An Early Thought

Markets are down this morning but let's remember a few things. 

1.  Year ends today for mutual funds and certain other partnerships.  This can have the effect of whipsawing markets as funds try to lock in gains or eek  out performance in the last day of their trading years.

2.  Market has had a huge run up in October.  This is currently going to be the best October since 1974!  There are a lot of people sitting on very large short term gains and there could be pressure to sell some of that to lock in positions.

3.  We are very overbought in the short term.

4.  Many averages are sitting right near their 200 or 150 day moving averages.  Expect to see some selling as these important resistance points are tested.

None of this takes away from my belief that markets will be higher by year end based on what we currently know as too many investors need it that way by December 31st.  However, we could see a bit of profit taking over the next few days or weeks as the market adjusts itself.

Happy Halloween to all the little ghosts and goblins on Ashland Avenue and to everybody else as well!

From Chart of the Day.

"For some long-term perspective, today's chart illustrates the Dow adjusted for inflation since 1925. 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 up 145% since its 1929 peak and trades 74% above its 1966 peak – not that spectacular of a performance considering the time frames involved. It is also interesting to note that the Dow is up 86% from its March 9, 2009 low which is actually slightly more than what the inflation-adjusted Dow gained from its 1966 peak to today."

Link:  Chart of the Day :The Dow

*Long ETFs related to the Dow Jones Industrial Average in certain client accounts.

The Feast For All Souls

'Oíche Shamhna'

Out Today

I have some client meetings today.  Next post will be on Monday.

PreMarks 10.27.11 {Europe Edition}

Markets set to open sharply higher on news out of Europe on a series of policies to help avert their debt crisis.  So far this is what has crossed the wires that I've seen.

-Greek debt holders to take a voluntary 50% haircut on Greek debt.

-New European stabilization fund {EFSF-don't ask me what all the letters mean!} will be leveraged about 5 times which gives it a lending capacity over 1.5 trillion Euros.  This is probably enough to not only deal with Greece, Italy, Spain and maybe Ireland and Portugal.

-Over 100 Billion Euro recapitalization of European banks.

Whether this is a real solution or a band-aid markets are euphoric this morning.  Set to jump anywhere from 2-3% on the open.    When you look at the better than expected GDP numbers coming out of the US {GDP grew about 2.5% in the previous quarter} then here's a few things we can say for now.

-Recession talk is off the table for the time being.

-European collapse is off the table for the time being.

-Corporate earnings have come in for the most part better than expected so far for the 3rd Quarter.

All three of these ought to backstop the market between now and the end of the year.  Couple that with market seasonality market seasonality gives us a greater probability of higher stock prices between now and December 31st. 

This is likely a trend changer meaning that the market will be back in "risk on" mode and a "buy the dips" mentality is likely to prevail between now and year's end. 

Time For A Contrary View

Interesting Telegraph article on America.  The Brits claim that we may be actually getting our act together.  Who knows?  Maybe sometime you need an outsider to see the obvious.  {Excerpt with my highlights}

World power swings back to America

The American phoenix is slowly rising again. Within five years or so, the US will be well on its way to self-sufficiency in fuel and energy. Manufacturing will have closed the labour gap with China in a clutch of key industries. The current account might even be in surplus.

Assumptions that the Great Republic must inevitably spiral into economic and strategic decline - so like the chatter of the late 1980s, when Japan was in vogue - will seem wildly off the mark by then.  Telegraph readers already know about the "shale gas revolution" that has turned America into the world’s number one producer of natural gas, ahead of Russia.   Less known is that the technology of hydraulic fracturing - breaking rocks with jets of water - will also bring a quantum leap in shale oil supply, mostly from the Bakken fields in North Dakota, Eagle Ford in Texas, and other reserves across the Mid-West.

"The US was the single largest contributor to global oil supply growth last year, with a net 395,000 barrels per day (b/d)," said Francisco Blanch from Bank of America, comparing the Dakota fields to a new North Sea.  Total US shale output is "set to expand dramatically" as fresh sources come on stream, possibly reaching 5.5m b/d by mid-decade. This is a tenfold rise since 2009. ..."The implications of this shift are very large for geopolitics, energy security, historical military alliances and economic activity....

Meanwhile, the China-US seesaw is about to swing the other way. Offshoring is out, 're-inshoring' is the new fashion.  "Made in America, Again" - a report this month by Boston Consulting Group - said Chinese wage inflation running at 16pc a year for a decade has closed much of the cost gap. China is no longer the "default location" for cheap plants supplying the US.  A "tipping point" is near in computers, electrical equipment, machinery, autos and motor parts, plastics and rubber, fabricated metals, and even furniture......The gap in "productivity-adjusted wages" will narrow from 22pc of US levels in 2005 to 43pc (61pc for the US South) by 2015. Add in shipping costs, reliability woes, technology piracy, and the advantage shifts back to the US.....

Boston Consulting expects up to 800,000 manufacturing jobs to return to the US by mid-decade, with a multiplier effect creating 3.2m in total. This would take some sting out of the Long Slump.  As Philadelphia Fed chief Sandra Pianalto said last week, US manufacturing is "very competitive" at the current dollar exchange rate. Whether intended or not, the Fed's zero rates and $2.3 trillion printing blitz have brought matters to an abrupt head for China.

Fed actions confronted Beijing with a Morton's Fork of ugly choices: revalue the yuan, or hang onto the mercantilist dollar peg and import a US monetary policy that is far too loose for a red-hot economy at the top of the cycle. Either choice erodes China's wage advantage. The Communist Party chose inflation.  Foreign exchange effects are subtle. They take a long to time play out as old plant slowly runs down, and fresh investment goes elsewhere. Yet you can see the damage to Europe from an over-strong euro in foreign direct investment (FDI) data.....Volkswagen is investing $4bn in America, led by its Chattanooga Passat plant. Korea's Samsung has begun a $20bn US investment blitz. Meanwhile, Intel, GM, and Caterpillar and other US firms are opting to stay at home rather than invest abroad.  Europe has only itself to blame for the current “hollowing out” of its industrial base. It craved its own reserve currency, without understanding how costly this “exorbitant burden” might prove to be.   China and the rising reserve powers have rotated a large chunk of their $10 trillion stash into EMU bonds to reduce their dollar weighting. The result is a euro too strong for half of EMU......The switch in advantage to the US is relative. It does not imply a healthy US recovery. The global depression will grind on as much of the Western world tightens fiscal policy and slowly purges debt, and as China deflates its credit bubble.   Yet America retains a pack of trump cards, and not just in sixteen of the world’s top twenty universities.  It is almost the only economic power with a fertility rate above 2.0 - and therefore the ability to outgrow debt - in sharp contrast to the demographic decay awaiting Japan, China, Korea, Germany, Italy, and Russia.

Europe's EMU soap opera has shown why it matters that America is a genuine nation, forged by shared language and the ancestral chords of memory over two centuries, with institutions that ultimately work and a real central bank able to back-stop the system. The 21st Century may be American after all, just like the last.

Link:  World Power Swings Back To America

an tSionna {10.21.11}

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

China

From Chart of the Day: 

"For some perspective on one of the more important global stock markets, today's chart focuses on Chinese stocks and presents the current trend of the iShares FTSE/Xinhua China 25 Index (FXI). As today's chart illustrates, Chinese stocks have endured what amounts to an extremely wild ride since 2005. The FXI trended upward at an ever accelerating rate (i.e. parabolic) from 2005 to Q4 2007. As the credit bubble began to unravel, so too did Chinese stocks with the FXI trending downward at an ever accelerating rate from Q4 2007 to Q4 2008. Beginning in Q4 2008, the FXI surged -- gaining over 155% trough to peak. Since that post-financial crisis peak back in Q4 2010, Chinese stocks initially treaded water but more recently have entered in to a steep downward trend channel. Considering China's increasingly significant contribution to the global economy, this recent stock market action is most definitely a red flag."

Link:  COTD: China

*Long FXI China ETF in certain client accounts.

Chicago-Two Great Movie Quotes

Well this is perhaps the best fictional quote ever about Chicago courtesy of the film "The Untouchables".

Now comes the new STARZ television series Boss .  I haven't seen this show yet but John Kass  over at the Chicago Tribune writes about it today in an editorial.  Kass pulls out another great fictional Chicago quote that never-the-less hits close to home.  In the scene Kass describes, the fictional mayor tells a young politician with growing asperations and with an Obama cadence about the "city of tribes".  "City of Tribes", if you ever read Kass, is his term for this area  and tells you all about Chicago that you really need to know:

"They want to be led," Mayor Kane says of the people of Chicago. "They want their disputes settled. They want their treaties negotiated, jobs dispensed, their mutinies punished. And they want their loyalties rewarded. And to those who would lead them to all they want, they get power. It's a covenant. Unspoken and elemental. When a part fails, (pause) it needs to be fixed."

Oh maybe we should add a third phrase describing the way things are often done around here.  "Nobody saw nuthin."

Chicago is a big complicated city with lots of moving and diverse parts.  I don't comment on whether all of this is good or bad.  I just say that it is what it is.  And at the end of the day, it is  "The Chicago Way."

Link:  Kass on the series "Boss".

Jobs Statistics: Depressing

Reuters  takes a look at government pay data statistics for 2010.  In a word it was just awful.  {Excerpt with my highlights}

Anyone who wants to understand the enduring nature of Occupy Wall Street and similar protests across the country need only look at the first official data on 2010 paychecks, which the U.S. government posted on the Internet on Wednesday.  The figures from payroll taxes reported to the Social Security Administration on jobs and pay are, in a word, awful.

These are important and powerful figures. Maybe the reason the government does not announce.....their release or writes about them each year — is the data show how the United States smolders while Washington fiddles.   There were fewer jobs and they paid less last year, except at the very top where, the number of people making more than $1 million increased by 20 percent over 2009. {Some highlights}

-The median paycheck — half made more, half less — fell again in 2010, down 1.2 percent to $26,364. That works out to $507 a week, the lowest level, after adjusting for inflation, since 1999.

-The number of Americans with any work fell again last year, down by more than a half million from 2009 to less than 150.4 million.

-More significantly, the number of people with any work has fallen by 5.2 million since 2007, when the worst recession since the Great Depression began...

-This means 3.3 percent of people who had a job in 2007, or one in every 33, went all of 2010 without earning a dollar.

-In addition to the 5.2 million people who no longer have any work add roughly 4.5 million people who, due to population growth, would normally join the workforce in three years and you have close to 10 million workers who did not find even an hour of paid work in 2010.

These figures come from the Medicare tax database at the Social Security Administration, which processes every W-2 wage form. All wages, salaries, bonuses, independent contractor net income and other compensation for services subject to the Medicare tax are added up to the penny.

In 2010 total wages and salaries {when adjusted} for inflation, {were} almost identical to 2005, when the U.S. population was 4.2 percent smaller.....

...At the same time, nonfinancial companies are sitting on more than $2 trillion of cash — nearly $7,000 per American — with no place to invest it profitably. This money cannot even be invested to earn the rate of inflation.  All this capital is sitting on the sidelines waiting for profitable opportunities to be invested, which will not and cannot happen until more people have jobs and wages rise, creating increased demand for goods and services......On top of this are the societal problems caused by something the United States has never experienced before, except during the Depression — chronic, long-term unemployment.  Having millions who want work go years without a single day on a payroll is more than just a waste of talent and time. It also can change social attitudes about work and not for the better.

The data show why protests like Occupy Wall Street have so quickly gained momentum around the country, as people who cannot find work try to focus the federal government on creating jobs and dealing with the banking sector that many demonstrators blame for the lack of jobs.

Link:  2010 Payroll Data 

Current Sector Weightings

Bespoke Investment Group takes a look at the current weightings of the S&P 500.  Financials have fallen significantly in terms of its sector weightings over the past three years:

According to Bespoke "as shown, the Technology sector is currently a fifth of the index, which shows just how important movements in tech stocks are on the overall market. The Financial sector, which used to hold the top position prior to the financial crisis, has whittled down to 13.41%. Industrials, Consumer Discretionary, Consumer Staples, Health Care and Energy rank 3rd through 7th and have weightings between 10.43% and 12.09%. Utilities, Materials and Telecom -- all with weightings in the 3s -- have little impact on the market regardless of what they're doing."

I don't think financials really start to rally until they first hit single digits in terms of representation in the S&P 500 but what do I know!

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

Link:  Bespoke: Sector Weightings.

an tSionna {10.18.11}

 We posted  last week why probability indicated markets were vulnerable to some sort of pullback.  Yesterday stocks lost on average between 2-3%.  There were many explanations for this such as Europe or slowing growth out of China.  Sometimes though it is just as easy to look at whether stocks are overbought or oversold.  By last Friday we had reached a point where we were overbought enough to be ripe for a sell-off on profit taking.  Yesterday's news provided that excuse.  Thus you get yesterday's beat down.  Here's the chart as we see it in regard to money flows below.  You can double-click on the charts to make it larger.

Probability suggests at this point that any sell-off absent substantially new negative news will likely be bought.  Probability also suggests that stocks will consolidate these gains and then potentially head higher in the coming weeks and months.

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

Are Stocks Cheap? Look At PE's

This from Chart of the Day  regarding Price to Earnings {PE} ratios of the markets.  {My highlight below}

"...{T}he recent rise in earnings as well as the recent stock market action has impacted the current valuation of the stock market as measured by the price to earnings ratio (PE ratio). Generally speaking, when the PE ratio is high, stocks are considered to be expensive. When the PE ratio is low, stocks are considered to be inexpensive. From 1900 into the mid-1990s, the PE ratio tended to peak in the low to mid-20s (red line) and trough somewhere around seven (green line). The price investors were willing to pay for a dollar of earnings increased during the dot-com boom (late 1990s), surged even higher during the dot-com bust (early 2000s), and spiked to extraordinary levels during the financial crisis (late 2000s). As a result of the recent spike in corporate earnings as well as relatively lower stock prices (e.g. the S&P 500 currently trades 11.7% off its April 2011 post-financial crisis highs) the PE ratio has dropped to a level that has not existed since 1990."

Link:  COD: PE Ratios.

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

Investor Infallibility

At some point I want to do either an article or a series on perceived investor infallibility and investor failure.  I saw this article yesterday over at Market Watch and decided to excerpt it here for your benefit.  We'll come back to this I hope at a future time.  {Excerpt with my highlights.}

Link to Stock Gurus Aren't What They Used To Be.       By Matthew Lynn

LONDON (MarketWatch) —  ......The stock gurus aren’t what they used to be...In the last few weeks, we have discovered that John Paulson, one of the few money managers to emerge from the subprime debacle with his reputation enhanced, is just as fallible as the rest of us. Over here in London, one of the U.K.’s best-known fund managers, Fidelity’s Anthony Bolton, is struggling with a much-hyped investment trust. It doesn’t seem that anyone can make the kind of money consistently that stars like George Soros, Warren Buffett or Julian Robertson could in the past.

Maybe that’s just bad luck. Then again, maybe something more interesting is going on. We may be entering an era when there aren’t any real stock gurus anymore — in the sense of exceptional individuals who can consistently beat the market.  ....

John Paulson’s mega-bet against the subprime mortgage industry made him a star in the investment industry — as well as one of the wealthiest men to emerge in the last few years. Forbes magazine estimates his net worth at $15.5 billion.  But this month has seen heavy losses on the funds run by Paulson & Co. His fund dedicated to gold investments lost 16% in September, a lot more than the 11% fall in the gold price. His Recovery Fund lost 14% in September and is down 31% on the year. The Paulson Advantage Fund is down by slightly more so far in 2011.  Those are disappointing figures for any money manager; for a star such as Paulson, they are catastrophic.

In the U.K., Anthony Bolton has been one of the few money managers with a loyal following.......When he came out of retirement last year to launch the Fidelity China Special Situations investment trust investors stampeded into the new vehicle.....By last week, the share price had fallen by 37% so far this year, compared with a 28% drop for its benchmark....

Those are two high-profile names. But right across both the traditional fund managers and the hedge funds, returns have been disappointing — hedge funds on average lost 5.2% in September, according to research by Bank of America.

Big-name investors, such as George Soros, haven’t fared so well in the recent bear market.... In the past, there were always a few stock gurus who seemed to have the magic touch. Money managers such as Buffett or Soros or Robertson, the founder of Tiger Management, all rode the markets with a sure touch all through the 1980s and 1990s. True, their performance was not infallible. There were occasional bad years. But they endured over two decades or more, beating the market with a consistency that suggested something more than just luck was involved......No one like that seems to be around any more.  True, maybe that is just bad luck. Even the greatest of investors have the occasional rotten year. And even the dumbest gets things spectacularly right occasionally.  But it also raises a more interesting possibility. Stock gurus may no longer be able to consistently beat the market.

Is that possible? There are a couple of reasons for thinking it might be.  First, it now looks as if we are in a Japanese-style bear market, which may drag on for 20 or 30 years..... In reality, we are more than a decade into a bear market, and it doesn’t look like ending anytime soon. In a bear market it is virtually impossible to out-perform. You get lucky one year. Then you get caught out the next.

Secondly, the financial markets have become driven by politics. It is central banks printing money, or governments bailing out banks, that determines whether asset prices rise or fall. The decisions made in parliaments and senates count for a lot more than any that are made in the boardroom. That makes a difference. While a few very clever people can predict trends in free markets, it is impossible to predict what political systems might do. They are inherently unstable, and unpredictable.....

The harsh reality is that even the smartest stock-pickers can’t make money in these markets. Which, rather worryingly, suggests there isn’t much hope for the rest of us.

Matthew Lynn is a financial journalist based in London. He is the author of "Bust: Greece, the Euro and the Sovereign Debt Crisis," and he writes adventure thrillers under the name Matt Lynn.

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

Best Credit Scores? Wisconsin

This excerpt from 24/7 Wall Street. 

"The people with the best credit scores live in Wisconsin. That may be because there are few pockets of poverty there. Any other explanation would be hard to prove. It would also be hard to prove that there is any set of circumstance that would make these scores much worse, or that the areas with poor credit scores are likely have those credit scores get any better.

The new Experian “Annual State of Credit Map” shows that among the ten cities with the best credit scores are Wausau, Green Bay, Madison and La Cross, Wisconsin. Close-by Minneapolis is on the list as well. Most of the cities on the list share many of the characteristics of Wisconsin cities. Their populations are homogenous and mostly white. Unemployment in the areas tends to be low.

The other end of the credit spectrum is in cities that include four of the poorest cities in Texas — Corpus Christie, Harlingen, Tyler and El Paso. These are border towns with concentrations of immigrants. Among the other cities at the bottom of the list are Las Vegas, Jackson, Mississippi, and Shreveport and Monroe, Louisiana.

The Experian data are part of broad set of statistics that show that the regions of poverty, low education attainment, collapsed home prices and unemployment are in the same place they have been for years. A good demographer can point them out on any map of the U.S. No government program or social engineering has been able to change the fates of these regions. They are proof that all demographics are local......

There is a theory that the unemployment and education problems in the U.S. can be solved with broad policies that work from the top down. The federal government can provide money for “shovel-ready” programs and tax credits for firms that hire out-of-work people. In the poorest parts of the nation, there are not likely to be healthy construction firms ready to begin new work. And there are certainly not businesses that can hire new workers for a tax credit of several thousand dollars.

Credit scores are low in parts of Texas and Mississippi because there are few jobs in those places, little food and education, and a lack of government programs aimed at the most troubled geographic sections of America. The old saying is that it takes credit to get credit. That is as true in the poorest parts of Louisiana as it is in the richest parts of Wisconsin. 

My comment:  When I see statistics like this I think of how people from Illinois make fun of Wisconsinites.  I've spent a fair bit of time up in the parts of Wisconsin listed in the article.  That part of the state was long ago settled by people from Germany and Scandinavia.  This are people who come from a rootstock that have a long history of saving money.  Basically Germany and Scandinavia are being asked to bail out the EU right now.  Why.  Because again they are historically saving nations with cash in the banks.

Link:  Best Credit Scores-Wisconsin

To Fly, To Serve

For some reason the "Brits" just seem to do commercials better than we do.  Check out this new add for British Airways titled "To Fly To Serve"

Hey BTW look at us!  Finally figured out how to post video from Utube on the web.  We're positively 21st century now!

October Strong Starts

Adding on to the comments I posted in the chart below, according to Bespoke Investment Group, " the S&P 500 is currently up 5.05% through the first six trading days of October. Going back to 1928, this ranks as the 8th best start to October (through first six days) for the index, and the best start since 1982".  Bespoke says that from here on end on average in these kind of circumstances the average performance for the rest of the month is 0.08% (median 1.25%), with positive returns 7 out of 11 times..  Their comment on that is from here on till month's end "Not great, but not bad either."  

A pullback and flattish trading for the rest of the month might coincide with my oversold and resistance comments in the chart below.  That kind of trading could set the stage for a rally in the last two months of 2011. 

Link:  Bespoke: Best starts to October.

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

an tSionna {10.12.11}

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

Be Well Dad

We sure miss ya!

A Quick Note 10.10.11

Before I head out I will note that CNBC just posted that the Dow Jones Industrial Average has managed to have a triple digit move for the 10th time in 11 sessions.  That's volatility!!!!!

*Long ETFs related to the Dow Jones Industrial Average in client accounts.

PreMarks 10.10.11

Futures are set to rally on some loose talk out of Europe about a debt deal between Germany and France.  I've not seen enough yet today to comment on this.   I would say that markets are now, for at least the shortest time period we follow, in rally mode.  The real news will likely start to come in this week when corporations start to report earnings.  We'll see how stocks react to that.  What we don't want to see today is this open get sold.  One other thing to remember is that this is a holiday for banks and the like so the trading today may not be indicative of what we see the rest of the week. 

I'm in and out for much of the next two days in a series of meetings so the next posting here will likely be Wednesday. 

an tSionna {10.07.11}

From Bespoke Investment Group:  "Despite a rally off the lows of more than 8% this week, the S&P 500 still has more work to do before its short-term downtrend line comes into play. In order to break that downtrend, the S&P 500 would need a further rally above 1,160 from its current level of 1,150."

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

Link:  Bespoke: Trendline

Steve Jobs Post-Script

The world is awash in a celebration of Stove Jobs' life today.  I will add only one little thing.  Steve Jobs left this world having built a business {well several businesses if you count Pixxar and the like} that made people happy.  Most capitalists can't say that.  They may build something that is necessary but very few of us build things that so move the masses the way Job's creations did.  

Somewhere tonight a mouse is welcoming Mr. Jobs into heaven.

"You can design and create, and build the most wonderful place in the world. But it takes people to make the dream a reality."-Walt Disney.

"A dream is a wish your heart makes when you're fast asleep. In dreams you will lose your heartaches. Whatever you wish for, you keep. Have faith in your dreams, and someday, your rainbow will come smiling through. No matter how your heart is grieving, if you keep on believing, the dreams that you wish will come true." -Cinderella

Steve Jobs Commencement Speech At Stanford In 2005.

Ar dheis Dé go raibh

None Of Your Mutual Funds Are Making Money

This was published over at thestreet.com this morning:  {Excerpt}

"U.S. stock mutual funds that invest in a diverse array of companies turned in a shameful performance last quarter, as none -- that's right, none -- made money.  Among funds that buy mainly U.S. stocks and use no leverage or short positions, only three sector-specific {utility}funds eked out gains from the beginning of July to the end of September, according to fund-research firm Morningstar....

The stock-market rout gathered steam last month on concern the U.S. economy is slipping into another recession and Europe's debt burden will sink more banks and lead to a further decline in global corporate profits. In September, materials stocks fell the most, by 13%, followed by energy, with a 10% drop, and financial services, which tumbled 8.3%, according to Capital IQ. Utilities shares were the sole sector to rise, by 1%."

Link:  None of your Mutual Funds are Making Money 

Post Script.

Concurrent with my letter of yesterday we will move our shortest term indicators to NET MARKET POSITIVE.  This mostly reflects my belief that things will start to work themselves out at least enough to enable markets to move higher by year's end.  It also reflects the fact that I have been putting mostly new money to work for clients over the past several days.  This only reflects our shortest term indicators as we have been NET MARKET POSITIVE in our intermediate and longer term indicators for most of the year.  You can click here  for a definition of these terms.

Thoughts Going Forward

This post will be a follow up to my "End of Quarter Market Thoughts"  .  Below I've listed some of the principle themes we'll be watching as we move towards year's end.  Here we also discuss what the playbook says we ought to do in situations like this and our game plan  for doing so.

The upcoming corporate reporting period may be the most important earnings season that we've witnessed since 2008.  The next 2-3 weeks will likely be critical in determining market direction for the rest of the year.  Market's are worried that the slow patch the economy entered this summer will turn into a recession.  So far economic data is not showing that to be the case.  Corporations will soon start reporting how they did in the 3rd quarter and will give some insight into future business.  A bad earnings season could lend credit to the recessionary argument.  Corporate reports that in general paint a picture of economic growth could lead to a market rally.  If we are not entering a recession then there is a greater probability that investors will bid stocks higher into the year's end.

What are the Europeans willing to do regarding their debt issues?  Stocks rallied sharply higher yesterday afternoon on news of a possible plan for recapitalization of European banks.  This indicates to us that investors overriding concern is financial collapse overseas, mirroring what happened here in 2008.  Any real coordinated plan of attack on debt issues could lead to a US stock rally.  As an aside the Europeans really have no choice in somehow finding a solution to this issue.  They can pick a plan of their own choosing or be forced to accept the one that the markets will dictate to them if they continue to do nothing. 

Will there be any solid  bipartisan deficit plan from the super committee appointed by Congress this summer?  Recall that what started the major portion of our slide in August was the inability of our politicians to come to grips with our debt issues. This led to a downgrade of our credit rating.  Markets have basically been in a correction mode since that time.  The committee is scheduled to deliver its report to Congress sometime in late November.  Failure by Congress to approve the committee's plan results in harsh automatic cuts in both military and discretionary spending.  The committee is charged with finding over a trillion dollars of either spending cuts, tax increases or a combination thereof.  Passage of a reasonable bipartisan plan is most likely positive for stocks. 

How much lower will the price of gasoline go? Gas here in Chicago is something like twenty-five cents lower since Labor Day.  {We still pay too much and more than almost any other place in the country!}  There are some experts  who suggest that every ten cent decrease in gas puts nearly 14 billion dollars annually back in the pockets of consumers.  This is a quiet benefit that hasn't perhaps been as acknowledged as it should have been.  It of course works both ways.  Right now lower gas prices are helping the economy.  We'll be watching to see which way prices go and if any further decline helps discretionary spending.

What the playbook and game plan are telling us.  The playbook is situational analysis based on historical market results. We study money flows along with the disciplines of fundamental and valuation analysis to see how markets have responded to similar historical events. The playbook gives us different scenarios regarding current market activity. We use it to then formulate our game plan. The game plan is a tactical and strategic allocation of assets based on what the playbook tells us has historically occurred. It is then further refined to the specific risk/reward parameters of our various clients.

The playbook gives us a set of metrics that we regularly use to gage economic activity.  These are currently not indicative of a recession, although they have suggested a slowdown in the expansion.  If there is no 2012 recession and if Europe somehow avoids a credit conflagration, then by most of our investment indicators stocks look cheap.  These investment metrics leads us to believe that the US will narrowly avoid a recession in the first half of 2012 and that we will see better indications of economic growth as 2012 progresses.  This could obviously change, but for now that's how our indicators read. Again we think we'll know more about the state of the economy as we progress through this earnings season.   The playbook also tells us what to look for in terms of market phases by our measurement of money flows.  Many of these indicators are now close to flashing positive signals.  For example, the number of stocks trading below their 200 day moving average has reached oversold levels that historically has led to a positive move for stocks. 

Money flow indicators that begin issuing positive market signals suggests a higher probability of positive returns on a 12-18 month basis.  Now no system is foolproof and our indicators can flash these signals and then continue to sell off for a while.  For example these indicators flashed positive in November, 2008.  Market rallied through early January of 2009 and then sold off to retest the previous October's lows.  But ultimately purchases  made during that time period gave us fairly substantial returns.  We will monitor these systems in the week's ahead.  In general we have carried above average cash balances this year and we believe we are getting close to the time when it will be necessary to put some of that money back to work according to our strategies and our client's mandates. 

The game plan calls for us to look for what we believe are undervalued sectors of the economy. It also tells us what to do in the event we are wrong with our analysis.   Areas of likely investment concentration include technology, energy and certain health care sectors.  International sectors and higher dividend paying exchange traded funds are also attracting interest at this time.

*Please note that the above reflects solely the opinions of Lumen Capital Management, LLC. As such it is designed solely for the clients and friends of our firm. Since we do not know the investment parameters of casual readers of this blog, they are advised to consult their own investment adviser's or do their own homework. Nothing in this posting should be construed as a recommendation or a guarantee of any sort. Better yet, hire us and we'll show you how our work is done!!!

Late Upside Reversal

The market rebounded sharply this afternoon on a news out of the Financial Times  that European officials had come up with yet another plan to recapitalize their banks.  This sort of price action seems to me to be indicative of a market held hostage to outside events while ignoring our underlying economic fundamentals.    I think if we can somehow get beyond the European financial issue here than stocks could have a pretty good run going into the end of the year.

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

an tSionna {GE}

I have a certain cadre of my clientele that are retirees of General Electric {GE}.  I was asked yesterday by one of them what I thought about the stock.  I thought I would post this today since I did some money flow work recently on the company.  

GE reached a closing high of 21.50 on February 14 of this year.  Since then it has been all downhill.  At yesterday's close of 14.69 the stock is down over 31% from it's high and is down nearly 20% for the year.   GE is also back to trading right at the price levels from which it broke out in 1996! 

GE yesterday broke through the support range that it has held since the market sold off back in August.  The next level of support lies about a dollar below where it closed last night in the 13.50-13.90 range. 

GE is likely selling off more than the market due to it's international exposure and its industrial components.  Based on consensus earnings for 2011, GE trades with a 9 PE ratio.  This likely expresses Wall Street's fear that its earnings will need to be revised lower.  GE also has a current dividend yield around 4%.  From what we know today that dividend is likely safe assuming that we don't have a much worse economic period than analysts currently think possible.  Based on historical models and based on current earnings estimates,  if we avoid a recession we can impute a fair value forecast for GE between 16-22 for 2012.  If we do go into a recession then we can come up with a fair value forecast for GE between 11-16 for 2012.  Please note these are estimates based on historical factors and based on information that we currently have available.  There is no guarantee that any of these prices may be met, nor are we saying that the stock could not go lower than that $11 implied price value!  

GE pretty  much illustrates the current market quandary.  Markets are so confused about the direction of the economy that there must be two sets of analysis for almost everything.  That is markets have to develop scenarios for the US having a recession or a period of slow growth.  The problem is the market right now is confused on which way we're going.  When confusion reigns prices flop around or sometimes like now go lower. 

*Long GE in certain client accounts.

End Of Quarter Market Thoughts.

Statistics compiled by Bespoke Investment Group and written up in Barrons this past weekend, indicate that the just completed third quarter was the weakest since 1928. I haven't looked that far into the past but I do know that this quarter was the worst 3rd quarter performance since 2002.  If you remember back then we were getting ready to invade Iraq.  The S&P 500 was down a bit more than 14% for the quarter.  It lost 7% in September. For the year the index is down just a bit over 10%.  Our markets ended up being the best house in a bad neighborhood. Overseas markets fared much worse in the quarter. According to Bespoke {linked above}, Russia was down the most at -34.35%, followed by Italy with a -32.54% decline, Germany at -32.06%, and France booked at -31.08% loss.

Taking a look at the chart above shows that most of our damage was actually done mid-summer. {You can double click on the chart to make it larger and easier to see!} Stocks took in most of their losses  between July 26 and August 8th. Markets have traded roughly flat since then, albeit with a sharp increase in volatility.   This reflects investor anxiety and indecision over the economy and the global debt crisis. See our column on market swings for a more in depth discussion on volatility.

The markets sniff recession or at the very least a period of much slower growth than was originally forecast back in the spring. The European debt situation reminds many of the problems we experienced here in 2007-08.  The political stalemate here at home has also done nothing to help investor confidence. One of the catalysts that began this current downturn was S&P's downgrade of U.S. debt.  That came on the heels of our politician's inability to come to a government funding agreement back in mid-summer.  So far economic data does not seem to support recessionary fears.  We will get a better idea of that possibility in the weeks ahead as corporations report 3rd quarter earnings and give us some indication of what they are seeing going forward.  One positive take away is that so very few companies have "pre-announced" earnings shortfalls for the quarter just finished.  That likely means their businesses held up during the summer or any sales declines were within expectations during what for many companies is a seasonally weak period.  It will be the forward guidance they deliver in the weeks ahead that investors will focus most upon.

I am not in the recession camp at this point. I think it is likely we'll skirt an actual decline in GDP although growth may be slow enough in the next few quarters that it feels like we're in one. It is also unclear to me how much stocks are already discounting that scenario given the 20% decline in prices we've seen since the spring. That being said, the market's vote far outweighs my opinions and we'll take our cues from how stocks behave in the coming weeks. In particular we will see whether stocks can hold above the floor put in back in August which has turned into that dark red support line you see highlighted in the chart above.

As we noted previously in a column  "What is it About August?" , we've had the defensive team out on the field most of the time since last spring. This has in general meant for many clients and strategies carrying larger than normal cash positions, redeploying assets and concentrating on sectors and groups that we think are historically cheap and that may act as hedges in a slower growth environment. One area in which we have taken further position's are ETFs that concentrate on dividends. Many of these are at historic levels when measured against bonds and bond funds.  While dividends can always be cut in a recession, we believe that prices currently reflect most of that possibility.  Dividend paying stocks and ETFs should also hold up better in a declining market environment than most other sectors and groups.  We will likely continue to be interested in dividends as long as this historic difference versus bond yields stays around.  

October typically signals the end to the period of seasonal weakness in stocks which we discussed here last summer.  November and December are typically stronger months for the markets. Even in 2008, one of the worst years for equities that I can ever remember, stocks advanced close to 20% from their lows to their close on December 31st. We should also have a much better idea on economic growth after companies report over the next month and that should enable us to begin to build our game plan for 2012.

We have been using a year end price target for the S&P 500 of 1,350 to 1,400 for 2011. That price target is still a possibility if corporate earnings come in on target and investor confidence rebounds. However, given where we are in the year and given the current level of uncertainty both here and abroad, we think those price targets are now less likely to be achieved in 2011. We will instead bring our year end range down to 1,250-1,300 for the S&P 500.  That is still a 10-15% potential increase in asset prices by year end. We will use a preliminary price target of 1,350-1,450 for 2012.  That's a 20-25% potential increase in stock prices over the next 15 months.  I'll warn you now though that these price targets are based on the US and world economies avoiding a major recession next year.  A recession would likely lead to substantial revisions lower in these 2012 estimates.   While a recession does not seem likely based on current economic data, that possibility has risen over the summer.  We place the odds of a recession in 2012 {recession being  defined as two consecutive quarters of decline in GDP} as between 20-25%.  While that is a lower probabilty event, it is not zero.  We will monitor this situation closely in the months ahead.

Finally I will say that you have to go back to my late high school and college years {1977-1983} to find such a sustained period of anxiety in this country.  From the economy to politics we seem to have taken a most pessimistic view regarding nearly everything.  Of course Americans could be forgiven about their sour mood given what's happened over the past decade.  Yet even a cursory view of our history shows that at some point we muster up the will to fix what's broken.  This time could be different, but I'll bet with history and say we'll look back on this period as part of the groundwork that laid the foundation for better times ahead.  Why I think that is a possibility is the stuff of another article at a future date.  Stay tuned!  

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

**Please note that the above reflects solely the opinions of Lumen Capital Management, LLC. As such it is designed solely for the clients and friends of our firm. Since we do not know the investment parameters of casual readers of this blog, they are advised to consult their own investment adviser's or do their own homework. Nothing in this posting should be construed as a recommendation or a guarantee of any sort. Better yet, hire us and we'll show you how our work is done!!!