A Smörgåsbord of Issues

July 11, 2011

Good morning. Despite Friday’s surprise poor numbers from the Labor Department the SPY still managed a positive week, closing up .49 at 134.40 (.4%). That small move up maintained the very strong 5.6% move up from the week before, when really the market could have had some serious losses on Friday. The Thursday ADP numbers (private sector jobs) showed a very strong 157,000 advance, causing many to revise estimates of the governmental numbers on Friday to well over 100,000, and had many thinking the surprisingly bad number of May would be revised upward. In fact the total jobs number last Friday came in at 18,000, and last months (May) bad number was revised downward by 29,000, not the upward revision most (including me) had expected. This brings up two separate questions. The first is whether we “believe” the government numbers. The ADP numbers, and some other anecdotal evidence, seemed to indicate some strength in private sector hiring, and most believed private hiring would exceed the continuing shrinkage of employment in the public sector. I am having trouble believing they are as bad as they show, but the revision to the downside of even the May numbers certainly has increased my concerns. The second question, assuming we believe the numbers, is whether they are somehow a temporary blip, maybe delayed from bad weather or Japan. If not, they are pretty bad and surely bring up the thought of a double dip. July should tell more, three months like this and I think the problem is real.

What is the smorgasbord of issues affecting the market? As of this morning we can start really anywhere on the globe. China has slowing growth and increasing inflation, causing the hint of a slowdown even in Australia. Europe has added Italy to the “in the press” list of problem areas, with the yield on Italian governmental debt starting to rise versus that of Germany. In the U.S. there is the continual saga of the increase in the national debt ceiling, with members of Congress and the White House at odds over a compromise that will shrink the runaway budget deficit going forward. We also had the end of the “official” QEII at the end of June, which, if true, will take away much of the monetary stimulus that has been a part of whatever recovery the U.S. has had to date. On the plus side large corporations have very strong balance sheets and are generally seeing solid, even growing, profits. There also is some evidence that the housing market, while still horrible, might be starting to at least flatten out.

I have been of the opinion for quite some time that a large share of the tentative recovery is due to the fiscal and monetary stimulus being provided by both the Treasury and Federal Reserve, and that the strength of the recovery was and is very meager given the huge size of the stimulus. I also have felt that the devastation of the housing crash continues to cause huge wealth issues especially in the middle class, and that, despite tremendous subsidies and bail-outs to some, very little of the money spent has made it to the problem areas. It really surprises me, make that stuns me, that the rhetoric coming out of Washington on both sides seems to still not address the magnitude of the issues. On the Republican side there appears to be no concern at all of what might happen to the economy (growing at 1.9% at best) when you withdraw some of all of the now 4-5% of the economy that is Federal stimulus borrowed from overseas. The Democrats continue to use potentially very unrealistic growth numbers going forward as they minimize the ongoing effect of the absurdly large deficits. Everything is “By my numbers everything will be fine in the year 2525, since I am assuming this all works and growth will be 3% at least.” I have never seen people who are supposed to be responsible adults arguing over which of two failed strategies (Bush and Obama) should be the plan going forward. Let me help you, neither the often tried and never successful Republican trickle down staple or the Democratic throw money at everything through bad and fraud filled programs is the answer. I get more concerned by the day that our leaders either cannot break out of their sound bite box, which is a problem, but worse, still cannot grasp the magnitude of the now multi-decade problem. It is hard to prescribe a cure when you cannot comprehend the injury. We need understanding of the situation and some new ideas!!!

The investing dilemma is really quite clear, and also very difficult for the “average” investor to deal with. Is it possible for the companies that have either become multi-national or somewhat monopolistic in a certain space continue to do well when all of the “traditional” indications of economic strength show weakness? In short, if I or anyone else sees problems everywhere around us in terms of income or economic strength, can a company like IBM, or CAT, or BA advance for the long term seemingly in defiance of certainly the U.S. economic situation? The harder question is whether a prudent investor can ignore that weakness and invest anyway? Clearly, some people can. I suppose an investor from Greece, for instance, does not even consider how well people in his local business community or even country are doing when considering an investment in AAPL stock. Maybe it is ego, and an ego that has to be squashed, but it is sure hard to feel that way living in the U.S. I am just not ready to declare that the U.S. (and China slowing down) no longer matters to big firms, and still believe that inability to find answers to our economic issues will eventually weigh on these companies.

If anyone would want to read a concise article regarding the causes of the economic slowdown, and potential reasons why the recovery will be slower than anyone may predict, check out this article by Rex Nutting from Market Watch entitled “How the Bubble Destroyed the Middle Class.” In it Mr. Nutting refers to $7.38 trillion decrease in wealth caused by the housing crash, compounding a period of more than a decade where wages (other than the upper levels) did not keep pace with inflation. He sights that the average middle class family had as much as 90% of household wealth tied up in their house, and that so far none of that wealth has come back. These are real problems, as this has been the group that has been the driver for the consumption driven growth of the last 10-20 years. Can they be totally replaced by emerging markets? Maybe so, but I am having a problem with that bet.

As far as investing, there have been some very solid technical trades in the last several weeks. An issue we are certainly having is that a lot of the stock movement is happening outside of the trading day. News generated from Europe or someplace causes the Futures to be up or down pre-market, and after the opening of our markets there is little movement during most of the day. Yet we have seen some trading opportunities with back and forth movement. In fact, we have had a couple of ratio back spreads on for our Protected Index Program clients that were successful, but could have been wildly successful if we had played them more aggressively. That is hard to do, it is much easier to get the hoped for move, take a profit, and move on. Lately it would have been better to get the first move, cover the one side for a break even worst case, and then hope for the complete reversal. It is rare for that to work, but it can be hugely profitable. This constant political drone from everywhere of “Oh no, we have a crisis” and the next day “We have a plan, it is fixed” might have us changing our normal trading style to take advantage. One of these days I am hoping we can return to more normal markets, in the meantime it is a constant observe and react to whatever outside shock has hit the market last, good or bad. The relative ease at which the market rallied 6-7% in a very short time has me very concerned about how orderly a sell-off of the same magnitude might play out. Everything we do has to be of the limited risk variety. The flash crash was not that long ago, and nothing has been fixed since then. There also has been some opportunity in single stocks. Some areas are moving forward, some stocks are hot. We continue to look at opportunity in these other areas, including some of the commodity ETF’s.