The recent hoarding of cash in M2 portends a slowdown in corporate profit growth.

The panic driven stuffing of cash into banks in recent weeks has set in process an unavoidable slowdown in profit growth. We saw this relationship in 1990, 2001 and 2008.  At worst it could cause profits to actually decline although any decline should be modest and short lived.  Jeb Terry, Sr. Aug 17, 2011

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M2 Update – When this much cash gets sucked out of the economy we must expect a slowdown – not necessarily a recession, but certainly a slowdown.

I have updated the data series on money supply to see how severe the panic has been in recent weeks.  As expected, the spike in M2 – representing consumer/small business bank accounts and money market funds has exploded upwards.  $272 billion was hoarded just in July alone. July saw the biggest single monthly increase in M2 in both absolute dollar and percentage terms in my data set going back to 1959.  It deprives the real economy of investment.  It is logical to expect the upcoming economic reports for August/September to be weak and encouraging to those who are betting on a “double dip” recession.  The good news is that the economy isn’t anywhere near the shape it was in 2008.  This sets up the potential for a quick reversal back into Main Street businesses in Q4.  Clearly there are gobs of cash available for the holiday spending season.  Jeb Terry, Sr. Aug 14, 2011

Source: St. Louis Fed

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Markets not pricing in inflation. The TIPS implied inflation is tame.

Despite all the fear over inflation the securities that are uniquely structured to be sensitive to inflation, TIPS, are not signaling any pickup in inflation over a 5 and 10 year horizon.  TIPS are decidedly not retail investor securities.  So, institutional investors are betting real money that 5 and 10 year inflation will be a non-event.  Hmmm . . . do ya think maybe gold prices are a bit bubbly? Low inflation is good for stocks.  The chart below is courtesy of a and can be found on their blog here  Jeb Terry, Sr. Aug 12, 2011


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The trucks keep rolling. The Ceridian-UCLA Pulse of Commerce report still pointing up.

While July saw a slight contraction the trend has not rolled over.  The folks at UCLA believe the forecast is for slow growth but still growth.  Actually they called it “persistent, wobbly uncertain growth”. Jeb Terry, Sr. Aug 12, 2011

Source: Ceridian-UCLA Pulse of Commerce Index

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The patient has a pulse. The San Francisco Fed Tech Pulse Index still in growth zone.

Fifth consecutive up month, best monthly gain since August 2010, no froth – just solid growth.  There could be a pick up as we finish the year as unspent budgets get put to work.  The amount of cash on tech company balance sheets is enormous.  M&A activity was strong before the recent unpleasantness in the stock market.  Expect to see elevated M&A activity as the recent market correction has pummeled many tech stocks and thus made them very cheap.  Jeb Terry, Sr. Aug 12, 2011

Has the growth rate slowed? Sure  Is it critical? Nope  The “pulse” is growing @ 8.8% annualized rate – far faster than the overall GDP.

Source: San Francisco Federal Reserve

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Signs of Financial Panic Revisited

On February 27, 2009, 6 trading days before the bear market low, I published the following list of stages of a financial panic as were described by C.P. Kindleberger in his 1978 book Manias, Panics and Crashes: A History of Financial Crises.

6 Stages of a Financial Panic:

 1. Exogenous shock such as technology, financial innovation, regime shift.

 2. As profit opportunities are created, credit creation accelerates -new banks enter, personal credit increases, new credit instruments are used

 3. This leads to speculation – which leads to overestimation of the true expected return and excessive leverage.

 4. Speculation spreads from one market to another & internationally (display of psychological mechanisms such as animal spirits, herding mentality)

 5. At the peak some insiders leave the market, there is “financial distress” and a bankruptcy or the revelation of a swindle leads to the final stage; the rush for liquidity.

 6. The panic feeds itself until either prices become so low that people are tempted to once again go into less liquid assets OR a lender of last resort convinces the market that there is enough money for all.

The European Central Bank is getting close to satisfying stage 6. The news of Aug.7 of their plans to provide more liquidity may set the predicate for a final resolution of the lingering European sovereign debt crisis.

We have seen the rush to liquidity in recent days/weeks.  We are now seeing extreme oversold and pessimistic sentiment indicators that were common at prior market bottoms.  We have fundamental indicators telling us equity values are bargains.  We should be near a bottom of this correction in stock valuesJeb Terry, Sr. Aug 7,2011

The amount of cash on the sidelines is astounding. MZM exceeds 68% of GDP, near the peak of the 2008 panic. $404 billion has “gone to cash” from year end 2010 to mid July.

The amount of cash in MZM – money of zero maturity – has reached a new record high dollar level.  It exceeds 68% of nominal GDP.  A more normal amount would be 41% of GDP.  The implication is almost $2.9 TRILLION in excess cash is basically earning zero and not fueling productive investment.  When that money begins to flow back into productive use there will be significant recovery in economic growth and equity valuations.  It has been written that equity markets can expand by as much as 10X for every $1 of net inflow to mutual funds.  While that multiplier seems aggressive it is nonetheless plausible that there would be a material virtuous multiplier effect.  Now the trick is to figure out how to restore confidence – and greed – in the folks sitting on all the cash.   Jeb Terry, Sr. Aug 6, 2011

Source: St. Louis Fed

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Drunken sailors . . . Have a look at the growth in US Treasury Debt. Households and businesses have been reducing debt – the US Government has gone berserk with spending and increasing debt since 2008 – I will let you all connect the dots.

Yardeni research has recently published enlightening data on the size and growth of the U.S. debt. (See their Flow of Funds Chart Book here and on the Yardeni blog here).  I have selected two charts that help put the recent debt ceiling debate and the S&P downgrading of U.S. long term debt into perspective.  The first chart is of the total non-financial debt outstanding in trillions.  The 2nd chart shows the change in outstanding debt and isolates the growth in US Treasury debt vs. the drop in Non-Federal debt.  The amount of publicly traded U.S. Treasury debt has increased $3.64 TRILLION since year end 2008.  The amount of total nominal GDP has only gone up $0.9 trillion . . . Hmmm . . . maybe if the government quits spending and borrowing so much the private sector can have access to more funds – it’s a thought.   Jeb Terry, Sr. Aug 6, 2011.

Source: Yardeni research

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The Wildebeest Feast 2.0

Please follow this link to the full report: The Wildebeests Feast 2 0 8-4-11

We have a confluence of indicators in support of an approaching market bottom and prospects for a rally.

  •  An extended number of consecutive down days in the stock market.  The Dow dropped 8 days in a row and is down in 9 of the last 10 days.  As I have written in the past, these events are unusual and tend to occur near the end of a corrective phase.
  •  The market sustained a severe “90/90” panic day yesterday where 99% of the volume on the NYSE and the NASDAQ was down volume and 93% of the issues traded were down for the day.  This kind of fear driven, indiscriminant selling is common at or near market bottoms.
  •  Oversold market conditions. The S&P500 is the most oversold since late 2008.  It is more oversold than at the bear market low in March 2009. 
  • There has not been a sustained decline in the market when there is strong earnings growth such as seen in the market up to now.  Earnings for the S&P 500 are estimated to end the Q2 earnings season up 23.9% over 2010 on a trailing 12 month (“LTM”) basis.  The median LTM earnings growth since 1980 has been 8.6%.                                           
  • The earnings yield has not been as strong as now since June 1989. More importantly, the spread between the earnings yield and the 10 year Treasury rate is the widest since 1979 when the S&P 500 gained 12.3% for the year.  Spikes in the spread such as now have been coincident with market bottoms. 
  • The combination of low Treasury rates and a high earnings yield results in a record low undervaluation since 1970.  The tool we use says the S&P 500 is 68.7% undervalued.  For a frame of reference, the same tool calculated the market was 59% undervalued at December 2008 and 58% at the low in March 2009. 
  • We have not entered a recession or a bear market when the yield curve is steep, like now, when earnings are rising, like now, and when leading indicators are rising, like now. 

As has been the case previously, the recent sell off appears to be an overreaction.  Investors are clearly spooked by the hyperbole of the recent debt ceiling debate and the continuing Euro debt crisis.  I am unable to predict the outcome in Europe.

 March 2009, with similar conditions as now, marked the start of a greater than 90% move from the low to the April 2010 high close for the NASDAQ, where all of our stocks are listed.  July 2010, a time when there had also been persistent selling pressure, marked the start of a similar move that lead to gains in the NASDAQ of 12.3% in Q3 of 2010, 27% by year end 2010 and 33% by the April 2011 high.  That said, it is logical to expect the Street to cut estimates for GDP growth and earnings growth in light of recent developments.  Though the technicals indicate that we are at or near a bottom, the market is trading on pure emotion.  We call this FUD (fear, uncertainty and doubt).  We can’t predict the exhaustion of such emotional selling, but the buyers in this area will be rewarded in time.