Will Fundamentals Improve Fast Enough to Keep Up with Markets This Week?

Thanks very much for comments on my first two Seeking Alpha articles. Factors and ratings below are my opinion of the equity markets’ current views, not my personal views. Markets are very dynamic, and risk preferences, time horizons, etc., differ very widely; thus this article does not offer investment advice.

Market Status

After the big global equity rally in July, the key question heading into Aug is, can fundamentals start improving fast enough to keep up with markets, or are the latter increasingly at risk of running too far ahead of the former?

Global risk taking accelerated in July, with MSCI world index up more than 8%; China equity and property markets increasingly frothy, Shanghai Composite largest gain in 2 years; S&P at 9-month high just below 1000, 87% of its stocks over 50-day ma, see chart at end of article; high-risk Eastern Europe equity markets best performers the past month.

2Q GDP consumer spending and most recent consumer confidence report were worse-than-expected, but ECRI’s Weekly Leading Index (WLI), which has been in strong uptrend since bottoming Mar 6 along with the S&P, increased strongly this week, its growth remaining at a 5-year high, suggesting a better-than-expected U.S. recovery in late 2009-early 2010. Since May-June consolidation ended July 13, bulls continue to respond to incrementally positive but still mediocre new info, e.g. 2Q calls on earnings outlooks, by giving the shape and size of the U.S. recovery the benefit of the doubt.

Also, bulls currently appear not overly concerned that key central banks will signal they will start removing their unprecedented proverbial party "punch bowl" (“exit strategy”) while interest rate and dollar risks seem contained, despite on-gong concerns over Treasury issuance of $446 b in 3Q, up 30% from 2Q. Yet not too far in background lurks question WSJ asks July 31, “Bond Worry: Will China Keep Buying?”

Bulls perhaps also feel that political anger over “free market”-with-bailouts is played out, lessening threats domestically (regulation) and internationally (dollar). Bulls sweeping time bombs under rug for now, but not yet defused, such as option arm resets, commercial real estate, consumer credit, Eastern Europe.

What’s Changing

For bulls: 2Q real final sales of domestic product -0.2% vs -4.1% in 1Q, large 1H inventory drawdown likely to start reversing in 2H, swing in external balance also helps. 2Q U.S. earnings reports continue “better than expected” (BTE) primarily on cost cutting, international demand.A week of shaky large Treasury sales finally ended with successful auction Thursday. Housing market data continues to slightly improve. ECRI WLI shows sharp weekly increase. Weak German economy seems to be getting a little better. Obama using up political capital on health care.

For bears: U.S. consumer remains weak in 2Q GDP and most recent consumer confidence reports. U.S. market increasingly overbought, leader QQQQ reversed and closed on low Thursday. China equity and property markets becoming frothy, Shanghai Composite fell -5% Wednesday on concerns of China tightening. Financial time bombs remain, e.g. Lithuania reported depression level 2Q GDP -22%.

Next week: Key inputs for bulls’ global recovery story include Aug 1 China PMI; Aug 3 U.S ISM, S. Korea exports, Brazil IP; Aug 3-4 CAT analyst meeting; Aug 5 CSCO earnings; Aug 6 ECB policy decision, U.S. initial jobless claims; Aug 7 U.S. unemployment, Taiwan exports, Germany IP.

Key Factors This Week Update

The info below is greatly condensed mainly from news sources, primarily Bloomberg. After first five factors, the order of others changes each week, based on market importance that week. If rating changes, previous rating in ( ). Charts referred to are grouped at end of article. BTE abbrev for better-than-expected, WTE worse.

+ Earnings: According to Bloomberg compilation, as of 7/31, 75% of S&P companies beating estimates in 2Q vs 62% in 1Q; according to S&P in WSJ, operating income of companies reporting declined -16%, revenue -11.5% from year ago; consensus S&P 2010 estimated to $74.55, from $72.54 in May; bulls slough off comments on poor demand visibility. Bulls’ main themes for 2Q are cost cutting boosting margins and international demand, ignoring bears’ “can’t cut your way to sustainable growth.”

0 (+) Technical/Sentiment: 88% of S&P 500 stocks now over 200-day ma, highest since Feb 2007, from less than 3% in Jan and Mar; 87% over 50-day ma, level that has often lead to pullbacks, see chart below; SPX touched 996 Thurs, just below 1000, Nasdaq reached 2009 before pulling back below 2000; SPX support at 956; PM’s, retail investors underweighted equities caught flat-footed since July 13 presumably very anxious to “buy dips.”

0 Valuation: S&P 16.7 times T12M earnings; 13.3x 2010; GS raised S&P target to 1060.

+ Interest rates and credit: Shaky huge Treasury sale this week closed with successful 7-year auction, next sales start Aug 11; 10-year note 3.51% Fri, well below June 11 at 4%; Geithner ensures China “sustainable” deficit by 2013; 30-year mortgage rate rises for 2nd week, to 5.25%; Libor-OIS spread below 30 bp, first time in 18 months; inflation concerns about Obama’s deficit and Bernanke’s exit strategy have receded somewhat; composite indexes of financial conditions (spreads, etc) have more than fully recovered from last September's collapse.

++ (+) Leading indicators: Weekly Leading Index (WLI) increased strongly this week, ECRI says “recovery is apt to be stronger than many expect," 1-wk chg of both WLI’s 4-wk ma and its AGR (annualized growth rate) increased for 1st time in 6-7 weeks, 4-wk chg (“second derivative”) of AGR positive but declined for 5th week, see table below, discussed in my July 26 article, “ECRI vs. Roubini, Round Two,” WLI in strong uptrend since Mar 6 low (same day as SPX), see ECRI chart at end of article; OECD area CLI up last three months (thru May).

Wk Ending	WLI	1-wk Chg	4-wk MA	1-wk Chg	4-wk Chg	AGR	1-wk Chg	4-wk Chg
24-Jul	119.6	1.3	118.8	0.6	1.7	8.8	1.1	4.9
17-Jul	118.3	0.2	118.2	0.2	2.1	7.7	0.7	5.6
10-Jul	118.1	(0.9)	118.0	0.3	3.4	7.0	0.8	7.6
3-Jul	119.0	1.6	117.8	0.7	4.6	6.2	2.3	9.7
26-Jun	117.4	(0.2)	117.1	1.0	5.2	3.9	1.8	11.0
19-Jun	117.6	0.6	116.1	1.4	5.2	2.1	2.7	11.4
12-Jun	117.0	0.8	114.7	1.5	4.8	(0.6)	2.9	10.9
5-Jun	116.2	2.7	113.2	1.3	4.3	(3.5)	3.6	10.1

- (--) Employment/Income: Continuing jobless claims decline for 3rd straight week to 6.2 m, lowest since early Apr, 4-week ma of new jobless claims fell for 5th straight week to 559k, lowest since Jan, see chart at end of article, auto-related s.a. distortions working through, unemployment rate among benefit-eligible held at 4.7%; consensus is rate will exceed 10% by early 2010; bulls spin about productivity, bears on impact of employment on deleveraging households.

+ (++) China: consensus GDP estimates of 8.5% in 3Q and 9% in 4Q, peaking over 10% in early 2010; CCP Politburo and China’s central bank affirm “moderately loose” monetary policy; regulators warn banks not to divert loans to financial markets; Shanghai Composite down -5% Wed, most in 8 months, on concern government will curb investment; State Construction world largest IPO in 16 months, price up 56%, 2.5 b shares traded on 1st day, 51x 2008 earnings; Chinese stocks at 35x reported earnings; Shanghai Composite at 26x est earnings; Bank of China, largest lender in 1H, “will continue to expand lending”; China Construction Bank to cap 2009 loan growth at 900 b. yuan after 709 b. in 1H; traders target Fib 50% retrace of Shanghai’s huge decline at 3,894; property boom expected to take over from infrastructure spending; money-credit growth of 28-34%, concerns about exit strategy previously popped up in government bill sales

0 Housing: New home sales rose 11% in June, see chart below, largest increase in 8 years, 9% above consensus, 8.8 mths of inventory, lowest since Oct 07; Case-Shiller in May up 0.5% from prior mth, first time in 3 years, -17.1% yr-yr price decline, smallest in 9 mths; GS says residential investment, home sales, housing starts have bottomed, not prices; FHA report says in past busts real home prices took 10-20 years to recover peak; XHB back to early May highs; sales seem to have stabilized at a very low level, bulls tout affordability, new home sales way below household formation, bears high inventory, upcoming option arm resets.

+ US Economy: 2Q GDP -1%, BTE, -3.9% from year ago, worst since 1947; consumer spending -1.2%, WTE, after 0.6% increase in 1Q; big drop in inventories, expected to reverse in 2H; 1Q GDP revised down to -6.4%, worst in 27 years; consensus GDP est of +1% for 3Q and +1.9% for 4Q; June orders for non-defense capital goods +1.4%, May +4.3%, see chart below; Conf Board consumer confidence 46.6 WTE (49 consensus), from 49.3 in June, 2nd consecutive monthly decline; “cash for clunkers” helping showroom traffic, may be terminated; what (asset bubble?) will drive economic expansion after inventory cycle recovery; PIMCO’s “New Normal” 2% sub-par long-term growth current consensus; Roubini, Goldman around 1% for 2010 GDP, consensus around 2.5% but final demand under 2%.

+ Other Developed: Japan June unemployment rate of 5.4% a 6-year high, June retail sales fall for 10th month, -3% from year ago, Japan deflation concerns rising; Markit Eurozone PMI up, July retail sales fell for 14th month; German business confidence rose in July for 4th month; adj jobless rate in Germany unchanged at 8.3% in July, German July retail sales fell at slowest pace in 14 months; S. Korea 2Q GDP 2.3% non-annualized growth from 1Q, most since 4Q03, June exports +13% from May.

+ Emerging markets: India’s RBI leaves rates unchanged, signaling end of cuts on inflation concerns; MSCI Asia Pacific P/E 25, about 2x start of year; with China (see above) leading, these markets have far out-performed developed in 2009, how much further can that gap go, can they decouple? Lithuania -22% 2Q GDP.

+ Cyclical stocks: GS upgrades steel stocks to attractive from neutral; DOW, IP BTE earnings push material stocks Thursday; KMT, CMI do same for machinery group Thursday; CAT analyst meeting Monday/Tuesday.

+ Technology stocks: QQQQ maintains market leadership but lagged on Thursday rally, semi eqp stocks reverse to close at lows; shrugged off MSFT, AMZN disappointing earning calls; CSCO earnings next Wed; IBM to buy SPSS for $1.2 b; Silicon Valley unemploy rate at 11.8%, its clean energy “new new thing” notwithstanding, solar inventory glut.

0 Financial stocks: XLF still slightly below May 8 high; DB, CS join GS, JPM with higher trading income; GE Capital says does not need to raise more capital, rallied 7% Thursday, CreditSights says in “severe case” GE would need $15 b., raised to “Buy” by GS, CDS at 10-mth low; according to WSJ, loans of 15 large U.S. banks shrank by 2.8% in 2Q, more than half of loan vol in Apr-May came from mortgage refi and renew bus credit; about $165b in commercial real estate debt matures in 2009.

0 Dollar: first falls to 2009 low; then rises on safe-haven trade; would breaking key support around 78 be positive sign of less risk aversion for safe haven trades, or put Fed in tighter spot on its easy money policy?

+ Oil/Commodities/Gold: mainly hedge fund, ETF trading vehicles; September crude oil futures fell 6% as stockpiles surged, recovered next day; metals prices still rising, copper inventories too high, scrap prices at widest discount to futures since last July; oil below $70 is positive for economy, stock market; CFTC “must seriously consider setting strict position limits in the energy market”; GS says attempts to curb speculation may be “disruptive” to markets.

Comments

[thechaser]

You put a lot of work into a boatload of data to sift and analyze. I will do so and comment further. One item on Valuation is you say 16.7 ttm spx. My reading of S&P's spreadsheet report was Q3-08 at 18, Q4-08 at 0, Q1-09 at 10 and Q2-09 probably about 13, summing 41. Divide into 980 and you get 24. And of course this is only "operating" earnings, not the actually accounting results which makes it hard to calculate a ratio on four quarters of negative numbers. The market is a figment of many imaginations but for all securities not paying a quantifiable dividend, they have little to do with "earnings".

2009 Jul 31 04:27 PM

[buyforeclosures]

markets a scam ..may go to Dow 10,000 but then it is a flat out SHORT everything except defensives..go long there..


I Intend to make a lot of money short when thios bubble burst

2009 Jul 31 07:08 PM

[Carneades]

I like the abundance of charts and data.

What I don't like is this Cetin character who continues to spam these pages. Every time, without fail, his spam ruins my usually good mood. I am forced to gaze upon that despicable I AM N%^ link that has appeared so many times before. The typing of the URL alone should disqualify one from this site.

2009 Aug 01 01:12 AM

[Pauly B]

I see some strength starting to develop over in the bond market in the TLT and IEF. Also the VIX is starting to take a bid. Many of the mega cap names are posting shooting stars and weakness in the candle patterns showing that buyers are not buying at these levels. I sense institutions are not buying for now. I look for a pullback and more volatility and consolidation over the next two weeks.

2009 Aug 01 11:47 AM

[whidbey]

Too much data and too little analysis.

What are the implications of failure to increase jobs, not transfer payments? Increase consumption, not inventory cycle replenishment. When will residential fixed investment move up, not down? And trade: when will exports rise? Only government spending has risen consistently - that moves a few things, but nothing lasting.

The lack of employment is the key , the rest of it is just noise, misinformation and damned lies.

What are the probabilities of a gain in jobs? Not clear, but likely long time coming.

2009 Aug 01 02:29 PM

[Tom Colangelo]

P/E RATIOS SET TO RISE IN Q4 2009 THRU 2010

WARNING: IF YOU CAN'T CONCENTRATE FOR MORE THAN 60 SECONDS, SKIP THIS ENTRY.

The New Normal theory states that the recovery will be long and hard with GDP at 1.5 - 2.0% for possibly a decade.

If true, Earnings will bump along at a similar pace and will not recover to the high Earnings before the recession. So now we have low Earnings.

Why should the Price part of the P/E ratio rise?

Simple. Once investors that have nearly a trillion dollars earning nothing in money market funds come to accept this new low Earnings rate, and they come to realize that this is the way it will be for some time, they will decide to jump into the market because it is the lesser of two evils (i.e. no earnings vs. low earnings with some risk). This will bid up the price of stocks based simply on greater demand, not greater performance.

So now you have a new LOW Earnings number and a new HIGHER Price number and the new P/E ratios will jump higher than before the recession.

Again, this will not signify a higher expectation of future earnings as in the past, but instead, will reflect the New Normal of low growth, high unemployment and a long drawn out 5 years of debt defaults in credit cards, commercial loans, and housing mortgages which will force the further consolidation of the banking industry.

WHAT THIS MEANS TODAY IS THAT YOU CAN INVEST IN JUST ABOUT ANYTHING AND YOU WILL SEE A GAIN IN YOUR POSITIONS OVER THE NEXT 6 – 12 MONTHS, JUST BECAUSE OF THE NEW MONEY POURING BACK INTO THE MARKET.

2009 Aug 01 03:27 PM

[lazzybum]

The comments of this article and many others are mostly negative. I like this phenomenal. It means more bears at this time. More people are not in the market with their cash. What goes up must come down. What goes down will go up. March 9TH may or may not be the bottom. What I do know is that when more people realize cash means shranking asset, the market will benefit.

2009 Aug 01 07:12 PM

[John Furlan]

Thanks for your comment, and that on my previous article on “ECRI vs. Roubini, Round Two.” Re "too much data," if, as you say, the "probabilities" and timing of the things that you mention are "not clear," then perhaps wouldn't it be useful to continually monitor the data, especially leading indicators, for subtle clues of shifts in as close to real-time as possible, and note them? That's what the "key factors" format of this and my June 23 initial article is trying to do.

This article covers a wide breadth of factors because the investment world is so inter-connected, analyzing them in any depth here would make it far too long. Focusing on data is what has worked best for me in the past. I am wary of becoming too committed to any analysis to the point where it affects my ability to see subtle early clues in data. Understandably those managing a large fund might feel they have to build a position by committing to an investment view, at the expense of more flexibility. Investment commitment may work best in stable markets (and businesses in general), flexibility in more unstable ones.

I also feel that those considered extremely well versed in standard economic theory haven’t enjoyed an edge this decade, if anything they may have been handicapped in seeing the seemingly, to them, unexpected right in front of one’s eyes, supposed black swans.

E.g., it seems that economic experts like Bernanke were continually surprised by the full extent of the very glaring credit bubble (admittedly they are very constrained by what they can say in public), perhaps in part because the full facts about deliberately opaque financial instruments, off-balance-sheet structures, etc. were simply too hidden and not well-known to most Ph.D. macroeconomists. I.e., they were surprised as much by not having the data, as by getting their analysis wrong.

Greenspan was supposedly very data-focused and not very analytical, but he also was unable or unwilling to admit to the very obvious facts of the housing, credit and tech bubbles. Perhaps analytically if Greenspan had better stuck to a Taylor rule in 2003-2004, things would have been much different. Such analysis might be useful when dealing as Fed Chairman with the U.S. economy, it's just not my focus in this article.

On Aug 01 02:29 PM whidbey wrote:

> Too much data and too little analysis.
>
> What are the implications of failure to increase jobs, not transfer
> payments? Increase consumption, not inventory cycle replenishment.
> When will residential fixed investment move up, not down? And trade:
> when will exports rise? Only government spending has risen consistently
> - that moves a few things, but nothing lasting.
>
> The lack of employment is the key , the rest of it is just noise,
> misinformation and damned lies.
>
> What are the probabilities of a gain in jobs? Not clear, but likely
> long time coming.

2009 Aug 02 12:38 PM