2009May3 Week in Review

 

The recent few weeks of market rally have been a relief for accounts that suffered through the secondary but severe declines in January and February. While experiencing relief, wellness has not arrived.

 

Reported earnings have been slightly better over all. Upon examination, the greatest have come from the areas that were the most severely battered, i.e., financials. Other industries that have exercised good cost control, i.e. lay offs, have been able to overcome previously negative earnings trends.

 

As we finish April with the market struggling for additional advance, we look at the drivers to justify higher pricing. Obviously, even higher earnings would help. Consumers, however, are getting harder to come by as they accelerate debt reduction and exercise constraint on the use of credit in general.

 

There has been some easing in interest rates in the non-Treasury parts of the credit market. This is usually a bullish sign. We expect to see continuing improvement as investors tire of the already dismal interest rates available from the primal fear asset of choice – the US Treasury obligation.

 

We should not ignore the economic impact of the swine flu. The biggest impact of the swine flu outbreak will likely be to dent the bullishness in oil sentiment – the oversized driver of the oil market in recent weeks. Fundamentals for oil have remained dismal with huge on-tanker storage, 20-year highs for onshore inventories, and counter-seasonal stock build-up despite unprecedented discipline by OPEC.

 

Oil’s recent strength has been driven by expectations that things will get better in the second half of 2009, but the possibility of a swine flu pandemic will highlight the fragility of the global economy. This could dent the bullish expectations.

 

Investors should remain wary of the impact of the housing market on the overall economy. Many banks are not listing their foreclosed housing inventory. Prices are so soft; they expect to wait for some depletion before adding to the inventory available. However, 25% of prime loans are now greater than their property value. Fifty percent of subprime, 45% of Alt-A and 73% of option ARM loans are underwater. As these loans reach the reset date for interest and amortization, economic outlook will become gloomier, and the current market advance will turn south again.

 

With significant price discounts to value in the general stock market having disappeared in the past six weeks, we hold our bias for high grade fixed income over equities. We view equities, in general, as close to fair pricing. In this economy, waiting for euphoria to push prices higher is a fool’s bet.