Weekly Market Comments (October 11, 2010)

I was having a recent conversation with a well respected lawyer and very intelligent investor in my community (his specialty is timber- which is in a bit of a recession itself). After some pretty good discussion on a range of topics he asked me the obvious question- why is the stock market up?

I gave him the obligatory answers someone in my position is expected to give and off we went onto the next topic. However, this time that question stuck with me. Why was the stock market rallying?

Was it all the jobs being created in the economy…. nope.

Was it the slew of clearly positive data during this week’s economic reporting calendar let’s see:

  • Factory Orders shrank by -.5%
  • Chain Store Sales shrank by -.8%
  • The ISM Non-Manufacturing showed some strength.
  • Revolving Credit balances shrank which is good for balance sheets but not good for consumption, while Non-Revolving credit balances grew demonstrating that lower interest rates are having a positive impact of larger purchases like vehicles.
  • The work force shrank again losing another 95,000 jobs but the private sector added 65,000 yet the Unemployment rate held steady at 9.6%.
  • Bookings for non-military capital goods excluding planes increased 5.1 percent, the biggest gain since March.
  • The number of contracts to buy previously owned houses rose 4.3 percent, topping the median forecast of economists surveyed by Bloomberg News, data from the National Association of Realtors showed.

Well it looks like a mixed bag of data so that can't be driving the markets

Was it Warren Buffett's comments this week? He announced this week that his Berkshire companies are "coming back" and when asked about his outlook on equity markets he said investors buying bonds after yields fell this year "are making a mistake." He went on to say, “It’s quite clear that stocks are cheaper than bonds, I can’t imagine anyone having bonds in their portfolio when they can own equities.”….Perhaps?

How about Goldman Sachs, the pillar of social justice and their outlook for our economy?

They lowered their outlook for next year's GDP growth to 1.5% to 2% saying the economy could be "fairly bad to very bad" for the next six to nine months… That can't be why the markets are rallying.

Could it be investors looking at the third year effect that I posted on twitter that moved the markets? Since I only have 43 followers I don't think so but the data is outstanding and you can find it on Twitter @PHCOAdvisors (Article: http://yhoo.it/cSwojJ). The article simply suggests that markets rally a lot when there is gridlock in the 3rd year of a Presidential Cycle, something to the tune of 16% to 21%.

So what is it? My conclusion is twofold:

Major market participants have already discounted a pretty tough start to next year. They have also discounted a pretty difficult earnings season we are entering into. My belief is that the season will have more surprises to the upside due to the fact so many analysts guiding down over the last few weeks.

Second is all this talk of QE2. QE2 is not a ship. What all the noise this last week was about is Quantitative Easing being considered by the fed. Simply put the Fed will resume buying treasuries and other interest rate instruments. The thinking goes something like this: when the Fed buys these financial vehicles it will put liquidity into debt markets and support business and consumer credit.

The hope is consumption and investment = Jobs, wages and profits which equals more consumption and more investment

Here's a slight wrinkle in the Fed's thinking. They might be assuming it's the supply of money (lending) that's the problem. What if it's the demand for money? My thinking suggests it might be that most business (small and mid size) are not saying their business is bigger than the debt they can take on or at least the debt service they would take on.

So the capital markets are rallying and that's a good thing. Anything can happen in the equity markets and it usually does.

The labor markets are still shrinking and that's bad.

Someone or some company will need to breach the supply for money and demand for money void and make a move to grow. Animal Spirits (Keynes) will need to kick in and the profit motive will move some smart CEO or Company to make a move to grow.

While all of this goes on I continue to find relevant themes to invest.

  • I'm still focused on yield, yield, yield. Select corporate bonds that can provide the appropriate yield with the right controlled risks.
  • I especially like the Mega Cap US based export driven companies with a continuing weak dollar theme.
  • Of course the iPad that I'm writing this post on right now, and other tablet PCs, promise to provide a nice segment of companies to invest in. This is also another theme I would consider.
  • Don't forget Media (both print and on-line)
  • With all the trade war talk between China and Japan the Rare Earth space also seems to be heating up.

In the mean time, the capital market can continue to rally and labor market can continue to suffer but at some point one has to support the other.

Tim Phillips, CEO