Not a Stockpicker’s Market

May 31, 2009

The S&P500 moved higher last week, closing up 3.6%.  Notably, volume declined for both the prior week (when prices ticked up slightly) and this last week. 

The declining volume is suggesting that buyers are not jumping in with both feet pushing the market higher; instead, the declining volume calls into question the strength and sustainability of the latest up moves.  For this rally to continue, buyer volume must grow.  It’s not happening.

As ususal, last week’s macro data was weak.  The Case-Shiller home price index disappointed with prices dropping almost 19% per year; because housing is ground zero for the global financial crisis and the recession, the continuation of plunging home prices does not bode well for consumer demand and credit market lending.  Durable goods orders, while ticking up, followed the recurring pattern of big downward revisions for the previous month; as if on cue, the markets focused on the current data and largely ignored the negative revisions.  Q1 GDP was revised to -5.7%, worse than the -5.5% expected.  And in the mortgage market, we learned that over 12% of all residential mortgages are either delinquent or in foreclosure–this record high number again points to the underlying mess (likely additional losses) residing within the massive $10 trillion mortgage market.  Initial claims were worse than expected (at 623,000) and continuing claims moved up to a record 6.79 million.

Technically, the daily charts are still look toppy with the downward price movement (from two weeks ago) still holding.  On a monthly basis, we’re stll firmly in a bear market.

This week in Barron’s, Michael Santoli highlighted some research that debunks the often-cited sales pitch from mutual fund managers that we’re now in a stockpicker’s market.  Why does this matter?  Well, if your mutual fund manager (the stockpicker) doesn’t make a difference in your fund’s performance, then why should you pay a fat (1.5% or more) fee?

Well it turns out that over the last three months (according to Barron’s), the “correlation among all stocks has been running above 0.8”.  And according to obvious empirical data, this correlation was just as high for all of 2008.  This suggests that almost all of a particular stock’s direction has been market driven–not driven by its unique traits and therefore capable of being “picked” by a manager.

Ouch!  Add to this, that about 99% of U.S. equity mutual funds lost a ton of money last year, it’s easy to wonder exactly why anyone would want to pay a mutual fund anything for managing your money.

When a monkey can do as good a job as your average mutual fund manager, the mutual fund industry is in danger of being exposed for what it really is–an asset gathering marketing machine designed to maximize profits for the managers, at the expense of the investors.

Banana anyone?

Gold, Treasurys and Dollars—Oh No!

May 23, 2009

The S&P500 failed to reverse the prior week’s decline.  Although it closed the week with a small gain (less than half a percent), the market was skidding downward most of the week.  Such a failure–moving higher and then closing lower–is a bad sign for bulls.  It suggests that the buyers are running out of steam.

While the data flow was light, the results were meaningful.  Housing starts and permits (which were some of the key reasons behind the green shoots propaganda) fell dramatically–not only reversing the prior month’s gains, but diving to all time lows.  Initial claims did not behave as needed to support the glimmers of hope message–it stayed in the mid-600K range.  And continuing claims hit another consecutive record; at 6.66 million, they’re about to breach 7 million–astounding given that they were only 3 million about a year ago.

The technicals suggest that a strong topping formation has developed on the daily charts.  And more ominously, volumes have been growing stronger on down days while dropping on up days.  Volume seems to be confirming a downward direction in price.

In the macro world, several key indicators have taken a turn for the worse.  Gold priced in U.S. dollars has been soaring over the last three weeks, closing above $960 an ounce at the end of the week.  The U.S. dollar, as measured against the major currencies, has been falling.  And the ten year Treasury’s have been collapsing; after bottoming around 2% at the end of 2008, the ten year is almost 3.5% today.

Why is this worrisome?  Because these markets provide important feedback to the Fed and to the President and Congress; these markets offer clues about the limits on the amount of monetary and fiscal stimulus that the rest of the world–our creditors–will put up with.

And so far, these clues are not positive. 

If the Fed prints too many dollars (quantitative easing), or keeps the cost (interest rates) of the dollars too low, or overspends fiscally (runs huge deficits and amasses colossal debts), then our creditors will rightfully protest that that they’re incurring too much credit risk (default risk stemming from getting paid back in a debased U.S. dollar).

What will they do?  Buy gold, sell Treasury’s and sell the U.S. dollar. 

Recently, when asked by Congress what’s the limit of the Fed’s balance sheet, Ben Bernanke replied, essentially, that he did not know what the exact limit is.  Well, the markets are now stating–quite clearly–that the Fed’s monetary measures and the government’s fiscal overspending are nearing a limit.

The dilemma for the government is this:  if the measures are curtailed now, then our economy would surely resume it’s free-fall.  But if the measures continue for much longer (or if they’re increased), then the world could turn away from the U.S. as it would from any typical banana republic; this would also cause the economic free-fall to resume.

Oh no.

Inflation, Deflation, or Goldilocks?

May 16, 2009

At last, the S&P500 turned down, ending the week witha 5% loss.  The bounce off the March lows defied skeptics and ran further than most analysts expected.  The VIX also crept up a bit, but not in any way that suggests panic selling. 

The equity markets marched up anticipating a V shaped recovery in the economy.  And leading the rally were the trashiest group of stocks–financials and retailers, the same groups leading this market and the economy downward starting in late 2007.

But the economy is not bouncing back so quickly, as this week’s data revealed.  Retail sales slid in April, as opposed to rising as projected.  Initial claims jumped back up into the mid-600,000 zone and continuing claims soared to 6.56 million (the 15th consecutive record high).  GM and Chrysler notified about 2,000 dealers (combined) that their franchises will be terminated; this move alone could wipe out over 100,000 more jobs.  CPI and PPI  both fell, on a year-over-year basis, the most since 1955.  And industrial production and capacity utilization both continued their relentless slide downward.

Green shoots?  Hardly.  The economy is beaten down and from this low point, still showing no signs of turning up.  The falling off a cliff may have ended, but a slow death by a thousand cuts is no cause for celebration.

Technically, the long term bear market trend is still in force.  The daily charts show a very overbought condition that is breaking down.  We need another week of data to confirm the correction to the downside.

Read the press today and you’ll get two contradictory forecasts for the future of the U.S. economy.  One forecast calls for massive inflation.  The Fed and the Treasury have lent, spent or guaranteed over $10 trillion to push up economic activity as well as asset prices.  The scale of the stimulus, relative to GDP, is unprecedented (truly, not just in recent memory).  The problem is that the government–in unleashing such massive fiscal and monetary stimulus–will have a hard time taking it away when the economy starts to turn up.  The result is that the government could overstimulate (especially on the money supply) causing inflation to rise. 

The other forecast calls for massive deflation.  With total credit market debt at record levels relative to GDP (370%), the debt load in the future must unwind.  If debt contracts (by default or principal paydown), then asset prices–both real and financial–should contract as well.  This push down in asset prices and wealth could restrain future lending and aggregate demand (especially consumption), causing economic activity to fall and prices to drop.

What’s the answer?  Actually both forces are at work.  Think of these forces as two tsunami-size waves, both crashing into each other from opposite directions. 

The result?  Not clear.  It’s possible that the two waves will perfectly cancel each other out.  As desirable as this is, it’s highly unlikely to happen.

What is clear is that one of the two waves will probably swamp the other.  And that’s the problem.  It’s highly likely that either inflation will spike or that deflation (Japan-style) will kick in.  Not knowing which wave is going to dominate is less important than knowing that one of them will.

Why?  Because it rules out the goldilocks scenario–the one that is currently priced into the equity markets.  If either inflation or deflation predominate, stock market prices should fall, possibly a lot more, sometime over the next 12 months.

Buying Time

May 9, 2009

The rally continues, mirroring (inversely) the relentless sell off that dominated January and February.  The S&P500 ended the week up 5.9% defying quite a few skeptics who don’t trust this move.  Some of the most troubled sectors (financial and retail) led the way; whereas many of the most fundamentally solid groups lagged (tech and consumer staples).

Economic fundamentals did not impress.  Sure the number of pending home sales improved (as it always does in the spring); and ISM services went up to 43.7, but still well below the 50 level signalling neutrality.  Inital claims stayed above 600,000.  Continuing claims jumped to 6.35 million (a 14th consecutive record).  Consumer credit (the fuel behind consumer spending) dropped much more than expected.  The unemployment rate rose to 8.9%, the highest since 1983.  And officially, 539,000 jobs were lost in April.  Unofficially, when  72,000 of obviously temporary Census workers are deleted and 60,000 of statistical add-backs are deleted, the real number of jobs lost was closer to 670,000.

Technically, the market jump last week looked like a blowoff top formation on the daily charts.  Prices clearly went up, but the force of the move was weakening and volumes were tapering off.  This is a negative divergence that resembles, very closely, the patterns formed in July 2007 and October 2007.  On a monthly basis, the bear market is still alive.

The key selling point, and it truly has been a sell job, is that the economy’s rate of decline is slowing.  This is the simple logic behind the green shoots and glimmer of hope messages put out by the Obama administration and the Federal Reserve.  What Mr. Geithner and Mr. Bernanke want the masses to do is believe that things are getting better.  Why?  To buy time.

If the public’s mood improves, if our collective animal spirits become more optimistic, then theoretically consumers might increase their spending and businesses might increase their hiring.  This would hopefully break the current negative feedback loop in which the opposite is happening:  consumers cutting back on their spending and businesses cutting back on their payrolls.

At the same time, the less valuable assets in our economy (real and financial) would have a greater chance of reversing their own price drops.  In other words, real estate, stocks, bonds and other securities might stop falling–this would stop the vicious cycle of collateral falling causing credit to contract, which leads to more collateral price reductions.

But the true measure of recovery, is not a slower rate of decline in the economy, but rather, an actual increase:  in consumer spending, in business investment, in real estate prices, in employment, in capacity utilization.   Green shoots won’t matter if the plants never blossom.

But what if the economy doesn’t turn this critical corner?  What if it continues to decline, in a more gradual, slow motion kind of way?

If the economy doesn’t show positive data, and soon, then the entire buying time gambit may fail.  Mark Zandi, a leading economist from Moody’s (and a Democrat) stated this week in the New York Times “The moment of truth is coming soon….If we don’t see something real in the data by June, then I get very nervous.”

June is only weeks away.  Perhaps we should be getting nervous today.


May 2, 2009

Upside momentum pushed the S&P500 to another small gain this week, rising 1.3%.  The S&P, although still down for the year, has bounced back strongly since its March 6 lows, less than two months ago.

The fundamental data, on balance, are still pointing to an economy that’s deteriorating, not rebounding.  The Case-Shiller index fell 18.6% on an annual basis for the 20 city composite; not to mince words, housing prices are still collapsing.  Initial claims came in at 631,000 and continuous claims hit 6.27 million–a record high for the 13th consecutive week.  First quarter GDP, at -6.1%, was far worse than consensus estimates of -4.9%.  Personal spending was lower than forecast.  Personal income was also lower than estimated.  And personal savings (the enemy of spending and support for the economy) rose to 4.2% in March from 4.0% in February.  Factory orders were lower than forecast and auto sales for March were also at, or below, consensus estimates.  Although consumer confidence and Michigan sentiment rose, they’re still at abysmally low absolute levels.

Technically, the charts are screaming overbought on a daily basis.  Longer term, on a monthly basis, the bear market is still in effect.  We’re a long way away from breaking a downtrend that began in November 2007.

Which leads to the big picture question:  if the market is signalling a turning point, what’s changed–at the root level–with the economic causes that created the bear market and great recession in the first place?

As explained in prior posts, the underlying cause of our recession was a massive asset and credit bubble that began to burst about a year and a half ago. 

How big did the bubble get?  Total U.S. debt (all credit market debt, including household debt, corporate debt and government debt) peaked at 370% of GDP over the last 12 months.  This level of debt was typically only 150%-200% of GDP for the last 90 years. 

In the Great Depression, the credit bubble peaked at about 250% of GDP, and then promptly deflated and stayed beneath 200% until the early 1980’s when it began its rise to 370%.  Not coincidentally, the great secular bull market in equities also began in the early 1980’s.

Where is the total credit level today–17 months into the worst recession since World War II?


The point is that when anyone–especially on CNBC–peddles the government’s propaganda-like victory message, namely that the economy has turned a corner, try to remember that the root cause of our great recession has not gone away.  On the contrary, simple math suggests that to revert back to pre-bubble credit levels, the amount of credit that needs to be paid down or written down is about 200% of GDP–or $30 trillion. 

Conceivably, the worst is yet to come.