I think the positive case for the market in the relative short term is reasonable.
(1) We've had a nice correction - cleared technically overbought condition.
(2) The Fed has affirmed "exceptionally low rates for an extended period" - go for it, boys.
(3) The only thing we have an oversupply of right now is doom and gloom - great for climbing that wall of worry and catching people on the sidelines.
(4) Earnings and revenues have been solid leading to positive revisions - got 4Q09 earnings season out of the way, now let us party in the vacuum.
(5) Market valuation is looking very attractive in the context of recovery - come on in the waters fine.
(6) 1H10 GDP has a decent chance of surprising on the upside.
(7) ZIRP drives incentives and therefore market behavior - banks got to do something with that cash.
(8) At some point, the retailees who went to bonds and missed the move will convince themselves that it is safe to get back in - liquidity filip.
(9) EU won't let Greece spoil the party.
(10) Oh yeah. There is more fiscal stimulus from last year due to hit.
And so, although it grates against my bigger picture outlook, I think there is a decent chance we could get a pretty substantial rally. But if it does rally strongly, it sets up a good fade and short.
Friday, February 26, 2010
Strategas make some good points
In a piece entitled, "Bar bets for restless financial professionals," Jason Trennert offers several constructive observations.
I think he quite rightly points out that peak earnings this cycle are unlikely to surpass peak earnings from the prior cycle ($91.47). That, despite the fact that we have had a 600% rally in EPS from the pit (GAAP EPS fell 92% top to bottom in the financial crisis), and 2011 estimates are already above the prior peak at $96 EPS (bottom-up estimates are always greater than top down estimates...top down estimates pitch S&P 500 EPS at about $81). The reason is simple and reasonable (but does require buying into a reversion to the mean assumption). "At the peak, Financials accounted for almost 2/3rds of S&P earnings...it is difficult to see another industry that could make up the difference over the next few years." If you believe that we were in an earnings bubble brought on by an oversized Financial sector that also helped leverage Industrial earnings, then it is hard to believe, given the reversal of that trend, that we will be quickly surpassing those bloated earnings. [the only industries with sufficient size and operating leverage to do so would be Energy and Materials combined in a cyclical climax - which would likely weigh upon other sectors). The takeaway from this observation and the concomitant current expectation is that the market is likely to be disappointed.
A second point he makes is that he thinks it unlikely the US savings rate will eclipse 8% this decade. The main reason posited is a "subpar expansion and structurally high unemployment." An unemployed, tapped out consumer makes for someone just trying to hang on, rather than someone with the breathing room to squirrel away savings. And to support his contention, he points to the savings experience during the recession. He is also implicitly disavowing the potential for the current crisis to bring on "a true culture of austerity."
I think he quite rightly points out that peak earnings this cycle are unlikely to surpass peak earnings from the prior cycle ($91.47). That, despite the fact that we have had a 600% rally in EPS from the pit (GAAP EPS fell 92% top to bottom in the financial crisis), and 2011 estimates are already above the prior peak at $96 EPS (bottom-up estimates are always greater than top down estimates...top down estimates pitch S&P 500 EPS at about $81). The reason is simple and reasonable (but does require buying into a reversion to the mean assumption). "At the peak, Financials accounted for almost 2/3rds of S&P earnings...it is difficult to see another industry that could make up the difference over the next few years." If you believe that we were in an earnings bubble brought on by an oversized Financial sector that also helped leverage Industrial earnings, then it is hard to believe, given the reversal of that trend, that we will be quickly surpassing those bloated earnings. [the only industries with sufficient size and operating leverage to do so would be Energy and Materials combined in a cyclical climax - which would likely weigh upon other sectors). The takeaway from this observation and the concomitant current expectation is that the market is likely to be disappointed.
A second point he makes is that he thinks it unlikely the US savings rate will eclipse 8% this decade. The main reason posited is a "subpar expansion and structurally high unemployment." An unemployed, tapped out consumer makes for someone just trying to hang on, rather than someone with the breathing room to squirrel away savings. And to support his contention, he points to the savings experience during the recession. He is also implicitly disavowing the potential for the current crisis to bring on "a true culture of austerity."
Thursday, February 25, 2010
A risk you've got to take
Ever since the govt decided to be fully committed to "solving" the crisis, the key has been to re-boot growth. Failure to do so, means you end up in a worse position than when you started.
The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).
In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.
With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.
Sadly, the risk you've got to take increases the chance of failure.
The paradox, or the dilemma, is that in order to re-boot the economy you must cover the growth shortfall by creating demand (in the hope that this artifical stimulus will get you across the growth divide). Unfortunately, given the weak starting position of the govt's balance sheet, options are limited and running out, and any failure to re-ignite growth poses serious risk to the economy and the financial system (again).
In other words, having already committed to the current course of action, the government has no choice, but to go for it (it is already "all in"). Conversely, if it fails and the markets lose faith, then we have a bigger problem on our hands.
With each lapse or fault in the market/economy, the government will continue to bail with all its might. It has no choice. But in so doing, it raises the chance of bringing about a collapse in the system (markets call their bluff...an emperor with no clothes). Confidence is a psychological phenomenon. It is transitory. The general stability of the markets/economy to which we are accustomed, mask a more fragile reality.
Sadly, the risk you've got to take increases the chance of failure.
Wednesday, February 24, 2010
Eye of the hurricane
We are in the eye of the hurricane.
"the eye is characterized by light winds and clear skies, surrounded on all sides by a towering, symmetric eyewall."
The seas (economic data) are still choppy (mixed), because we have cross-currents coming from all directions (sovereign systemic risk concerns, stimulus withdrawal effects, state/local crisis, 2nd wave of mortgage defaults, high unemployment, China bubbling, commercial real estate teetering, Japan a mess).
This should be a time of preparation for the backend of the hurricane (more wind and rain). The consumer will continue to deleverage, while the govt will continue to bail. Should confidence in the govts ability to bail erode, then the system is at greater risk. It is going to be touch and go this time around, but if we do avoid another meltdown, then we have only deferred it for another day.
"the eye is characterized by light winds and clear skies, surrounded on all sides by a towering, symmetric eyewall."
The seas (economic data) are still choppy (mixed), because we have cross-currents coming from all directions (sovereign systemic risk concerns, stimulus withdrawal effects, state/local crisis, 2nd wave of mortgage defaults, high unemployment, China bubbling, commercial real estate teetering, Japan a mess).
This should be a time of preparation for the backend of the hurricane (more wind and rain). The consumer will continue to deleverage, while the govt will continue to bail. Should confidence in the govts ability to bail erode, then the system is at greater risk. It is going to be touch and go this time around, but if we do avoid another meltdown, then we have only deferred it for another day.
Thursday, February 18, 2010
When do structural problems weigh on real world results
Corporate profits and the market are saying sayonara to the recession (and the worry-warts), but I still see us facing many structural headwinds in the future. The problems are not insurmountable, but they are serious and require substantial change in order to address the issues.
The question that I am asking myself is, when will those problems reflect in real world results? When will they weigh on profits? For example, the Pew Trust came out with a study today indicating a $1 Trillion funding gap for State and local government pensions. At what point will that funding gap impact the real world and who within corporate America will be effected by that? Is it possible that most of the problems are isolated to government entities and, as such, will only effect the private sector indirectly? I find that hard to believe. The ultimate solution to government over-indebtedness is increasing revenues (taxes) and reduced consumption - or default. All of which impact the consumer and companies doing business with the government directly and indirectly.
Pension funding gaps are only the tip of the structural iceberg. We have significant Federal obligations from unfunded medicare and social security liabilities, structural funding gaps at both the Federal and State/Local government levels, over-indebted consumers, not to mention more rounds of default and delinquency in the residential and commercial mortgage markets. Where is the money going to come from to pay for all these things?
The market typically goes blithely along ignoring structural problems until it is forced to deal with a situation - usually in crisis mode. Is the market that dumb? and, Why does it do that? Are we simply playing a game of chicken, and that is the way the game has always been played?
The question that I am asking myself is, when will those problems reflect in real world results? When will they weigh on profits? For example, the Pew Trust came out with a study today indicating a $1 Trillion funding gap for State and local government pensions. At what point will that funding gap impact the real world and who within corporate America will be effected by that? Is it possible that most of the problems are isolated to government entities and, as such, will only effect the private sector indirectly? I find that hard to believe. The ultimate solution to government over-indebtedness is increasing revenues (taxes) and reduced consumption - or default. All of which impact the consumer and companies doing business with the government directly and indirectly.
Pension funding gaps are only the tip of the structural iceberg. We have significant Federal obligations from unfunded medicare and social security liabilities, structural funding gaps at both the Federal and State/Local government levels, over-indebted consumers, not to mention more rounds of default and delinquency in the residential and commercial mortgage markets. Where is the money going to come from to pay for all these things?
The market typically goes blithely along ignoring structural problems until it is forced to deal with a situation - usually in crisis mode. Is the market that dumb? and, Why does it do that? Are we simply playing a game of chicken, and that is the way the game has always been played?
Slicing and dicing the consumer
Everyone wants a piece of the consumer. It ain't going to be pretty.
In the future higher taxes will take a bite out of the pocket book (income, state, sales and property - we've got to pay for what we have deferred). Also, higher telecommunications costs (cell phone, data plan, cable), higher energy costs (electricity and gasoline, and cost of climate management), higher water/sewage/trash costs (got to pay for infrastructure investment), higher living expenses (food), higher retirement costs (increased savings bought on by greater financial insecurity).
Any way you look at it, there is less and less disposable income available for discretionary items (did I mention inflation robbing real income). Welcome to the future! Welcome to a more comfortable life with higher living standards (although reduced relative to our faster growing third world brethren), offset by less discretion and less financial flexibility.
In the future higher taxes will take a bite out of the pocket book (income, state, sales and property - we've got to pay for what we have deferred). Also, higher telecommunications costs (cell phone, data plan, cable), higher energy costs (electricity and gasoline, and cost of climate management), higher water/sewage/trash costs (got to pay for infrastructure investment), higher living expenses (food), higher retirement costs (increased savings bought on by greater financial insecurity).
Any way you look at it, there is less and less disposable income available for discretionary items (did I mention inflation robbing real income). Welcome to the future! Welcome to a more comfortable life with higher living standards (although reduced relative to our faster growing third world brethren), offset by less discretion and less financial flexibility.
Monday, February 15, 2010
EU at crossroads
The EU is at a crossroads.
The Greek crisis is just the first test of an infant union, but it has brought all the weaknesses of the EU into stark view.
The Germans and French are suddenly realizing the implications of their grande idea, and are having second thoughts. Their fortunes, for better or worse, are inextricably tied to all the other member states. I've got to believe that, instead of dithering, they'll wake up and realize they have no choice.
They must therefore forcefully fill the breach, and continue to do so, or risk their labors unravelling.
Although the probability is small, it is higher than in a normal state, investors need to be careful about the possibility of global dislocation caused by political upheaval.
The Greek crisis is just the first test of an infant union, but it has brought all the weaknesses of the EU into stark view.
The Germans and French are suddenly realizing the implications of their grande idea, and are having second thoughts. Their fortunes, for better or worse, are inextricably tied to all the other member states. I've got to believe that, instead of dithering, they'll wake up and realize they have no choice.
They must therefore forcefully fill the breach, and continue to do so, or risk their labors unravelling.
Although the probability is small, it is higher than in a normal state, investors need to be careful about the possibility of global dislocation caused by political upheaval.
Monday, February 8, 2010
Whereto our living spaces
It is currently fashionable to assume that re-urbanization (moving from the suburbs back into the city) is going to be a long term trend. And possibly it will. But much less talked about is the fragmentation of cities into satellite parts, and the reversal of people moving from rural to urban.
Modern telecommunications in conjunction with a growing knowledge-based economy make it likely that we see the disaggregation of migration trends and the prospect, at some point, where people begin moving back out to the country. It will require a little culture change within companies and good software (to keep in touch and to keep an eye on people), but all of the ingredients are already here.
I would be a nervous holder of anything but AAA office space in a CBD location.
Modern telecommunications in conjunction with a growing knowledge-based economy make it likely that we see the disaggregation of migration trends and the prospect, at some point, where people begin moving back out to the country. It will require a little culture change within companies and good software (to keep in touch and to keep an eye on people), but all of the ingredients are already here.
I would be a nervous holder of anything but AAA office space in a CBD location.
Friday, February 5, 2010
A tough circle to square
Is global infrastructure an asset class? Don't know, don't care.
It doesn't matter. What matters is that there are great hopes and great needs to build out and support infrastructure (water, power, transportation) around the world over the next 20-30 years. I saw in one place that they estimated global infrastructure spending at around $35 trillion over the next 20 years. Even if it is half that amount (which is probably more likely), it is a substantial amount of money.
Quite apart from the obvious need and the potential investment opportunity, the case for global infrastructure development begs the question. Who is going to sponsor the development? Where are the funds going to come from to pay for it? and, What will be the cost of those funds?
Infrastructure sponsorship is generally the domain of government. But governments the world over are going to be balance sheet and budget constrained as they pay out on the accumulated obligations of the past while trying to meet the generous promises of the future. Consumers (at least developed country consumers) will be going through their own weight loss program, but at least in cutting back they are likely to be saving a little more and so provide a source of funds (although it will be constrained because they are going to be tapped out by higher taxes to pay for everything and higher costs associated with paying for the new/improved services - not much discretionary spending in the future). Finally, corporations. They are going to be only too happy to provide the product/services to develop infrastructure, but don't have the independent financial capacity to borrow sufficiently to fund projects. A conundrum.
When demand is greater than supply, prices go up. With government needs for funding set to rise, massive global works projects waiting in the wings, it only makes sense that the price of money goes up.
It doesn't matter. What matters is that there are great hopes and great needs to build out and support infrastructure (water, power, transportation) around the world over the next 20-30 years. I saw in one place that they estimated global infrastructure spending at around $35 trillion over the next 20 years. Even if it is half that amount (which is probably more likely), it is a substantial amount of money.
Quite apart from the obvious need and the potential investment opportunity, the case for global infrastructure development begs the question. Who is going to sponsor the development? Where are the funds going to come from to pay for it? and, What will be the cost of those funds?
Infrastructure sponsorship is generally the domain of government. But governments the world over are going to be balance sheet and budget constrained as they pay out on the accumulated obligations of the past while trying to meet the generous promises of the future. Consumers (at least developed country consumers) will be going through their own weight loss program, but at least in cutting back they are likely to be saving a little more and so provide a source of funds (although it will be constrained because they are going to be tapped out by higher taxes to pay for everything and higher costs associated with paying for the new/improved services - not much discretionary spending in the future). Finally, corporations. They are going to be only too happy to provide the product/services to develop infrastructure, but don't have the independent financial capacity to borrow sufficiently to fund projects. A conundrum.
When demand is greater than supply, prices go up. With government needs for funding set to rise, massive global works projects waiting in the wings, it only makes sense that the price of money goes up.
Thursday, February 4, 2010
Disconnect
We're seeing signs of a disconnect.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
General economic trends are moving in the right direction, earnings are coming through better than expected.
And yet, the market is getting sold!
Welcome to a balance sheet recession.
We have hollowed out core economic institutions (bankrupt state governments, overleveraged consumer, increasing financial risk on the sovereign) which mean bombs can go off anytime (after all it is a confidence game) and there is less margin for error.
Greater market volatility likely to ensue.
And now for something completely different
When I look back over my posts, there is a lot of negativity.
Am I that much of a sadsack? I guess so, and yet, it ain't all bad.
We may be heading into a slow patch, but the future is known. Progress, development, and economic growth are in the long term forecast.
Not only that, but I'm hopeful culturally and generationally we are learning some valuable lessons.
Am I that much of a sadsack? I guess so, and yet, it ain't all bad.
We may be heading into a slow patch, but the future is known. Progress, development, and economic growth are in the long term forecast.
Not only that, but I'm hopeful culturally and generationally we are learning some valuable lessons.
Monday, February 1, 2010
These guys kill me
There are a lot of technical commentaries out there right now looking at the current pullback in comparison to all the other pullbacks since the low in March 2009. I've seen lots of means, medians, ranges, averages, % above/below 50 day MA, etc. bandied about, all inferring that the recent past is a good approximation for what is likely to happen this time.
Quite apart from conducting dubious statistical analysis with limited explanatory power on a meaningless sample size, what kills me is that they do it everytime and they invariably miss the forest for the trees.
The technicians are always very good at describing what has happened, but like all other prognosticators, they are not so good at telling us what will happen.
Addendum: It's all about the graphs. It also really bugs me when someone uses a volatile data series depicted in graphs to make their case. They invariably extrapolate some future scenario based upon (1) an historical pattern, (2) the current trend, or (3) both 1 and 2, but with so much noise in the data, it is a crapshoot.
Quite apart from conducting dubious statistical analysis with limited explanatory power on a meaningless sample size, what kills me is that they do it everytime and they invariably miss the forest for the trees.
The technicians are always very good at describing what has happened, but like all other prognosticators, they are not so good at telling us what will happen.
Addendum: It's all about the graphs. It also really bugs me when someone uses a volatile data series depicted in graphs to make their case. They invariably extrapolate some future scenario based upon (1) an historical pattern, (2) the current trend, or (3) both 1 and 2, but with so much noise in the data, it is a crapshoot.
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