Tuesday Markets Update

This will be a brief comment, and postings will be diminished over the next several days due to travel and other annoyances.

Yesterday indeed proved to be manic in that stocks and bonds rose strongly in price, but gold rose more and the more speculative metals that I recently highlighted as having more upside potential than gold rose more.

Today, the strength in bonds continues, and I wonder if my hypothesis that the market is going to correct so that a more traditional relationship between stock dividend yields and Treasury bond yields re-establishes itself.

If they merely get back to the level of equality that was never seen before about 1960, consider that the S&P 500 yields under 2% (depends how you measure) and the 10-year Treasury yields whatever it is yielding when you read this- say 3.4%. Now, corporate dividend yields can in fact rise a lot if companies cease buying back shares and if some dividendlesss companies start paying dividends, but Treasury rates are historically low.

I almost invested in the Japan stock market a couple of years ago at much higher prices because even then, stock dividend yields were greater than bond yields. You never know, in other words. But I hate to bet against reversion to the mean.

In other words, business conditions may improve, but fundamentally there is a great deal of risk in the stock market. When rates are unnaturally low, high P/E's and very low dividend yields look OK; but the rates are low only because the economy is so weak, so that's ultimately a flimsy crutch for valuations. If rates rise a lot, dividends lag and then the disparity favoring bonds over stocks becomes tilted more against stocks.

Now, stocks are nowhere nearly as overpriced as at their all-time (possibly) overpriced peak about a decade ago. But that's not saying much. The technical action still favors precious metals, and you don't give up much current yield by owning them.

Copyright (C) Long Lake LLC 2009

Here are several economic-financial related charts and other data presentations. The first shows the current unemployment rate as compared to the (recently-derived) "baseline" case and "more adverse" (low probability event, allegedly, according to the Fed) for the national unemployment rate.

Whoops!

Here's another example of forecasters getting it very wrong, and recently, from the Philadelphia Fed:

First Quarter 2009 Survey of Professional Forecasters
Release Date: February 13, 2009 (click on the hyperlink, then click on "First Quarter 2009):

An upward revision to the forecast for the unemployment rate accompanies the outlook for economic growth. The forecasters predict that unemployment will rise from 7.8 percent this quarter to 8.9 percent in the fourth quarter of 2009. Previously, unemployment was forecast to rise from 7.0 percent to 7.7 percent over the same period. Unemployment is expected to average 8.4 percent this year and 8.8 percent in 2010. On the jobs front, the forecasters project job losses in the current quarter at a rate of 548,400 per month. They also see a reduction in jobs of 311,200 per month in the second quarter and 202,100 in the third quarter of 2009.

Both of the above were found at Mish's post from today.

Let us examine the facts. Also thanks to CR, consider Regulators Eye Pay Czar:

A Bankrate Inc. survey also released today showed 70% of survey respondents said they felt secure in their jobs despite the rising joblessness. Of those remaining at their jobs, 54% responded they’d received some sort of pay reduction: pay cut, reduced hours, reduced work days, suspended raises, bonuses or 401K match, or a combination of these.

So, the unemployment rate and pace of job losses are well above those projected just four months ago. Deflation in job benefits is proceeding. There is no inflation except in commodities, which are speculative.

Those seers such as Nouriel Roubini and Mish who stated in Q1 2009 that the economy would underperform the consensus forecast have been proven correct. The public is now probably more optimistic than the facts support. Others such as Robert Prechter and Paul Lamont who two or more years ago foresaw the recent, ongoing severe "debt deflation" and then a stock market pop upward beginning a few months ago are fearing a major new stock market downturn, perhaps after more optimism pushes stock prices up higher.

Amongst stocks, there are some that do not reflect the horrible bear market. Here are two charts that reflect successful businesses.

That the price of a security has fallen does not tell you that it has fallen too far. On the other hand, a security that has resisted the fall of most others tells you a lot. If its price has risen consistently over the years and has other fundamental characteristics that you like, it is not determinative as to whether one wants to own that security whether the prices of other securities are attractive.

Right now, the stocks of large consolidators such as Teva (generic pharmaceuticals) and deep discounters such as Ross Stores (clothing), the long term price charts of which are shown above, reflect businesses that are thriving and can continue to grow long-term in any economic environment (excluding complete and utter devastation). They pay dividends equal to money in the bank and have low double-digit price-earnings ratios. While their stock prices will certainly fall if the stock market makes new lows, over a full economic cycle, they are likely to be profitable investments and provide a different sort of hedge from inflation than gold.

Finally, regarding gold, I have previously commented on it as unexciting from a chart pattern. If an increasing percentage of the public remains sold on a Goldilocks scenario and continues to pay rising prices for risky assets, then the price of the perceived safe haven of gold is likely to suffer.

Short term, gold is unexciting at best.

Meanwhile, sentiment remains horrible or even beyond horrible for intermediate to long-term U. S. Treasury bonds. Yet a Goldilocks scenario for stocks has to imply diminishing counter-cyclical deficit spending and acceptable inflation, and thus cannot mean a durable bear market for Treasuries soon.

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Land of the Rising Sun Going Our Way?

For those interested in the prosperous but no-longer fast-growing (!) country of Japan, an interesting set of posts has appeared in the Asia-Pacific Journal. The articles cover Japanese electoral and economic policies. Given the view here that the U.S. situation has a number of parallels with post-bubble Japan, it may be worthwhile to click on the above link. The related posts, one following the other, are not technical.  They relate both to the recently-passed "stimulus" bill in the U.S. and to a lesser degree to the issues related to the troubled money-center banks here.

Some of the same central planning-type thinking that is common here is debated in Japan, as the posts say:

" . . . Japanese authorities are once again stuck trying to stimulate aggregate demand."

And,

"So wrote Paul Krugman in his 1998 analysis of Japan's prolonged economic crisis, in which he argued that to escape its liquidity trap, it was necessary for "the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs.'"

DoctoRx here: The merchants of debt, growth at any costs crowd, and inflationistas cannot stand a slow-growth but stable, prosperous and peaceful society that Japan has been for decades.

Japan is a very prosperous country.   People live a long time there.  Unemployment has been low.  However, there is little in-migration and the population is aging.  There is no point in depleting savings in an aging society. It is arguably better to live in a country where one earns 1% year on a 10-year Government bond when prices fall 1% a year than to live in a country that lives beyond its means.

The advice from balmy Florida to the Japanese is the following:

You have had a good thing going. Don't screw it up and print more and more money to try to persuade a nation of cautious savers to emulate spendthrift Americans.

Copyright (C) Long Lake LLC 2009

Not Lovin' It Cause They're Still Doin' It

STOCKS

The only Dow 30 stock to be up year on year is McDonald's. This blog has highlighted MCD several times this year as one to watch. Unfortunately, it has begun to break down on the charts. It declined a bit today as the Dow rallied a bit and has broken to a more than one-month price low despite a recent positive earnings surprise and rising earnings estimates for both 2009 and 2010. When the leader starts rolling over despite good news, beware. Perhaps the downmarket move from Starbucks discussed here yesterday, and related competition, is behind the growing weakness in the stock.

Meanwhile, the head of the International Monetary Fund has said that the U.S. and most of the rich countries are in a depression, not recession. What is the natural trend of stock prices in a depression? Down indeed. Trying to pick a bottom remains a job for gamblers.

For example, Procter & Gamble stock has fallen almost by 1/3 in 1/2 year, to about a 5-year low. Poof! Five years worth of stock gains vanished. And that's with earnings having exceeded expectations most of that time. Let's see what happens with continued earnings estimate reductions. If this stock continues falling, then at some point analysts will point out what this blog has already detailed, which is that P&G has a large negative tangible book value. So, what is the company worth on a fundamental basis? The answer is that no one has any idea. Your guess is probably better than that of an analyst, who talks to management and therefore is continuously spoon-fed garbage.

BONDS

In other markets, this blogger put his money where his mouth was and indeed purchased 10-year Treasury bonds two days ago at what for now is the peak of the large correction/bear market in yields. The theory is that Treasuries are seriously hated and we may be at a peak in that hatred. Also, barring true Weimar Republic/Zimbabwean hyperinflation or out-and-out default, there is no such thing as a bubble in Treasuries the way there was a bubble in Internet stocks in 1999. Hold to maturity if you must and you will get the stated yield. In the meantime, I purchased a zero-coupon security, which both has a higher yield than a par bond and has greater price appreciation for every up-move in bond prices. We'll see. Not that that anyone has forgotten around these parts that going back to FDR, a Democratic President combined with a Democratic Congress have generally been bad news for bond prices. Yet the feeling remains that this is more like 1931, with more Great Recession/Minor Depression action yet to unfold, and that at some unpredictable point this year, investors and speculators will get scared again big-time and rush back to Treasuries, temporarily ignoring the tsunami of debt issuance. In that scenario, they will dump corporates and munis, just as they did last year. It should be interesting.

GOLD

Gold has gone to a six-month high. For the first time in some time, the 12-month return on gold as judged by the GLD stock is positive. Despite the positive price action and all the reasons to fear inflation, the fact is that deflation is the order of the day. Furthermore, there is so much current slack in the U.S. and global economy that even if we are at the bottom of the economic cycle, historically inflation diminishes as recovery begins. Extra production can come on at very low marginal cost, so the per-unit cost of production drops as demand increases.
(That includes labor costs.) So re gold, there is little conviction here about its next major move, but the suspicion remains that deflationary fundamentals could push it a lot lower. That would surprise the greatest number of people, it would appear, and markets love to do that, don't they?

OTHER

The Japanese stock market would look like a screaming buy if its chart were turned upside down and if the economic data had positive instead of negative signs. Japan's stocks are a disaster and represent a cautionary example for the U.S. The Japanese stock market is roughly 20 years from its peak. It is down about 80% nominally. Japanese Government bonds yield less than the dividend yield on stocks, but that was also the case months ago, when stocks were much higher. The Nikkei 225 has broken below its declining 50 day moving average and is down 2% in the morning session in Tokyo. There is no obvious bottom for the Japanese stock market.

The recent established order, the nouveau ancien regime, is crumbling. This order is/was based at its core on financialization of anything and everything that could be financialized. Enron did it. So did and do IBM, P&G, AT&T, and especially GE. Even hawkers of precious metals, God forbid, did it. Caveat emptor and caveat "holder".

For me, it's enough to recall Cole Porter: "Birds do it; bees do it; even educated fleas do it; let's do it, let's fall in love".

But don't fall in love with any financial product. For now, purchases should be with a renter's mindset.

Copyright (C) Long Lake LLC 2009