2009May24 Week in Review

May 24, 2009

WEEK IN REVIEW:

 

The stock market rally of the past two month’s has softened lately with profit taking. While the index of weekly leading economic indicators has increased its bullishness as has the MS Business Conditions Index (BCI), there are significant areas of concern regarding the sustainability of market prices. It seems likely that the run up in prices is overly optimistic.

 

It is true that credit for businesses has improved significantly for “credit worthy” borrowers. The underlying assumption is that businesses will now expand and profitability will return supporting even higher stock prices. However, availability of credit from lenders does not increase demand.

 

Major firms are continuing to lose pricing power that puts pressure on profit margins. The quality of corporate earnings is generally considered to be worse year over year. Overall, this continues deflationary pressures that we have addressed in a recent letter to clients.

 

This presents a conundrum. Shrinking margins and an expected rise in earnings requires an increase in sales. The last two quarters of consumer spending are trending downward, not up. The poor news on the job from and the seriously damaged balance sheets of consumers does not bode well for the assumption that sales will improve. Margins may improve if sufficient costs can be cut by plant and store closings which result in more jobs lost.

 

Very few firms in the BCI expect to increase investment in fixed assets at the present time. Recent payroll increases are dismal and there is no improvement seen the near future. However, hiring personnel is the last expense incurred when recovering from a recession.

 

At this point, we expect the economy to trend toward recovery by having less negative news. For the stock market, it remains a traders market but prices seem unsustainable for longer term investors.