Market Commentary – July 13, 2009

General Market Comment:    July 13, 2009

 There has been a great deal of discussion regarding the “weaker than expected” labor numbers for June reported July 2.  The assorted punditry have been debating if the economy is getting weaker, if we all need more “stimulus” from Washington, if the terrific Q2 stock market performance was unsustainable  . . . etc. etc. etc. . . . Hey – they all have deadlines and they have to say something to earn their paychecks.

 The data still tilts more toward recovery than relapse into deeper recession.  I have refreshed some charts to illustrate the point.

ScreenHunter_01 Jul. 14 10.18 

The Institute of Supply Management issued their survey results in recent days and both non-manufacturing and manufacturing survey data point to significantly improving employment albeit both indexes are still below “50” and hence still showing contraction.  Note that they were also below “50” back in 2003 when we last exited a recession and the market took off.  By the way – we just happened to have Chrysler and GM go bankrupt and close dealers around the country in June which could’ve depressed employment just a touch – eh?

 Along with improving employment data the ISM surveyors also found materially improving new order data as I show in the following chart for both manufacturing and non-manufacturing businesses.

ScreenHunter_02 Jul. 14 10.18 

The new order books are charging back toward the “50” level.  Please recall that I have previously found that the direction of new orders also helps predict the direction in employment – of course assuming some calamity doesn’t cause a market panic.  Here is a chart of the new orders and employment survey data for manufacturing businesses.

 ScreenHunter_03 Jul. 14 10.18

The correlation is obvious and the direction is up.  Here are some comments from the ISM survey report of July 1. I have chosen to highlight some of the remarks.

  • “Customer inventory burn is complete and real demand has reappeared.” (Machinery)
  • “… a lot of people are requoting old business and using favorable pricing to negotiate with their current suppliers.” (Computer & Electronic Products)
  • “Banks are reluctant to lend to businesses, and until this changes the economy will continue to be weak.” (Fabricated Metal Products)
  • “Slow June, but firm large orders in July, August and September.” (Food, Beverage & Tobacco Products)
  • Market appears to have bottomed out as aftermarket has picked up slightly over the past month.” (Transportation Equipment)

The conclusion is that employment is likely in a bottoming process.  The recovering orders will accelerate as businesses exhaust their inventories.  Which leads me to the other key area I want to discuss . . . the upcoming earnings reports that will flood the financial news in the next 4 weeks. 

 Businesses are lean.  They have cut jobs, inventories, capital spending, advertising . . . you name it – “Smithers” was ordered to cut it.  What that means is that as, when and if business starts to recover . . . that would be now according to the data I have showered you with in recent weeks . . . earnings will grow “like a scalded dog” , so to say.

 Here is a chart of operating earnings per share for the S&P 500 through March and the bottom up estimates out to December as published by Standard and Poors.

ScreenHunter_04 Jul. 14 10.19 

If the market were to recover back to the level it was in 2004 when earnings last rose above $16, as they are projected to in Q4 of this year, then the S&P 500 would rise 28% from Friday’s close . . . not bad.  Of course interest rates are lower today than back then and there is more cash sitting idle.  2004 is also relevant as it too was a year when the economy was in recovery and earnings were accelerating.

 The market needs earnings data to get its mind off of the idiocy in Washington.  Earnings growth is highest as companies compare with the bottom of the cycle – that will be Q3, Q4 and Q1 of 2010.  You will want to be fully invested before the earnings outlooks for Q4 are broadly assimilated.  The Q2 earnings that will be reported in coming days will be secondary to the outlooks and guidance provided by management for the upcoming quarters.  If the ISM surveys and other leading economic data I have presented to you in the recent past are valid, the guidance should not disappoint.  I continue to believe the market consolidates in the near term but does not appreciably fall as we head toward a much stronger Q4.  Declining Obama popularity and an impasse on healthcare reform and cap and trade legislation going into the August Congressional recess will help the market.

DISCLAIMER

Market Commentary – June 29, 2009

Q2 comes to an end this week – Q3 begins . . . here are some seasonal points to keep in mind. The 4th of July holiday week is typically very quiet as vacations kick in – (I will be away from June 30 to July 7). There is usually quarter end “window dressing” by institutions that will likely close the quarter on an upward note. Q3 is the weakest quarter of the year and given the huge gains in Q2 2009’s Q3 should be no exception. Portfolios are often rebalanced following the first half of the year as retirement fund contributions flow in during July. Since retirement funds are too heavily invested in cash and bonds the rebalancing this quarter should give us a boost in equity purchases. This year’s Q2 earnings season will show sequential gains and begin to include improving earnings guidance as the signals of economic recovery translate into management and analyst outlooks.

The weekly leading economic indicators from ECRI are booming. We are in the midst of the strongest rebound in their recorded history since 1967. So far this tool is showing quite an impressive “V” shaped recovery.

ScreenHunter_04 Jun. 30 10.47
We are witnessing the strongest one month improvement since the 1992 recovery and the strongest 6 month improvement since the 1983 recovery. The point to keep in mind is sharp improvements in the ECRI have led sustained equity bull markets. The only thing that is standing in the way of the upside is bad government economic policy (i.e. raise taxes) which unfortunately is in ample supply at the moment.

Mark Perry’s Carpe Diem blog once again highlighted additional evidence of the economic recovery taking root. The signal is now coming from consumer sentiment.

Carpe Diem Chart
Carpe Diem Chart

LA TIMESConfidence among U.S. consumers rose this month for a fourth straight time, reflecting signs that the worst of the recession has passed. The Reuters/University of Michigan final index of consumer sentiment gained to 70.8, the highest level since February 2008, from 68.7 in May.

Recent reports show some areas of the economy, such as housing and manufacturing, are seeing a smaller pace of decline, consistent with the Federal Reserve’s projection this week that the slump is “slowing.” Government data today indicated that efforts to revive the economy are allowing consumers to spend even with unemployment at a 25-year high. The data also showed savings surged to the highest level since 1993.

MP: The last time the Michigan consumer sentiment index increased in four consecutive months was the period from October 2001 to January 2002, which signaled the end of the 2001 recession (see shaded area in chart above). The four-month cumulative increase of 14.5 points in consumer sentiment from March to June 2009 (see shaded area in chart) is even greater than the 11.2 point increase in late 2001-early 2002.

The data is compounding. The fact that the economy is recovering should be undisputed. You want to be allocated to equity as economic recovery becomes sustained. Earnings growth is highest as companies compare with the bottom of the cycle – that will be Q3, Q4 and Q1 of 2010. This fact will mitigate the seasonal drag on Q3 mentioned above. Q4 has the potential of being one of the best quarters in years. You will want to be fully invested before the earnings outlooks for Q4 are broadly assimilated. You will also want to maximize capital gains and minimize ordinary income given the emerging signs of increased income taxation. Owning stocks helps accomplish this earnings goal.

DISCLAIMER