EQUITIES: TIME TO GO FISHING but NOT BOTTOM FISHING!

In a June 11 article, the WSJ brings back the notion of the Bernanke put:

One reason investors appear less worried this time is that last year’s troubles didn’t last. On the back of a Federal Reserve program to stimulate U.S. financial markets through heavy bond-buying, stocks recovered all their losses last year. The Dow surged almost to the 13000 level before topping out in April of this year.

So, last year’s troubles didn’t last! Let’s see:

  • The US employment situation has barely improved.

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  • US real weekly earnings have turned negative and the US Personal Income Tax Rate has risen to 10.1% in April 2011 from 9.3% in August 2010. Only a sharp dip in personal savings has prevented a big drop in consumer spending. The US savings rate is now below 5%, its lowest level since October 2008.

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  • But discretionary spending appears to have been seriously hit lately.

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  • As have car sales which, by the way, remain substantially below their peak.

  • US inflation has risen but only in a “transitory” way according to Fed officials. Core inflation has nevertheless inched up recently. If the relationship with China’s CPI continues, the “transition” could be to something worse than Bernanke and Co. have in mind (see THE ECONOMIC AFTERLIFE). MIT’s daily online price index, up 3.5% YoY in early May, is showing no sign of peaking. It had peaked at +2.8% YoY last August.

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  • The US housing sector is clearly double dipping.
  • The Ceridian-UCLA Pulse of Commerce Index is barely above its August 2010 level, is stalling and threatens to turn negative YoY.

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  • Unfortunately, it seems that Japan’s tragedies do not explain everything as FT’s Gavyn Davies clearly shows. Notice how the recent “slowdown” is much worse than that of 2010:

  • US manufacturers’ inventories have risen dangerously. They are not lean as in 2010.

  • No surprise, then, that the JPMorgan Global New Orders Index is weakening and is now below its 2010 level.

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  • The US consumer is obviously not alone to be squeezed. Eurozone retail volume remains well below its 2008 peak and shows little momentum. The PIGS’ problems are exacerbating the problem and darkening the outlook even more.

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  • China’s economy has slowed as the Chinese government is busy battling inflation. The Shanghai SE Composite Index has dropped 13% since mid-April.

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China Economy by Numbers - April

  • A large number of emerging countries are fighting inflation with monetary and/or fiscal tools that can only slow their economies down.

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In all, contrary to the WSJ’s assertion that last year’s troubles didn’t last, it sure looks like things have worsened and become more complicated. Rising inflation across the world, in effect, has diminished purchasing power right when many stimulative policies are ending. Unemployment rates have remained stubbornly high and the renewed decline in house prices is eroding consumer wealth even more. Additional fiscal help will soon be needed but the ammo room has gotten pretty empty, if accessible at all. How much hope can we have watching the spectacle in Washington these days? And Europe offers no better harmony, only more drama.

Renewed monetary help? Seems like pushing on a string, doesn’t it? The wealth effect from rising equities that Bernanke was hoping for last year has come but it has not spilled over as expected. And now, it seems to be waning. Oh! but wait, here’s some unexpected support for equities: Alan Abelson is warning against too much bearishness (no typo):

We’re not suggesting you ignore this frightening array of red flags. The woes are real and most are not likely to vanish anytime soon. For stocks to do an about-face and suffer a prolonged plunge ending in a resounding crash requires, at least in our book, the surging momentum furnished only by surprise and panic. But surprise, whether economic or market-based, is conspicuously absent at the moment. And so we don’t think the timing is right for the kind of uncompromising swoon that spelled finis to the dot-com boom or housing bubble.

Now, that is a surprise if there is one!

Unfortunately, Alan is missing many points:

  • Back last summer, the S&P 500 Index had declined 14% between April and August, twice as much as what we have lost since early May.
  • Back last summer, the S&P 500 Index was undervalued by more than 20% (US EQUITIES ARE CLEARLY UNDERVALUED. The current 12% undervaluation is obviously relatively less attractive and even more so since it is highly dependent on a stabilization of inflation which has jumped from 1.1% in August 2010 to the current 3.2%.
  • Back last summer, quarterly earnings were rising strongly (+25.6% between Dec. 2009 and Sept. 2010) and broadly. During the last 6 months, earnings have gained only 4.7% and, in Q1 2011, key sectors like Industrials, IT, Consumer Discretionary and Consumer Staples registered earnings declines.
  • Back last summer, profit margins were low and rising. They are now at an all time high.
  • Back last summer, productivity was low and rising rapidly and unit labor costs were declining. Q1 2011 showed the slowest productivity gain YoY since Q1 2009 and unit labor costs rose 0.9%, the first YoY gain in over 2 years.
  • Back last summer, economic and earnings expectations were low and economic surprises were rising, a fertile ground for positive earnings surprises. The current landscape seem fraught with potholes…

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Obviously, a more positive economic scenario remains possible, especially if US employment finally displays sustained growth, oil prices decline, inflation subsides and interest rates remain low after QE2. Possible, but how likely?

I have been an equity bull since March 2009 and remained so up to recently on attractive valuation and rising earnings. I turned very cautious in April and even more so in May as valuation did not appear attractive enough to cover for rising economic and earnings risks. (See all my market valuation work here).

As we approach the 200 day moving average (1253 on the S&P 500) after having easily broken the 50 and 100 day m.a., which have both turned down, I read Abelson again,

We’re not suggesting you ignore this frightening array of red flags. The woes are real and most are not likely to vanish anytime soon.

and I just do not feel that I should wait to witness the missing

surging momentum furnished only by surprise and panic.

Alan, I’m going salmon fishing with dry flies for a while, until the woes begin to vanish. As you may know, this is as far from bottom fishing as there is. You should do the same.

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