Daily Investment Interpretations

Thursday, March 27, 2009

2009-3-27:   The NASDAQ fell 41.80 points (-2.63%) to 1,545. The Dow jettisoned 148.38 points (-1.87%) to 7,776, and the S&P 500 parted with 16.92 (-2.03%) to end the day at 816. Oil was down slightly at 52.28, while Gold fell $16.90 to $925. The VIX rose a little to 41.04.
Yesterday (Thursday, March 26th) was the last day for portfolio managers to buy before the end of the first quarter.
    One contributor to this modest pullback: today is the day after the last day (because of the "three-day rule") that portfolio managers could buy and sell to dress up their portfolios for the quarter. That may have had something to do with yesterdays' upsurge and today's letdown. The official end of the quarter will be Tuesday, so there may be some end-of-quarter distortions. Then will come first-quarter  earnings reports that, everyone agrees, will be worse than what everyone is  expecting, and since everyone expects that they'll be worse than everyone expects, the markets may already factoring in this bad news, and the bad news may arrive on little cat feet..
Real consumer spending fell in February
    Today's economic numbers for February were slightly negative. Real consumer spending fell 0.2%, leading to a forecast of an inflation-adjusted 1.3% annual rise: Consumer spending cools with incomes. This is low but it's positive, and much better than the 4.3% average decline in last year's fourth quarter.
Personal incomes fell in February
    Inflation-adjusted personal incomes fell 0.4% last month, and the personal savings rate dropped from 4.4% in January to 4.2% in February. (Note that transfer payments such as Social Security and unemployment benefits rose 0.8%.)
Core inflation has fallen about a half point over the past six months, and we expect to see a more rapid and substantial decline through the rest of the year given the enormous slack building up in the economy,; wrote David Greenlaw and Ted Wieseman of Morgan Stanley." 
    But our bullish guru, Stephan Hadley says, "'
The odds of deflation any time soon are fading fast,' wrote Stephen Stanley, chief economist for RBS Greenwich Capital. 'At the risk of beating a dead horse, the empirical support for the output-gap model of inflation is scant, and those economists, including at the Fed, who are counting on several years of moderating core inflation even after the economy begins to recover are likely to be well wide of the mark.'"
Will the stock market continue to go up from here (with minor pullbacks) or will it fall to new lows?
There's a gaping chasm here between the gurus who are claiming that the current rally marks the beginning of a new cyclical bull market, and those who are saying that this is still a bear market rally that will be followed by lower lows. Within the next few months we're going to find out who had it right and who didn't.
    Sometime in April, the first report on GDP changes for the first quarter should appear. At that point, we should begin to know which camp is correct. If the GDP is improving and trending toward the only-2% decline in GDP that's forecast for the third quarter of this year (as in 0% by the end of September, and slightly positive for the rest of 2009), then we'll know the bulls got it right. In the meantime, we'll (or at least I'll) have to improvise.
   Todd Harrison has reminded his readers that three weeks ago, he was forecasting a market upturn when everyone else was incredulous regarding such an idea. Now he's urging caution. Sentiment has gotten too bullish. Institutional cash is returning to the marketplace, meaning that the crowd is climbing on board the bus: Harrison: Should I stay or should I go?Freaky Friday Potpourri: Slippery When Wet!
    Near-term, the indices may pull back to something like the 800 level on the S&P 500.
    Second-quarter earnings might produce some shocks, although a generous allowance for earnings disappointments may already be baked into the cake.
Three Future Scenarios?
    It seems to me that there are three future scenarios that we might define for where the economy and the stock market are going.
(1) The Bullish Case
    It seems to me that the bulls are saying that the economy is showing the traditional signs of pulling out of a financial contraction. Never mind why. This is what's happening. Their theoretical argument is (I think) that the U. S. government is pumping, (including the fiscal stimulus package, the TARP and the TALF), at least two trillion dollars into the U. S. economy. The Congressional Budget Office has estimated that the economy will face a GDP shortfall of something like three trillion dollars over the next two or three years. But $2+ trillion should fill the lion's share of that gap. But in the end, the bulls' case is simply that traditional signs of a bottom are appearing, and it's not for us mere mortals to argue that the storm is going to get worse and worse when the sky is brightening off to the west.
    It's easy to dismiss the bulls as "just not getting it", but that may not be the case. There are some fine minds in this world of high-finance, and they may have their own rule-of-thumb calculations that underpin their conclusions.
    In any case, data trumps theory.
    We have well-defined meter-stick by which to measure the bull's case: roughly
-5,1% change in the 2009 GDP for the April-June quarter, and roughly -2% change in the GDP for the July-September quarter. 
Bottom Line: According to this thesis, we're approaching, or have already passed the inflection point at which the rate of decline of the economy peaked. March 9, 2009, represented the bottom for this cyclical, several-year market cycle. The economy should bottom  sometime in the third quarter.
(2) The Bearish Case
    The bearish case is, I think, the one so ably set forth by Paul Krugman and John Kenneth Galbraith. This is not a normal postwar recession. We're staring deflation in the eye and the programs being instituted by the U. S. government don't look as though they're sufficient to stop the bear. In addition, the level of debt that has to be unwound, and the degree of dysfunction in not just the visible financial services system but also, in the unregulated "shadow banking system" are going to require, given the perceived inadequacy of U. S. government programs, years of additional pain... at best, a "lost decade". At a total-debt-to-GDP ratio of nearly 4-to-1, we're more than twice as indebted as was the case during the Great Depression, when the total-debt-to-GDP ratio stood at 1.76-to-1. At least so far, the Dow is following in the tracks of the Great Depression. This contraction won't exactly replicate the Great Depression-- for one thing, GDP had fallen much farther at this 17.6-month mile marker in 1931 than it has now--but the two charts are eerily similar.
    In considering the bearish case, I think it's important to add what, Ray Dalio, the founder of the world's largest hedge fund (Bridgewater Associates, $80 billion under management), has said. First of all, he distinguishes between a recession and what he calls a D-process (what I've dubbed a "deflationary recession"). And, he says, we're in a D-process.
t seems very likely that stocks will get materially cheaper," he says. "We have to go through an important debt restructuring process, and a lot of assets are going to be for sale, huge numbers of assets. And there's going to be a shortage of buyers."
    He continues,
"Too many people have a systematic bias toward positive economic growth. I think that what we're going to probably have is an economy that's going to get worse, with most people positioned for it to be better."
    Never heard of Bridgewater Associates? Perhaps that's because Bridgewater Associates works only with large institutional clients such as pension funds and sovereign wealth funds (270 of them). It has never lost more than 2% in any given year. It uses the latest technological techniques to generate wealth for its clients. Ray Dalio has assembled a "notebook" with 100-page timelines of the four major deleveraging episodes of the past century--the hyperinflation of the Weimar Republic in the 1920s, the Great Depression, the Latin American crisis of the 1980s and Japan's lost decade of the 1990s. Dalio employs 800 of the best and brightest minds he can find. He depends upon a proprietary formula that reduces risk by 80%, but scours the world for opportunities in a broad range of investment areas, but focused in the fixed-income and currency markets.
    It may be worth noting that Dr. James Simon's Renaissance Technologies is at the bottom of the list, with $20 billion under management. Dr. Simon is a mathematician who has also assembled a team of "quants"-- mathematicians, physicists and financial wizards--who also scour the world for opportunities.
Bottom Line: This camp holds that what we're currently witnessing is a quite-strong bear market rally, but the stock market will hit one or more new lows before it turns around. And when it does, it won't get very close to its October, 2007, highs for a number of years.
3) The Todd-Harrison Case:
    The stock market will hit a new low at 600 or lower before it goes higher. At that point, Mr. Harrison will invest 25% of his money. Then the S&P 500 will begin a prolonged rally or will enter a cyclical bull market.
    I have no more information than this regarding Mr. Harrison's vision of the future.
Bottom Line: Sometime later this year, the S&P 500 will hit a new low at approximately S&P 500 = 600, at which point, it will be safe to invest 25% of our money in a bet on a rising market.
    By no later than the end of this year, and probably earlier, we'll know which of these three scenarios fits the facts. 

    My personal bias is
Case (2): that present U. S. federal plans aren't going to work very well, and that the economy and the stock market will continue to fall. I don't tend to see a recovery starting here in the U. S. later this year. But I could be utterly wrong, and for this reason, I'm going to hedge my bets by creeping cautiously back into stocks, with trailing stops to minimize losses. But beyond that, I'm primarily going to invest in overseas markets, and particularly, China. For one thing, I'm picking up vibes that other investors are also deciding that China is a good investment venue, and that it  could be a good wave to surf until the Chinese market again becomes overheated.
    I'll try to provide more on this tomorrow.
Phil Dow: The rally has legs yet  This expert points out that with the markets having come up so far, portfolio managers will want to look good at the end of the quarter, and will be buying at least through the end of the quarter (next Tuesday). (But Todd Harrison has stated that many of these purchases must be made three days prior to the end of the quarter--which was yesterday, March 26th.

The Cabot China and Emerging Markets Newsletter has issued a cautious "buy" signal, Brimelow: Rattled by the roiling rally lists the two stocks that the Newsletter recommends: Shanda Interactive Entertainment Ltd,.(SNDA), and Aluminum Corporation of China, ACH, (try to buy at 15). In the meantime, the Cabot Market Letter is now 25% invested in three stocks (one of which is a gold mine).    
S&P Watch: Testing the Bounce
2009 is no longer looking like such a horrible year for stocks