NEW$ TO U(SE)

David Rosenberg, Gluskin Sheff chief economist and strategist, sees most things with a very cautious eye these days:

• The market has gone nowhere over the last three trading days despite what was being construed on bubblevision as unrelenting good news (home prices, house sales, consumer confidence, durable goods orders, Bernanke’s reappointment) — any other time in the last five months, these “green shoots’ would have turned the equity screens green. Could be a sign that a lot of good news is already being discounted.

• While it is often reported that over 70% of S&P; 500 companies beat their 2Q earnings estimates, only 46% did so meaningfully. Not only that, but only 23% significantly beat their top-line revenue projections. See page C2 of the WSJ (The Rally Revenue Forgot).

• Leading stocks have been seeing reduced trading volumes of late.

• VIX futures and the put/call ratio on the S&P; 500 have shot upwards in the past few sessions.

• The ECRI leading economic indicator fell 0.4% in the latest week, the first decline in six weeks and only the second falloff in the past eighteen.

• Sentiment is far too bullish — to an extreme level. A sentiment index quoted in today’s NYT business section is now 89% bullish, the same as it was in October 2007; at the March lows, it was sitting at 2%. See Some Once-Bullish Analysts See an End to Market Rally on page B1 of the Monday NYT.

• Corporate insiders sold nearly 31 times more stock than they bought in August (TrimTabs data) — the long run average is 7x and it was 2x at the lows (apparently a heck of a buying opportunity at that time).

• Small-cap stocks are down for back-to-back weeks and Chinese equities are on a four-week losing streak. Finally, the market has turned in the precise same 50% advance over the same 117 time period that it enjoyed coming off the 1929 lows — that rally ended despite all the hype at the time and the market lost more than 50% in the ensuing year.

• Of course, there are the negative seasonals too — since 1950, the S&P; 500 is down 1% in September, on average, and has declined twice as often as it has rallied during the month.

• The H1N1 flu is a clear obstacle. This is a time when psychology becomes a factor — a USA Today/Gallup poll shows that over one-third of adults are now worried about an outbreak, doubling since May.

• Commercial real estate defaults loom very large on the outlook and have emerged as a top priority now for the Fed — see page A2 of the WSJ.

• Geopolitical risks — see the editorial comment on page A12 of today’s WSJ (Israel, Iran and Obama).

• Protectionist sentiment is another and you may want to circle September 17 on your calendar because that is the deadline for Obama’s first true test on this score — to rule on the ITC’s recommendation that the White House slap on a 55% tariff on imports of Chinese-made tires.

U.K. house prices rose for the first time in two years in August as a dearth of homes for sale pushed up prices in London and the southeast, Hometrack Ltd. said.

The average cost of a home in England and Wales rose 0.1 percent from July to 155,800 pounds ($253,000), the London-based property research company said in an e-mailed statement today. The increase, the first since July 2007, left house prices 6.7 percent lower than a year earlier, the smallest annual decline in a year.(…)

“After seven consecutive months of rising demand, agents and surveyors now believe that prices can be pushed upwards without any detrimental impact on sales volumes,” said Richard Donnell, director of research at Hometrack. (…)

Full Bloomberg article

98% of US companies have reported:

In the U.S., S&P; 500 Q2 EPS came in at US$14.00, down 29% YOY and ahead of earnings expectations of -35% at the end of June. On a sequential basis, S&P; 500 quarterly EPS was up 38% from Q1 (US$10.11). 12-month trailing EPS stands at US$40 and should hit US$55 at the end of 2009. We are forecasting a 31% jump to US$72 in 2010.

93% of Canadian companies have reported:

With over 90% of TSX members having reported, Q2 EPS is down 26% YOY based on Bloomberg figures. Consensus was looking for a 38% contraction back in June (see Exhibit 4). Five of 10 TSX sectors posted positive YOY EPS growth in Q2 and 12-month trailing TSX earnings roughly stand at $650. For calendar 2009, we expect TSX EPS to settle near $600 (-37% YOY) followed by a 25% gain to $750 in 2010.

ScotiaCapital strategist:

■ Although the news flow continues to steadily improve, the equity markets’ reaction has been muted in August with performances ranging from 4% in the U.S. to 1.7% in Canada to -16% in China. Nonetheless, the S&P; 500 closed near its YTD high of 1,030 last Thursday and the index is up 11.9% since the start of Q3. We believe the lack of momentum in August, and the potential for a pullback in September/October, have more to do with the current overbought situation and seasonality than overpriced equity markets.
■ As illustrated in Exhibit 1, the S&P; 500 has been stuck in euphoria territory since late July based on our panic/euphoria indicator. Such overbought levels typically lead to flat-tonegative returns over a short term span. Exhibit 2 compares our panic/euphoria reading with the S&P; 500’s 10-week forward return. As we enter the back-to-school period with overbought conditions, investors should prepare for softer markets.
■ Our panic-euphoria model should be viewed as a tactical/trading barometer since it captures the market’s near-term emotions. Any panic/euphoric reading also has to be interpreted in the market’s context, i.e., bear or bull cycle. Since we believe the S&P; 500 entered a new bull market in June when the index got its golden cross (50-day moving average crossing the 200-day on the upside), the current euphoric reading means the S&P; 500 is looking more like a near term hold. We are in higher high/higher lows environment and recommend
buying the dips, not selling the rallies.

Investors Wonder Whether Profits Based on Cost Cutting Can Long Endure

As stock investors turn their focus to earnings prospects for the second half and 2010, they are zeroing in on one of the market’s biggest challenges: lackluster corporate revenue.

The market barreled ahead this summer and is hovering near its high for the year, fueled in large part by stronger than-expected second-quarter earnings. But a significant driver of the good news was cost cutting. Many companies posted disappointing sales.

In the short-term, earnings prospects may remain favorable for the market. Aggressive expense control and modest inventory restocking could boost third-quarter numbers, while the fourth quarter has easy comparisons against an awful 2008 that will give the appearance of healthy profit increases. But in 2010, the ability of stocks to sustain or extend their advances will have to come from a revival in sales, strategists say. In an uncertain economic environment, that won’t be an easy task.

"You can not simply cut costs forever to have sustainable earnings. You need revenues to grow them over time," says Dirk Van Dijk, chief equity strategist at Zacks Investment Research. However, "it’s going to be really, really tough" to increase revenue in the current economy, he says.

(…) According to Goldman Sachs Group Inc., 46% of companies beat Wall Street’s earnings expectations by a wide margin, but only 23% significantly bettered revenue forecasts. Sales among companies in the Standard & Poor’s 500 stock index fell 16% in the second quarter from a year earlier, following a 14% decline in the first quarter.

David Kostin, an equity strategist at Goldman, points to a decline in a key line item on corporate income statements known as "selling, general and administrative expenses" otherwise known as SG&A.; Included in SG&A; are salaries and costs of doing business, such as travel or advertising.

SG&A; plunged 6.4% in the second quarter from the year-earlier period, Goldman says. In contrast, in the last recession, SG&A; fell just 0.2% and in 1991, it dropped 4.1%.

"There’s been an unprecedented decline in overhead costs," Mr. Kostin says.(…)

Mr. Kostin says the most likely sources for revenue growth are outside the U.S., where technology, energy and materials companies get the greatest percentage of revenue.

More narrowly, Brazil, Russia, India and China are likely to be the strongest performing economies, and, Mr. Kostin says, the best revenue prospects. Already, a basket of stocks that Goldman identifies as having the greatest business from those so-called BRIC nations has done 29 percentage points better than the S&P; 500 this year.(…)

Full WSJ article

Obviously, this significant revenue problem is part of the valuation equation for equities in general. See EQUITY VALUATION ANALYSIS, AUGUST 2009

Dennis Gartman, of the Gartman Letter issued an interesting view on gold on Friday.

First, he presented the following chart of spot gold:

To which he commented (our emphasis):
The trading range is drawing down tighter and tighter as the bullish and the bearish forces face each other in the trenches at ever closer range. Soon one side shall have the other on the run; we’ll join the winning side, allowing others to be braver than we.

According to Gartman, therefore, there’s a bit of a gold war being staged between some sizable but unidentified forces. This can be seen by the fact that gold held very, very steady on Thursday, including during the period when crude, grains and even share prices – for the briefest of moments – came under pressure.

As he commented:

Through it all, gold held steady, and gold priced in currencies other than the US dollar held steadiest of all. As we write, spot gold in US dollar terms is trading $950, and as the chart of gold in US terms at the upper left of p.1 this morning shows, there has been someone or “something” willingly selling gold at progressively lower dollar levels since early this month. They or “it” stopped gold firstly at $970; then again at $960; then again at $957 and again thus far this morning at $950. If $957 is taken out to the upside, we shall have no choice but to be very much impressed.

Which led Gartman to conclude on a somewhat bullish note:
More important than that, however, shall be gold in EUR and Sterling terms. In EUR terms, gold is trading €663 as we write and a movement upward through €668 would be even more impressive, and be of greater importance, than the movement through US$957 noted just above. In £ terms, the trend is even more definitively upward, and a movement upward through £586… it is trading £584 as we write… would mean that anyone short of gold in £ terms since June of this year is losing sizeable sums of money. Simply put, a real bull market in gold should take place in the terms of any and all currencies. That, we suspect, is about to happen.

Via FT Alphavile

Rail carloadings for the week ended August 22 were at their highest level since early March. Intermodal traffic seems to be leveling off.

Tid-bits from Isaac Kedim’s great blog News from 1930. The chart will help you figure out the wisdom of some comments. Thing may not be a-changing, after all.

AUGUST 30, 1930:

Editorial: Gov. Roosevelt’s proposed state-supported unemployment insurance may be debatable, but he’s at least called attention to a crucial problem. Workers make a majority of the national income (in 1928, 46.6M workers of a total population of 119M made $50B of a total income of $89.4B, the rest being interest, dividends, rents, etc). Therefore, business life depends on workers’ income and consumption, and it’s crucial that there be steady and well-paid work for all those willing and able. Automation and other factors have contributed to unemployment; solution “calls for deep study of experts and an economic, not a political cure.”

Pres. Hoover meets with heads of govt. building activities with view to accelerating programs.

Market sentiment quite hopeful. Some reports of increased public buying. Most observers now recommend buying standard stocks on reactions.

Recent strength in banking stocks considered positive – this group suffered heavily in panic last fall; only recently has renewed accumulation been evident.

Some bears have been arguing that stocks are still selling at higher price-earnings multiples than at low point of previous depressions; optimists counter that the greater current financial strength of corporations justifies the higher multiple.

AUGUST 29, 1930:

First Natl. Bank of Boston reports on New England business: slump has been severe and long; industrial production in first 7 months 19% below 1929 level; index of activity in July at 81.7 vs. 109.4 in July 1929; decline for all of US has been similar. While depression may be lifting, recovery is likely to be slow and irregular. Crux of problem is general overproduction and lack of purchasing power; decline may be self-reinforcing. While depression has the benefit of forcing greater efficiency and removing waste, “something more than efficiency … is necessary for good business. There must be effective demand, which in turn rests upon an equitable distribution of purchasing power.” One bright spot is “irresistable urge of the American people for continuance of the high standards of living.”

AUGUST 28,1930:

Editorial: Some have called for extension of branch banking by pointing to the 5,000 bank failures in the past 10 years, many of which were small independent banks in rural areas. In fairness, many of these failures were due to “extraordinary economic changes … not likely to be witnessed again for a long time,” including deflation in agricultural prices and collapse of real estate boom. “When a bank fails it is the bank officials that must bear the blame … but in the end the local community, carried away by the speculative fever, is not without … responsibility.” Change in banking system should come naturally, not by scrapping old system.

There’s a large amount of money on sidelines waiting for investment opportunities; this should be felt in market when “cheerful sentiment is more firmly intrenched.” Economists point out that banks and insurance companies “never before had so much money lying idle.”

Fed. Reserve seen continuing easy credit policy pursued since start of year. Some concern that increased reserve credit “will flow into speculative channels,” but this doesn’t seem to have happened much yet.

Recent market strength seen in strong response to good news, resistance to weakness in isolated spots, and declining volume on setbacks.

Atchison, Topeka & Santa Fe Railway reports July income up over 1929 in spite of decline in revenue; achieved by cutbacks in expenses including capital improvement and maintenance; considered hopeful sign that other rails can do the same.

Changes in women’s dress styles have enabled Princeton to reduce width of stadium seats from 19 inches to 17.5, allowing 6,000 more seats in stadium.

Dow Jones reports first large increase in steel production in several months; US Steel ingot production in week ended Monday was at 66% vs. 62% previous week; industry average was 58% vs. 54.5%.

Rail freight loadings in week ended Aug. 16 were 922,823 cars, up 18,666 over previous week but down 179,744 or 16.3% from 1929.

Doug Short does the ultimate research on monthly volatility.

The accompanying chart shows the monthly performance the S&P; 500 since 1950. The blue bars represent the average monthly close variance from the previous month.

January does tend to outperform, but so do March and April. July has often been host to summer rallies, certainly in comparison to the lackluster June and August. November and December tend to end the year on a high note. Together with January, March and April, they’ve combined to inspire the "Sell in May, buy Halloween" strategy. February is the naughty winter month.

If February is often naughty, September has been worse, the chronic bad month. October appears to mark a rebound to average performance. But it has a history of deception. It is the most volatile month — the one with the widest range of interim highs and lows. It also has a bit of manic-depressive disorder disguised by its 0.61% average gain over the September close. Of the eight previous bear markets since 1950, four of them bottomed out in October (1957, 1966, 1974 and 2002).

The gray bars represent the monthly averages of daily closes. In effect, we’re incorporating the intra-month daily volatility into the monthly measure. This method of comparison probably has little interest for short-term traders. But long-term investors may find it intriguing for a couple of reasons. By averaging in the daily volatility, we may catch a better view of the underlying seasonality of the market. Also, since we have the data for monthly averages of daily close since 1871 (thanks to Yale Professor Robert Shiller), we can compare seasonal trends over many different historical periods.

This alternative approach, at least since 1950, looks remarkably different from the monthly close variances. The values are less volatile (i.e., the high-low range is narrower). Also, in six of the months (Jan, Feb, May, Jun, Aug, and Sep), the monthly averages show greater positive variance than the monthly closes. For example, the January effect is more powerful, with the first month of the year moving into first place for the average monthly gain. September is far less grim, and February looks much better — coming very close to the average monthly gain.

October, noted in our previous discussion as a so-so month with manic-depressive volatility, is now revealed as the poorest overall performer in the post-1950 market, a distinction that seems appropriate for the month that has hosted half of the bear market bottoms since mid-century.

Here we’ll apply the second method — monthly averages of daily closes — to the seven two-decade periods since 1871.

Let’s study a table showing the results of our calculations:

As we can readily see, there has been little in the way of long-term consistency in monthly seasonality based on monthly averages of daily closes. The notion of a summer rally, for example, had more substance before 1950 than after. The reverse is the case for end-of-year rallies. November and December have had a better record since mid century.

The two consistent months have been January and October. January alone has turned in above-average performance in all our two-decade snapshots. October has been the only perpetual underperformer. However, these 20-year timeframes obscure a key difference between the two. January has been more consistent in its positive monthly averages of daily closes. Since 1871 the first month of the year has registered in the green 69% of the time compared to October’s 51%. However, when we compare the average of the negative months, the nasty side of October becomes apparent. The 43 negative Januaries have averaged -1.65%. The 68 negative Octobers have the stunningly bad average of -3.73%. The worst October on record was in 2008 with its -20.39% decline in its monthly average of daily closes. Since 1871 there have been two months with more dismal records: -23.97% in April 1932 and -26.47% in November 1929.

Next up in the 2008 calendar is September. How has it fared since 1871? It falls about midway between January and October with its 59% positive performance in our featured metric. However, like October, the negative years have been disproportionately painful with a -3.48% monthly average of daily closes.

Let’s hope September and October show us their sunnier personalities in 2009.