BIG HEADWINDS COULD SLOW U.S. ECONOMY FURTHER, From Charles Biderman, CEO, TrimTabs
Wages and salaries are no longer rising sequentially, year-over-year growth in online job postings has leveled off and there remains little or no private sector job growth. But what concerns us more than what is happening now is what we think will happen later this year.
States and cities facing severe budget shortfalls will be forced to lay off hundreds of thousands of employees. According to Meredith Whitney Advisory Group, state and local budget deficits will amount to $250 billion this year, and we see no way these deficits can be closed without layoffs. While the federal government could try to minimize these job losses, we think a big bailout for states and cities will be a tough sell in Congress. Tuesday’s issue of TrimTabs Weekly Macro Analysis will examine this issue further. Millions of jobless Americans will probably lose their unemployment benefits. The Senate last Thursday rejected a package of tax cuts, aid to states, and emergency jobless benefits. The Labor Department estimates that more than 2 million people will have lost their unemployment benefits by the time the Senate can reconsider the measure after the Fourth of July recess.
Some investors will probably sell assets in the fourth quarter to avoid paying higher taxes next 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% and the top personal income tax rate rises to 39.6% from 35%. The Census Bureau will lay off the roughly 550,000 temporary workers it hired in the first five months of 2010. We estimate that 275,000 of those workers were laid off in June. Businesses will also have to deal with continuing intervention by the Obama administration in almost every aspect of the economy, from energy to finance to health care to housing.
CAUTIOUS IN THE SHORT-RUN, From Jeffrey D. Staut, managing director, Raymond James & Associates
As touched on in last week’s letter, there are currently two major questions raging on Wall Street – is this a new bull market; or, is what we have experienced over the last 15 months just a rally in an ongoing secular bear market? Fortunately, secular bear markets are rather uncommon. More common are broad trading-range markets punctuated by numerous tactical bull and tactical bear markets. For example, in 1966 the D-J Industrial Average (DJIA) first approached 1000. By 1982 the DJIA was still hovering near 1000. Yet, over that 16-year time period there were 13 rallies/declines of more than 20%.
As often stated, since the Dow Theory “sell signal” of September 1999 I have suggested the equity markets were likely going to be in a trading range pattern similar to 1966 – 1982. Clearly, that is what has occurred over the last 10 years. Most recently, the 54% slide from the Dow’s October 2007 peak into its March 2009 low has been followed by a 70%-plus rally that ended in April of this year. Subsequently, the senior index experienced its first double-digit decline since the March 2009 bottom, ushering in cries of “the bear market rally is over!” To me, however, all that’s transpired is another decline within the context of the broad trading range the Dow has been in since the turn of the century. Nevertheless, I must admit I am concerned because a Dow Theory “sell signal” was registered during the recent decline. Accordingly, I am back in a cautious mode, which is why investment accounts should have some cash, while trading accounts should be relatively “flat.”
I also have to admit I am worried about the weakening economic reports. To be sure, the number of economic indicators surprising to the downside is about equal to those surprising on the upside. The astute Bespoke Investment Group noted, “Of the eleven economic indicators released last week, only six came in ahead of expectations, while five surprised to the downside.” One of those downside surprises was Wednesday’s shockingly weak New Home Sales, which inked the weakest reading since the statistics began in 1963. That said, I don’t think housing is going to spin the economy into another recession, because going from 1.5 million housing starts to 400,000 is plainly impactful. But, going from 400,000 to 300,000, well who cares? To me participants should be much more nervous about the sharp decline in the Economic Cycle Research Institute’s (ECRI) weekly leading economic index. Readers of these missives should recall I often referenced this index as proof of the economic recovery when the index was ramping at its sharpest rate in history. Regrettably, it is now declining at one of its sharpest rates.
While I am indeed concerned about the ECRI’s weekly index of leading indicators, it should be noted that while the ECRI Index has been an excellent predictor of the economy, it has NOT been very accurate in predicting the stock market’s direction. Still, given the Dow Theory “sell signal,” the intermediate “sell signal” registered by my proprietary trading indicator, and the “hook down” in the monthly stochastic indicator (all of which can be seen in last week’s letter), I have no choice but to be cautious until circumstances change.
The call for the week: I continue to attempt to “keep” the profits accrued since the March 2009 bottom. Accordingly, I remain cautious in the short-run for the aforementioned reasons. Longer-term I continue to think the equity markets are okay into the midterm elections, which as stated should be a referendum between the progressives and their more fiscally conservative counterparts. If the progressives “win,” I think it puts a HUGE headwind into the economy and the markets. The quid pro quo would suggest easier “sailing” going forward. Until then, the yield-curve is still relatively steep, credit spreads have not leaped, the Advance/Decline Line appears steady, and earnings comparisons should remain favorable; so unless it is different this time the recent correction in the equity markets should resolve itself with higher prices.
A REASONABLE TIME TO RE-ENTER, From Christian W. Thwaites, president and CEO of Sentinel Asset Management
1. Inflation or Deflation? Neither. Economics and markets rarely give Manichaean choices. The inflation bears point to deficits, money supply and commodities as the inflation canaries. Deflationists point to ever-lower prices, consumption deferred and investment drying up. They throw in the specter of higher taxes for good measure. But broad price equilibrium is the norm in modern economies, not 1970s inflation or Japanese stagnation. We expect much of what we’ve had for the last decade: inflation running at 2% with occasional supply squeezes interrupting the steady state. Secular forces like household deleveraging and debt destruction will keep prices firmly in check. The market agrees. TIPS (inflation-protected bonds) predict 2% inflation for the next 10 years and have underperformed fixed-rate Treasuries for months. Commodity prices have drifted and real asset prices, another classic inflation hedge, stagnated. We don’t know what the recently launched inflation protection funds are going to invest in, but there won’t be money made fighting a chimera.
2. Eurozone Collapse: Not quite. The pressures to keep the euro intact and its economies going intensified in the last few months. Markets greeted the dramatic rescue of Greece with enthusiasm. Here, after all, was the TARP-like program to keep liquidity in the system and an impressive, if temporary, political unity. Bonds rallied and spreads narrowed. Sigh of relief. However, fundamentals reasserted themselves. The bond and credit default markets quickly revealed the underlying stresses. Since May, spreads between 10-year Greek and German debt widened by over 350bp to 780bp and the CDS widened by 500bps to 928bp. The markets judged that you can not bring a liquidity knife to a fiscal gunfight. The tensions cannot hold. What we will see next is greater fiscal discipline from Germany and other balanced economies and slow demoralizing contraction for everyone else. The only solution for Greece is default but please call it a “restructuring” in polite company. The good news is that Germany, Austria and Netherlands are all seeing steady progress in demand, manufacturing and business confidence
3. U.S. Consumer: Flat but not broke. Recent statistics have been maddeningly ambiguous. What we are seeing is a winding down of distorting incentives. In the 2000s, the government incentives were to leverage and buy real estate…if you doubt this, check out tax incentives for borrowing, Congressional mandates on sub-prime lending and the constant Federal Reserve free put option. Recent incentives to buy cars and new houses merely brought forward unnatural and unsustainable consumption rates. With incentives removed, sales plunged 34% and 22%, respectfully. Recent increases in consumption have come at a heavy cost of reductions in personal savings and U.S. total debt (government and households) stands at 300% of GDP. When faced with a choice of deferred or instant consumption, American investors consistently choose the “now”. This is not sustainable. Therefore, we will see a classic deleveraging cycle, which will lead to repaired household balance sheets and a welcome new era of probity. This may not be enough to move headline unemployment numbers but sustainability is what counts now and it’s long overdue.
Market and futures traders drive the summer season more than fundamentals so there will be plenty of opportunities to accumulate. One well-known large ETF, the SPDR, turns its stocks over 10,000% per year and bargains routinely come around with that sort of volume. So judicious timing works. Stay with large caps and companies with strong cash flow yields. Buy into U.S. bonds anywhere above a 3.5% yield…and FNMA mortgages above 4.2%. Both will provide a strong support to any investment program for next 12 months. Avoid financials…we’re seeing downgrades because of commercial real estate (classic late cycle stuff). Financial reform is messy and heading to some sort of increased capital and margin requirements.
THE WEEK IN REPORTS
Monday, June 28:
4-Week Bill Announcement, Personal Income and Outlays, 3-Month Bill Auction, 6-Month Bill Auction.
Tuesday, June 29:
Consumer Confidence, 4-Week Bill Auction, 52-Week Bill Auction.
Wednesday, June 30:
ADP Employment Report, Chicago PMI, EIA Petroleum Status Report, Bank Reserve Settlement
Thursday, July 1:
Pending Home Sales Index, Jobless Claims, Motor Vehicle Sales, ISM Mfg Index, EIA Natural Gas Report, Fed Balance Sheet, Money Supply, 10-Yr TIPS Announcement, 6-Month Bill Announcement, Construction Spending, Monster Employment Index.
Friday, July 2:
Employment Situation, Factory Orders.