This is normally an off week for our piece, but because of the events of this past week we felt it might be a good idea to share some thoughts. Violent protests in Greece regarding austerity measures, fear of Portugal, Spain, and others including the U.S. to possibly domino similarly, and what appears to be a technology black swan set the stage for a one day drop in stock prices that made history. All this only to have Monday bring a sigh of relief 400 point Dow rally since it only takes a trillion dollars to solve last weeks problems.
Another in a series of coincidences occurred last week regarding my missive and what occurred in the market last Thursday. We had covered the topic of High Frequency Trading and how the firms that employed the strategy had an distinct advantage over the majority of investors and especially Main Street type investors. Lo and behold it appears HFT was part of the “glitch” that caused the Dow to be off nearly 1000 points at one point Thursday.
We do not understand how Washington and the regulators let these types of situations unfold. Like Wall Street really needs another advantage over us? Especially one that potentially compromises the function of the markets? We do not want to get started on that as it is not the point of this letter. We are confident we will write more about the topic in the future and hopefully it will cover the terrific job our policy makers have done in leveling the playing field for those who are not the Wall St. privileged.
Today we want to cover the stock market itself, the quick transition of complacency to fear that has unfolded and what that might mean moving forward. We have been in the camp that has not trusted this rally of the last year. We felt the fissures in the financial system, the burgeoning debt issues, and the wounded real estate market would create enough fear to mute any advance stocks could muster. WRONG! So far the strategy to buy all the toxic loans, re-inflate assets, and stimulate the economy has unfolded pretty well. The final, most important task is to shift the manufactured stimulus to an organic recovery (private sector dominating economic growth) and maybe we have the seeds of a Secular Bull?
A bona fide economic recovery could possibly heal the long term ills the credit and real estate bubbles inflicted. We have to give credit to Fed head Ben Bernanke and the Obama administration for getting the strategy to work this far. We do not believe the economy will have the momentum to overcome the growing deficits and unfunded liabilities that will be garnering more and more headlines as this decade develops. The probable outcome of austerity is a tough pill to swallow, just ask your Greek friends. What we think might surprise some is the unintended consequence the European bailout may have for the US. When uncertainty leads to volatility money often flows to more stable vehicles. When stocks were falling last week, bonds were mirroring the move to the upside (we sat spellbound for twenty minutes). Money was flowing freely out of the US dollar for most of last year as many thought the best days of the US economy might be behind us. Many foreigners spoke critically of the debts we are amassing.
Below is a chart of the US dollar going back to early last year and you can see the drop that got you to $20 for a Big Mac when you travelled abroad.
The move from the November lows has been very constructive and appears to want to move higher. Below is the Index of the Euro and you can see they have a strong inverse relationship.
The announced trillion dollar rescue package has shifted the fear of untenable deficits from the US to the Eurozone. We think most of the world feels when push comes to shove we have the more powerful printing press at our disposal. If the continued strength in our currency attracts funds and investments from those who are nervous about the weakness in the Euro and the European economy in general, those fund flows could enhance the traction of our economic recovery. In the coming months there is a possibility that both our bond and equity markets could be beneficiaries of a more Spartan Europe. Austerity plans usually don’t ignite GDP and if the rest of Europe responds the way Greece did to the terms of their restructuring, a period of prolonged anemic growth could grip the entire region.
That leaves the US with a stock market that has still a relatively constructive technical look to it, lean and mean corporate inventories and balance sheets, a sentiment level that is more fear oriented than complacent of a couple of weeks ago, an economy gaining traction, and now foreign investment eyeing our markets. This is a tried and true recipe that may lead to the next leg of the bull market. A few months ago we could not have imagined myself writing these words, but arguing with the market is rarely productive and we could not see the strategy working as well as it has.
One other factor that we think probably makes a new 52 week high sometime this summer is the upcoming midterm elections. An incumbent administration has historically been know to prime the economy for presidential elections, that is why the third and fourth year of the Presidential Cycle has regularly provided outsized stock market gains. With what is at stake this November we imagine this administration will pull out all stops to produce strong economic numbers and a buoyant equity market during this campaign period. The Plunge Protection Team is an important component in a President’s tool box and this administration has seemingly been effective with these instruments.
Obviously there are headwinds; we just entered the poor time of the year for stocks (Sell in May and go away), maybe the market does look out further than a year and see the impact growing debt has on the economy, the situation in Europe gains momentum, the recovery in China is revealed to be more manufactured than even its strongest critics are suggesting, and that unsightly technical break last week evolves into more than a flesh wound. As usual there are reasons to be bullish and bearish.
We are thinking the acknowledgement by the stock market regarding the levels of debt worldwide will not play out until after the elections or into next year. The scary sell off last Thursday and in 2008 we believe are now part of the investment landscape and needs to be considered when constructing a portfolio. Secular Bear markets are usually not effective for a Buy and Hold strategy as they do not employ an effective Sell Discipline.
Our take right now is that many who have missed the persistent upside of late are saying “See we told you so” after last week (righteousness is such a good thing). If you are one of them as we was prior to March it might be worth your while to watch the action this next week closely. After similar Greek headlines in January led to a scary sell off, the recovery in mid-to-late February was relatively quick and led to new highs. We believe we could have a replay with another rally worth participating in. Just a thought, but having an eye on the exits is always a good thing in markets like this.
Did You Know
S&P 500 Trivia - The trailing 5-year performance of the S&P 500 as of 4/30/10 is a gain of +2.6% per year (total return). The trailing 50-year performance of the S&P 500 as of 12/31/09 is a gain of +9.4% per year (total return). Between 3/24/00 and 10/09/02, the S&P 500 fell by 49.1% (change of the raw index not counting the impact of dividends). The 30½ month downturn was the lMarket Selloff: 2008 Revisited Or Opportunityongest running bear market of the last half century. The trailing 5-year performance of the S&P 500 as of 3/31/00 was a gain of +26.8% per year on a total return basis. Between 10/09/02 and 10/09/07, the S&P 500 rose by +101.5% (change of the raw index not counting the impact of dividends) during a 5-year bull market. The trailing 5-year performance of the S&P 500 as of 9/30/02 was a loss of 1.6% per year on a total return basis. Thought you might want to know. (source; BTN Research)
Final Thought
“Never trust a computer you can't throw out a window” - Steve Wozniak
No comments:
Post a Comment