Market Commentary: July 31st, 2009: 10:00 am (PST). Posted by Manu Walia
“The economy is coming closer to the end of recession based on the advance estimate for second quarter GDP. The economy contracted in the second quarter by only 1.0 percent, following a revised 6.4 percent drop in the first quarter.” Source: Bloomberg.com
The mother of all variables is the development in the overall economy. It is obvious from the readings on the chart below that the last quarter GDP decelerated at a much slower rate relatively. This is great news for investors so why did the market react tepidly. As I write this, the Dow Jones Industrial Average (9.52 am, PST) is trading in the positive by 6 points. In other words the actual deceleration in the economy was almost half of what was expected by most economist and financial pundits.
I believe that most of the recovery for 2009 is factored in the market. As mentioned in our previous commentary, we believe that the earnings growth has been factored into the markets and the S&P 500’s fair value (factoring earnings growth expectation) should be in the range of 1050-1100. This could mean that the markets could gain another 10-12 %. On the flip side, the fact remains that the markets have gained almost 14% over the last 3 weeks or 15 trading days. That is too much too quick in our view. We believe that the markets can pull back in the short term. Investors with a longer horizon who are willing to withstand interim corrections should do well. In the short term we would be harvesting profits to raise cash for better entry point.
Market Commentary: July 30th, 2009: 1:00 pm (PST). Posted by Manu Walia
“First-time jobless claims jumped 25,000 to a roughly as-expected level of 584,000 (prior week revised 5,000 higher to 559,000). The Labor Department told Market News International that the results are a “return to trend” following earlier-than-usual auto layoffs that had skewed claims lower in the prior four weeks.” Source: Bloomberg.com
It can be observed from the jobless claim figures illustrated in the adjacent chart that the claims are stabilizing a bit. This can also be observed from the Market Commentary posted on July 23rd and July 16th. On the same token the unemployment situation is not actually turning around and there may be a few more quarters before this situation is becomes healthy.
On the other hand, majority of the earnings announcements have been robust and so far over 80% of the companies that have announced earnings have been able to beat the consensus earnings forecast from various analysts. Due to the improvement in the overall economic variables and the adrenaline shot through better than expected earnings, major broad based indexes have gained 13-14% over the last three weeks.
I believe that a rising market is a great variable for the economy to grow as it instills confidence in investors helping fuel consumption and investments. On the same token we have to review the reasonable valuations that are a function of earnings and the multiple we are willing to pay for that growth. Now, despite the earnings increase, the S&P 500 companies are projected to grow at 25-30% over the next year. In other words, the earnings projection for the S&P 500 is approximately $70 for 2010. Using a reasonable multiple of approximately 15-16 (80 year historical average), we can deduct that the fair value of S&P 500 should be in the range of 1050-1120.
Again, it sounds logical and reasonable that we gain another 4-5% on major indexes. We believe that there is a chance that the indexes may overshoot on the upside similarly they over shot on the downside. Our prediction is that there will be short term corrections of 5-7% while we move forward. Currently, we would be inclined to harvest profits and wait for a pull back before allocating further capital to the market.
Market Outlook:
Fundamentally, the markets have experienced government intervention that initially alleviated the severe problems in the financial sector. Subsequently, the Federal government attempted to stimulate the economy with fiscal and monetary policy. In other words, the government indicated in unspoken words that they are willing to do whatever it takes to control the debilitated financial sector due to the severe decline in the housing market. The major damage to the economy happened in the second half of 2008 and hence corporate earnings declined over 61% in the last quarter or 2008.
Fortunately, the economy seems to be bottoming which is evidenced by the better than expected earnings announcements so far in Q2, 2009. In addition, most analyst (take this with a grain of salt) have increased the 2010 earnings estimates for the S&P 500 companies. My belief is that the investor sentiment, who still have a significant assets stored in cash, will start to feel a bit more comfortable about the markets and start to invest gradually. On the same token, institutional investors need to keep up with the indexes and can not afford to be in cash for ever.
I believe that because the markets have gained 30-40% in a short time frame, since the March lows, they are ready for a technical pull back in the near term. This is due to my analysis of the major broad based index values based on future earnings. I believe that as an investor, one should be cognizant of market moves as a 5-7% decline in broader indexes can have a magnified impact on equity based portfolios. A prudent method to this madness would be to enact some type of risk mitigation strategy that we as unique investors are comfortable with. Remember, no particular strategy will completely inslate an investor from the downside, but it can position one to capture a smaller decline and be ready to start investing at lower levels.
Market Commentary: July 27th, 2009 : 9:15 am (PST). Posted by Manu Walia
“Proud to be behind the curve…” Story of an average Wall Street analyst, now showing on statistics everywhere!!!
Wall Street analyst predicted a 19.7% decline in fourth quarter 2008 earnings. Unfortunately, the S&P 500 companies experienced a 61% earnings decline. Well, now the same analysts are predicting that the S&P 500 companies will experience a 36% increase in earnings in the year 2010. Mind you, that these projections come after 78% of the companies that have already announced earnings for Q2, 2009 have been able to beat earnings estimates. In other words, approximately 80% of the analyst’s projections have been behind the curve through out the worst time in the capital markets when investors needed their guidance the most.
The truth of the matter is that analysts are also human beings suffering from the dominating emotions known as fear and greed. Their corporate incentive is not to always beat the market but unfortunately regurgitate information in an articulated manner with a few sprinkles of financial jargon. I guess, follow the apparent trend gets them their bi weekly paycheck and investors feel confident even accepting conventional failures over unconventional success by being a contrarian.
Then again, Warren Buffett did not become a multi billionaire by following Wall Street analysts….OOOOPs
Market Commentary: July 23rd, 2009: 3:30 pm (PST). Posted by Manu Walia
“Initial jobless claims rose 30,000 in the July 18 to a slightly lower-than-expected 554,000 (prior week revised slightly higher from 522,000).”
Our market commentary on July 16th and 17th had focused on Jobless Claims and Housing Starts respectively. Even though it is too early to make inferences by weekly data, we are encouraged by improving fundamentals in these very crucial factors for the economy to strengthen.
It can be observed that there is stability in the unemployment data (See chart below). We feel that as the employment situation improves, it will have a direct impact on the housing sector in a positive way. Currently, the depressed housing prices and government incentives should help stabilize housing prices. This would be a very strong variable to help boost the bottom like of most financial institutions that have exposure to subprime and Alt-A type of mortgages.
The important point to understand is the endeavor of the government to help improve the basic flow of funds through the economy. We believe that this is a self fulfilling prophesy. As the housing markets stabilize, the write downs on most financial institution’s balance sheets will improve increasing earnings. As a financial institution’s Tier 1 capital ratio improves, it provides and incentive to increase their lending practices. We do believe that most financial institutions will be the benefactor of this phenomenon in 2010 and beyond. Once again, patient early adopters and investors in the financial sector will do well over the next 2-3 years.
Chart Source: Bloomberg.com
Market Commentary: July 22nd, 2009: 3:30 pm (PST). Posted by Manu Walia
Since July 10th, the major broad based indexes have gained approximately 8%. One can attribute this directly to the better than expected earnings announcements from major blue chip companies that started with Goldman Sachs on July 14th followed by bellwethers like JP Morgan, Bank Of America, Caterpillar, Intel, IBM etc. As you can observe these companies belong to different sectors in the market, illustrating that the economic recovery is in progress. Not so fast.
The positive earnings announcements have a few common themes amongst these companies. One, most of the companies announced increasing profits margins but decreasing sales. In other words, these companies are benefiting from cost containment and structural reorganization. On the other hand they are also experiencing reduction in revenues as domestic and international consumers pull in the spending reins. The point is that companies all over the world recognize that the abundance of lost cost capital in the form of home owner’s equity or interest only loans with no down payments are a phenomenon of the past, at least for a few years to come. In my view this situation compels any smart and capitalistic company to stretch its competitive muscle and transform it into a nimbler more efficient entity. That concept of increasing value with lowering cost is at the core of enhancing standard of living. Now I also believe that this is a result of global competition and access to established processes in various sectors. I believe that the markets will make new highs due to the perception that we as a nation is over a disastrous economic phase we experienced the last half of 2008 and first quarter 2009.
Human sentiment has an uncanny tendency to gravitate towards a mean and then overshoot it. The mean in our arena, the stock market valuation is an aggregate perception of investors participating in it. Initially, the front runners or the early adopters move into the areas that they believe are undervalued. With some reinforcement from the fundamentals, which could be a self fulfilling prophesy, the confirmers of the investing population move in slowly after they see some fruition in those particular sector(s). Once the momentum is built, the rest of the population starts to not only trickle in but jump into the same investment area. This fuels the sector or the asset classes and we have the making of a bubble. When greed sets in and we feel giddy with the need to invest, contrary to instinct we should be selling. On the same token when we feel queasy, once again contrary to instinct, its time to buy. If we as investors can use this concept and amalgamate it with a bit of patience, we could benefit in this game we call investing.
Market Commentary: July 20th, 2009: 10:30 am (PST). Posted by Manu Walia
“Led by the month’s spike in long rates along with gains in building permits and a dip in jobless claims, the Conference Board’s index of leading economic indicators posted a convincing third straight gain, up a sizable 0.7 percent in June following 1 percent and above gains in May and April.” (Source: www.bloomberg.com)
The Dow Jones Industrial Index (DOW) was at 8,800 on June 12th. It then lost 700 (-8%) by July 10th or within a month, only to gain 700 (+8.6%) in less than 10 days subsequently. One of the most important technical indicators according to me is the volume on the NYSE. The total number of shares traded during the recent 7-8% decline has experienced one third the volume that was experienced in early March 2009. This illustrates the lack of fear within the investor community. In addition the VIX (Volatility Index) has stayed at a very benign level, illustrating decreasing risk averse attitude among investors.
We believe that investors convince themselves about bullish or bearish conditions based on herd mentality. Last year experienced investor sentiment that started to develop into an Armageddon type of paradigm and now we are compelling ourselves to view the positives. Obviously, technical issues like heavy selling last year resulting in accumulation of almost $4 trillion in cash among various investor brokerage accounts provide an oversold situation. There are fewer players left to sell and therefore the markets start to stabilize. Subsequently, when there is light at the end of the tunnel and investors come to a realization that the world in not coming to an end, they start gravitating assets to riskier asset classes moving the markets.
We believe that markets are gradually building confidence to wade into the risky waters of the investing arena. In our view, this includes both retail and institutional investors who have been waiting to see if the economy is actually on solid footing. We see the markets (DOW) moving to the mid 9,000 based on 15-20% earings projections. We would be investors in the Financial, Industrial, Materials and the Technology sector as we believe that the phenomenon of globalization is intact and a burgeoning middle class in emerging economies like China and India can only boost global trade.
Market Commentary: July 17th, 2009: 8:30 am (PST). Posted by Manu Walia
“Housing starts in June came in unexpectedly strong, continuing a robust gain the month before and indicating that we may have passed the bottom in housing. Starts increased 3.6 percent, following a huge 17.3 percent spike in May.” (Bloomberg.com)
We are great proponents of the importance of investor psychology. We see the financial sector stabilizing without peeling through the nuances of each aspect of the recent earnings announcements from major banks like Goldman Sachs, JP Morgan, Bank Of America and Citigroup. Most of these institutions have indicated improving conditions and or moderating negative aspects in the sector. In addition, we believe that the unemployment levels will also start to moderate and improve over the second half of the year. We have also experienced some signs of stability in the housing market exhibited in the chart below.
The important point to realize is that investors overreact on both the upside and the downside. We believe that the majority of investors had been compelled to liquidate significant amount of their risky assets and gravitate towards safer assets that comprise of cash and Us treasuries. US 10 years treasury rate has declined from approximately 4% a few weeks ago to 3.6% today. As yields move opposite to bond prices, this is a clear indication that investors have started to take on more risk and gravitate towards assets with a higher risk return reward.
Market Commentary: July 16th, 2009: 8:30 am (PST). Posted by Manu Walia
“The Labor Department said new claims for unemployment insurance plunged last week by 47,000 to 522,000, the lowest level since early January. Economists polled by Thomson Reuters predicted an increase to 575,000.”
We can clearly observe from the chart below that the unemployment trend has started to become favorable. Despite this improving situation, we still face a high employment rate which needs to start declining quickly for the economy to regain its lost strength.
We do not believe that we will revert to a stable environment quickly in terms of economic growth and employment gains. What we believe is that the markets have started to move in to a sluggish mode for a lack of better mode. A lack of activity from retail and institutional investors in capital markets shall reduce major gyrations in the markets which should instill confidence on a technical basis.
We believe that the financial sector has and will continue to improve over the next 3-4 quarters. Standard & Poor’s has projected that the financial sector in the US will post the highest growth in earnings amongst various sectors over the next two quarters and fiscal year 2010. We are in agreement as any economy needs a sound and robust financial infrastructure for sustained growth.
We also believe that high per capita production worldwide and competitive labor cost will contain inflation for the foreseeable future. This is the time for investors to look deep down and find a sense of conviction for respective investments. Investors who can withstand the intermediate volatility will be rewarded handsomely over the next two to three years in our view.
Market Commentary: July 15th, 2009: 8:40 am (PST). Posted by Manu Walia
The broad based indexes are up approximately 2-2.5% today after gaining 2.5% over the last two days. I hate to be so short term oriented but the pivotal point in the economic turn around has compelled the savviest of market participants to focus on whether the leading economic indicators are headed in the right direction or not.
Low interest rate environment and a super accommodative fiscal policy catalyze inflation. In addition, high unemployment is a major deterrent in the successful turn around in the domestic economy. Fortunately, inflation fears are abated with the benign Consumer Price Index numbers announced this morning. In addition, the manufacturing activity seems to have stabilized with a reversal in sight. The icing on the cake is the better than robust earrings posted by Goldman Sachs yesterday, a unique but major financial institution and Intel this morning, a forerunner in the technology sector.
I believe that the market wants to pay attention to the positive news. The last half of 2008 and the first quarter of 2009 was challenging to the point of pushing majority of investors out of the major growth oriented investment products. The sentiment to accept higher risk, or lower risk aversion seems to be increasing in the markets. We believe that the mandates of institutional investors compel them to invest with an endeavor to beat their respective index benchmarks. As the market shows stability and gains in value, these investors can not afford to be left out. In order to stay close or beat the market these investors are looking for opportunities and will continue to feed the capital markets with the cash they have accumulated over the last 12-18 months.
In my view, the banking sector should show a high degree of earnings growth over the next 12-18 months. Not all banking and financial institutions will survive this tumultuous time, but we as investors will talk years from now about the investment opportunities that were present in 2009. Some will take advantage and majority will follow eventually…
“Fortune is biased in favor of the bold…”
Market Commentary: July 13th, 2009: 10:40 am (PST). Posted by Manu Walia
It is amazing to see how a comment from one analyst can add approximately 1.5-2% to the market indexes in a span of few hours. I am referring to the brief interview with Meredith Whitney of Whitney Research (formerly with Oppenheimer) CNBC broadcasted this morning. Ms. Whitney made positive comments on Goldman Sachs and also the attractive valuation of Bank of America. Both companies experienced a 5-6% gain in their stock values by mid day. In addition, the Dow Jones Industrial Index gained over 1.7% based on these projections from one research analyst. This is nothing more than dumb driven cattle behavior in my view.
We as self proclaimed investors exhibit such ridiculous behavior that it makes one wonder how perception can move markets on either direction. The movie Wall Street has a dialogue between Gordon Gecko and Bud Fox. The characters are arguing about ethics and capitalism. In the midst of this scene Gecko is explaining the ridiculous price others will be willing to pay for a painting he bought a few years ago for a pittance. Gecko’s exact words are, “…the illusion has become real…”.
Similarly, Ms. Whitney’s fruitful predictions in the past have compelled us to believe in the illusion of her market prediction and turnaround prowess. One thing we all forget is that majority of the times we get fooled by randomness. In other words, success may have come to someone or something due to random events. Subsequently, we as error prone humans believe that this phenomenon will repeat. It may not…
Having said that, I do believe that financials will continue to rebound for various reasons. The fact that the domestic and global business can not function without a sound financial infrastructure, compels me to believe that governments all over the world will do whatever to revive this sector and investors who enter this sector early will be rewarded in due time.
Market Commentary: July 9th, 2009: 11:50 am (PST). Posted by Manu Walia
It can be clearly observed by the chart below that jobless claims have been declining for the last three to four months. The 4 week average of new jobless claims has been trending down as well.
Initial jobless claims declined 16,000 to 614,000 for the week ending June 27 as reported by Bloomberg. We stated in our July Newsletter that we would be in the camp of expecting better employment numbers as we head into the second half of 2009. In addition to the unemployment situation, Alcoa (a Dow Jones index component) reported better than expected earnings and the management’s belief in improving global economic conditions.
At the end of the day, the investor and consumer population has to feel positive and reassured that we are headed in the right direction; both politically and economically. Major economic variable are pointing towards the stabilizing health of our patient known as The Economy. Do we now believe that the political doctors are doing all they can to reehabilitate this patient to improve the overall economic situation. Only time will tell…
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