Happy Halloween

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Happy Halloween Weekend!

Since the ghoulish season covers an entire weekend this year, we want to do a Happy Halloween shout out to all the little ghosts and goblins on Ashland Avenue! While we have no "trick or treaters" among the employees of Lumen Capital anymore, we do expect visits from our neighbors on Sunday!

Have fun and another big shout out to the bigger ghosts and goblins over at Oak Park High School and Providence College!

The Coming Political Tsunami {Our Analysis}

From our soon to be published investment letter.  I'm placing this part on the web today as I believe it needs to be discussed before next Tuesday.

Incumbents everywhere have large bull’s eyes on their backs. This year is producing a "this has got to stop" moment similar to elections that put Reagan and FDR in the White House and gave Republicans a house majority in 1992. Signs point to at least a change in control of the House and smaller Democratic majorities in the Senate. Analysts and pundits are all over with predictions of catastrophic Democratic losses. One estimate I’ve seen says Democrats could lose as many as 100 House seats!

Don’t buy this hype! Analysis of past elections similar to 2010 indicate that on average the party in power loses somewhere between 40 and 50 seats. This is enough to swing control to the Republicans. Yet Republican control or smaller Democratic majorities is irrelevant as the outcome will be the same.

Whoever controls the Senate will not have 60 seats and will lose the ability to end a filibuster by shutting off debate. Whether they lose the House or not, the Democrats will lose the ability to pass legislation at the will of the House Democratic leadership. Republican victories in one or both houses will likely not give them the votes to override presidential vetoes. Thus any agenda they bring forth will have to be the result of negotiations between the President and the Republican Congressional leadership.

What we do know is that Congress beginning in 2011 will initially be about the economy. The results will likely be more fiscally responsible and pro-jobs policies. A more evenly divided government will also check the more populist policies of the President. It is likely that much of this is already priced into stocks. Because of that I think it is possible stocks could either tread water or decline between now and shortly after the election. Don’t be surprised if the initial results are met with disappointment by investors until the realization that pro-economic growth candidates will be in charge of Washington in January. I think it is likely stocks will resume their rally into the year’s end once these results are factored in.

Bond Bull Market Over?

Bloomberg News story about Bill Gross calling a top in bond prices.  For the majority of us who don't really follow the bond market that means interest and yields are, according to Gross, currently seeing their cyclical lows.  Excerpt with my highlights.

Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co., said a renewal of asset purchases by the Federal Reserve will likely signify the end of the 30-year bull market in bonds.

“Check writing in the trillions is not a bondholder’s friend,” Gross wrote in his monthly investment outlook posted on Newport Beach, California-based Pimco’s website today. “It is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead end where those prices can no longer go up.”

The Fed will announce another round of large-scale asset purchases when policy makers meet next week after deploying $1.7 trillion to pull the economy out of the financial crisis, according to a survey of the 18 primary dealers that trade debt with the central bank. Fed officials, who already cut interest rates almost to zero, are discussing more purchases of Treasuries to flood markets with cheap money as well as strategies for raising inflation expectations to prevent stagnating prices from undermining the recovery.

Gross, the co-founder of Pimco, said in March that bonds may have seen their best days while making an argument for investors to own fewer. He reduced holdings of government- related debt in the Total Return Fund for the third straight month in September, after the securities accounted for 63 percent of assets in June, the highest since it held an equal amount in October 2009.....

.....The yield on the 10-year Treasury note dropped from a 2010 high of 4.01 percent in April to a low of 2.33 percent on Oct. 8, according to Bloomberg data, as investors purchased Treasuries in anticipation of further asset purchases by the central bank. The record of 2.04 percent was set in December 2008.

“Having arrived at its destination, the market then offers near zero percent returns and a picking of the creditor’s pocket via inflation and negative real interest rates,” Gross wrote. “It will likely signify the end of a great 30-year bull market in bonds and the necessity for bond managers and, yes, equity managers to adjust to a new environment,” Gross wrote.

Treasuries have returned 8.3 percent this year after losing 3.7 percent in 2009, according to Bank of America Merrill Lynch indexes.  Under what Pimco calls the “new normal,” investors should expect lower-than-average historical returns with heightened regulation, lower consumption, slower growth and a shrinking global role for the U.S. economy.

“If QEII cannot reflate capital markets, if it can’t produce 2 percent inflation and an assumed reduction of unemployment rates back towards historical levels, then it will be a long, painful slog back to prosperity,” Gross wrote. .....

Comment.  I'm going to have more to say about this in the next couple of days as I discuss a purchase that I have started in TBT, an ETF that basically bets on an interest rate increase.  Suffice it to say that I think bonds, especially longer dated maturity bonds are going to be a losing trade soon for many years to come.

*Long TBT in certain strategies and in certain client accounts and in personal accounts.

Link:  Gross on Bonds

an tSionna {10.26.10}

Busy chart.  You can double click on the chart to enlarge it!  Stocks remain more of  the same and are still overbought.

*Long ETFs related to the S&P 500 in client accounts.

Dow Adjusted For Inflation.

From Chart of the Day.  The Dow Adjusted for Inflation:

"For some long-term perspective, today's chart illustrates the Dow adjusted for inflation since 1900. There are several points of interest. For one, when adjusted for inflation, the bear market that concluded in the early 1980s was almost as severe as the one that concluded in the early 1930s. Also, the inflation-adjusted Dow is a little more than double where it was at its 1929 peak and trades 65% above its 1966 peak -- not that spectacular of a performance considering the time frames involved. More recently, the Dow has retraced 60% of the financial crisis bear market and is currently testing post-crisis highs. It is interesting to note that the 70% gain produced during the post-crisis rally is actually slightly more than what the inflation-adjusted Dow gained from its 1966 peak to today."

*Long ETFs related to the Dow Jones Industrial Average in certain client accounts.
Link:  The Dow Adjusted for Inflation.

Who Can Fix the Economy?

This is a great article in the current issue of Fortune Magazine that in 6 pages does a very good job of explaining what's wrong with the economy and why it is likely to take many years to fix it.  The article is too long for me to excerpt so I will provide this link instead. 

However, I found within the article a discussion of quantative easing where the author does a pretty decent job of explaining what it is and how it works.  I will excerpt that part below. Enjoy!

"The closest we're likely to come to free money is the Fed's proposed quantitative-easing moves to buy Treasury securities......Let's say the Fed buys $1 trillion of Treasury securities in the secondary market. Out of thin air, it creates $1 trillion in credit balances in the sellers' accounts. The sellers have $1 trillion more cash than they did, increasing the money supply. There is now $1 trillion less of publicly traded Treasuries, which props up their price. By contrast, if Goldman Sachs wanted to buy $1 trillion of Treasury securities, it would have to find $1 trillion of cash to pay for them. Sellers would have $1 trillion more cash than before, Goldman would have $1 trillion less. There would be no increase in the money supply or decrease in the Treasury supply.

If the Fed could buy endless amounts of Treasury securities without any side effects, it would be almost like free money. The securities would cost the Treasury little or nothing in the way of interest, because the Fed turns over its profits....to the Treasury. So if the Fed buys $1 trillion of 2.5%, 10-year Treasury notes, Treasury's $25 billion annual interest expense is offset by the $25 billion of extra profit the Fed would make, all (or almost all) of which would be turned over to the Treasury. See? Isn't that grand?

There is, however, a problem. The Fed can't do that indefinitely without touching off inflation, debasing the dollar, or both. Markets are bigger and more powerful than the Fed. Consider the reaction of people like veteran Wall Street value investor Hugh Lamle of M.D. Sass to quantitative easing. "It's one thing to do $800 billion once," he says. "But if the federal government is going to print $1 trillion a year for five years, maybe I don't want to be in dollars." A second factor is that long-term rates are already so low that it's not clear how much stimulus you get from cutting them more. It's a big deal to cut interest rates to 5% from 8%. But at lower levels, the result is less dramatic. Do you think the difference between 3% and 2.5% is going to matter? Meanwhile, these ultralow rates are penalizing American savers -- especially retirees relying on CD income to supplement Social Security. They tend to spend all their income, and it's down sharply. That's one reason the economy is weak."

As For The Bulls....

BeSpoke yesterday also took a look at the number of Bulls out in the market now.  They noted yesterday's "release of weekly sentiment figures from the American Association of Individual Investors (AAII) showed that bullish sentiment rose close to 50%, which is the highest level since early September. Prior to that, you have to go all the way back to the Summer of 2009 to find a bullish reading as high as it is now."

Since we highlighted the extremely low levels of negativity, I felt we also need to see the other side of that coin.  Look  how optimistic the world seems to be right now!!! 

I think this means that somewhere along the way the election news gets sold. I've felt this way for a few weeks now and so far I've been wrong!

Link:  Bullish Sentiment.

Where Have The Bears Gone?

According to BeSpoke Investment Group, "After climbing to its highest levels since April 2009 back in September, bearish sentiment has been in a steady decline since the market's Fall rally began. At a current level of 22%, the Investors Intelligence weekly survey of bearish sentiment is now at its lowest level since the first week of May. As luck would have it, just when bearish sentiment was declining to multi-month lows, the S&P 500 had its worst day in exactly two months {on Tuesday}."

Just one more hit against bullish armor that so far cannot be dented much.  There seems to daily be strong buying pressure under stocks.  While the market is over bought it can certainly stay that way for a longer period of time than most investors expect.  Still think we'll get some sort of decline between now and election day.  However, that prospect dims the closer we get to the event!

*Long ETFS related to the S&P 500 in client accounts.

Link:  Bearish Sentiment.

an tSionna {10.20.10}

{You can double click on this chart to make it larger.}

Yesterday was one of the first negative days for stocks in a long time. Stocks are now a slave to the dollar -meaning that stocks are basically going in the opposite direction of the greenback. Yesterday the buck had a nice rally. Its rise, still more negative news out of the financial sector regarding mortgages, and what were perceived as slightly disappointing earnings news out of Apple and IBM meant for a down day. Perhaps in the end though it was just an excuse for traders to sell and lock in some profits. It's possible that stocks would have sold off like this one day this week in any event.

Hard to say whether this is the beginning of something more drastic. As we've mentioned before there are some strong institutional reasons for stocks to do well going into the end of the year.

Due to that end of the year bias, it's possible that stocks could just churn around for a bit while working off their over bought conditions instead of experiencing a larger sell off. I think the elections are going to be an excuse for some sort of consolidation now before resuming their upward climb later in the year. I'm going to go into that a bit more in a more detailed post soon.

Regarding market direction we will let our indicators guide us and right now they are still very over bought. In appropriate accounts and investment strategies we took off another level of risk yesterday. That still leaves us very exposed to equity price increases but does increase our hedge posture {via cash} in a more uncertain time of the year.

*Long ETFs related to the S&P 500 in client accounts. Long Apple in two client accounts per their request. Please note that I stated that only one client owned Apple yesterday. That is an error on my part. Long Apple and IBM as components of various ETFs we own in client accounts.

Apple

The stock of the day is Apple Computer {APPL} which is down at this writing about 2% after reporting a pretty darn good quarter but not as good as perhaps its most recent run up warrants. Like a lot of stocks APPL is currently overbought so a pullback or at least consolidation could be in order right now. We pay attention to this because it is about 20% of the Nasdaq 100 index {QQQQ}. It is just another indicator saying that perhaps this current market rally is getting long in the tooth. Generally you don't like to see good news getting sold like this.

One aside to that however, is that APPL opened at much lower levels and has since clawed its way back as of this writing.

*Long APPL in one client account per that client's request. Long APPL via certain ETFs of which it is a part. Long QQQQ and certain variations of this index in many client accounts.

Barrons: Week in Review

Michael Santoli over at Barrons on last week's trading.  {Excerpt with my highlights}

....Stocks are now a neglected asset class, slave to the bond and currency markets. The fact that the Treasury market wasn't open for business Monday—and therefore that the largest pool of investment assets on the planet wasn't out there twitching to every hint and whisper of future central-bank action–deprived equity traders of their principal cue.....

.....Not unrelated is the bounce in 10-year Treasury yields last week, from 2.38% all the way to 2.57%. The bond market is, hesitantly, transmitting the notion that even if the Fed does embark on a new asset-purchase campaign, perhaps the markets have already discounted it.

In the short term, the general neglect of equities is a headwind for the market, yet over a longer span it's a benefit. As long as stocks continue to act as nothing but the tail being wagged by the dog of the macro data driving the dollar and bonds, the less likely equities will become captive to any public mania and get overvalued and therefore vulnerable to another bruising downturn.

....And yet, the public has been a net seller of stocks for five straight months, according to the Investment Company Institute. The future returns following prior such streaks of public liquidation of equity funds have been far better than average, as BNY Convergex recently noted.

This is pretty much the salient market theme right now– investors are a bit overconfident and complacent in the very short term and yet in a broader sense are more cautious and skeptical than the economic data and market action warrant......

....On some level the market is simply reflecting the less-reported signs of healing in the economy. Retail sales just re-attained the level right before Lehman Brothers' failure. Nominal gross domestic product is at a record high. Mergers and acquisitions look poised to accelerate. The market has held up despite the stark underperformance of financial stocks, just as it did in 2004 in the face of stagnant semiconductor stocks (then considered a bellwether).

It's not a novel thought to offer that stocks seem ripe to pull back or at least flatten out for a bit. Whatever the salutary effects of a Republican rout on Nov. 2, they seem already more than discounted. Yet there's enough skepticism there, that any stiff pullback would likely be a reason to buy, and not to panic.

Link:  The Storm That Wasn't

*Long ETFs related to the S&P 500 in client accounts.

Dollar Collapse

Probably the best way for most investors to purchase the dollar as a currency is via Powershares DB US Dollar Index.  {UUP}  The above chart of UUP shows the absolute collapse of the dollar since June.  Very over sold but it's locked in a nasty bear market spurred on by poor fundamentals {US Treasury is going to inflate its way out of our debt it seems by printing gobs of money}.  Nothing to see here right now people.  Move along!

*No Positions.

an tSionna {Update Of Today's Post.}

As an update from what I said this morning, I did make tiny sales in some my client's most aggressive strategies just to raise some cash as a few of our price points were hit.  These were very small amounts, in some cases raising cash positions up maybe one or two percentage points.  Even then I still have very little cash in most of these accounts.  I felt in all fairness I should pass this along. 

Disaster de Jour: APOL

Remember you can double click on any of my charts to make them larger!

*No postions in APOL although it may be a component in some of the ETFs we hold.

an tSionna: Stocks Over Bought

BeSpoke Investment Group noted the above factoid yesterday:

"Following today’s rally, 77.6% of the stocks in the S&P 500 are trading more than one standard deviation above their 50-day moving averages. Since the S&P 500 reached its all-time peak back in 2007, there have only been three other periods where more than 75% of the S&P 500 was trading at overbought levels." BeSpoke Link: Stocks Over Bought.

BeSpoke is simply giving voice to what some of our other shorter term indicators are telling us. These indicators, such as percentage of stocks trading above their 40 day and 200 day moving averages, are showing extreme levels of being over bought.

The playbook calls for caution in periods like this hence our short term Net Market Negative decision which we discussed here and here back on September 23rd. Click this link for a definition of what Net Market Negative means.

While the normal thinking would be for stocks to stage some sort of retreat, it is also possible that stocks will spend some time now simply churning around in a 3-5% range. Stocks can correct by price {a decline} as well as time {churning action} or a bit of both.

Regarding our current game plan, we remain at investment levels appropriate to our account strategies that we've had in place most of the summer. This translates that we've done very little selling in client accounts as we are neutral/positive on stocks in our intermediate and longer term time frames.

However, we have established defensive levels where we will raise appropriate levels of cash per client mandates and per our investment strategies should our indicators tip us more to the defensive side of the ledger. There are also certain defensive hedges we are looking to employ in some of our more aggressive investment strategies if our indicators suggest a larger decline is possible.

*Long ETFs related to the S&P 500 in client and personal accounts.

Financials {10.12.10}

Financials will start the day off on a positive note after a nice earnings report from J P Morgan.  We looked at a chart of the financials via the ETF KBE back at the end of September.  We noted then how financials  had underperformed the market and that this index was one of the few not approaching an over bought status. 

Banks have started to act better.  KBE is approaching its resistance levels now which should also be an important junction for other financials.  Index is also not over bought.  The playbook also states that markets do much better when financials are along for the ride so if this index is starting to perform better then it could bode well for the overall market the rest of the year and also into 2011.

*Long KBE in client accounts.  Long JP Morgan in a few legacy accounts.

an tSionna {10.12.10- Gold}

Gold via the GLD.  Goldman Sachs upped its 12 month targer on gold to $1,650 an ounce from a previous forecast of $1,365 an ounce.  That would equate to a 165 price target in the GLD.

*Long GLD in certain client accounts and investment strategies.

EQIX-One Advantage of ETFs

One of the main advantages of ETFs is that they don't preannounce earnings and drop $35.00 like this stock did Wednesday.  ETFs remove the event risk of bad news from a individual stock in investor's portfolios.  That risk, to the extent it's born in an ETF if a stock such as EQIX is part of the index, is diluted by diversification.

*No positions in stock shown above.

Q's

Chart of Nasdaq 100 Composite {QQQQ or Q's for short.}  Apple is something like 20% of this index so it's not surprising that Apple's chart looks a lot like this one.  Apple is also over bought by our work.

*Long QQQQ in client accounts.  Long Apple in certain client accounts.

IMF Says World Economic Growth To Slow

From 24/7 Wall Street:

"The International Monetary Fund is out taking the wind out of the sails of growth. Not just in the United States. Elsewhere too. The good news is that this is is still a move farther and farther away from the notion of a true double-dip recession. The world economy is expected to grow 4.8% in 2010, and that figure is now put at 4.2% growth for 2011.

....But it is an unbalanced recovery, sluggish in advanced countries, much stronger in emerging and developing countries.” Another quote, one which governments need to heed, is, 'Unless advanced countries can count on stronger private demand, both domestic and foreign, they will find it difficult to achieve fiscal consolidation. And worries about sovereign risks can easily derail growth.'

Growth in advanced economies is expected to be 2.7% in 2010 and 2.2% in 2011, but economic slack is expected to remain substantial and unemployment persistently high for some time. Emerging and developing economies are projected to grow at 7.1% in 2010 and grow by 6.4% in 2011.'

Link:  IMF Downgraded Growth.

Oil- A Daily View

Daily view of Oil via the USO. Remember that it is not a perfect play on oil because it uses futures and derivatives.  Also remember that you can double-click on these charts to make them larger.

*See post below for oil disclosures.

Oil

Above is a weekly chart of the oil ETF, USO which is one of the most basic ways to play a rise in crude, the commodity {as opposed to buying an ETF or individual stock that specializes in either oil production or oil exploration. USO is not a perfect way to view oil as a commodity however. It is a futures and derivatives based investment and that somewhat complicates how it trades in relation to the actual product. But we can use it to show a longer term view of how the underlying commodity has traded. So when we analyse oil below remember that dollar for dollar the index will not match the price of crude.

The chart above shows that crude has moved in a basing pattern for over a year. It traded around $69 per barrel in late summer and we've seen an almost 16% since then. The chart shows that this move basically puts the commodity smack back in the middle of its longer term trading range.

It is also worth noting on a fundamental basis that in the midst what many economist are calling the worst recession since the Great Depression in the 1930's oil has rarely cracked the $60 level on the downside. This begs the question of what happens to its price as world economies rebound. Given that oil traded above $100 { at one point reaching nearly $140 per barrel} back in 2007, it is not unreasonable to suppose that we could trade back to that level at some point as things get better

.

Developing countries have fared much better in this recession and their demand for oil is actually up on a year over year basis. China also continues to import more than its exports now. More important reserves that were once plentiful in Mexico are drying up. One of Mexico's largest oil fields, Cantarell , is facing a steep drop off in production. OPEC has also kept production at full bore so demand has started to outrun supply.

Add in the factor that much of what is left in the world is now being found in places that are extremely hard for it to be extracted from the ground, is located in places with a lot of social unrest or located in countries hardly friendly to Western interests and you have the recipe for potentially much higher prices in this commodity in the coming years.

*Long ETFs related to oil as a commodity but not long USO. Long ETFs related to oil exploration and production. Long all of these in client and personal accounts.

Valuation

Oppenheimer's Carter Worth made some observations yesterday about the market's valuation.  I thought I would put up his basic statistics as a measuring rod as we begin the 4th quarter.  Remember I think stocks may be choppy and weak this month as investors wait the results of the elections but after that I think there is a real possibilyt that stocks move higher into year's end. 

*As of October 1st, the total value of the U.S. equity market stands at some $12.8 trillion, with the companies in the S&P 500 representing 81% of the total with a value of $10.4 trillion.

*The market's growth characteristics - and the valuation thereof - are as follows:

· The S&P 500 is trading at a price/earnings multiple of 14.9 on a trailing 12-month basis and a price/earnings multiple of 13.1 on a forward 12-month basis.

· The earnings growth rate of the companies comprising the S&P 500 is 27% on a trailing 12-month basis and is projected by First Call to be 13% in the coming 12 months.

· The price-to-cash flow ratio for the S&P 500 is currently 9.3 (versus a 20-year median price-to-cash flow ratio of 10.3).

· The price-to-sales ratio is 1.2 (versus a 20-year median of 1.3).

· The return on equity of the companies comprising the S&P 500 is running at 14.9% (versus a 20-year median ROE for the SPX of 15.1%).

Source:  C.B. Worth, "Money in Motion,"  Oppenheimer & Co. Inc.   October 4, 2010, page 1.  Data courtesy of Standard & Poor's and Thomson Reuters

an tSionna {10.04.10}

Picture points to a market that is more over bought than last week. At best stocks will probably churn around now for a while.

*Long ETFs related to the S&P 500 in client and personal accounts.

Out Today!

I am out today and posting may be sporadic until the middle of next week as I have meetings with clients. Look for my year end thoughts coming soon!!!!