The S&P 500 fell 2.1% last week. The greatest decline came on Thursday after news broke that George Soros' fund's largest position, according to second-quarter 13F filings, was a put option (a short position) on the S&P 500. Specifically, Soros Fund Management's S&P 500 put position rose to 4.79% in the second quarter vs. 1.28% in the first quarter. The market was spooked by this news: The Dow fell 225 points Thursday and 344 points for the week, reacting to a raft of new bearish concerns.
Gloom & Doom Dominates the Media, but Most Fears Aren't Justified
George Soros is the latest big investor to make headlines by turning bearish. Another example is Marc Faber, author of The Gloom, Boom & Doom Report. Faber says that 2013 is on the same track as 1987. I usually ignore these ultra-bearish forecasts, but since Faber's prediction was featured on the MarketWatch website, I thought I'd share a few of my counter-arguments.
Faber says that 2013 is similar to 1987. He expects a 20% or more market decline, similar to October 1987. Faber argues that both 1987 and 2013 saw declines in corporate earnings. By contrast, I have argued that this year is more like 1995 when the stock market shot higher almost without interruption. What I believe both 1995 and this year have in common is a sudden rise in bond yields that caused fixed income investors to increasingly move away from the bond market and into the stock market.
Positive forecasts seldom capture the headlines, but we believe the stock market is rallying because economic growth is improving, the Fed is still pumping out more money, the S&P 500's dividends still yield more than the bank, plus the sales and earnings environment is improving this quarter. As we look back on 2013, I believe we will see that this year is more like 1995 than 1987.
Of course, the world is filled with truly sad stories, but they don't usually impact the stock market. For instance, crude oil prices hit a two-month high Friday due to the uprising in Egypt and reports of several hundred dead and the fact that Muslim Brotherhood is now starting to fight the Egyptian military. News reports showed a video of Muslim Brotherhood protestors pushing a military vehicle full of troops off a bridge. In response, the Egyptian military has been dispersing protestors with armored military vehicles.
Despite the fact that some perpetual bears are saying how dangerous the world has become, they typically ignore the positive news. Looking forward to the third quarter earnings reports, a higher-than-normal percentage of companies has provided positive earnings guidance, so the market will likely continue rising for the rest of this year. But the sad fact is that "fear" sells much better than hope. The latest array of fear stories will attract more readers and viewers, but most of these fears have little or no basis in fact.
Stat of the Week: Retail Sales Rose 5.4% in the 12 Months
We saw a wide array of encouraging economic indicators released last week. On Tuesday, the Commerce Department announced that retail sales rose 0.2% in July - the fourth monthly rise in a row. In the past year, retail sales are up 5.4%, so consumers are definitely spending, but consumers can be fickle. They tend to re-adjust their appetites month-to-month. For instance, car sales were down in July after posting unusually strong gains in May and June. But the important point to remember is that consumers have more money in their pockets. They just keep changing their minds on where to spend it, and on what.
Wal-Mart (NYSE:WMT) spooked the market on Thursday when it reduced 2013 sales guidance from 5% to 6% down to 2% to 3%, due in part to changing consumer tastes. Also, Wal-Mart's same-store sales, excluding fuel, declined 0.3% in the second quarter, so consumer spending on staples may have temporally leveled off.
The news on the inflation front was generally good last week. On Wednesday, the Labor Department reported that the Producer Price Index [PPI] was unchanged, while the core PPI, excluding food and energy, rose 0.1%. Economists expected a 0.3% rise overall, with the core PPI rising 0.2%, so inflation remains subdued. In the past 12 months, the PPI has risen 2.1%, while the core PPI has risen 1.2%.
On Thursday, the Labor Department reported that the July Consumer Price Index [CPI] and core CPI each rose 0.2%, in line with economists' expectations. In the past 12 months, the CPI is up 2% and the core CPI is up 1.7%, so inflation remains subdued enough so that the Fed can continue adding new liquidity.
The remaining economic news last week was mixed. The Fed reported on Thursday that industrial production was unchanged in July, the worst reading in three years. A sudden 1.7% decline in vehicle production and parts last month was largely responsible for the disappointing industrial production data.
The other important economic news on Thursday was positive: New jobless claims declined by 15,000 to 320,000, the lowest level in almost six years (since October 2007), so optimism is building that the August payroll report may be significantly better than July's disappointing payroll job growth.
There was also good news on the housing front last week. On Thursday, the National Association of Home Builders reported that its homebuilder confidence index rose to 57 in July, up from 51 in June, the third straight monthly rise in homebuilder confidence, which is now at its highest level in over seven years (since January 2006). And on Friday, the Commerce Department reported that new home starts rose 5.9% in July to 896,000, due largely to a 25.5% surge in multi-family starts. It was especially impressive to see this positive improvement in housing starts in the face of rising mortgage interest rates.
The Latest News from the U.S. Treasury & the Federal Reserve
Something interesting is going on at Jacob Lew's Treasury Department. In July, the federal government ran a $97.6 billion deficit, but the official Treasury debt remained unchanged at $16,699,396,000,000 for all of July, according to the official Monthly Treasury Statement. With the current debt ceiling at $16.7 trillion, Treasury Secretary Jacob Lew admitted to Chris Wallace on Fox News a few weeks ago that the Treasury would enact "extraordinary measures" (i.e., accounting gimmicks) to stay under the debt ceiling.
When Congress comes back in September, the debt ceiling will likely be the subject of a bitter debate. I expect it will raise the debt ceiling, like it always does, but not before much bickering over sequester cuts.
Treasury bond yields continue to rise. The 10-year Treasury bond hit a two-year peak of 2.84% on Friday, and we might see even higher bond yields if the Treasury's accounting mess becomes a major news event. During the financial crisis of 2008, Treasury Secretary Lew's Alternative Investment division at Citigroup lost the company $21.1 billion, so the joke around Wall Street has become: "Just because Jacob Lew blew up Citibank, that does not mean that we should let him blow up the U.S. Treasury and the U.S. economy."
Turning to central bank news, the fans of quantitative easing [QE] were deflated after Japan announced that its second quarter GDP slowed to a 2.6% annual growth rate, down from the first quarter's revised 3.8% pace. Economists had expected 3.6% GDP growth, so this ignited a debate over whether QE is just good for a short "pop" or if it can sustain long-term GDP growth. That debate continues at the Fed, which seems frustrated with the impotence of QE, especially in fulfilling its mandate for generating new jobs.
The good news is that despite Japan's GDP deceleration, worldwide GDP growth is on the road to recovery. For example, Eurostat announced on Wednesday that GDP growth in the euro-zone rose to a 1.2% annual pace in the second quarter, higher than economists' consensus estimate of a 0.8% annual pace. Portugal, Germany, and France led the way with annual rates of 4.4%, 2.8%, and 2.0% GDP growth. With Europe's two biggest economies growing at 2% or better, the euro-zone outlook is looking up.
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Disclosure: I am long WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.