Market Commentary: October 29th, 2009: 10 am (PST). Posted by Manu Walia
“Today’s moderate increase for third quarter GDP should provide some psychological lift for consumers and businesses since it is the first positive growth for the overall economy in just over a year. And financial markets are likely to like it since it is all about expectations and the advance estimate topped expectations. Real GDP in the third quarter rebounded an annualized 3.5 percent, after declining by only 0.7 percent in the second quarter. The third quarter boost came in above the market consensus for a 3.0 percent increase.”
“Jobless claims are not offering a clear indication of what to expect for the October employment report. Initial claims held steady for a fourth straight week, edging 1,000 lower to 530,000 in an Oct. 24 week that was not skewed by special factors. The four-week average is at 526,250 and does show improvement, down about 20,000 vs. this time last month. Continuing claims, where the latest data is for the Oct. 17 week, fell substantially, down 148,000 to 5.797 million and, for the first time since April, bringing the four-week average below 6 million at 5.961 million.”
As mentioned in our previous commentary this month, we believe that the economy is improving despite the naysayers and bearish economists. It is also true that the economic is primarily driven by the stimulus packages provided by the government which in turn is funded by tax payers.
There are two ways to consider this phenomenon; one, we can criticize the government of using tax payer funds carelessly for lost causes like the troubled banking system, or two viewing this as a community coming together to help put out a fire on a burning house so that they can save the rest of the community. As mentioned many times before, the endeavor is to support and improve the debilitated enterprise arena and create jobs in the process. This in turn is expected to provide the revenue in shape of taxes that should help diminish the growing federal deficit.
Whether this happens or not is yet to be seen. I do believe that the government should put some controls in place with an emphasis to deleverage major banking and financial institutions with the same phenomenon to follow for individual consumer. The US consumption relies to a great extent on borrowed funds. We as a nation have gravitated away from having tangible products and services to back our insatiable consumption. In other words, plastic can only last so long to pay for our needs. At some point our debt will surpass our earning power and we shall not be able to service that debt. That is why it is important to instill an attitude to spend within our means and not continue to expect our assets (real estate, equities and bonds) to continue to inflate endlessly and pay for our endless wants and desires.
Market Commentary: October 25th, 2009: 10 pm (PST). Posted by Manu Walia
Most market pundits are of the opinion that the excess liquidity created by various governments has fueled the recent global market ascent. We believe that there is pertinence to this theory, but at the same token liquidity is also a crucial ingredient for corporate growth.
This phenomenon can be viewed as tax payers getting together to bolster an ailing corporation, in this case primarily the US financial sector. The most important expected ramification is the growth of corporate enterprise in the US and in turn growth in taxes. If the Obama administration is successful in its endeavor then we should expect the repeat of the mid 1990 s. The dot.com boom in the mid 1990 s was considered a new paradigm and a significant source of taxes came from inflated stock option selling by insiders and major stock holders. Be that as it may, we have to also consider the other side of low cost of capital (low Fed Fund rate).
Following is the US treasury yield curve which clearly shows that the short term rates are almost negligible and long term are relatively high. In our opinion, this can be interpreted that fixed income investors are crowding towards the short end hence expecting bonds to correct and stocks to continue their upward trend. One of our major concerns is the exposure to corporate bonds, especially high yield bonds. Even though Bernanke & Co., has little reason to worry about inflation, rates can not go any further below where they stand. In addition, Australia has already started raising rates and South Korea could be next in line.
At some point, whether its inflation, growth in the US economy or the need to bolster the dollar (even though no one will admit that), rates will revert to their mean. When this happens, and it could be in the shape of change in Bernanke’s tone, most bonds will start to correct. We therefore, recommend that investors consider harnessing profits in their corporate bond investments, especially high yield and gravitate towards high dividend yielding US large companies.
Market Commentary: October 22nd, 2009: 7:30 am (PST). Posted by Manu Walia
“Initial jobless claims edged higher in the Oct. 17 week, up 11,000 to a higher-than-expected level of 531,000 (prior week revised higher from 514,000). But the four-week average continues to move lower, down for the seventh week in a row to 532,250 for a decrease of about 20,000 from month-ago levels, a decrease that points to improvement for the October employment report.” Source: www.bloomberg.com
“The index of leading economic indicators jumped 1.0 percent in September for the sixth gain in a row in what the report says is consistent with developing recovery.” Source: www.econday.com
As mentioned in our previous commentary, the Macro news has been positive and improving. In addition, over 150 companies have reported 3rd quarter earnings and of off those over 75% have beaten earnings estimates and in addition, increased the future earnings guidance. Now, once again, we believe that as long as the perception and we repeat, the perception is that the economy is headed in the right direction; the market will continue to factor this growth.
We have therefore been cautious and would recommend investing in companies with low margin of risk. A specific example of investment class in our opinion would be high dividend paying stocks that will hold up when Federal Fund Rates start to go up. Also, companies with exposure to the international markets should do well if inflation shows its ugly head.
We are currently recommending shifting from the debt asset class, especially high yield bonds and bond funds, in favor of international and domestic financial, technology, material and healthcare companies.
Market Commentary: October 13th, 2009: 10:00 am (PST). Posted by Manu Walia
It seems that markets are in a jolly mood and the trend continues to push the indexes higher. They say that the trend is your friend, till the trend reverses…
Obviously, the economic indicators with an exception of unemployment have improved considerably. Without sounding like a broken record, we believe that the markets currently perceive most news more positively than reality may explain. As mentioned in our earlier commentary the Price Earning for the S&P 500 index has expanded in direct correlation to the increase in earnings estimates for the S&P 500 companies by major analysts.
We believe that the markets can sustain its rally mode until the earnings guidance is northwards. We emphasize that it is not the actual earnings but the aggregate guidance and projections of these earnings that continue to expand the P/E multiple and catalyze the markets to overshoot on the upside.
We would therefore be very selective in choosing stocks from a valuation perspective. In other words, we recommend that investors keep two aspects in mind while investing:
- Dollar Cost Average: Start building positions instead of buying all at once.
- Have enough conviction in your investment ideas in order to maintain or add to those positions if the markets experience another interim downturn.
Market Commentary: October 5th, 2009: 9:00 am (PST). Posted by Manu Walia
Fewer workers are filing for unemployment claims in what is encouraging news for the economic outlook. Initial claims fell significantly in the Oct. 3 week, down 33,000 to a 521,000 level that is much better than expectations (prior week revised 3,000 higher to 554,000). The four-week average is at 539,750, down 9,000 in the week. Continuing claims also fell, down 72,000 in data for the Sept. 26 week to 6.040 million.
It can be clearly seen that the employment conditions are improving gradually. In addition, we have mentioned umpteen times that consumer confidence, which has improved significantly has a great deal of attribution from the positive movement in the capital markets in the US and worldwide.
We would like to direct attention to statistics that show us how the markets have reacted to expectations of economic and as a result corporate growth. Since March 2009, the Price earnings ratio of the S&P 500 index has expanded from approximately 11 times to the current ratio of over 15 times. This is a 29% expansion. Obviously, this expansion was translated in the 50% + gain in major indexes over the last 7-8 months. During this time, the earnings expectations of the S&P 500 companies have gone from a loss of approximately -16% for fiscal year 2009 to a positive growth of +27-28% for 2010. In other words, the markets have discounted a 25-30% gain in the earnings over the next 12-15 months which can be observed in the P/E expansion of almost 29%.
We now believe that the money market assets sitting on the sidelines of approximately $3.3-$3.4 trillion will chase the markets up till the time the perception in the markets is that earnings will continue to grow. As long as companies provide guidance that point to expansion, we can see the P/E expansion to levels in the overbought range. Again, indexes shot below a reasonable level during panic and now we could be in euphoria for sometime in the future.
Market Commentary: October 5th, 2009: 9:00 am (PST). Posted by Manu Walia
“The ISM’s non-manufacturing index finally pushed beyond 50, at 50.9 in September for a solid 2-1/2 point gain and indicating that the bulk of the nation’s businesses are now reporting month-to-month gains. New orders had been lagging but no longer, up more than 4 points to 54.2 and pointing to an extending run of positive overall reports in the months head.” Source: www.bloomberg.com
We can choose to analyze the nitty-gritty’s or we can decide to view the more macro economic environment we may be in currently. We believe that despite the influence of fear and greed, capital markets are inherently optimistic in the long term. We say that because we believe in the innate optimism of humans in all aspects of their lives. No one wants to deliberately regress in life.
It is however important to observe how the human sentiment translates to important economic indicators. Following are some positives and negatives that we have talked in the recent past. In addition, we will provide some inferences subsequent to listing these economic indicators:
- Consumer Confidence: Improving
- Current environment of low cost of capital (low interest rates) and low inflation: Positive
- Healthy corporate Balance Sheets: Major restructuring and cost cutting by US corporations has put them in a favorable position to take advantage of improving economic conditions.
- High Unemployment rate: Even though unemployment is a lagging indicator, it has a direct impact in the US economy. Retail investors comprise of approximately 70% of the economy and hence their participation in the economic revival is of prime importance.
- Real Estate: Even though real estate has not completely ruined around, there are signs that the precipitous fall in this area has decelerated substantially. Despite the overhang of negativity in the commercial real estate, certain parts of the country are showing improvement in the residential real estate.
We believe that the markets are now in a state of some normalcy and despite interim corrections will head higher. We are strong believers of mean reversion and believe that the 50%+ decline from the high of October 2007 to the low of March 2009 was too dramatic, too fast. Earnings have been revised upwards and the markets have followed this perception by providing significant gains.
As mentioned earlier, we would recommend investing in blue chip US and international companies with emphasis on Financials, Technology and Healthcare.
Market Commentary: October 2nd, 2009: 8:00 am (PST). Posted by Manu Walia
The September jobs report was disappointing-but the consensus may have grown too optimistic. In reality, job losses are not nearly as severe as earlier in the recession and the unemployment rate is drifting up slowly as expected. Nonfarm payroll employment in September fell 263,000, following a revised decline of 201,000 in August and a revised decrease of 304,000 in July. The September drop in payroll employment was worse than the consensus forecast for a 170,000 contraction. August and July revisions were down a net 13,000 (the net declines were worse). Source: www.bloomberg.com
We have been very encouraged with the improving economic indicators over the last quarter. In addition, we also believe that earnings going forward should provide investors with higher confidence level. We believe that the fourth quarter 2008 earnings were so dismal that investors will be encouraged by relative comparison which the positive fourth quarter 2009 earnings is projected to provide.
On the same token we have been expecting a 5-7% correction since August 2009. Even though the markets gained 10% since our cautious outlook, we now believe that the resilience in the market is a buying signal and growth oriented investors should start to accumulate larger US companies in the area of healthcare, technology and financial services.
Market Commentary: September 29th, 2009: 10:00 am (PST). Posted by Manu Walia
“Consumer confidence did not improve in September according to the Conference Board’s index that fell back to 53.1 from 54.5 (54.1 initially reported). The worse news in the report is the current assessment of the labor market with substantially more saying jobs are hard to get, 47.0 percent vs. 44.3 percent, and less saying jobs are plentiful, a miniscule 3.4 percent vs. Augusts’ 4.3 percent.”
We have been monitoring important leading economic indicators to view how the markets could behave going forward. So far, as mentioned umpteen times before, most leading indicators are moving in the positive territory. Having said that, one can not and should not ignore how the markets have performed based on facts and not projections. Following is a chart of the corporate bond yield spreads relative to US treasury bonds.
The endeavor with studying the yield spreads is to understand investor perception of risk. As yield of any debt instrument is inversely related to its price, the higher the price the lower the yield. It can be observed by the chart below that investors were very fearful of the corporate high yield bonds (worried about the economic viability of an average US corporation) and favored the safety of a treasury bonds. The difference between the yield of a CCC (junk status) corporate bond and the 10 year treasury hit a high of approximately 21% in the fourth quarter of 2008. Since then the yield spread has stabilized and improved to approximately 8%, which is the level experienced pre Lehman Brothers collapse.
We infer from this spread contraction that the average investor has gravitated towards higher risk asset classes and believes that the markets are in a state of some stability. Once again, we do not believe that the capital markets can sustain the type of rally we have witnessed, especially in the debt markets going forward. We would encourage investors to harness profits in the corporate bond environment as interest rates can not go down any further. If the US economy starts to improve and inflation shows its ugly head, the government will have no choice but to raise rates. In that situation, the high yield bond market can take a significant hit.
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