2011Jan16 Week In Review: Crystal Ball, Any one?

We cannot mortgage the material assets of our grandchildren without risking the loss also of their political and spiritual heritage. We want democracy to survive for all generations to come, not to become the insolvent phantom of tomorrow."." Dwight D. Eisenhower: Farewell address January 17, 1961

 
Economy:

Times have changed since President Eisenhower’s era. Medicare and Medicaid did not exist. Government spending was 10% of GDP for our national defense. We have reduced that by more than half. Today, entitlement programs, our largest obligation, consume 9.9% of GDP and interest on the federal debt is in a rapidly rising second place.

The CBO’s projections for federal revenues indicate we will barely cover the cost of entitlements for 2010. Even with a forecast of increasing revenues through this decade, the federal government will run deficits indefinitely. Even if Congressional committees can identify and eliminate ALL abuse, fraud and waste in non-defense programs, a balanced budget is unattainable.

A former director of the CBO told Fox News “We know we can’t pay all the Social Security and Medicare benefits that we promised. There isn’t enough money in world to do that…” Programs must be changed or our remaining workers will soon be facing a 33% income tax just to cover entitlements! If the CBO projections are overly optimistic, as we think they are, the problems are much more severe. We are staring into the face of Ike’s warning: “…the insolvent phantom of tomorrow."

Historically, this type of financial problem has been confined to undeveloped or totalitarian economies. We are witnessing European economies with too much national debt. They have already passed the tipping point and are unable to maintain entitlement payments. 

Domestically, Illinois, California, New York and Michigan are microcosms of our national spending spree coming to an end. When you run out of money to pay the interest expense, the end has arrived. Smaller municipalities are already going over the proverbial cliff. If the federal government bails out the states, which one is first, and how many can we afford before China and Japan say “No more”?

How much of a tax increase will we tolerate to continue current programs? Will the children and grandchildren of the Boomers work with perhaps a 50% tax to maintain entitlements for retirees?

Real Estate:

December was a relatively good news month with foreclosures declining 26%. However, legal problems with documents were the cause. We expect this quarter to be a catch-up quarter as banks perfect their claims on chains of title. Whether or not they can is still unknown. Either way, this is still a mess.

While more than one million homes were repossessed last year, notices of default and auctions were nearly two million additional. RealtyTrac.com reports another five million homeowners have serious delinquencies that are not yet in foreclosure. The decline in home values has now fallen more than in the Depression period of 1928-33. The era of declining home values is not over.

Stock Market:

Gold and silver have dominated news (and advertisements) in the commodity asset class. Since August, weather has adversely impacted agriculture to coal mines (Australian floods). As an asset class, commodities have been gaining strength catching up with equities. Exchange traded funds and notes provide portfolio access without the typical risks associated with direct investment.

Cotton and copper have had greater price increases than gold or silver. Chile is the world’s largest producer of copper with China it largest importer. To maintain a pricing advantage against a stronger US Dollar, Chile began intervening in currency market. In addition, it implemented a mining tax to pay for damage from the last earthquake. The tax was not well received and impacted Chilean stock prices.

This week brought a flood of economic data that will be absorbed by investors. Updated CPI data showed inflation at ½% year over year which was higher than expected. Even so, consumer prices have been rising since the “end of the recession” at a slower rate than prior periods of economic growth since 1960 which averaged 7%.

The consumer shift from “bricks” to “clicks” for electronics has continued its positive trend. It is seen as positive for on-line firms such as Amazon (AMZN). Executives at firms like Best Buy (BBY), where market share is dropping, can’t be as happy about the electronic industry’s year over year sales improvements.

This is the season for market predictions which are relied upon with great risk. Consider Forbes Magazine’s “Company of the Year” cover stories. Nvidea, NASDAQ, and Monsanto were there last three companies of the year. Last year, Monsanto was the worst performing S&P500 stock through September rescued a bit with the year end rally ending -15%. In 2009, NASDAQ finished down in a rising market. 2008’s cover was Nvidea which finished its year -76%. $100 invested at the beginning of each year and rolled into the new featured company would have ended 2010 worth $16. So far, Forbes hasn’t released its next “Company of the Year.” If they do and you own it, consider the recommendation to be a sell signal. This is rational since reporters are working on history which must be good to be a cover story. History is not predictive of the future. Being featured is more a timing issue than it is a statement of a company’s quality.

Consider stock market strategy in light of forecasting a football winner. Starting with pre-season data, fans pick their favorites. As the season progresses, new stats are created. Fans update the odds of their team reaching the play-offs or the Super Bowl.

Stocks work the same way. Pulling weak players from a portfolio quickly is important. Retaining performing players increases the probability of having a successful “big yardage play.”

Evidence that trends are changing exist in two different arenas. Weyerhaeuser Company (WY) has been on a relative strength sell signal since February 2000. Investors have been pushing the price up. If this continues it will soon change to a relative strength buy for the first time in nearly a decade.

When tech stocks were booming in the late 90s, Herman Miller (MLHR) office furniture was the rage. The bursting bubble hurt the manufacturer. The strength of the past two months may be an indicator that tech companies are expanding again which would be a good sign for more economic strength ahead.

Industrial production and capacity utilization are indicating improvement in the economy. The index of Industrial Production has reached levels not seen since August 2008. It has grown almost 40% faster since June 2009 than our average period of expansion.

Likewise, Capacity Utilization has risen to 76% which is where it was in August 2008. Its growth since the end of the recession has been more than double the average since 1960 during periods of economic expansion. Relative strength identified ETFs for our portfolios last year where both of these factors have been beneficial to our portfolios.

“When the facts change, I change my mind. What do you do, sir?”  - John Maynard Keynes

Our plan is “the plan will change.” What is your plan?

Relative strength measures the price performance of a stock against a market average, a selected universe of stocks or a single alternative holding. Relative strength improves if it rises faster in an uptrend, or falls less in a downtrend. It is easily applied to individual positions in your portfolio and to sectors and asset classes.

If you would like a free relative strength analysis of your portfolio’s asset allocation, sectors and positions, call us at 800-317-9119. The call is free. The report is free. Or email us.