A MACRO MOMENT, From Bob Doll, vice chairman and chief equity strategist, BlackRock
While many investors have been unnerved by current events, we believe the broader economic recovery remains on track. The cyclical recovery in most countries (including the United States) remains intact, as interest rates remain low and leading economic indicators continue to have a positive tone. That said, we acknowledge that US economic data has been somewhat less positive in recent weeks, with the decline in unemployment claims having stalled and with upward revisions to corporate earnings slowing down. In any case, we expect second-quarter gross domestic product growth to come in over the 3% level, but it will likely not be over 4%.
Given the magnitude of the recent currency and sovereign debt concerns, equity market performance is likely to be driven by the broad macro outlook rather than company-specific fundamentals. This is usually the sort of environment where volatility remains high in both directions. It is important to remember that corrections during times of economic recovery are normal, but are often intense and quick.
Regarding the current correction, we believe the worst should be behind us in terms of the magnitude of the downturn, but it will likely take some additional time before markets can repair themselves. Looking ahead, one positive factor is that market valuations have become more attractive in recent weeks, as prices have dropped while earnings have increased. Over time, we expect that additional clarity around the situation in Europe and financial market reform in the US should provide a measure of stability; and a sense that the economic recovery remains on track should help spark a turnaround in the recent aversion to higher-risk assets.
WHERE TO FIND THE BULL MARKET, From Jeffrey Saut, chief market strategist, Raymond James
Since the mid-1970s, I have voiced the mantra, “There is ALWAYS a bull market somewhere and it is my job to try and find it.” For example, even in the vicious bear market of 1973 – 1974, where the DJIA lost nearly 50% of its value, there were stocks that went up. That said, by my method of interpreting Dow Theory, there was a “sell signal” last week when the DJIA broke below its May 7th closing price of 10380.43, confirmed with a similar break by the Transports below their May 7th close of 4298.12. If past is prelude, however, so much energy has been expended in registering the signal typically the market rallies on said signal, especially given the aforementioned oversold metrics. While some modern-day Dow Theorists opine there has been no “sell signal,” because there wasn’t enough time between May 7th and the May 20th breakdown, I was not taught to view Dow Theory that way. Hence, if a rally develops, I will be watching the stock market’s “internals” for signs of the rally’s health. My “lens” will be indicators like Buying Power and Selling Pressure, Advance/Decline Lines, New Highs versus New Lows, on-balance volume, etc. as I think the strategy will be pruning weaker stocks from portfolios and becoming more defensive.
The quid pro quo is, for last week’s Dow Theory “sell signal” to be reversed requires the Industrials to close above 11205.03 confirmed by the Transports close above 4806.01(IMO).
Speaking to “there is always a bull market somewhere,” I was on CNBC last week with a particularly bright fellow. Todd Schoenberger, of LandColt Trading, talked about crude oil as being the world’s future currency. I agree for a multiplicity of reasons and would note the disaster in the Gulf of Mexico pretty much assures the value of Alberta’s Tar Sands, which is the second largest crude oil deposit on the plant.
WHEN WILL BANKS START LENDING? From Milton Ezrati, senior economist and market strategist, Lord Abbett
After falling 10.2% in 2009, overall bank lending has fallen an additional 7.2% so far this year, even in the face of a developing economic recovery. The continued drop in 2010 is widespread, too. Commercial and industrial loans have dropped nearly 16%, commercial and residential real estate loans 6.8%, and consumer loans 7.0%.
All this has occurred despite considerable heat coming out of Washington. In addition to the president’s impatient demands, perhaps more remarkable is the passion shown by Sheila Bair, chief of the Federal Deposit Insurance Corporation. The banks “need,” she has insisted, “to step up to the plate” and increase lending. She has spoken of shining a “very public light on banks where credit is not being provided.” Though Ms. Bair wants to avoid a command and control “situation where regulators are starting to order banks to lend,” she seems happy enough with a pattern of bullying.
At the same time as the lenders have reason to hold back, a recent Fed survey indicates that neither businesses nor individuals seem to have much interest in borrowing. Fed surveys of senior loan officers at both large and small institutions reveal that banks, after significantly tightening their lending standards throughout 2009, have generally resisted any further tightening into this year, except in commercial real estate. But the bankers universally report slack loan demand across a broad front, especially smaller businesses.
loan demand seems poised to rise on at least two counts. First, consumer confidence has begun to return, as residential real estate prices have stabilized, equity markets have strengthened generally (if not particularly in this most recent period), and households are beginning to establish a reasonable savings flow. The rate of consumer spending has turned up already. When labor markets begin to improve, albeit likely gradually later in the year, consumer confidence and willingness to borrow should turn up as well, though the magnitude will hardly return to the imprudent eagerness of former years. Second, and even sooner, businesses will likely begin to borrow for inventory rebuilding. To date, they have hardly needed much from banks since businesses already have a lot of cash on their balance sheets and, more important, they have continued until very recently with the cash-generating liquidation of inventories. But here matters are changing. As the economic recovery proceeds and businesses increasingly need cash to build inventories, they also will need more credit.
YOU ARE BAILING OUT EUROPE, TOO, From Charles Biderman, CEO, TrimTabs
European Union officials assured the world last Monday that there will not be a massive austerity push throughout Europe. According to the EU’s Economic and Monetary Affairs Commissioner Olli Rehn, “Not everyone will accelerate consolidation in a very uniform way.”
We think European leaders are providing such assurances because they have the Federal Reserve’s liquidity swap lines backing them. Through the magic of the Fed’s printing press and liquidity swap lines, U.S. taxpayers could be shouldering lots of the staggering credit losses facing the EU.
Here is how this scenario might unfold. In a U.S. dollar liquidity swap, the European Central Bank sells the Fed a specified amount of euros in exchange for dollars from the Fed at the market exchange rate. Then at a future date, from the next day to three months later, the ECB buys back euros at the previously agreed exchange rate. The ECB also pays interest to the Fed.
After the ECB draws on its swap line, the ECB transfers the dollars it receives from the Fed to European financial institutions. The ECB, not the borrowing banks, is obligated to return the dollars to the Fed.
But what if one of these banks is unable to repay its loan to the ECB? Who will take the hit for the loss? We suspect the Fed will agree to reduce or forgive the ECB’s liability, pushing the responsibility onto U.S. taxpayers. Potential losses through the Fed’s swap lines will be in addition to those the U.S. is likely to bear as a supporter of the International Monetary Fund, which is supposed to provide €250 billion of the new €690 billion bailout fund.
STAY FOCUSED ON THE LONG TERM, from Jeffrey Kleintop, chief market strategist, LPL Financial
We often take the view that volatility can offer an opportunity to be tactical when investing by taking advantage of temporary mispricing in the markets. However, those who avoid making tactical changes in their portfolios and hold a long-term, strategic perspective are often worried when volatility picks up. These investors can take heart. We believe the next 10 years may be better for stock market investors than the losses suffered during the last decade.
History has made it clear that the most consistently accurate predictor of long-term stock market returns is the S&P 500 price-to-earnings ratio (P/E). The P/E is obtained by taking the price level of the index and dividing it by the earnings per share over the past four quarters. Essentially, the P/E is how many dollars investors are currently willing to pay per dollar of earnings. It makes sense that the price you pay when you buy a stock can have a big impact on your return. The levels of the P/E and the annualized return on stocks over the next 10 years have a very close relationship: The higher the P/E, the lower the return over the next 10 years. Currently, this relationship predicts that single-digit gains are likely, on average per year, for the stock market over the next 10 years.
The P/E has a nearly perfect track record of forecasting long-term performance over the past 20 years or so. Based on P/E, investors should have felt confident of long-term gains and have been putting money to work in the stock market over the past year. However, many stayed on the sidelines and believe that it is different this time given the troubled banks, European credit problems, geopolitical tensions, risk of rising inflation, U.S. budget deficit, and rising tax rates among other concerns. We do not dismiss these issues. However, the P/E has demonstrated consistent success predicting long-term returns over the entire history of the S&P 500 index—going all the way back to the 1920s.
The current annualized loss of about 2-3% over the past 10 years is a result of the record high 30 P/E 10 years ago in early 2000. However, we believe the current P/E of about 16 forecasts a better decade for performance ahead.
Often, investing can be emotional and the near term clouds of uncertainty too often obscure what we may feel more certain of over the long - term. This simple predictive relationship between P/E and return gives us hope that it is not different this time.
Monday, May 24:
April Existing Home Sales
Tuesday, May 25:
Retail sales (weekly), March S&P/Case Shiller Home Price Index, May Consumer Confidence Index (Conference Board), May Investor Confidence Index (State St.)
Wednesday, May 26:
Mortgage applications (weekly), April Durable Goods Orders, April New Home Sales
Thursday, May 27:
First Quarter GDP, Jobless Claims (weekly), First Quarter Corporate Profits
Friday, May 28:
April Personal Income and Expenditures, May Consumer Sentiment (Univ. of Michigan)
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