really penalize returns. If an investor missed just 40 of the biggest up days in the market over the last 20 years (1987-2007), their return would have totaled 3.98% versus remaining fully invested and achieving an average annualized return of 11.82%.

The market research firm DALBAR went one step further and looked at the returns of mutual fund investors over the 20-year period, 1986-2006, and reported the average market timer return was -2%. During this same time period, the S&P 500 Index returned 12%.

• Additionally, during the 10-year period 1997-2006, the S&P 500 Index achieved an annualized return of 8.4%. If an investor missed just the top 20 days during this period, their return fell to -.4%.
• Further, 21 of the best 40 days came during the bear market period 2000-2002.
• Lastly, nearly three-fourths of the 40 best days came within two weeks following a worst market day.

A key investment decision for an investor should be to review their overall asset allocation. If the review, and investor risk tolerance, indicates additional equity exposure is appropriate, then maybe now is a good time to begin averaging into the market.

Source:
Market Timing Doesn't Work
Charles Schwab OnInvesting
By: Liz Ann Sonders
Fall 2007

Volatility and Complacency Make Strange Bedfellows
Charles Schwab OnInvesting
By: Liz Ann Sonders
Summer 2007

Third-Quarter Profit-Warning Trends

After a handful of third-quarter earnings reports last week, the major banks take center stage this week and next. BofA pre-announced weak third-quarter results last week, probably a harbinger of things to come from the banks. However, there have been surprisingly few profit warnings from blue-chip companies outside the banking sector. Still, for the stock market as a whole, the number of negative warnings and the ratio of negative-to-positive pre-announcements are both up sharply from the second quarter. This is, perhaps, an indication that smaller companies are starting to really struggle. The ratio of negative-to-positive pre-announcements varies a great deal at the sector level. What jumps out to us is that there have been nearly as many negative warnings from Technology stocks as from Consumer Discretionary stocks. Again, since the warnings have not come from the likes of Cisco and Apple, they are perhaps not as visible. But we could be starting to see a broader weakening of earnings.

source: Argus Research Market Watch, October 13, 2008

Market Pricing for Big Earnings Decline

Are analyst estimates far too high? The market seems to be saying so. In the previous bear market of 2000-2002, the S&P 500 fell by nearly 50% from its peak and earnings ended up falling about the same degree from peak to trough. The S&P 500 is currently down about 35% from its peak of 1576 late last year. S&P 500 earnings peaked at an annualized rate of about $87.50 per share in the second quarter of 2007. A 35% decline from that peak implies earnings of about $57, well below the Street’s most bearish forecasts. Attaching a long-term average P/E of 15 to earnings of $57 implies a fair value for the S&P 500 of about 850 — implying a further decline of about 15% for the S&P 500. While we may need to cut our EPS estimates further, we do not expect earnings to fall by nearly as much as currently implied by stock prices. We recently reduced our 2009 EPS forecast for the S&P 500 to $85 from $90 per share. Our 2008 EPS forecast remains $80.


source: Argus Research, Market Watch, October 9, 2008

World Central Banks Cut Interest Rates in Unison

Federal Reserve and other central banks announce reductions in policy interest rates. The Fed cut its key lending rate by 50 BPs to 1.5%. In a coordinated effort, ECB and Bank of England each drop their key rates by 0.5%, to 3.75% and 4.5% respectively. "Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets. Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability. Some easing of global monetary conditions is therefore warranted."

Louis Navellier's Thoughts on the Market

This is Louis Navellier. It is Tuesday, October 7th.

Well, let me tell you what's happening. First of all, we had good news on the commercial paper front. The Federal Reserve is intervening and starting to buy commercial paper. This is so important, folks, because the commercial paper market has been frozen ever since Lehman Brothers went bankrupt.

So, this is a very, very positive development. Big companies like General Electric and credit card companies go to the commercial paper market for short-term funding. So, that was a big development. That's the good news.

The bad news is the LIBOR rate, which is the inter- bank lending rate, is still very, very high because banks don't trust each other. There are very serious banking problems in Britain. They've been having some meetings, there's supposed to be a bailout package announced on Wednesday, but the truth of the matter is, is any bailout package is just a bandaid on the problem. What the market needs, what the market wants, and what the market is demanding are massive central bank rate cuts. Now, we had a rate cut in Australia, a full one percent. What we need is a rate cut from the Bank of England, they're going to meet this week, so we expect at least a half percent cut. The European Central Bank is supposed to meet in early November. We need a cut from them; a significant one half a percent would be nice. Our Federal Reserve meets on October 28th and 29th and in all candor we expect a full one percent rate cut but we'd like it before then. You see, Ben Bernanke talked today and he acknowledged that the economy is weak; he acknowledged that there are some complications out there and so we're all saying, "Okay Ben, where's the rate cut?" And the market sold off after his speech today because we're just waiting for the cut. We want a full one percent Federal Reserve rate cut; that would spark an incredible rally in the market. The cash on the sidelines is well over thirty percent of market value; it's the highest I've ever seen in over three decades.

So, this if very, very exciting. We think there will be a spark that will cause money to pour into the market. In the interim, our energy stocks and agricultural stocks were up for much of the day. They did settle down late in the day, but they held up much, much better. We hope they will merge an oasis. This is where some of the strongest earnings are and the third quarter earnings are around the corner. According to Zacks, they're supposed to be up six percent over the same quarter a year ago. These are easy year-over-year comparisons because in the third quarter a year ago, there were some big write downs, but the market can get bailed out by earnings, but more than likely they'll be bailed out by a Federal Reserve rate cut. So, hang in there folks. We're not sure what's going to spark the market. It could be something as simple as Mr. Obama saying that he can't raise taxes in this environment. That could spur the market on, but I think we really need leadership from the Federal Reserve. So, let's hope they have that full one percent rate cut and then we'll have a big rally and we'll wonder what the fuss was about. In the interim, this is a challenging environment, but I am encouraged that a rate cut is definitely going to be forth coming. I'm encouraged by the strength in agriculture, energy, and other stocks that are going to have good third quarter earnings. We can almost see the light at the end of the tunnel here folks. Let's just hope that we get our rate cuts so that the market can rally and remove a lot of the uncertainty out there. Take care everybody, I know this is tough for a lot of people and I know this is very, very stressful.
...

Louis Navellier's Thoughts on the Market

Louis' Transcript:

This is Louis Navellier. It is Monday, October 6th.

Obviously it's very stressful out there for all investors, and I'd like to just kind of take a step back and explain to everyone what's going on and what this latest development in the stock market meltdown is all about.

What's happening is there's a credit crisis out there, and you've heard about the commercial paper market falling apart after Lehman Brothers went broke; now what's happening is something called the LIBOR rates -- the London Inter-Bank Offering Rates -- are skyrocketing because the banks don't trust each other. Now what happened last week is Ireland stepped in and said, "We're going to back our banks."

Now in Europe they don't have bank insurance like we do in the United States. In places like the U.K., insurance is only £2000 per account so that's less than $4000. So for a country like Ireland to come out and say "Well, we're guaranteeing everything in Ireland," really sent shockwaves through the European Union. So they had an emergency meeting on Saturday, and then they came out with a statement that they wanted to reassure everybody that they're going to back all the banks, so they're going to do the same thing Ireland did. But there was no "teeth" to their plan; there were no specific proposals, and it was widely reported that the German finance ministers were very annoyed at the Irish finance ministers, etc.

So the banks still don't trust each other; and on Monday, just a day, the LIBOR rates went up. And that is why the market got up on the wrong side of the bed, for lack of a better word; and it opened up poorly in Europe, and it opened up poorly in Asia, and of course it carried over here to the U.S.

Now if you want some reassuring news, our Fed and the Treasury has done a lot of intervention here starting today; of course the $700 billion bailout package was signed, so there is a lot of market intervention. However, market rates have plummeted so what we're really going to need is a Federal Reserve rate cut -- and secretly, I was hoping the Fed would cut rates today, a full one percent -- we'll see.

If you watch CNBC you've heard rumors that the G8 were going to get together and there might be a coordinated rate cut. This week the Bank of England is getting together and we expect a cut by Thursday. The European Central Bank has already hinted at a cut at their next meeting in November. And of course our Federal Reserve meets on October 28th and October 29th, which is the Federal Open Market Committee Meeting and we expect a cut then.

So, the question is why do we have to wait for the cut when market rates have collapsed? Can't the Fed cut rates now? I think a Fed rate cut is coming. In the interim, at least in the last hour today the market did have, for lack of a better word, what I would call, "dead cat bounce." There were some bargain hunters out there.

You know the woes in the financial services industry are not going away. Bank of America announced after the close that their earnings were sub-par, that they're cutting their dividend in half and that they're going to have to raise some capital in the open market. So, this leads to weak opening on Tuesday for the financials, but earnings are coming out soon and we know some of our stocks started to rally late in the day, so that's very, very encouraging.

So, let's hope we get the Fed rate cut, we have a lot of good earnings reports coming out for our stocks, and as long as the silver lining of critical path emerges I think we'll be fine.

Please remember folks that we go into every earnings season locked and loaded. Our stocks have stunning sales, stunning earnings they trade at very reasonable price-earnings ratios, and right now there is over $4 trillion of cash on the sidelines that represents over, literally over 30% of market value. What we're waiting for is a spark, whether it's a Fed interest rate cut or Mr. Obama saying there's not going to be any tax increases, something like that to get the market going because there's a lot of a fear out there in the market. So, interesting times we're in, very stressful but on all counters it's too late to sell. There's been a lot of very serious liquidity problems out there and we expect that a Federal Reserve rate cut in the upcoming third quarter earning's announcement's season will help show up our stocks immensely. So, hang in their folks, we know it's been very, very painful for a lot of you but I think help is very, very near.
...

Bank Failures Expected to Increase

Bank failures exploded with the real estate bust and S&L crisis of the 80’s and early 90’s. In the current environment, we are not predicting anything on that scale in terms of the number of failures to come. First of all, there are thousands fewer commercial banks today after years of M&A. Also, banks generally hold more capital against their assets. So bank failures have become very rare – and or several quarters, from 2004 through late 2006, there were no bank failures at all in the U.S. But smaller banks are very exposed to consumer loans and tend to hold mortgages on their books (versus securitizing them). While they often are more conservative underwriters than the big banks, they are still staring at major losses. Also, smaller banks tend to focus on lending to local real-estate builders and developers, another shaky industry in which the big banks are experiencing rapidly deteriorating credit quality. When we first ran this piece in June, there had been 3 failures in 2008. Currently, that number stands at 13.


source: Argus Research, Market Watch, October 2, 2008

Economy Expands by 2.8% in QII

U.S. economic growth advanced by a revised 2.8% pace during the second quarter – the strongest quarterly gain since QII07 (4.8%), and slightly more than three times the first quarter increase of 0.9%. We seriously doubt that a similar posting will be seen for a few quarters. We expect third-quarter growth to be in the vicinity of 1.0%-1.5%, and fourth-quarter activity to advance by a lowly 1.0%. To date, the credit crisis has had little economic effect, except for the dampening of consumer spirits and the curtailment of business lending. Unless there is some plan implemented to help the situation, a recession seems to be a certainty. However, we suspect that some solution will help ease the crisis, and unclog the lending channel. If our assumptions are correct, we then believe a recovery will commence sooner rather than later. We also anticipate economic growth of 2.4% in 2009.

source: Argus Research, Market Watch, September 30, 2008

Commodity Prices Sink

The pace of commodity price deceleration has intensified in recent weeks amid a drop in the pace of global economic demand and the somewhat stronger level of the U.S. dollar. Economists like to observe the trends in the Economist’s Commodity Price Indices since these trends don’t have the volatile influence of crude oil prices. The Economists All Items Index has fallen 7.7% over the last month, but remains 4.9% higher than year-ago levels. Similarly, the Food Index has fallen by 8.4% in the past month and remains 15.3% higher year-over-year. The big drop has been in Industrial commodity prices, which are down 6.8% over the last month and 6.5% over the last 52 weeks. We expect a general continuation in this downward trend, but caution against complacency. There are still a number of emerging economies in need of commodities and we suspect demand will rebound once the crisis and the economic slump has dissipated.

source: Argus Research, Market Watch, September 25, 2008

Tobin’s ‘q’ at 0.68 in QII

The Federal Reserve recently released its quarterly Flow of Funds data for the second quarter of 2008, which permits us to estimate a back-of-the-envelope value of Tobin’s ‘q’ – a measure of market valuation. The ‘q’ is defined as the ratio of the market value of a firm to the replacement cost of its assets – in this case we are estimating those figures for the entire industry. According to Nobel Laureate James Tobin, the ratio of total stock market value to the stock market’s net worth (corporate net worth) is a reliable indicator of market valuation. When the stock market trades at a ‘discount’ to the replacement cost of its assets, the market is inexpensive, or cheaper to buy than build. This discount possesses ‘q’ ratios that are less than 1.0. Conversely, when “q” exceeds 1.0, the market trades at a premium. The run-up from 1996-2000 had ‘q’ approaching the unthinkable value of 2.0. Encouragingly, the most recent (2Q08) level of 0.68 implies a reasonable valuation of market conditions. The long-term average (since 1952) for Tobin’s ‘q’ is 0.75.

Argus Research, Market Watch, September 24, 2008

Rereading Warren Buffett

"Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell."

...

"We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful."

- Warren E. Buffett

Home Prices Driving Loan Defaults

Housing inventory sits at nearly 12-months, or more than twice the average level. Foreclosures are adding to supply. As a result, more downside in home prices seems assured. Home prices are already down about 15% from the 2006 peak, according to S&P Case Schiller. Many of the major banks are forecasting additional price declines of that same magnitude. Less well publicized is that home prices doubled nationally from 1998 through mid-2006, and ballooned by far larger amounts in the markets now seeing the biggest declines. Still, for those that signed up for highly leveraged mortgages late in the boom, delinquency rates continue to skyrocket. The percentage of home loans more than 30 days past due is already at its highest level since the early 1990’s. On September 5, the Mortgage Bankers Association reported that as of June 30 more than 9% of mortgage loans were either at least one payment past due (6.4%) or in foreclosure (2.75%), both records.


Source: Argus Research Market Watch, September 18, 2008

Financial Headlines

Bernanke deals with dissent by giving hawks a voice
Federal Reserve Chairman Ben Bernanke is coping with a financial crisis, possible recession and also inflation, while dealing with an unusual level of dissent among his team of policymakers. To make the Fed more democratic and transparent, Bernanke incorporates the views of his colleagues in official announcements. The strategy may sometimes muddle the Fed's position, but it gives the hawks a voice and likely means that the Federal Open Market Committee is running properly. The Economist (11 Sep.)

U.S. trade deficit soared to $62.2 billion in July
A record-high oil price propelled the U.S. trade deficit to $62.2 billion in July, the highest in 16 months. This month, the price of oil is down more than 25% from that peak price. There is reason to believe that inflation is either stagnant or slowing, as import prices exclusive of oil fell slightly this month. The New York Times (11 Sep.)

Market participants debate best way to deal with crises
The rally in markets after the U.S. government's rescue of Fannie Mae and Freddie Mac ended quickly as investors appeared concerned about the health of other financial institutions. Some market participants are pushing for a systemic solution. Others are suggesting different fixes. Former Federal Reserve Chairman Alan Greenspan said a formal framework should be established to deal with financial institutions on the verge of collapse. Financial Times (11 Sep.)

Fed's Kohn says house prices still have room to fall
Although the rate at which house prices are falling has slowed, Federal Reserve Vice Chairman Donald Kohn does not see the decline as having hit bottom. Mortgage conditions have tightened since the spring, and that impact has yet to play out. Kohn recommended that banks and other lenders build up buffers during prosperous times to guard against economic downturns. Reuters (11 Sep.)

The market opened down more than 1.5% Thursday morning, but was able to recover. The S&P 500 managed to rally and finish the day in the black more than 1% higher. While this volatility may appear normal, reversals like this aren't. From a historical perspective there have been 26 other days where the S&P 500 was down more than 1% at one point, and able to finish the day up 1%+ higher. It has happened three times this year. The only other years where there have been three or more of these type of reversals were 1987-3x, 1990-3x, 1998-5x and 2002-6x.

Financial News Headlines

Report: U.S. reliance on foreign capital leaves it vulnerable
America's reliance on foreign central banks and sovereign-wealth funds for funding may restrict Washington's policy options, according to a report from the Council of Foreign Relations. "This does not mean foreign creditors are certain or even likely to use their financial assets as a weapon. It does mean that they could do so if they want," said Brad Setser, fellow for geoeconomics at the council. Reuters (09 Sep.)

Buffett's Berkshire caps insurance level of bank deposits
Kansas Bankers Surety, a subsidiary of Berkshire Hathaway, will quit insuring bank deposits for more than the amount guaranteed by the U.S. government, according to the Wall Street Journal. Reuters (10 Sep.) A significant indication of just how worried Buffett, and likely others, are about future bank failures.

Greenspan applauds government takeover of Fannie, Freddie
Former Federal Reserve Chairman Alan Greenspan applauded the U.S. government's bailout of Fannie Mae and Freddie Mac. Greenspan had urged Congress to empower the government with authority to manage large companies in crises to protect taxpayers, although he proposed that the Fed should not be relied on for handling bailouts and that the process needs to be transparent. CNBC (09 Sep.)

Stunted shopping means difficult Q3. Consumer spending will take a decided turn for the worse in Q3, economists say. "The seemingly resilient U.S. consumer is finally buckling." The slump will slow GDP growth to 1.2% - less than half of the prior quarter's 3.3%. Factors: Eight months of falling employment; weakening consumer confidence; and falling property values. seekingalpha.com

Pending Home Sales fell 3.2% in July vs. June, and 6.8% vs. a year ago - worse than the -2.1% M/M consensus. The drop indicates that the U.S. housing market may continue to weaken over the coming months. "Pending home sales are oscillating month-to-month, with the long-term trend essentially flat," NAR's Lawrence Yun said. "Overly stringent lending criteria imposed by Fannie Mae and Freddie Mac in the past month no doubt held back contract signings," implying the recent Treasury move to free up mortgage funds may be a net positive for the industry. seekingalpha.com

V-Shaped Recovery for Earnings in 2009?

As we have said repeatedly over the past year or so, earnings expectations are too high among both stock analysts and market strategists — but especially among analysts. Analysts in general are notoriously slow to adjust expectations at inflection points in the business cycle. Since stocks are valued based in part on earnings forecasts, we have turned our attention to analyst expectations for 2009. What we found is that double-digit earnings growth is expected in every sector. What jumps out most is the 130% rebound expected in Financial earnings. Granted, Financial earnings are expected to drop by more than 50% in 2008. Still, we believe that forecasts for the group remain too optimistic. Earnings from Consumer Discretionary stocks are expected to jump 30% next year. Expected growth rates for 2009 have grown as estimates for 2008 have been slashed. But in our view, stocks will struggle to rally meaningfully until expectations for 2009 come down as well.

Source: Argus Research Market Watch, September 4, 2008

Financial News Headlines

Bank loans from Fed set new high. U.S. banks hit a new record this week in the amount of funds borrowed from the Fed. The daily average of $18.98B beats last week's record of $18.47B. The increase in how much banks borrow from the Fed signals that banks are increasingly reluctant to lend to each other, making it more difficult for private and commercial consumers to obtain financing for home purchases and business operations.

More jobless claims. Initial jobless claims reached 444,000 vs. consensus of 420,000, up 15,000 from last week's 429,000 (revised from 425K). The Four-week average dropped 3,250 to 438,000. Economist Michael Gregory said, "we're continuing to get sort of a grinding slackening in the labor markets... Businesses are becoming more cautious about hiring and layoffs continue. At some point this begins to weigh increasingly heavily on the consumer."

Productivity rises. Q2 Productivity rose 4.3% vs. +3.5% consensus, revised up from 2.2%. Unit labor costs were -0.5% vs. 0%, revised down from +1.3%. Hourly compensation increased 3.7%, but declined 1.3% after accounting for consumer price inflation. Says economist Peter Morici: "Rapidly rising productivity growth coupled with easing oil prices will bring down headline inflation, as well as the closely watched core index."

Non-Mfg Survey shows signs of expansion. The ISM Non-Manufacturing Survey showed economic activity in the non-manufacturing sector grew in August, following two months of contraction. Its service sector index reading of 50.6 (50+ = expansion) exceeded estimates of 49.5.

BoE leave rate unchanged... Bank of England kept its benchmark rate at 5%, as expected. Policy makers judged the fastest inflation in more than a decade outweighed the possibilty the U.K. economy is wading into recession.

and ECB follows suit. Following in the footsteps of BoE, the ECB left its benchmark rate at 4.25%. President Jean-Claude Trichet weighed inflation of 3.8% against recent evidence that some eurozone nations are on the brink of recession.

Source: Seekingalpha.com/wallstreetbreakfastmustknownew

Financial News Headlines

Fed minutes show inflation disagreement. Three of 12 Federal Reserve regional banks would have liked the discount rate increased to 2.5% from 2.25% on June 26, according to FOMC minutes. Officials from Chicago, Kansas City and Dallas were worried that inflation risks were greater than downside risks to growth.

Consumers feel better- but not by much. ABC's weekly Consumer Comfort Index, released yesterday, showed American consumer confidence rose slightly on improved perceptions about the consumer spending climate. The index was up to -47 in the week to Aug. 31, but still dangerously close to its all-time low of 51, reached in May.

Quote:
In Seth Klarman's "Margin of Safety", he says "Security prices sometimes fluctuate, not based on any apparent changes in reality, but on changes in investor perception."

It was recently reported that "Value Investing was Dead"; thank you for reporting that because it's time to Value Invest. They said the same thing a little over 8 years ago at the height of the tech bubble. Warren Buffett was "out of touch" with investing. Well, over the past 8+ years who won - Warren did. His return using Berkshire Hathway as the proxy up 3X, the S&P 500 for the past 8.5 years .1%.

When people begin to speculate about the demise of history's most successful investing strategy, emotions run the day and great opportunities will arise.

Inflation Trends Higher

The government said that the pace of consumer inflation advanced by 0.6% during July, bringing the 12-month pace to 4.5% — the fastest rate since February 1991. Meanwhile, prices (excluding the volatile food and energy component) increased by 0.3% or 2.4% from year-ago levels. This increase in core inflation exceeds the Fed’s desired 1.0%-2.0% comfort zone. In fact, the core PCED hasn’t resided safely in that comfort zone since late 2003. The real Fed Funds rate is a super-stimulative -2.33%, the lowest in several decades. With inflation climbing at this pace, it should come as no surprise that the Fed is considering a rate hike as its next move. Unfortunately, given the instability in the credit markets and the slumping housing and auto industries, we don’t see the hike taking place in the near term.


Source: Argus Research Market Watch, September 2, 2008

September - Worst Month for Market Performance

Many investors believe October is the worst month for equity market returns. This can be partly attributable to the fact some large one day declines have occurred in October. The one market decline many investors think of is Black Monday that occurred on October 19, 1987 when the Dow Jones Industrial Average fell 508 points or 22.6%.

In actuality though, the worst month for market returns is September. Although the average return in September is negative, the magnitude of the decline was no worse the -1-1.5%.

The below chart from Chart of the Day details the average monthly returns for the Dow Jones Industrial Average for two time periods: 1980 - present and 1950 - present.


Source: www.seekingalpha.com August 29, 2008 ; Chart from Chart of the Day

Adjusted for Household Size, Real Income Reached an All-Time High in 2007

The Census Bureau just released its annual report that includes real, median household income for 2007 ($50,233). From the report:

Between 2006 and 2007, real median household income rose 1.3%, from $49,568 to $50,233 (see top chart above)—a level not statistically different from the 1999 pre-recession income peak ($50,641 in 1999 and $50,557 in 2000). This was the third annual increase in real median household income. Compared with 1967, the first year for which household income statistics are available, real median household income has increased 29.6%.

Comments: A comparison of real median income in 1967 of $38,771 per household to income of $50,233 per household in 2007 (29.6% higher) doesn't take into account the significant 22% decline in average household size over this period, from 3.28 persons per household in 1967 to an all-time low of 2.56 persons per household in 2007 (Census data here for income, here for average household size), see top chart above.

When adjusted for household size, real median income per household member reached an all-time high of $19,546 in 2007 (see bottom chart above), 65.6% higher than the $11,820 income per household member in 1967, and more than 2 times the unadjusted increase per household of 29.6% reported above.

Lost in all of the discussions and media reports about stagnating wages, income inequality, and the decline of the middle-class, we have this amazing statistical reality: In just a little more than one generation, real median income per household member has increased by a factor of almost 2/3!

It's been said that "the media constantly dwell on minor problems without celebrating the broader, more upbeat context in which they exist." A 2/3 increase in real income per person in just 40 years is definitely part of the broader, more upbeat context.

Source: Seeking Alpha, August 28, 2008

Bond Bulls

Wall Street strategists have generally become more bullish on bonds as interest rates have declined. The chart below shows the normalized trend in 10-Year Treasury yields along with the average recommended bond allocation by strategists at a group of Wall Street firms. For most of this decade, strategists have recommended that investors keep about 25% of a balanced portfolio in bonds. At the end of August, the recommendation was that almost one-third of a portfolio should be in bonds. These strategists are pretty smart and we suspect that some are focusing on safety, amid worries about housing and some financial firms. But as contrarians, we think it is simply worth considering whether bonds deserve a bigger portion of your portfolio when the 10-year Treasury is yielding 3.8% and the inflation rate has surged from 1.3% at the end of 2006 to 5.6% in July, the fastest pace in 17 years.

Source: Argus Research, Market Watch, August 28, 2008

Financial News Headlines

Dollar intervention planned, abandoned. Nikkei business newspaper reports that the U.S., Europe, and Japan created a dollar rescue plan in March when the currency was plummeting. The officials did not choose which exchange rate would trigger the plan, but were prepared to aggressively buy dollars and sell yen in the event of continued dollar weakness. The intervention was never put into action, but makes some investors wonder whether a future fall in the dollar could spark a new multi-governmental rescue plan.

U.S. companies might start using international accounting rules. The SEC proposed a tentative timeline on Wednesday that could require U.S. companies to switch to international accounting standards by 2014. Until now, the U.S. has used Generally Accepted Accounting Principles [GAAP], which are considered less flexible and more clearly defined than the international financial reporting standards [IFRS] used in Europe and in dozens of other countries. The timeline fits with a global plan to converge GAAP and IFRS, a move that would be welcome to many in the accounting industry.

MBIA to reinsure FGIC municipals. MBIA (MBI) has agreed to backstop $184B in FGIC municipal bonds. FGIC's future remains uncertain and the reinsurance agreement allows it to focus on other problems connected to mortgage securities. MBIA will receive a $741M premium.

Bankruptcies soar. Bankruptcy filings shot upwards in the year ending June 30, to nearly 1M total. Business filings were up 41% and personal filings rose 28% on the previous year. Filings are expected to reach 1.2M this year.

Job market confidence same as 2001. A new survey shows worker confidence at a low last seen during the 2001 recession. With unemployment at a four-year high, 65% of respondents said this is a bad time to find a quality job, and 33% of workers said they don't always have enough money to make ends meet.

Durable goods show surprise growth. July durable goods orders rose an unexpected 1.3% on strong transportation equipment demand vs. a consensus 0.2%. Excluding transportation, orders rose 0.2%. U.S. Treasury debt prices fell as the report suggested resilience despite the deep housing correction and credit crunch.

Lockhart: Fed prepared to raise rates when needed. Federal Reserve Bank of Atlanta President Dennis Lockhart said Wednesday that the Fed's interest rate is consistent with slowing inflation, and signalled readiness to raise borrowing costs if such a move is needed.

Source: SeekingAlpha

Headline Financial News - 8/27/2008

Fed Minutes show weak outlook, split on inflation. Minutes released yesterday from the August 5 FOMC meeting show the Fed expects weak economic growth and moderating inflation through to the end of the year, and committee members marked down their forecast for growth in the second half of this year and 2009. The central bank's interest-rate target remained unchanged at 2%, and though committee members expect to raise interest rates at some point, the timing of such a move is unclear since most committee members believe the interest rate is not too low given the current economic situation. Fed officials appeared divided on exactly how great a threat inflation poses and to what extent financial stress is weighing down the economy.

FDIC may replenish funds with Treasury loan. Increased bank failures have pushed the FDIC's reserve ratio to 1.01% ($45.2B), low by historical standards, forcing the FDIC to develop a restoration plan to replenish the fund. Risks remain high, with 117 banks on the FDIC's "problem" list compared to 90 in Q1. Chairman Sheila Bair said Treasury borrowing could be needed to cover short-term cash-flow pressures created from reimbursing depositors immediately after a bank failure. The loan would be repaid once the failed bank's assets had been sold. Washington regulators are concerned that the FDIC is turning to the Treasury after only nine bank failures, a move that underscores the weakness of the U.S. banking system in the wake of the credit crisis.

U.S. consumer confidence hits near-record low. ABC's weekly Consumer Comfort Index shows American consumer confidence fell to a near-record low as gasoline prices remained high, and inflation and unemployment continued to weigh down the economy. The index was down to -50 in the week to Aug. 24, one point lower than the previous week, and dangerously close to the all-time low of -51, reached in May.

S&P/Case-Shiller see housing decline moderating. S&P/Case-Shiller says broad-based declines in U.S. home prices continue. Q2 prices fell a record 15.4% vs. a year ago. It does see the decline moderating, and a possible bottom in some regions.

Source: SeekingAlpha.com