Market Commentary – September 28, 2009

General Market Comment:    September 28, 2009

 Life goes on . . . we are now a year after the collapse of Lehman and this week we will anniversary the near death experience of Sept. 29, 2008 when the Dow dropped over 700 points.  Back then Congress was dithering over the TARP, banks were failing/being shotgun married off, money market funds were “breaking the buck” . . . It was all together as unpleasant a time as I have ever experienced or ever to care experience again.

 So – where do we stand today?

 The broad equity indexes are approaching or matching levels from just prior to that time.  Multiple indicators are signaling economic recovery is taking root.  While many of the indicators we read about everyday, such as the labor statistics we will see this week, are lagging data I was curious what some of the forward looking indicators are telling us.

 One forward looking indicator I like is the price action of high yield bonds.  This is a market that is played overwhelmingly by pros – no retail money should tread there.  The market is a proxy for the health of the companies that have issued high yield bonds, a signal for the outlook for interest rates and importantly the risk appetite of institutional investors.  The market for high yield bonds has fully recovered and is above last September’s level.

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 This is a remarkable turn around.  Logically one should consider if this action is sustainable.  One tool that helps us with this task is the trend in credit default swaps and the spread in those swaps between investment grade corporate debt and high yield debt.  Have a look at the following chart from Scott Grannis’s blog “Calafia Beach Pundit”.  (the indexes measure the spread between the relevant corporate rate and the 5 year Treasury note).

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 This forward look into default risk has improved dramatically in absolute and relative terms.  So far it suggests at least two outlooks.  Firstly, it suggests there is more upside to bonds as the price as expressed by the spreads remains high relative to pre-Lehman crash levels.  Secondly, it suggests the outlook for the economy is improving.  The implication for the equity market is that it too should continue to improve.  Bespoke Investment Group generated a compelling chart contrasting the change in the CDS index and the S&P 500 since the scary days of last September.

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The CDS index in the chart expresses the default risk of 125 North American investment grade entities.  As it went up, stocks went down and vice versa.  An important point highlighted by Bespoke is that the S&P 500 would have to rise approximately 20% to return to the level of June 2008 when the CDS index was last at its current value.  The very sharp drop in the CDS index in recent weeks may be signaling a material return to the markets by institutional investors as they transition out of money market investments and into higher return asset categories.  We have in fact seen approximately $60 billion leave institutional money market funds in the last 30 days.

 As I have said over the last several weeks . . . “The here and now data supports the case for rising tech stock prices and low and behold they continue to rise.  I continue to believe we will NOT see any material correction (i.e. down 10% or so) as we move toward Q4.  Q4 continues to shape up to be very strong.  Money managers that have missed out on this year’s great rally will likely be forced into the market in the October / November time frame as the Q3 earnings season unfolds.


Market Commentary – September 21, 2009

General Market Comment:    September 21, 2009

 We have some charts and comments from Merrill Lynch this week that I found of interest.  Merrill has started a series entitled “Global Quant Panorama” where they address global investment strategy.  A cornerstone of the work is a new data series centered on an amalgamation of global economic and market indicators they call the “Global Wave”.  I found the study instructive. It reflects the broad adoption of commonly applied U.S. analytical conventions and reporting and the increasingly tight integration and co-dependency of the global economic players.  It is a logical framework to appreciate the prospects for the earnings contribution from international activities for U.S. companies.  I have heard 60% of the earnings for the S&P 500 companies are attributable to international activity.  The “wave” is rising – surprise, surprise.

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Today’s lack of consumer confidence and capacity utilization lead to tomorrow’s operating leverage and above trend earnings margins and growth.

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The turn up in both global confidence and utilization support the rising earnings expectations I have pointed out in the recent past.

There should be no surprise that equity market performance is well correlated to and leads Merrill’s Global Wave.  We should see the equity markets return to a level of positive year over year change in October.

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 Merrill’s view on valuation is straight forward – stocks are cheap.  This chart uses long term earnings to calculate the P/E ratio for their global stock index.  Keep in mind that the “E” part of “P/E” will be rising faster than the “P” part over the intermediate term as operating leverage kicks in over the coming quarters.

ScreenHunter_11 Sep. 21 13.38 ScreenHunter_12 Sep. 21 13.38

 The debate over whether there will be another market “crash” will now start to shift toward the possibility of a drop in October – the month that has seen the most market crashes in history.  We will continue to let others debate – our job is to make money.

 As I said last week . . . “The here and now data supports the case for rising tech stock prices and low and behold they continue to rise.  I continue to believe we will NOT see any material correction (i.e. down 10% or so) as we move toward Q4.  Q4 continues to shape up to be very strong.  Money managers that have missed out on this year’s great rally will likely be forced into the market in the October / November time frame as the Q3 earnings season unfolds.


Market Commentary – September 14, 2009

General Market Comment:    September 14, 2009

 The focus of this comment is on the outlook for the technology sector – the sector where all of our investments reside.  You all may be aware of the stellar outperformance of the tech sector so far this year.  If not, I have charted the move in the “XLK” (Technology Select Sector SPDR that trades on the NYSE) compared to the S&P 500 (SPX).  The tech sector is up 33% and has beaten the S&P 500 by 15%.

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There is a simple explanation for the outperformance . . . faster earnings recovery and more profit margin than the rest of the S&P 500.  Yardeni Research has displayed the trend in forward earnings estimates for tech stocks since 1995.  The “squiggly” lines are the estimates for each year as they change over time.  The recent recession has been a cakewalk compared to 2000-2002.

ScreenHunter_07 Sep. 14 14.54 Technology companies are more profitable than the average S&P 500 industrial company.  Margins in Q2, while down from their peak, remain above 1999 levels and are rising.  Note that technology businesses are more “B2B” as in “business to business” oriented and hence somewhat less exposed to concerns over consumer spending levels.

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The Street analysts have been rapidly adjusting upward their earnings estimates for the technology sector.  The current level is consistent with past bull markets in technology stocks.

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 In addition to signals provided by tech stock prices and earnings estimates we have evidence of an improved outlook for the technology sector from the “Tech Pulse” index generated by the Federal Reserve Bank of San Francisco.  The index is computed from coincident indicators related to technology including investment, consumption, production and employment.  I have charted the most recent numbers as of August.  While the data series is bumpy it has turned up sharply consistent with behavior in the tech recovery of 2003 and supportive of the rising earnings estimates for the tech sector.  Since the technology sector generally produces more earnings than any other market sector (~2X more than consumer discretionary stocks for example) this will provide a prop for overall market performance.

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There seems to be endless debate over whether there will be another market “crash”.  The various causes or reasons which are vigorously presented include falling commercial real estate, rising inflation, a consumer who can’t / won’t spend etc. etc.  This is all good – it allows markets to discount imminent risks.  The more the debate, the less the risk of a surprise drop in the market.

 We will let others debate.  The here and now data supports the case for rising tech stock prices and low and behold they continue to rise.  I continue to believe we will NOT see any material correction (i.e. down 10% or so) as we move toward Q4.  Q4 continues to shape up to be very strong.  Money managers that have missed out on this year’s great rally will likely be forced into the market in the October / November time frame as the Q3 earnings season unfolds.


Market Commentary – September 8, 2009

General Market Comment:    September 8, 2009

 The focus last week was on the August labor report and private sector indications of the recovery’s status . . . the takeaway is the economic indicators continue to outperform expectations much to the chagrin of the bears.

 Here is some color on the employment report you might not have noticed in the breathless reporting on the financial networks.

 From Bespoke Investment Group ( we get the following comment:

This morning’s employment report for August showed that non-farm payrolls declined by 216K.  This is the best monthly reading (if you can call a decline of 200K+ jobs good) in the ‘post-Lehman’ era.

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In the 12 months since Lehman’s bankruptcy, the US economy has now lost 5.8 million jobs, which is the largest 12-month decline in history.  In percentage terms, the 5.8 million jobs lost in the last year is equal to 4.44% of the total workforce.  Over the last seventy years, this level has only been breached during two other periods.

 From Scott Grannis at the Calafia Beach Pundit ( we found that layoffs “have all but vanished”

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Layoff announcements by corporations have fallen dramatically over the course of this year, providing strong evidence that the recession has run its course

 From Mark Perry at Carpe Diem we found the following note:

 The Monster Employment Index rose in August, seeing its highest monthly rate of improvement in four years, as a majority of industries, occupations, and regions registered increased online job availability following the slow summer hiring activity. The Index’s annual rate of decline continued to moderate, indicating some signs of improvement in underlying demand for labor nationwide

 The labor situation is improving – period – don’t let anyone lead you astray.  It will get even better this fall – just in time for the Q4 holiday season and entering 2010.

 We also got information on the rate of improvement in the economy from the ISM Survey data on manufacturing and non-manufacturing businesses last week.  The data is presented in the form of diffusion indexes where a score above “50” means the economy or the particular data set is expanding and a score below “50” means the reverse – falling of contracting.  The series that got my attention were the “New Orders”, and “Employment” indexes.  Both are sharply moving up.  New Orders leads growth in Employment.  The charts are obvious – have a look below.

 ScreenHunter_03 Sep. 14 14.39


 Here is one of my favorite charts – New Orders overlaying the Employment index.  You don’t need to have taken even high school statistics to see the correlation.  The sharp recovery in new orders is consistent with the comments I have made in the past about the weekly leading economic indicators recording the sharpest recovery since ECRI began keeping records in 1967.

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Of course with the economic data recovering strongly we shouldn’t be surprised to see net earnings estimate revisions continuing to rise.  Rising earnings and rising stock prices . . . Hmmm . . . they go together like “peas and carrots” as Forest Gump might say – eh?

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I continue to believe we will not see any material correction (i.e. down 10% or so) as we move toward Q4.  Q4 continues to shape up to be very strong.    


Market Commentary – August 31, 2009

General Market Comment:    August 31, 2009

 We managed to get through August with another gain in the market.  The market is up 6 months in a row.  It has gone up 20 of the last 25 weeks.  We have seen remarkable strings of consecutive positive weeks.  The market (as I define as the NASDAQ) has gained over 56% from its March low.   In the vein of “no good deed goes unpunished” surely the market is due for a “correction” of some meaningful magnitude. 

 And now we are entering the dreaded month of September . . . the historically worst month of the year for the stock market. The NASDAQ has been down in September 46% of the time since its start in 1971.  The S&P 500 has been down 56% of the time going back to 1950.

 Why would one month always be so bad?

 There are many anecdotal explanations, some logical, some goofy . . . but since it has become the received wisdom that the market declines in September and since there are myriad ways to make directional bets on the market the downward bias has become an almost structural element in September.

 The most recent experience similar to what we now face was in 2003.  The NASDAQ had risen 7 consecutive months as we entered September 2003.  The economy was emerging from recession.  The market had made a terrific recovery of over 40% from a March low . . . sounds familiar – eh?  The NASDAQ declined a “whopping” 1.3% in September 2003.  It went on to rise over 8% in October 2003! 

 Here are some of the signs that give me encouragement that this September will be more like 2003. 

 The economic recovery is becoming more obvious by the week My favorite leading economic indicator – the ECRI Weekly Leading Index – continues to rock.  Here is what the Managing Director said last week . . . “”With WLI growth continuing to surge through late summer, a double dip back into recession in the fourth quarter is simply out of the question,” said ECRI Managing Director Lakshman Achuthan, reinstating the group’s recent warning to ignore negative analyst projections.  

 Markets don’t fall when earnings are improving The level of future earnings continues to rise.  As I have shown you in recent weeks the earnings reports for 2009 and for Q2 2009 in particular have far exceeded estimates.  This performance has analysts looking ahead with more confidence. The current earnings estimates support a valuation of the S&P 500 of as much as 14% greater than today if multiples of run rate earnings equal what was paid in 2003.

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  • Markets don’t fall when money is flowing into mutual funds        Inflows to equity mutual funds has been positive for 4 months in a row for the first time since 2007.  $100 billion of inflows can lead to $1 to $1.5 trillion in market capitalization growth.  That would imply a potential double digit percentage increase in the major index values.  Year to date inflows to equity funds has only been $8.9 billion.  There is much more to come – soon.

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  • Markets like political gridlock – which is looking more likely      The best market returns have occurred with a Democratic President and a Republican Congress.  The healthcare reform fiasco is weakening the Democratic Party’s ability pass their liberal agenda.  A definitive defeat of the healthcare legislation in September – as it appears increasingly probable if not certain – will allow the markets to begin to discount a change in control in Congress in the mid term election of 2010.  The polls are indicating a shift in voter sentiment toward a more center right orientation.  The more this is confirmed, the higher the market will go.
  • You ain’t seen nothin’ yet          There remains an unprecedented amount of cash on the sidelines.  M1 – i.e. checking accounts – continues to pile up.  This will stop. My guess is we will see some leveling off leading to a decline starting in Q4 and continuing in 2010.  You want to be long stocks when this happens.  A couple hundred billion dollars will flow back into the economy.

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 As I said last week – I am becoming more persuaded we will not see any material correction (i.e. down 10% or so) as we move toward Q4.  The implication is we won’t see one till Spring 2010 at the earliest.  Q4 is shaping up to be a barn burner – that means “very good” for all you city folks.  That sounds aggressive but that is how the facts are laying out.