Market: An august August?

If you prefer some lighter reading, check out my 2 previous blog posts today (labeled OTOH, which stands for “On the other hand”).

This week the market took a bit of a breather – up ~1% (S&P500), after its 11% surge in the preceding 10 trading days.  Normally, I would view this action as bullish – a more significant correction after such a surge is more typical; thus, a sideways move often suggests a further move to the upside.  However, since this was also the last week, in an up month, it is also normal to expect end-of-the-month buying (aka window-dressing) by investment funds.  So, we shouldn’t read too much into last week’s action.

The bullish case.  The increasing consensus is that the recession is over, i.e. GDP will be positive for both Q3 and Q4.  Since the March lows, the percentage of cash in mutual funds has actually increased.  Also, the percentage of assets in money-market funds (relative to stock market value) is still  higher than it was at the 2002 bottom.  So there is plenty of fuel to support the bullish case.

The bearish case.  Even if this is a new bull market, we have come too far, too fast.  A correction is due.  Also, even if are out of recession, attention is likely to turn to the nature of recovery.  We have excess capacity, and unemployment is continuing to increase and not expected to peak (at 10-11%) until 1 year from now.  Although the previous recession ended in Nov-2001, both the stock market and employment did not hit their lows until a year later.  Our financial system is still in a precarious state: (1) the worst of the commercial real-estate loan losses and credit card losses are still in our future; and, (2) the European banks are in far worse shape than the ours (i.e. they are more levered, and have not come to terms with their emerging market loans).   We also have long-term systemic problems (current account and fiscal deficits, unfunded federal, state, and local pension/healthcare liabilities, etc) that seem insurmountable.  A good discussion on some the intermediate-term and long-term issues and outlook is in this week’s Mauldin.  There is a guest column this week, by Tony Boeckh and Rob Boeckh, The Great Reflation Experiment (click it to get the PDF).

I am neither a bull nor bear on the stock market.  I have a mixture of longs and shorts, plus a high-percentage of bonds, and more in cash than is typcial.

There was no change this week in the Lowry indicators.  The short-term indicators are at Buys.  The intermediate-term indicator is at a Sell, and it moved a little farther away than last week from switching to a buy.  Selling pressure is now 7 points away from generating a Buy (vs. 2 points a week ago).  Various other technical indicators that Lowry follows are also more positive now.  So the Lowry commentary is more positive than previously.

Economy: The China Mystery, and a Canary Update

In this post, the China mystery, and then a quick update on Latvia.

In the last year, China GDP is up 8%, but China exports are down 20%.  Since many have reported that 40% of China’s GDP comes from exports (e.g. see East Asia: Exports in Decline), how can the GDP figure be right?  Thus, the mystery.

You know it is not an easy mystery to unravel when you also read that Singapore’s exports are 188% of GDP.  Singapore is a large re-exporter, i.e. goods stop off in Singapore on their way to someplace else.  This is not the case for China.  However, China does import a lot of raw materials that go into the making of the products that they export.  So, we would need to find out this number and subtract it. That is too complex for me.  But there are also other factors.  A large part of China’s GDP growth is the building of new factories and office buildings to accommodate their 20+% annual growth in exports (until this recession).  In fact, this is a larger factor in China’s GDP growth than its actual exports.

So, how does all this net out.  In this article (Will China come out to rescue the world?) from Oct-2008:

China’s dependence on exports is not as heavy as may seem at first glance. Officially, exports account for 37 per cent of its revenues and seem to be the driver of the Chinese economy.

But independent surveys by Dragonomics, an advisory firm specializing in China, put its “true” export share at just under 10 per cent of its GDP.

It is internal investments, which account for 40 per cent of its GDP, that are the driving force of China’s economy. Although part of them is channeled into export-oriented projects, the global financial crunch will not slow China considerably.

So with the 20% drop in exports, shouldn’t that have stopped the building of all factories and new office buildings?  And, what about all the workers that have been laid off from their factory jobs?

We can now turn to Mauldin’s weekly (click to download the PDF: http://www.frontlinethoughts.com/pdf/mwo072409.pdf), which is worth a read.  But this WSJ opinion piece is far better:  China Takes the Brakes Off.

The size of the China’s “official” stimulus package is about 16% of their GDP and is suppose to be spread over 2009 and 2010.  By this relative measure, it is about 3 times the size of our stimulus package. But there is more to it than that.  The Chinese gov’t have instructed the state-owned banks to put out loans (and, thereby increase their leverage).  In addition, the regional governments have huge infrastructure projects that are being financed by debt (30% coming from the state banks, and the rest from commercial ones).  The nature of China’s political system is a 2-edged sword.  On the positive side, they can and have acted quickly.  But it’s also the corrupt politicians that are directing the flow of money.

Credit expansion is up 30% in the 1H2009 (vs 1 year ago). China’s money supply shot up by 28.5% in June alone.

The size of the local government projects is estimated to be 5 times the size of China’s “official” stimulus package (from the WSJ piece).

China has taken the concept of “subprime loan” to a whole new level.  Makes me wonder if the financial wizards that were at Bear-Stearns, Lehman, Merrill, et al have infiltrated into China.  One tell will be if the Chinese package the loans into CDOs and sell them to the European banks. 😉

Although exports are down, China’s foreign currency reserves are up (due to an influx of capital), and are now at $2.1 Trillion dollars.  About $2 Trillion is in US Treasuries.  In this FT article (China to deploy foreign reserves), China’s premier has stated that China will use its reserves to buy assets outside of China.  This is expected to go to buying up natural and energy resources.  At the very least, this means that China will not be buying our future Treasury debt to finance our federal deficits.  From my piece last week, Japan will not be a buyer either.

Latvia – short update on the canary.  From a July 24 Bloomberg article on the Swedish Bank that is the largest lender in Latvia (More Than Half Swedbank Mortgages in Latvia Exceed Collateral ):

July 24 (Bloomberg) — More than half the Latvian mortgages issued by Swedbank AB, the largest bank in the Baltics, exceed the value of their collateral after property prices plunged.

The loan-to-value ratio exceeded 100 percent in 54 percent of home loans issued in Latvia by the end of June, said Jenny Clevstrom, a spokeswoman with Swedbank in Stockholm, in an e- mail yesterday. The share was 37 percent for Lithuanian mortgages and 24 percent for loans granted in Estonia, she said. …

“The decline in collateral prices is due to the present situation of the property market: according to Swedbank analysts the prices of apartments in Tallinn have declined by 53 percent from peaks in the summer of 2007,” said Mart Siilivask, Swedbank’s spokesman in Estonia, in an e-mail. “The price decline in the Latvian capital. Riga. has been 68 percent and in the Lithuanian capital, Vilnius, 28 percent.”

For more on the canary, see my previous blog post on Latvia: Economy: Canary Gets a Subprime Loan.

The author of the excerpts in OTOH: Shape of Recovery, V, U, or X? is Robert Reich, and was excerpted from his blog: http://robertreich.blogspot.com/

Economy: Canary Gets a Subprime Loan

In previous blog posts, I’ve discussed: (1) Japan’s economic problems; (2) the problems of the western European banks (e.g. in the UK, Germany, Sweden, and  Switzerland); (3) the more serious economic problems of the PIIGS (Portugal, Ireland, Italy, Greece, and Spain); and, (4) and Latvia, which I am using as the “canary in the coal mine”.  Latvia is representative of the Eastern European countries, in which the Western European banks lent a lot of money – their equivalent of subprime loans.  In this entry, I am going to do an update of Latvia, and then some new data on European banks.

Latvia.  For background read a previous blog post, Economy: Latvia, the Declawing of a Baltic Tiger, or make do with just this summary (taken from the FT article, What went wrong with Latvia?):

“This is how a country can blow a bubble that will definitely burst: 1) Run high inflation; 2) Borrow profusely; 3) Import much more than it exports; 4) Build an economy on speculation in assets; 5) Put no public funds aside for a rainy day; 6) Meanwhile, peg its currency to a stable currency. Latvia ticked every box.”

For the 1-year period ending 1Q2009, Latvian house prices declined by 36% (vs. ~17% for the USA).  Many of the mortgages are denominated in Euros (vs. the Lat, the Latvian currency).  The EU has committed to helping Latvia with an economic stabilization loans.  The IMF as well.  But in return the Latvian government has had to slash its budget, which causes layoffs and salary cuts, and deepens their recession.

In 2008, Latvia’s GDP declined by 4.6%.  In 2009, it is forecast to decline 18%, and 4% in 2010.  From a May report, unemployment is forecast to average 13.9% in 2009, and 17.4% in 2010.  But this may be optimistic, since it was 16.3% in May. Unemployment benefits run out after 12 months.

From Bloomerg this week (IMF Talks With Latvia):

The Parliament passed 500 million lati ($1 billion) in spending cuts on June 16, to unlock the loan from the European Commission. The country cut spending on state wages, pensions, and maternity support, in addition to other spending cuts to reduce this year’s budget deficit.  Now, it must find a similar sum of money from either budget cuts or raising revenue in next year’s budget.

The European Commission, the biggest lender in Latvia’s 7.5 billion-euro ($10.5 billion) international stabilization program, has said it will transfer 1.2 billion euros this month to the country. The IMF delayed a 200 million-euro transfer in March and has not paid out a second tranche of the same sum. Both organizations have missions in Latvia now.

$11 Billion in Economic Stabilization loans may not seem like a lot of money.  But that is about ~30% of Latvia’s GDP. The population of Latvia is just 2.2 Million people.  So the loan comes down to $5,000 per person in Latvia.  In other words, the EU just made the ultimate subprime loan. Will this prevent or just delay an economic catastrophe (not just in Latvia, but by ripple effects, in the other eastern European countries, then the western European banks, then Europe, then …)?  I’m not smart enough to know the answer.  But I will keep an eye on this “canary”?

Europe (aka, “the coal mine”).  Mauldin just came out with a great note (click on Europe on the Brink for the PDF).  It is a bit wonkish. So I will try to do an overly simplistic summary.  Mauldin presents some data on the amount of leverage employed by an average of the largest banks within a geographic region over time.  The amount of leverage that a bank uses is a key measure of the solvency of a bank.  To get this, you need at least banking 101.

Banking 101.  Lets suppose that I start a bank, and I invest $1M (million) dollars.  I then take in deposits of $9M dollars (e.g. checking accounts, savings accounts, etc).  I now have $10M dollars.  I loan out $10M dollars (eg mortgages, business loans, etc).  I have $10M in assets (the loans) and $1M in capital.  I am employing 10 to 1 leverage.  If I pay 3% per year on the deposits (3% * $9M = $270,000) and collect 5% on the loans (5% * $10M = $500,000), then when all goes well, I will make $230,000 per year – a nice return on my $1M investment.  But now suppose all the loans are home mortgages, and $2M (20%) of the loans go bad, I have to foreclose, and after expenses and selling the properties, suppose I net 50% of the original loan value.  I’ve lost $1M, my capital (i.e. my original $1M investment) is wiped out.  The FDIC takes over.  But now suppose, instead of 10X leverage, I was allowed to apply 50X leverage – i.e. only invest $200K (vs. $1M).  If all goes well, I now make $206,000 per year – I’ve more than doubled my investment in just 1 year.  However, if just 4% of the loans go bad and I am only able to collect 50% on the defaulted loans, I’m wiped out.  And, if more that 4% of the loans go bad, the FDIC which guarantees the depositors, will also lose money.

Banking 102. Banking regulations and regulators are suppose to make sure that the banks do not take on too much risk (ie leverage).  Banking regulators mainly look at Tier 1 capital ratios.  The banking stress tests looked at Tangible-Capital ratios.  The differences are complicated, so I will over-simplify.  If a bank was liquidated tomorrow, and the various capital assets sold for what they are on the books (e.g. the bank buildings, the federal reserve deposits, treasury holdings, etc), we are talking tangible capital.  But if we also include the assets that cannot be realized quickly (those that could only be realized over several years, eg tax deferred assets), we are talking Tier 1 capital.

Over the years, bank regulations have been loosened (repeal of Glass Steagall near the end of the Clinton administration), and the banks have figured out creative complex financial schemes (SIVs, conduits, etc) to get around existing regulations.

If you “groc” the above, you can now get my following summary and the graphs in Mauldin’s piece.  For each geography below, I’ll give you the approximate 2004 Tier-1/Tangible-Capital ratios, and then what they are in 1Q2009.

1. USA.  2004: 12/22.  1Q2009: 12/45.
2. UK.  2004: 20/32.  4Q2008: 38/55.
3. Eurozone.  2004: 30/38.  4Q2008: 35/55.
4. Switzerland.  2001: 28/50.  2004: 40/65.  1Q2009: 45/68.

Switzerland was already getting crazy in 2004, so I also included 2001 as more of a base line.  But this data is only for some of the largest banks in each geography (e.g. just 2 banks from Switzerland: UBS and Credit Suisse) – see Mauldin for the specifics.  Europe’s banks invested in our subprime mortgage-backed securities, and suffered great losses.  But they are now faced with the $4.5 Trillion that they have lent to various emerging-market countries, businesses, and consumers.

And, Mauldin’s piece only looks at the large European commercial banks.  It doesn’t look at the slightly smaller banks, like Swedbank of Sweden which did all those loans in Latvia.  It also doesn’t include the regional banks within a country (e.g. the Landesbanks in Germany, and the Building Societies in the UK) that are also in trouble.

I don’t know how the story will end.  In the early 1980’s, we had the Latin American Debt Crisis.  Commercial banks lent these countries billions, which they could not pay back.  If the banks had valued the debt as to what it was then worth, our large commercial banks would have been insolvent.  Instead, the Feds blinked, and allowed the inherent profitability of the banking model to work its magic, and they wrote down/off the loans over time.

So, perhaps, this scenario will play out the same way.  Or not.

Market: The Intel Rally

I wrote last week:

. . . since May 4^th, as measured by the S&P500 index, the stock market has been in a trading range of 880 to 950, testing the limits at both ends several times.  Before the last week, the lowest close was 883 on May 15^th.  On Monday, July 7^th, the S&P500 closed just below this low, 881.  And, we are now at 879.  So, this is not a convincing break of the trading range, …

Last week, the market had a great rally and is now back to the upper end of its trading range at 940, thanks in large part to Intel’s earning report.

Lowry’s conventional-short and intermediate term indicators are still at a Sell.  On Monday, July 13^th, Lowry’s more-volatile traders-short-term indicator switched to a Buy.  Lowry still sees this as a bear market rally.

I received an excellent article by Mauldin last Saturday on Japan (click on Buddy, Can You Spare $5 Trillion? for the PDF).  Suggest you read, or at least look at the charts.  Here is an excerpt:

Japan’s population is shrinking, and the number of workers per retiree is rising. Japan has the highest ratio of debt to GDP in the developed world. And that debt is growing by 7-8% a year, and does not include local debt. Interest rates cannot go lower. Savings are falling rapidly and will not be able to cover the need for new debt issuance, by a long shot. Within a few years, because of the aging of the population, savings will go negative. Social security payments are rising. GDP is shrinking, and export trade is off about 30-40%, depending on the industry. Machine tools are down 80%!

If rates were to go up by 1%, let alone 2%, over time Japan’s percentage of tax revenue dedicated to interest payments would double to 18% and then to 40% and then just keep going up. It is conceivable that it will take 100% of tax revenues in less than ten years, at the current trajectory. Why? Because Japan is going to have to start to compete with the rest of the world to sell its bonds. Who but the Japanese would buy a Japanese bond at 1.3%? From a country that is rapidly going to 200% of debt-to-GDP? Doesn’t really seem like a smart trade to me. And as the data shows, the ability of the Japanese consumer to buy more debt is rapidly waning.

Intel Update.  Everyone knew that Intel was going to beat analysts’ Q2 earnings estimates.  The surprising part was the guidance for the rest of the year.  I thought that Intel would be more cautious in its guidance – it wasn’t.  So, the analysts upped their 2010 earnings estimate.  Most have a 12-month price target of 18 to 20 times their 2010 earnings/shr.  Most estimates are at ~$1/shr.  By this measure, Intel stock is already at its “fair/full” value.  Merrill (Sumit Dhanda) and Wells Fargo (David Wong) are at $1.25/shr.  Assuming a modest worldwide economic recovery in 2010, Intel is likely to earn more than any of these estimates (~$1.50/shr), and will likely approach the high-end of its normal PE range (20-22).  So, we could see $30-$33/shr within the next 12 months.  However, I don’t think analysts will see this and up their estimates for another 6 months.  So, given the run-up in Intel over the last week, the stock is likely to trade in line with the market (perhaps, between $17 and $20 per share).  I hope to get a blog post out this week on my reasoning.  Until then, you can check my previous PGR posts on my June 2^nd PGR talk.

The headline and story of the week is from Andy Borowitz: Goldman Sachs in Talks to Acquire Treasury Department (click to read).

Market: Stuck in the Middle with You

Mid-week, we drove from the Berkshires to Boston.  I finally had the time to finish a Tech blog entry (Tech: PGR Presentation – 2c).  Back home in Miami Beach Sunday night.  Over the last few weeks, it’s been nice to get away from the heat/humidity.

No change in my stock market view: neutral/cautious, and leaning bearish.

Since May 4^th, as measured by the S&P500 index, the stock market has been in a trading range of 880 to 950, testing the limits at both ends several times.  We are now in the middle.  And, I certainly can’t tell whether the market is likely to break out of this range on the upside or downside.

Minor change in Lowry (technical perspective). It is still at an intermediate term Buy, from May 4^th, and a short-term conventional Sell since May 12^th.  The more volatile of their 2 short-term indicators went to a Buy after the close on Friday, June 26th. Lowry’s intermediate term indicator came very close to switching to a Sell after Monday’s fall, but didn’t, and then improved.  It would need a couple of solid down days from current levels to switch to a Sell.  As Lowry continues to note, the patterns in Selling Pressure and Buying Power are different from all the new bull markets that they have seen in their 76 year history.  So the odds favor a continuing Bear Market.

Given Lowry’s track record to bet against them, one would have to posture a reason for this time being different.  Is it?  Possibly.  Unlike the past, we have several ETFs that play the short side, and some with 2X and 3X leverage.  For example, the Financial Bear 3X ETF (FAZ) invests in short-instruments of Financial stocks (eg commercial and investment banks) with 3X leverage.  Theoretically, if this basket of stocks drops by 50%, and you bought FAZ, the value of your FAZ stock would triple.  And the reverse is true – from the March lows to yesterday, FAZ has dropped from $104/share to $4.73/share.  Do people invest in these kind of ETFs?  Yes.  The average daily volume of FAZ over the last 10-days is 201 million shares.

So these Leveraged ETFs (there are both Long and Short versions) are a relatively new bit of Financial Engineering, and regulations have not caught up.  In a Cash account (vs. a margin account), eg an IRA account, you cannot buy on margin and you cannot short a stock.  But you can buy these leveraged ETFs – both the long and short varieties.  And, for margin accounts, many of these ETFs can be bought on margin so that you can further increase your leverage.  On top of that, some of these leveraged ETFs have options on them.

Isn’t Financial Engineering wonderful?!  Almost as much fun as Computer Engineering!  Of course, the latter enabled the former.  Go figure!

In any case, these leveraged ETFs, as well as many other financial engineered creations employed by investment banks (e.g. Goldman Sachs) and hedge funds, could be skewing the Lowry’s stock market data, and possibly making Lowry’s analysis invalid.

But more importantly, these new creations might be ticking time bomb – potentially, a WMD.

Mauldin continues on his theme, “This time It’s Different”.  As in most cases, it is an interesting read.  Here is a link to the PDF:  The End of the Recession?.

For a more bullish view of the economy, and thus the stock market, check out Larry Kanter’s interview by Tom Keene (Bloomberg on the Ecomomy): “June 25 (Bloomberg) — Larry Kantor, head of research at Barclays Capital Inc., talks with Bloomberg’s Tom Keene about U.S. GDP, the increased savings rate, Federal Reserve policy and the global economy.”  Here is a link to the MP3 audio file: http://media.bloomberg.com/bb/avfile/Economics/On_Economy/vD5Lfmk9D4FM.mp3

For other Tom Keene interviews and to subscribe to the free podcast (which I do): http://www.bloomberg.com/tvradio/podcast/ontheeconomy.html. You will also see an interview with Nouriel Roubini there, which will give you the opposite view of Kanter.

“Even if you stacked all economists end-to-end, they still couldn’t reach a conclusion.”

Latvia. It seems the EU/IMF has not yet made a decision.

Market: A Bit More Bearish

Still up in the Berkshires.  So busy doing fun stuff: hiking, biking, kayaking, canoeing, jogging, strength-training, Pilates, eating great healthy food, etc.  So, I haven’t had the time to add to my Tech blog entries about Intel/AMD.

Although I remain neutral and cautious on the stock market, I am increasingly “leaning” to the bearish side.  But with a week to go in the quarter and the anticipation of better Q2 earnings than current estimates, the short-term downside risk seems low.

Before getting into Lowry and Mauldin, I will explain my confusion.  The normal course of events in a recession is bad economic indicators, then less bad ones, and finally good/great ones coming out of the recession.  We are definitely in the “less bad” state (in today’s times referred to as green shoots), and, in such times in the past, the stock market recovers since a robust economic recovery must be just around the corner.  In this phase of the stock market, there are always a lot of “new bull market” deniers.  It is easy to do, because almost all the economic indicators are still going down.

So, if the post-WWII recession scenario holds, we are in a new Bull Market.  But is this time different?  Back in mid-February, I wrote:

Although we have had deep recessions, eg 1974, I think that we will look back on this time and characterize it as a Worldwide Depression.  In the US, it will not be as bad (or even in the same ballpark) as the “Great Depression”.

We have the combination of a weak worldwide economy, deflation, and a sick financial system that is in the process of deleveraging.  The parallels that we face are not the US post-WWII recessions, but rather the Great Depression and the Japanese experience in the 1990’s.  But it is unlikely that our future will be as bad as either of these.  The bottom-line is that our recovery will be slow, and will have many bumps.

In this context, the stock market is ahead of itself.  It is operating on the premise that we are following a normal recession pattern.  We are not.

Minor change in Lowry (technical perspective). It is still at an intermediate term Buy, from May 4^th, and a short-term conventional Sell since May 12^th.  The more volatile of their 2 short-term indicators went to a Sell on June 15^th. Lowry’s intermediate term indicator is getting closer to switching to a Sell – it would need a couple of solid down days.  As Lowry notes, the patterns in Selling Pressure and Buying Power are different from all the new bull markets that they have seen in their 76 year history.

Mauldin has just started a new multi-week theme, “This time It’s Different”.  As in most cases, it is an interesting read.  Here is a link to the PDF:  This Time It’s Different.

For a more wonkish, bearish view of the US financial system, check-out Martin Weiss’s observations: New, Hard Evidence of Continuing Debt Collapse!.  And, then there is saga of Latvia and its ties with the Swedish banks.  But since the EU/IMF is about to bail-out Latvia this week, I’ll update in a few days.  I think of Latvia as “the canary in the coal mine” for Europe.

Market: Marginally Better; Housing, German Banks, Not

We got back from Italy on Monday.  But I have been busy prepping for a talk – see below.

Lowry (technical perspective) is still at an intermediate term Buy, from May 4^th, and a short-term conventional Sell since May 12^th.  However, after Friday’s close, the more volatile of their 2 short-term indicators went to a buy.  Lowry has become a bit less bearish than from recent weeks.

Mauldin (click to read) continues in the bearish camp.    In this week’s report, he covers 3 interesting areas: the danger/implication of the long-term Federal Budget deficit; the continuing seriousness of the US housing problem; and, a couple of the advantages of the US healthcare system vs. Canada/US.  I don’t share his views on the deficit and healthcare (but too busy now to offer the counter arguments), but I completely agree with him on housing, e.g. we are likely to continue to see price declines for about the next 18 months.  If you have just a few minutes, click on the Mauldin link above, and scroll down to just read the graphs.

A very long wonkish article on the German banks can be found here:  Germany’s Subprime Crisis. Here is my very short simplistic synopsis of one aspect of the problem.  The Landesbanks in Germany are owned/controlled by the local/regions (states) within Germany.  Starting around 2001, they starting issuing a lot of debt, guaranteed by the German government.  Did they use the proceeds to loan to German citizens and businesses? Nope.  They bought securities sold by the investment bankers in NYC and London, i.e. RMBS, CDOs, CLOs, etc.  And, they tucked a lot of these toxic securities off in conduits and SIVs, i.e. off-balance sheet activities.  To make matters even more interesting, in previous years, some local states used the “profits” of these banks to fund as much as 50% of their local budgets.  And, now there are no profits.  Some estimates put the total losses at 10% of Germany’s GDP.  Due to the incestuous relationship between the Landesbanks and the politicians, a lot of this remains hidden.

I remain neutral and cautious.

About 1 month ago, I agreed to do a keynote at a small (I think) half-day conference on June 2^nd in NYC for institutional  investors:  Technology Investment: Primary Global Perspectives, and the agenda.  So, I have busy since being back, preparing foils for my talk, catching up on mail, and recovering from jetlag.

Market: No Change

Iris and I are still in Italy, but are returning tomorrow (Monday).  If curious, you can see all of our photos:  Italy May 2009.  You can also see my new Italian invention here:  Gelato detection finder.

Lowry (technical perspective) is still at an intermediate term Buy, from May 4^th, and a short-term Sell since May 12^th.  Selling pressure would now need to increase by 10 points to switch the intermediate term to a  Sell (versus the 6 points needed 1 week ago).  Lowry still thinks that it is most likely that we are in a bear market rally from the March lows.

Mauldin (click to read) continues in the bearish camp.    In this week’s report, he describes some of the key reasons why the European banks are in worse shape than ours, and why many of the European economies are also in worse shape.

Over the last several issues, Mauldin has made a big deal of the US Federal Budget deficit projections over the next 8 to 10 years.  Although I agree that this is something to worry about, consider the patient whose doctor 1^st tells him that unless his cancer treatments are successful, he will die in 18 months.  The doctor next tells the patient that unless he loses 50 pounds, changes his diet, and starts exercising, he might die of a heart attack in the next 10 years.

So, until we can be sure that the patient (the world economy) is recovering from its financial cancer, I won’t worry too much of what needs to be done to assure the longer term health of the US and world economies.

I remain neutral and cautious.

Market: Caution

This posting is a bit late since Iris and I are now in Italy, and have been for the last 12 days.  If curious, you can see some of our photos:  Italy May 2009

Lowry (technical perspective) is still at an intermediate term Buy, from May 4th.  But they went to a short-term Sell after the close of May 12^th.  Also, if the selling pressure falls 6 more points, the intermediate term Buy (also, of May 4^th) will be reversed to a Sell.  A significantly weak trading day would do the trick.  Such a quick reversal in the intermediate term indicator would have major significance.  Such a reversal is not unusual for a rally within a bear market, but is practically nonexistent for the beginning of a new bull market.  On the other hand, Monday is starting out as a strong day, so who knows.

Mauldin (click to read) continues in the bearish camp.    As Mauldin notes, and you have probably heard, unemployment is a lagging indicator, i.e. the recovery will be occurring well before we see bottom in the jobs market.  But this recession may be different.  Mauldin has an excerpt from a Bridgewater report:

“Normally, labor markets lag the economy because incremental spending transactions are financed via debt, stimulated by interest rate cuts. But as long as credit remains frozen, spending will require income, and income comes from jobs. And debt service payments are made out of income. Therefore, in a deleveraging environment job growth becomes an important leading, causal indicator of demand and other economic conditions.

“… The bounce in the economy and the stabilization in markets reflect government actions that are big enough to impact near-term growth rates, but are not sufficiently directed at the root problem of excessive indebtedness to produce permanent healing. The deterioration in employment markets will continue because companies’ profit margins are so deeply damaged that a little bounce in growth won’t do much to alter their need to cut costs. This deterioration in labor markets will undermine demand and continue to pressure loan losses, which will keep the pressure on the banks and elevate the cost of capital for tentative borrowers, inhibiting credit expansion.”.

And from Mauldin, on the above: “This again illustrates the problem of using past performance to project future results. You have to look at the underlying conditions in order to get a real comparison, and we have not seen a deleveraging recession in the US for 80 years.”

On the other hand, credit does seem to be easing lately with several companies able to raise funds in the bond market.

I am neutral and cautious for now.

May is the best time of the year to visit southern Tuscany, and, we are enjoying the pasta, vino, and gelato of Italy, perhaps a little too much.

Market: Inflated Frogs

From W.S. Gilbert’s lyrics in the H.M.S. Pinafore, “Things are seldom what they seem, skim milk masquerades as cream.”  This has stuck with me since my freshman year in college, and is the theme for this week’s market post.  But when I looked it up on the internet to get the source, which I always forget, I came across the 2^nd stanza, which seems particularly applicable:

Black sheep dwell in every fold;
All that glitters is not gold;
Storks turn out to be but logs;
Bulls are but inflated frogs.

As mentioned in my entry on Monday, Market: Kissing a Pig, Lowry (technical perspective) went to an intermediate term Buy.  But such a signal indicates to commit 20% of available funds to the long side, and then with each further 10pt drop of selling pressure to commit an additional 20%.  Since Monday’s close, selling pressure has actually risen 3 points.

For various reasons, Lowry still thinks that the rally since March 9^th will eventually be proven to be a rally within a bear market, and not a new bull market.

Mauldin (click to read) is also in the bearish camp.  This week he has an interesting analysis of the monthly employment report that came out on Friday, and that most embraced positively.  Here are a few excerpts:

According to the survey, headline unemployment rose 0.4% to 8.9%, the highest level since 1983. But if you count those who are working part-time but want full-time work, as well as the “marginally attached,” the unemployment rate (called the U-6 rate) is an ugly 15.8%.

For whatever reason, the markets were happy that the headline number of the other BLS survey, the establishment survey of lost jobs, was “only” 539,000, down from a negatively revised 699,000 in March. At least, the thinking was, the numbers were not getting worse, though it is hard for me to be encouraged by half a million lost jobs. That may not be the worst of it, however, since 66,000 jobs were temporary workers hired for the 2010 census, and the BLS estimated that the birth-death ratio added 226,000 jobs as a result of new business creation. Really? This will mean that there will likely be a major revision downward at some future point. The number will likely be well over 600,000 in the final analysis.

As the realization that the economy is not due for a robust recovery sinks in, I think the chances for another serious bear market test of the stock market lows will become increasingly high. As David Rosenberg said in his final memo from Merrill Lynch (and good luck to him in his new position, where I hope we all still get to read his very solid analysis!), if a few weeks ago someone had said you could sell all your stocks 40% higher, most of you would have hit that bid. Now that price has in fact been bid. Do you want to gamble on a renewed bull run in the face of a continually shrinking economy? I suggest you give it some serious thought, or at least put in some very real stop-loss protection.

So, watch out for those inflated frogs.  I continue to err on the side of caution, and did a little more hedging of long positions this week.