Thursday, October 15, 2009

The '500' Fills the Gap

While many individual stocks look reasonably valued on a price-earnings basis, the market as a whole is looking more and more tired and more and more like a "sell" rather than a venue for gamblers.
The chart nearby (click on to enlarge) shows the S&P 500 for the past two years. It has now filled the gap around 100 created when things began to implode late in September.

Not shown is that the index is slightly more than 20% above its 200 day moving average. On the one hand, this reflects the dramatic turnaround in corporate profits. Teleologically, companies cut back inventory "too much", especially in view of all the government stimulative measures. Worse, companies cut back staff and are reluctant to hire; though, they will eventually hire if profits hold up.
Moving on, the VIX, an index that reflects actual or feared volatility and in practice correlates with the perceived trend of stock prices, has collapsed 25% from about 28 to about 21 in only two weeks. This is a large decline in a short time. In the rally since March, this situation has either been followed by a correction in stock prices or some stability in prices offset by a rise in the VIX (a rising VIX means rising volatility, and generally reflects bearish sentiment). Of course, past performance doesn't predict future . . . you know the rest. But it's nice to have precedent on your side.
From a technical standpoint, the financials, which led this rally, lagged today even as a bullish event happened over the past two days, which is a significant widening in the 2-10 year Treasury spread. Higher quality, boring stocks that have not participated in the rally began to participate, such as MCD and GSK. Might the fast money be "tired of" financials?
Nokia before the opening and IBM after the close each saw their stocks fall on bad news, which is what happens in an average market. Meanwhile, Intel had a legitimate beat-and-raise and the stock did not do much, even though it is depressed on a 2-year basis. And Alcoa, with a less impressive earnings beat, has also done little since an exuberant day; in fact it has trended down over the past week. So, under cover of rising averages, we are seeing lots of new 12-month highs, little but rising earnings estimates, and other bull market action, but evidence of fatigue.
What happens in a wild bull market is that you see stocks trading way above their 200 day moving averages. We are seeing this. When these stocks have the worst fundamentals, many prudent investors simply stand back. MU and AMD are two of many examples. Not counting its recent minor drop, GS is about 40% above its moving average and is quite the momentum stock these days. Meanwhile, there has been nearly zero corporate insider buying for several months. These guys are almost always right, though with a lag.
These sorts of stocks, even if the fundamentals are strong, have so much profit in them that in a normal bull market, one not fueled by short covering or hot money, that they move up more slowly.
Eventually, financial markets are weighing machines. The weights comprise return of capital or dividend payouts. A rising stock price for 2 decades did AIG shareholders no good when it went near zero, given the lack of meaningful dividend payouts along the way. With the S&P 500 once again yielding more or less exactly 2.0%, and with old Wall Street hand remembering when a normal (wide) fluctuating range of dividend yields was 3% at bull market tops and 6% at bear market bottoms, what we are seeing is levitation ahead of proven fundamentals.
Unfortunately, indicators such as's polling shows that consumer spending has not risen at all.
Based on 14-day averages of responses to smooth out weekend and other variations, Gallup found that in May 2008, consumers spent as much as $112/day above and beyond fixed costs such as mortgages (!).
Two months ago, that had rebounded from below $60/day to as high as $72 (Aug. 18). The index has dropped back to $60. Where are the money printers when we need them?
The same polling continues to detect no net hiring, which has been quite accurate in predicting the BLS monthly data. Employment is almost undoubtedly shrinking at a significant pace, and initial unemployment claims are probably understating the case due to reluctance of large and small companies to hire. And when they can hire overseas, they are doing so. There are no healthcare benefits and few if any payroll taxes in China!
The 10-year Treasury yield is back to 3.47% at a time when the CPI is negative and rents are falling for the first time in 17 years. The real yield is very high. As the peak momentum of the economic move off the bottom inevitably arrives--some week-- measured in various ways--it is likely that the media will start talking of a growth slowdown. Not only are Treasuries a buy for real return, if you ask virtually anyone which asset class will provide a better return over, say, two years or ten years, choosing between stocks, gold and Treasuries, how many people do you know who will say Treasuries? (I would also suspect that if people were asked to choose between all cash for 10 years vs. a 10-year Treasury, most people would take cash over a 3.47% annual yield.)
Gold was down on a day when oil surged. This smacks of profit-taking, given that the dollar was unchanged against a basket of other currencies.
The stock averages look vulnerable here, and many individual issues probably are more likely to drop than rise. However, the boring stocks such as MCD, GSK and WMT that have done little or nothing since March could rise even if the averages have what might be a pause that refreshes a/k/a a correction.
In a confusing world in which the financial crisis remains unresolved, yours truly remains long government securities, dividend stocks with strong long-term charts, gold and cash. Dynamic it's not. But given an outperformance over stocks by 40% last year by being in bonds and cash and out of stocks, I don't feel that aggressiveness is needed right now. Avoiding losses and investing for income and/or capital gains when they appear low risk is the DoctoRx watchword in managing money.
NOTE: Nothing said herein is investment advice for any individual. Econblog Review and DoctoRx are NOT professional money managers.
Copyright (C) Long Lake LLC 2009

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