Monitoring the Market News

david —  July 2, 2009

As we take stock of the market trends – which we do regularly – we like to highlight some of the most important recent economic activity. Given the continuing market turmoil, it is important to do so to gain perspective and context.

First, a salient quote:

“A bear market is a period of time during which people who think this time is different sell their common stocks – at prices which will never be seen again – to people who know that this time is never different.”
–Nick Murray Interactive, 3/13/09

I want to touch on a few developments that shed light on the positive direction the market seems to be heading. Most of the following is either not reported or under reported by the everyday news media. 

Americans are saving money again. Personal income rose 1.4% in May, the fastest since May 2008, largely driven by provisions in the American Recovery and Reinvestment Act of 2009, which reduced personal current taxes and increased government social benefit payments. April’s reading was 0.7%. Disposable personal income jumped 1.6% in May (0.2% if you exclude the effects of the government stimulus). Personal consumption expenditures rose 0.3% in May, as expected; April’s spending was flat. On a trend basis, real spending is down a record 1.8% from a year ago. The saving rate soared 1.3 points, the most in a year, to 6.9%, above its historical mean of 6.6% and at its highest level since December 1993. It seems people decided to save more of their extra income from the stimulus to help pay down debt.

Households able to pay debts: The household debt service (DSR) and financial obligations (FOR) ratios fell in Q1 to their lowest levels in more than four years. This indicates an increased ability to make required payments out of disposable personal income. The FOR fell 35 bp to 18.50%, while the DSR slipped 31 bp to 13.48%. While the drops are helpful, the ratios are still historically high and inconsistent with a secular trough, such as what was seen in the early 1980s. However, it is moving in the right direction! We would like to see the FOR at least get back to the 16%-17% range to lay the foundation for a sustainable economic recovery.

Sentiment is up, but mixed: The Reuters/University of Michigan Consumer Sentiment Index firmed in June, rising 2.1 points from May and 1.8 points from mid-month to 70.8, the highest level since February 2008. However, another widely watched barometer – the Consumer Confidence Index, is down to 49.3, after hitting a May level of 54.8. Because consumer spending accounts for more than two-thirds of economic activity in the U.S., economists and investors watch it closely. The chief of the research center said the decline in consumers’ current view implies “that economic conditions, while not as weak as earlier this year, are nonetheless weak.” While consumer sentiment has risen well above its new historic low of 25.3 in February, confidence is still well below what’s considered healthy. These contrary developments are part of what we should consider as the expected ebb and flow of the tide, as the economy recovers.

The labor market has stopped deteriorating: While it may not be improving, the labor market may have stopped deteriorating. Initial jobless claims rose 15,000 during the week of 6/17/09. On a four-week moving average basis, claims rose slightly, but remained close to its lowest level since mid-February. Remember that unemployment numbers are a lagging indicator, which is likely to change when the economy does, as employers want to be confident that things are better before expanding payrolls. It may take at least 6-12 months after the economy has picked up for hiring to come back. While these numbers are headline grabbing they are a lagging indicator. People are generally laid off after the economy has weekend and hired only after a rebound has occurred. It will take employment six months to a year to after a recession to really pick up. Of course, in the “If it bleeds it leads” news culture, that information is generally left out. Today (7/2/09) is a prime example of this phenomenon. It was reported this morning that payrolls shrank by 467,000 people last month, more than the expected number of 350,000. However, buried in the news was the fact that jobless claims fell last week by 16,000 while expectations were for a decline of 8,000.

Housing is doing better: Existing home sales rose for the second consecutive month, up 2.4% to a 4.77 million unit annual rate in May. Sales have risen 4.8% in the past two months, the first back-to-back gain since September 2005 and the largest two-month improvement since April 2004. Historically, as a recession eases, existing home sales pick up first followed by a rise in new home sales and then in new home construction. We are beginning to see prices stabilize on an absolute level, as homes in the $400,000-$500,000 range gained market share at the expense of lower-priced homes for the first time since last year. On a trend basis, home sales are off 10% to 12%, a welcome moderation in the rate of decline. Housing starts jumped by 17.2%, to an annual rate of 532,000 units. The sub-set that we watch closely, single-family housing, rose by 7.5%. That was the biggest one-month gain since January of 2006 and it was the third straight monthly rise in single-family starts. These numbers, while less reported, are more important than the employment figures. That is because housing has led the rebound from every recession in this country since 1960. Historically, existing home sales pick up first followed by new home sales and then new home starts.

Manufacturing is up:Manufacturing activity in the Kansas City Fed District rebounded in June, as the production index jumped 12 points to +9, its first positive reading since last August. The Philly Fed General Business Activity Index soared 20.4 points, the most in nine months, to -2.2 in June, its highest reading since September, and beating expectations. From a year ago, the index is up 15.5 points, the most since July 2004. Manufacturers are increasingly optimistic about activity six months from now. The Future Activity Index rose 12.6 points, its third straight increase, to 60.1, its highest level since September 2003, as all components advanced into positive territory with the exception of inventories.

The Leading Economic Index is up: The Leading Economic Index (LEI) rose for a second month in May, surging 1.2%, the most since March 2004, generating an expansion signal for the economy. The indicator has had almost a perfect track record in the past six recessions, identifying the end of downturn within two months. Expectations were for an increase of 1%. Seven of the 10 indicators improved, led by vendor performance and the interest rate spread. Over the past six months, half of the components have increased, the most since July 2007. Although the LEI is off 1.8% from a year ago, it is the slowest decline since December 2007. As well, the index has risen 2.4% over the past six months on an annualized basis, the first positive reading since July 2007 and the most since April 2006.

The market has come a long way since the dark days of last fall. Experienced investors know that even in a market that seems to be improving; there may still be a lot of pain to go through. Three steps forward are sometimes followed by one step backward. But all in all, the market and the economy look like they are on the mend, as things are looking up in many areas. As we finish this article, more encouraging news is breaking. The ISM Manufacturing index for June showed a rise of 2 points to 44.8 and production grew for the first time in 10 months. This indicator jumped 6.5 points to 52.5, the biggest monthly increase since August 2003. The ISM described the trend as “encouraging” and added that “a slow recovery for manufacturing is forming.”

Recent Trading:

It is also a good time to take a look at some of the recent trading activity. While we don’t plan on always reporting in a blow-by-blow fashion on trading activity, we thought it is appropriate at this time. Below is a table of the positions that we have closed in the last month and a half as we phase in our new selling guidelines. These stocks were sold because they either no longer met our traditional hold criteria, or the price had declined from its peak and we took profits (or limited losses).

Market Comment 07_02_09
If you take a look at the last line of the tables you can see these trades averaged a gain of 6.6% vs. a 1% gain for the S&P for the same holding periods. More importantly, the two stocks with losses over 10% (HEW and TDW) were bought last year prior to our institution of the new selling rules. Under the new rules, the maximum loss for those stocks would have been 20%. Also note that the large gains are much larger than the bigger losses. This is also consistent with our new selling rules to harvest profits sooner than we had in the past. We are pleased with the new selling rules so far and feel they will lead to better results compared to the results that our prior selling discipline would yield.

Currently, we have about 15% of the portfolios in cash. We have been outperforming the market on the upside in spite of not being fully invested. We plan on reinvesting these funds in buyback opportunities that are currently on our radar screen.