FEARS ARE RECEDING, From Bob Doll, vice chairman and chief equity strategist, BlackRock
Equity markets advanced for the second consecutive week as fears of contagion from the European sovereign debt crisis continued to recede somewhat. For the week, the Dow Jones Industrial Average climbed 2.4% to 10,451, the S&P 500 Index advanced 2.4% to 1,118 and the Nasdaq Composite rose 3.0% to 2,310.
Many observers continued to express concerns about the possibility of a double-dip recession that could derail the current bull market. True double-dip recessions are very rare, and would require a significant shock to demand levels, which we do not think will occur. What we do believe we have been witnessing is a pullback in growth momentum and a decline in risk appetites—events that are normal during economic recoveries.
There are several risks facing the global economy, and almost all of them are policy or politics-related, including the European debt crisis, the risks of regulatory reform, the implementation of austerity measures, Chinese policy tightening and the inflation/deflation debate inside the United States. On balance, we continue to believe that the economic recovery is on track, but we acknowledge that the downside risks to consumer and business confidence levels have become more elevated over the past couple of months.
We expect volatility and uncertainty levels will remain high for some time. Our interpretation of the recent rebound is that investors have become slightly more confident that the macro risks have not yet manifested themselves in a serious manner. Additionally, equity market valuations have become more attractive, especially when compared to alternatives. The forward price-to-earnings ratio of the S&P 500 recently fell to around 13 times, its lowest level since 1995. Compared to the extremely low yields being offered by Treasuries, many investors have decided that stocks have become more attractive. Regarding earnings, forward expectations for 2011 may be too optimistic, but for the rest of this year, we think they are reasonable.
First-quarter earnings advanced at close to $78 per share, and should come in somewhere around $82 for all of 2010. Looking ahead, we expect that equity markets should be able to make additional gains over the course of this year. This outlook is not so much a forecast of significantly improving economic news as it is an expectation that many of the risks facing investors will fade over the coming months. The direction of financial regulatory reform in the United States should become more clear and the slowdown in Chinese growth should result in a soft landing. The uncertainty surrounding European sovereign debt remains the chief wild card. Policymakers have made some progress in terms of obtaining funding and cutting some deficits, but much hard work (both economically and politically) still remains and the ultimate end game remains uncertain.
NURSING A PRECIOUS EXPANSION, From David Kelley, chief market strategist, JPMorgan Funds
The week ahead should be a relatively quiet one for economic data, with much of the focus being on China’s decision over last weekend to allow for increased “flexibility” in the Yuan’s exchange rate, next weekend’s G-20 summit in Toronto and the Fed’s mid-year FOMC meeting.
Numbers due out this week should continue to be on the soft side, as has been the case in recent weeks. Existing Home Sales for May could still be up from April levels while May New Home Sales could be down. The reason for the discrepancy is that existing sales are generally counted as the sale closes (and could thus be still elevated by the now expired home-buyer credit) as opposed to the numbers on new home sales which are reported upon the signing of a contract, an activity which was already probably being curtailed in May.
Durable Goods Orders could look uninspiring, as a sharp fall in orders from Boeing in May could cut the headline number. Ex-Transportation Orders should look stronger. Unemployment Claims will be watched closely, following a number of disappointing weeks. Less critical will be a second revision to First-Quarter GDP numbers and Friday’s Consumer Sentiment Report, both of which should show little change from earlier estimates.
China’s currency move has been broadly welcomed, although the Chinese are clearly signaling that they only intend the Yuan to appreciate gradually. Perhaps more important is the signal it sends about China’s willingness to play a constructive role in the global economy in advance of the G20 summit next weekend. Given the array of economic and geopolitical threats facing the major developed nations, this is obviously to be welcomed.
Given all of this, the Fed is very unlikely to change its policy stance at the FOMC meeting on Tuesday and Wednesday. Since their last meeting on April 28th, they have witnessed the European financial crisis intensify and then ease, as well as watching the U.S. stock market slump and then partially rebound. While the economic numbers aren’t as healthy as they would like, the U.S. remains in a gradual recovery.
As the Fed maintains its bedside vigil, all they can promise is what they have promised for some time, namely to maintain a steady dose of low interest rates for a long-time. Indeed, the fragility of global financial markets and the softness in U.S. economic data now suggest that they may not contemplate a rate hike before early 2011. Some have argued that they will postpone rate hikes even further. This may be the case, but the Fed is pragmatic, and their timetable will still be subject to the strength of incoming data.
For investors, the important thing is not to get too tied up in the minutia of Chinese exchange rates, home-buying credits, or even Federal Reserve adjustments. A gradual recovery in the U.S. and global economies should push both long-term interest rates and stock prices higher and it is important to be positioned to benefit from this broad theme rather than be victimized by it.
IS THE RECOVERY STALLING? From Charles Biderman, CEO, TrimTabs
Contrary to the sell side, which generally expects the U.S. economy to strengthen later this year, we have been warning for weeks that the economy is losing steam. The slowdown seems to be starting. Adjusting for our estimate of tax changes, income tax withholdings rose only 1.5% y-o-y in the past two weeks and 2.7% y-o-y in the past four weeks. These growth rates are much lower than the growth rate of 4.3% y-o-y in the past three months, which suggests wages and salaries are flat to lower sequentially.
Some of the slower growth is probably due to layoffs of temporary Census workers. But other indicators suggest private sector employers are not adding many jobs. Initial weekly unemployment claims rose 12,000 to a four-week high of 472,000 in the latest week, year-over-year growth in the TrimTabs Online Job Postings Index pulled back a bit in the past two weeks even though year-over-year comparisons remained easy, and the ISM Non-Manufacturing Employment Index was barely expansionary at 50.4 in May.
Along with waning stimulus, we expect tax hikes in 2011 to pressure the economy and the stock market later this year. As of January 1, 2011, the top capital gains tax rate rises to 20% from 15%, the top dividend tax rate rises to 39.6% from 15%, the top personal income tax rate rises to 39.6% from 35%, and the lowest personal income tax rate rises to 15% from 10%. Many investors probably will be selling assets in the fourth quarter to avoid paying higher taxes next year.
We are not turning bearish because both our supply and demand indicators remain bullish:
• Companies are buying more shares than they are selling. The TrimTabs Supply Index was 69.4 on Thursday, June 17 (readings above 50 are bullish). While new offerings rose to a five-week high of $3.7 billion in the past week, announced corporate buying (new cash takeovers + new stock buybacks) of $30.5 billion in June has been more than triple corporate selling (new offerings + net insider selling) of $9.9 billion.
• Our demand indicators are quite bullish. The TrimTabs Demand Index, which uses 21 flow and sentiment variables to assess investment demand, was 85.0 on Thursday, June 17 (readings above 50 are bullish). It is encouraging that investors in leveraged U.S. equity ETFs, who tend to be horrible market timers, have stopped betting on higher stock prices. In the past week, leveraged short U.S. equity ETFs issued 3.0% of assets.
THE BULL MARKET IN “STUFF,” from Jeffrey Saut, chief market strategist, Raymond James Financial
The current debate de jour centers on whether what we have experienced since the March 2009 "bottom" is just a rally in an ongoing bear market or the beginning of a new secular bull market. Plainly, this is not an unimportant question, for the difference is whether you become more invested on weakness or less invested on strength. As for me, since the 4Q01, I have been adamant that there is a secular bull market in "stuff stocks" (energy, agriculture, metals, water, electricity, cement, etc.), preferably "stuff stocks" with a yield, as well as a bull market in emerging and frontier markets. I still feel that way despite my near-term caution. For the other 20% of the portfolio (the trading account), I have recommended a more dynamic approach in an attempt to take advantage of the various mini-bull/bear market swings. The most recent example of this strategy was the recommendation to layer downside hedges, and bets on increased volatility, into portfolios during the entire month of April as protection for the long positions in the investment account. Currently, those hedges have been shed, leaving the trading account flat. And, this morning that looks to be at least partially correct given the Chinese news, albeit still half wrong since the trading account is indeed flat. As repeatedly stated in these missives, the essence of investment management is the management of RISKS, not the management of RETURNS. Well-managed portfolios start with this precept.
CHINA’S CURRENCY PLAY, from David Rosenberg, chief economist and strategist, Gluskin Sheff
Leave it to China to take our minds off Europe.
In what is widely being described as a brilliant political gesture ahead of the G20 weekend summit in Toronto, China has announced its intention to sanction a gradual revaluation of the yuan (back to a “crawling peg”). Details pending but most China experts are looking for 3-5% appreciation on an annual basis – the currency has already firmed today to a 20-month high and the U.S. dollar is also trading at a four-week low against the euro.
In turn, this will help to ease global trade imbalances, ward off the threat of trade protectionism, alleviate domestic credit strains and inflation pressures and accelerate the Chinese shift from export-led to consumer-led growth. It also suggests that the Chinese authorities have confidence over the sustainability of the global recovery.
Rough estimates show that every 5% yuan appreciation trims the U.S. trade deficit by just over $60 billion (so it would take something like a 35% appreciation to eliminate the gap altogether – call us in 2020).
The Chinese move has ignited a rally in risk assets to start off the week -- a rally of sizeable proportions. Global equities are riding a 10-day winning streak, the longest in eleven months, led by a 2.8% jump in the MSCI Asia-Pac index. These countries, along with several Latin American nations that compete with China are winners here. Emerging markets soared 2.5% and up nearly 10% from the lows of two-weeks ago (Chinese banks and property shares ripped overnight). European marts are now up for a ninth consecutive day -- also the longest in 11 months.
Gold has hit a new all-time high this morning (the news that Saudi gold reserves are twice as much as previously estimated is adding a further thrust to bullion this morning) and both oil and copper are bid as these hard assets priced in U.S. dollars gain ground from the resulting decline in the greenback. The once-parabolic chart of the DXY has reversed course and is now about to test the 50-day moving average of 84.7 for the first time in three months.
Meanwhile, the safe haven of government bonds has lots of allure as long-term yields back up in response and offer up another opportunity for Treasury bulls to re-load. CDS spreads are also plunging as investors turn their attention away from the global debt challenges, which most assuredly have not gone away just because of improved Chinese FX flexibility. The view that China will be “recycling” fewer dollars is a tad strange because if the U.S. current account deficit shrinks, as it should, then we are not going to need funding in any event.
HOW “GREAT” WAS THE RECESSION? From Stephen J. Huxley, Ph.D., chief investment strategist, Asset Dedication
Most economists believe that the US economy appears to be in a recovery phase from the recession that officially began in December, 2007, according the National Bureau of Economic Research. Its Business Cycle Dating Committee makes the official call on the turning points for peaks and troughs in the economy. December, 2007, marked the end of an expansion that started in November, 2001 and lasted 73 months. The 1990’s expansion lasted 120 months.
While the official end of the recession has not yet been called, statistical indicators suggest that it probably reached the trough in the third quarter of 2009. Its severity and length have inspired Paul Volker to call it the “Great Recession,” suggesting it should be considered the little brother of the Great Depression.
Is this warranted? Is this recession all that much different from previous recessions?
The answer is yes, according to the American Institute of Economic Research, which tracks leading, coincident, and lagging business cycle indicators. They defend the title “Great” based on comparisons back to 1948, which includes 10 recessions, and cite four main reasons.
First, assuming it did end in June 2009, the 18-month peak to trough contraction of economic activity would be the longest since the Great Depression, which itself lasted 43 months. Previously, the longest post-war recessions were 16 months (Nov. 1973-March 1975 and also July 1981-Nov. 1982).
Second, the impact on employment has been much deeper. Nonagricultural employment, the ratio of employment to population, personal income less transfer payments, and the average duration of unemployment are all worse than any prior recession since the Great Depression.
Third, and perhaps the biggest factor, is the drop in overall net worth for the household sector. Hit by the stock market decline in 2008, and falling home prices in the US where 67 percent of the population owns its own home, private individuals suffered a loss of nearly $8 trillion, or 25 percent. This is far greater than any drop since the Great Depression. Even in the 1973-74 recession, considered the worst prior to now, net worth dropped by less than 10 percent. It is unprecedented drop in net worth that appears to have fed the malaise that seems to be hanging on even today in the economy.
The fourth factor cited by the AIER is the magnitude of the federal government’s response, which has pursued the most aggressive monetary and fiscal policies since the Great Depression, in both absolute and relative terms. The full consequences of these policies are yet to be known, as are the potential effects of pending legislation for financial industry reforms.
These four factors provide a compelling argument that 2007-2009 has earned its title as the Great Recession. It may be years before the ripple effects of government policies fully manifest themselves and no one can be sure how long the recovery will take to reach it next peak. In the 1973-74 recession, it took 30 months for most of the economic indicators to return to their pre-recession levels. How long it will take this time remains the “Great Question.”
Tuesday, June 2:
Federal Open Market Committee Meeting begins; Retail Sales (weekly); May Existing Home Sales; April Federal Housing Finance Agency Housing Price Index
Wednesday, June 23:
Mortgage Applications (weekly); May New Home Sales; FOMC Announcement
Thursday, June 24:
New Jobless Claims (weekly); May Durable Goods Orders
Friday, June 25:
GDP (Q1 2010); Corporate Profits (Q1 2010); June Consumer Sentiment