2010Aug15 Week In ReviewEconomy:
Last year's G-8 meeting ended with tension as Chancellor Merkel of Germany refused President Obama's request for more deficit spending. Germany, the economic engine of the EU and leading example of fiscal responsibility, has reversed unemployment trends. With 11% unemployment at its peak, it has fallen nearly a third to 7%. Facing reality and dealing with profligate budgets, apparently, has its rewards.
Our newest $26 Billion of stimulus spending is not intended to create jobs. It is targeted at states that have not faced their own reality of reduced tax revenue. The general public is being levied taxes so mismanaged states can retain workers they can no longer afford. With China now a net seller of US Treasuries, we assume the Japanese must have faith in the Administration's plan for us to repay them.
The Federal budget deficit, increasingly worrisome for voters, increased $165 Billion. That is a 10% increase year over year. Tax receipts remain virtually flat while the jump in weekly jobless claims was the highest so far this year.
Chairman Bernanke's commitment to keep the economy edging forward resulted in the Fed purchasing another $1.7 Billion of mortgage backed securities. With that, the Fed's balance sheet expanded to 2.33 TRILLION DOLLARS. The big picture is to keep enough liquidity in the system to avoid deflation. We believe this is a difficult battle to win when facing the built-in demographic life style changes within our economy.
Behind the headlines, Morgan Stanley's Business Conditions Index shows credit conditions improving and some improvement in hiring. For the 17th straight month plans for expansion and hiring were increased or stable. Challenges, however, are never gone.
Real Estate:
With mortgage rates at 20-year lows and no tax rebate, housing sales continue to falter. With job losses, or fear thereof, and more buyers assuming prices will drop further, there is no pressing reason to act quickly. A better price and a better property may be just around the corner.
Waiting for housing starts to rebound as the true economic stimulus is misplaced hope. For several decades after WWII, the US had a housing shortage as Boomers left college. Home construction led the economy as buyers then purchased appliances and furniture built in the USA. Even if we had a housing shortage, the trailing economic stimulus would have more benefit for foreign economies that manufacture appliances and furniture.
Because of pending foreclosures and delinquencies, we do not know the extent of our effective vacant property inventory. Until it is known and reabsorbed by demand, real estate appreciation will slowly become part of "the good ol' days." At least our problem is not as severe as in China where vacant housing inventory is sufficient for 200 million people!
Stock Market:
At the beginning of this earnings season, emotions were whipsawed almost daily with rapidly reversing news. Overall the earnings disaster anticipated early on has not occurred. Analysts' forecasts are now more optimistic with net revisions back in reasonably strong territory.
Investors, on the other hand, remain mired in the swamp of poor job growth, exponentially growing federal deficits, rapidly approaching tax increases and intolerance for market volatility. By observing results in the Treasury market, we could conclude that most investors would be more interested in a prescription for Prozac® than tolerate another week like the ones recently experienced.
At the beginning of the year, Treasuries were trading at a premium and considered a potentially big winner if holding a short position. The opposite has been the reality. As has happened several times since the October 2008, investors have done what text books state is impossible. Investors have acquired five year Treasury Inflation Protected Securities for zero real return. Conclusion? TIPS investors not only don't see inflation in the next five years; they don't anticipate sufficient economic recovery to ramp up the inflation risk.
Since 1977 there have been 14 times that Treasuries have rallied as strongly as the present one. There have only been five recessions in that period. The stock market has rallied nearly 80% of the time over the following 3, 6 and 12 month periods in the aftermath of similar bond market rallies. Investors should be more concerned that their current flight to safety is more likely a harbinger of losses. Seventy percent of those rallies resulted in negative returns for long bonds a year later. The risk in bonds is not inflation but perceived potential default by the U.S. For now, the greenback is still the "safe currency."
Kudos to Morningstar® for its transparency. Releasing its own study on factors affecting performance of mutual funds, expenses are more important than its oft touted rating system. The study examined all major asset classes, one and five star funds. While not the sole factor for outperformance, expenses cannot be ignored. Using Morningstar's style boxes as a guide for portfolio construction is generally detrimental to performance.
Fundamentally, professional investors recognize value in today's market. Retail investors continue shoving money into bonds over equities. Until news on employment and housing shows some positive signs, equities will likely remain in a trading band which does not reward the "buy and hold" investor. Even if business slowly improves, if China successfully slows its economy and Europe mitigates its continuing sovereign debt problems, uncertainties will keep retail investors out of equities until a simplified investment system surfaces that allows for a more peaceful sleep.
Playing off an old Buick ad: "This isn't your father's market."
Active selection, monitoring and action are required today just as they were from 1962 to 1982. More confirmation has been published that Modern Portfolio Theory does not adequately address risk when risk rises. The issue is not that MPT is useless. It is not the magic black box identifying portfolio risk or investor tolerance. Other tools are essential to compensate for one of MPT's largest short-comings: protection of capital.
We believe our use of tracking daily prices through point and figure charts create an objective data set from which to evaluate every decision and every position in a portfolio. Prices aren't debatable at the end of the day. They are the arbiter of a good or bad decision. They are reality staring us in the face every day.
"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?
If you would like a free relative strength analysis of your portfolio's sectors and positions, call us at 800-317-9119 begin_of_the_skype_highlighting 800-317-9119 end_of_the_skype_highlighting.
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