The Economy Is Still Deteriorating

The following commentary was recently sent to subscribers of the Forbes Special Situation Survey.

Although the federal government now owns large chunks of formerly blue-chip companies, it seems investors have overcome their fear that capitalism is about to end. In fact, they now seem to believe that the worst of our financial and economic crisis is over. As a result, they are once again willing to put money at risk as evidenced by a number of factors. Spreads between yields on corporate bonds and Treasury securities have shrunk, the CBOE Volatility Index has declined significantly, and stock prices are up 40% from their March 9 lows. Yet despite this increased appetite for risk, we remain concerned that stocks will see another pullback. While there is plenty of evidence that the economy is deteriorating at a slower rate, we see nothing to suggest it is getting better.

First quarter earnings provided one catalyst for the stock market’s rally. Earnings were down from a year ago, but for the most part, they were better than expected. Many of the positive surprises were due to lower raw material and energy costs as well as layoffs and other aggressive cost cutting activities.

More recently, however, commodity prices have been on an upswing. The Goldman Sachs Commodity Index, a composite of energy, metals, and agricultural goods, is up 41% from its recent low. The Energy Information Administration, which in January had forecasted an average price of $43.25 for a barrel of crude oil for 2009, recently upped its forecast to $58.70. With oil currently selling for more than $70 per barrel, it may have to revise its forecast again. This rapid rise in commodity prices will squeeze gross profit margins for many companies.

Furthermore, corporate layoffs have pushed the unemployment rate to 9.4%, its highest level since 1983. Yet those fortunate to remain employed are getting squeezed. A recent survey conducted by Challenger, Gray & Christmas indicates that 52% of companies have cut or frozen salaries. Many have eliminated benefits such as contributions to 401(k) plans. On top of this, the national average price of gasoline is up almost 60% since the start of the year. Less income and higher gasoline prices will reduce consumer spending, the most important component of GDP.

In addition, housing, where all the problems began, remains troubled. Sales may be stabilizing, but prices are still plunging. The government tried to help by forcing mortgage rates to below 5%. However, the long-end of the Treasury yield curve has suddenly jumped and so have mortgage rates. Higher mortgage rates will only prolong the housing crisis.

In short, the economy is still deteriorating. Yes, things may be getting worse at a slower rate, but they are still getting worse. We agree that a rally off the March 9 lows was fully justified. We also agree that even at current prices stocks are attractive from a long-term perspective.

However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable. We are not suggesting you sell and get out of the market. Instead, take advantage of a pullback if it occurs to put more money into your favorite stocks.

Comments

[MarvinMBA:]

Great opportunities in commodities like gold with its distant relationships to forex pricing/

Jun 14 10:22 AM

[Donald Ingram:]

Do not risk what you cannot afford to lose.

Jun 14 11:21 AM

[conceptwizard:]

My Grandfather used to say "A fool and his money are soon parted".

More than a year ago the dollar hit a low on the USDX at 71.18. A phenomenal rally ensued from that level expedited by de-leveraging and the closing out positions within the carry trade. A good example of the carry trade was when a bank in NYC borrowed yen. At ½% interest, sold the yen for dollars and bought dollar denominated securities.

All of that is now history as the dollar comes under increasing pressure. I believe the dollar could test 71.18 this year. I also believe the dollar could break down to 40 to 55 over the next few years. The collapse of the dollar is certain. The Treasury and the Fed have committed the American taxpayer to $13.8 trillion of debt and before the dollar goes where it is ultimately going that figure could reach $30 trillion.

In modern times such fiscal and monetary irresponsibility is unparalleled. This abdication of moral responsibility has already begun the process of dollar deterioration and rising interest rates. The result will soon be hyperinflation.

Foreigners see the IMF, World Bank and World Trade Organization as Washington surrogates in a financial system backed by American military bases and aircraft carriers encircling the globe. But this military domination is a vestige of an American empire no longer able to rule by economic strength. US military power is muscle-bound, based more on atomic weaponry and long-distance air strikes than on ground operations, which have become too politically unpopular to mount on any large scale.
Foreign nations see themselves stuck with unpayable IOUs – under conditions where, if they move to stop the US free lunch, the dollar will plunge and their dollar holdings will fall in value relative to their own domestic currencies and other currencies. If China’s currency rises by 10% against the dollar, its central bank will show the equivalent of a $200 million loss on its $2 trillion of dollar holdings as denominated in yuan. This explains why, when bond ratings agencies talk of the US Treasury securities losing their AAA rating, they don’t mean that the government cannot simply print the paper dollars to “make good” on these bonds. They mean that dollars will depreciate in international value. And that is just what is now occurring. When Mr. Geithner put on his serious face and told an audience at Peking University in early June that he believed in a “strong dollar” and China’s US investments therefore were safe and sound, he was greeted with derisive laughter.

Jun 14 12:38 PM

[ken3602:]

With massive government intervention and the Fed's so called quantitative easing, things are only slowing down a bit, and everybody's happy like a child... CA is practically bankrupt, and another 60~90 days forclosure moratorium for the summer?? Delaying and hiding all the bad things will never solve the problem. If you want a real bottoming out, you have to be ready to endure the acute pain that brings for a while. Otherwise, you just make things much more painful for a real long period of time.

Jun 14 12:38 PM

[buyforeclos...:]

Lets see... the author wrote: "However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable. We are not suggesting you sell and get out of the market. Instead, take advantage of a pullback if it occurs to put more money into your favorite stocks".

So instead of selling now and buying after the retest of the the lows, I should cost average and cost myself a lot of money? Yeah that makes sense...?!?!?????

Either your a bull or a bear. You seem to be a near term bear .You should be telling people to SELL now and wait for pullbacks and/or buy puts to protect gains or for NEW money to wait for pullbacks and a more attractive entry points. That is if you have any conviction about the subject matter.

I dont see how anybody can say stocks are cheap. Compared to what? That massively manipulated Dow Jones 14,000 that never should have gotten there to begin with? It was like the housing bubble. My advice is to go with the flow...if sentiment remains bullish go with it, dow could see 9500 to 10,000 .... If sentiment begins to change, buy puts or sell and short... Simply follow the money. I did. I bought Oil service stocks even though I know the demand is low. It was simply following Goldman Sachs ( among others) manipulation, justified in their minds by a weak dollar type inflation hedge...it is working for the timne being. But if the economy doesn't show real improvement, Crude may well tank back into $50's after peak driving season is over..The dollar will need a little boost to help.... I think DTO is a great play when oil gets top heavy...I made a killing on that when oil went to $33 from $71

The market is a scam in the sense that the screamed world was ending as the shorted everything and took your hard earned dollars in your portfolio by scaring you out until Dow 6500 .....and then they waived a magic wand suddenly green shoots and all that other BS
and go long and reap the short squeezes up...
I followed the money so I can't complain....but the typical American retail investors got screwed...how long before they short again after luring you back in? If you can't beat em join em is my advice.
no time for spell check.....hope I didn't hack this!

Jun 14 01:35 PM

[buyforeclos...:]

Ken, I agree. I think that the AIG bail out was smart but many many others were not. This is a Capitalist society. Only the strong survive. Many companies should have just been left to sink or swim. Obama is getting bad advice by printing so much money.The dollar is getting hammered which in turn hurts the consumer by higher gas and commodity prices ( weak dollar tied to Oil and many things sends those commods higher) Since the GDP relies on consumer spending ( 2/3rds) are we not defeating the purpose by weakening the dollar? A weak dollar is good for exports, that is a fact, but its not nearly enough to truly effect the trade deficit and the better course of action would have been to keep the dollar relatively strong and keep prices down and bite the bullet for a couple, 3 years.... better to do it right and cry once...I think our children and grandchildren will be crying after this fiasco.... what in god name happened to this country where we have to rely on China and others? It makes me sick. I think I may need a little more Gold in my portfolio ...it if pulls back to 850-860 I am adding and in 3-4 years I will probably wish I had bought more. On Jun 14 12:38 PM ken3602 wrote:

> With massive government intervention and the Fed's so called quantitative
> easing, things are only slowing down a bit, and everybody's happy
> like a child... CA is practically bankrupt, and another 60~90 days
> forclosure moratorium for the summer?? Delaying and hiding all the
> bad things will never solve the problem. If you want a real bottoming
> out, you have to be ready to endure the acute pain that brings for
> a while. Otherwise, you just make things much more painful for a
> real long period of time.

Jun 14 01:47 PM

[Houston:]

The crazy dude on tv predicted 8300 and a revisit to 2003. It went there, then over shot on end times predictions and then found it again because there is enough capital to do it.. Many guys like Zoros predicted the bounce would be a square root sign. Off the bottom and then sideways until the economy can get it's feet under it. Looks plausible.

So many posters seem to want their doomsday predictions to be validated . I don't. My suggestion...Sit tight. Use your head. Don't try trick money out of the market.

Do something truly productive instead and let the market get it's footing on a trend line that isn't the creation of greed and rediculous credit extension. If that can be established..make a reasonable profit...spend time with the family. "compassionate capitalism."

Jun 14 03:06 PM

[Houston:]

"Ken, I agree. I think that the AIG bail out was smart but many many others were not. This is a Capitalist society. Only the strong survive."
.
Not to be argumentative but I don't think that is as true as it used to be for a lot of reasons. Society and institutions evolve like everything else.
Wild oat picking to crop cultivation to master and subject to merchant societies with communal arrangements such as communism constructed along the way as alternatives.

Capitalism devours itself through recklessness and greed every so often. Socialism can't sustain unless there is some capitalism going on somewhere to subsidize it. Capitalism, at least can build itself back after a collapse. Socialism offers no incentive or proof that it really ever worked.

So societal evolution is some kind of blend. My vote at this point in time...capitalism with strong and well founded oversight based on the collective good. If not...then every thirty to sixty years, the Madoff types destroy it for everybody after they have tricked it out of many lifetimes worth of personal wealth. (most get to keep it) That is the strong surviving I suppose, but I think that evolution seeks to temper that in favor of a collective good.

Jun 14 04:18 PM

[whidbey:]

well said. In short we don't know what to expect, so expect not too much in the short run. There will be run up to 1050 SPX then C down will drive lower may be reach or pass the lows.

Jun 14 07:45 PM

[cameroni:]

What the......?

I might not be bailing on everything and all just yet but I update my stop-losses regularly and don't want to be caught short in another sudden sell-off. That's another way of saying I will sell by default if the market collapses. I will add back to my portfolio when the dust clears. Averaging is Ok in a generally rising market but it is just plain nonsense when all the fundamentals are pointing down.

The big picture is still DOWN.

Think about it. Averaging down does not mean profitability. It is just words than suggest another way of taking losses. And I don't want losses.

On June 14th 2009 the Author wrote:

"However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable. We are not suggesting you sell and get out of the market. Instead, take advantage of a pullback if it occurs to put more money into your favorite stocks".

Jun 14 10:59 PM

[Fighting Yoda:]

Well the economy is certainly not doing well as evident from GDP/Employment/CPI data. But the stock market is way overvalued: Current S&P earnings forecast for 2009 - $ 43 (top down operating earnings consensus forecasts) - PE of 22, next year earnings forecast - $46.6 - forward PE 20.3. These PEs are way high. Earnings forecasts have come down over the last 3 months - so much for green shoots.

To get a perspective on historical PE ranges:
All time historical average PE -16
Bear market PEs - 6 -10
PE in Sept '07 (market peak) - 19.7

Jun 15 12:40 AM

[Fighting Yoda:]

Well the economy is certainly not doing well as evident from GDP/Employment/CPI data. But the stock market is way overvalued: Current S&P earnings forecast for 2009 - $ 43 (top down operating earnings consensus forecasts) - PE of 22, next year earnings forecast - $46.6 - forward PE 20.3. These PEs are way high. Earnings forecasts have come down over the last 3 months - so much for green shoots.

To get a perspective on historical PE ranges:
All time historical average PE -16
Bear market PEs - 6 -10
PE in Sept '07 (market peak) - 19.7

Jun 15 12:40 AM

[DONE_SONZ:]

Lets have a meeting called the G8 and talk about exit strategies!Brilliant.

Jun 15 07:33 AM

[perceptions...:]

"We agree that a rally off the March 9 lows was fully justified. We also agree that even at current prices stocks are attractive from a long-term perspective.
However, we also believe stocks have climbed too far too fast and a retest of the lows is inevitable."

Let me see, how should I put this -
Credible
Reliable
Abundant
Paradoxes

Watch out for "self interest" information, the likely trend of the real economy and currency, over time, is down!!!

Jun 15 08:38 PM

[Northstar10000:]

Crazy talk. We are going to retest the lows but buy dips. what is a dip and why would you want to buy part way down if we are going to retest the lows? Sell it all now, buy SDS and cover when we take out the old low.

Jun 15 09:10 PM