The Economy Is in Recovery Mode

Short and Sweet! I first need to announce I am putting together a petition drive that I believe will be the first ever to receive 100% support and zero detractors. I propose replacing the annual clubbing of the baby white seals (as fun as that has been) with “The First Annual Skinning of The Bears”. I know what you’re thinking, Brilliance! However I cannot take full credit. This year they have been highly visible, overly aggressive and annoyingly persistent which makes for easy targets. I’m looking forward to easy passage and celebrating every October.

The economy is inarguably in recovery mode. Consumer confidence is on the mend, though fragile. Home sales, both new and existing, is undergoing much of the same. Auto sales are stabilizing at close to a ten and a half million annual run rate. Wall Street? They are making money like they printing it. Oh, yeah, they are printing it. If everything is going so well, what’s the hold up? Well the “S” on this boy wonder's chest stands for Sustainability. Corporate America actually got it right this time. Much like the Federal Reserve, while late in recognizing the collapsing of the economy and end demand, once engaged they went full throttle on the guillotine, slashing head count and slicing inventories.

Now that the incentive programs for home purchase and autos have expired, will consumers retreat back to savings mode? Or do what they do best - buy buy buy? It all hinges right here. The good news is the global economy is not sitting back and holding its breath on the US consumer. This time around it’s not necessary. Domestic consumption in emerging economies is picking up some of the slack and doing some of the heavy lifting.

The (thus far) orderly retreat of the value of the US dollar is having the desired effect of making our goods more attractively priced overseas. As a result, exports are up again, and with imports down our trade deficit contracted again. I have to admit George W actually got this one right and acted on it when questioned about support for the value of the dollar. He responded with, “There is such a thing as a strong dollar policy and the wrong dollar policy”. By propping up the US dollar for the last three decades, US goods were at a decided disadvantage. Now the currency markets are searching for its equilibrium and not the pegged levels that hamstrung the US in the past. As long as the retreat is orderly, we should be fine. This needs very close monitoring. Based upon Fed comments and foreign central bank commentary, we are approaching levels where we should begin to level out.

Lastly, let's look at the glass half full. As I’ve stated in the past, earnings are spring loaded to impress to the upside. We are currently in the sweet spot, timing wise. The market is searching for the catalyst to determine the path of least resistance. Earnings should identify that rather clearly. Analysts are finally catching on. Estimates are being revised up almost daily. Current numbers for the S&P 500 for 2009 are targeted for $62.00 share up from $40.00 share a short time back. For calendar year 2010, estimates are coming in at $75.00 a share and as of now, $92.00 for 2011. To give some clarity about how analysts come to their projections, use a 16-17 multiple. This brings targets to 1250 for 2010 and 1380 for 2011. Now, for me it is way too early to give projections for 2010, let alone 2011. Too much can change between now and year end. It is a fluid process with new data coming in weekly. Really, an exciting time.

Now the caution. We need to be on high alert for any signs the China recovery is petering out. Any dents in the armor here and all bets are off. Clearly we are taking our lead and some comfort from China recovering along with the emerging markets. Just last week Australia’s Central Bank hiked rates. Let me emphasize what a bold statement that was. The Australian Bank Officials must have felt confident in the sustainability of their economic recovery as the last thing they want to do is flip flop. Hike rates too early and then the economy stumbles and they'll have to revert back to an easy money posture. They understand they would lose street cred (Wall Street that is) and most likely their jobs, when viewed as out of touch and incompetents. Now the question becomes, who will be next to hike?

It's worth keeping a close eye on any breach in the developing trend of lower monthly payrolls. Progress continues, coming from losses of 700,000 to, most recently, 255,000. Still, while making progress, we’re not creating jobs just yet.

We’ll be on the watch for continued progress in home sales. This too is an Achilles heel. The stated inventory figures are coming in around 4 million+ homes and a roughly 8 month supply. Taken alone, not bad. However, adding in the shadow inventory (homes taken off market, on bank balance sheets, in process of foreclosure), let’s add back in another 5 million homes. We see that inventories really are closer to a 2 year supply. This problem and overhang will be with us for 4-5 years. And that is assuming home builders don’t begin ramping up production, again further exacerbating the overhang.

Finally, I must admit I am constantly frustrated with reports of the market having rallied 50% off the market lows and the need to take a pause. When did we begin calculating returns from peaks and troughs and not year to date calendar? But, this feeds right back to my original purpose, which was to garner support for my First Annual Skinning of The Bears. With those out there using the March lows and not January one when calculating total market returns, they’ll be watching the markets continuing ascent, confused, while sitting on the sidelines. This makes for plenty of the furry beasts when my petition passes and pelts for everyone when the season kicks off.

I continue to be optimistic this market move still has some positive upside left in it. I will continue to monitor economic releases, the dollar, precious metals, cash flows, geopolitical tensions and signs for a market topping out and be in contact immediately should we need to adjust our strategy.

The Fixed Income markets continue to heal, and with it spreads continue to contract. Finding attractive income producing vehicles that produce attractive yields will continue to be become more difficult. We have one today, Entertainment Properties (EPR). Entertainment Properties is set up as a REIT. It develops and finances properties primarily related to Megaplex Movie theatres but also has diversified its portfolio. As the US consumer continues to seek inexpensive venues for enjoyment, this theme should play into EPR's hands. You can purchase the preferred stock EPR-D at a discount to par and capture just inside of 10% as of today.

Disclosure: In a note of full disclosure, I may currently own or plan to purchase for myself and clients the REIT and or the preferred stocks. Before making any purchase or sale do your own due diligence and consult your financial advisor.

Comments

[Jasper M:]

nay. naaaay!

I gather that Pollyanna here was on the Nobel jury, and is one of those guys who thinks everything can't help but get better from here (perhaps thanks to our magic president?).
I dissent. I detract. I argue to the contrary.

The mortgage reset situation is not continuous (I refer to Credit Suisse's data here), but come in waves. We are in a bit of trough at the moment, so casual observers like the author do not 'feel' the situation. The coming resets (in ALL classes of mortgages) will produced another spike in foreclosures, which will add to inventory (even if artificially held off the market by government intervention), driving down real estate prices again, and making clear that the valuation of mortgage related assets based on those properties is Never coming back

Auto sales 'stabilizing' was due to an unsustainable government handout.

And measuring from peak to trough is a necessary part of market technical analysis - try doing that with year end data only!

And Movie theaters!? Yeah, genius, THERE's a growth industry. Not like they've got any competition, with a lower overhead model, like say, some sort of bizarre scheme to, I dunno, Rent movies. Or maybe some sci-fi plan to deliver them electronically, over phone lines . . . nah, that could never happen.

This articel has some of the Worst advice I have sen on SA. And there is a Lot of competition there.

Oct 13 02:40 PM

[Mr. Big:]

I wouldn't put too much weight on exports when the bulk of the US economy is driven by domestic consumption.

I would also add that the weakness in the US dollar is NOT orderly. We are experiencing movements in currency that normally takes years to development.....not months. I would classify the rapid depreciation in the greenback as "alarming" and the underlying causes as "detrimental" and the potential consequences as "disasterous", if we continue the current path.

A recovery supported by stimulus and the changing of accounting rules does not give me much comfort. I truely do hope that the stimulus can actually kickstart the economy and induce a sustained chain of positive events, but from my perspective the stimulus was like a feather to a freight train

Oct 13 04:10 PM

[notsosmart:]

this guy is a joke. lets see how many retailers shut their doors in the 1st quarter of '10.now we have a foreclosure every 13 seconds,the chopped heads this guy talks about cant buy anything.in fact they cost by unemployment benefits & in some cases uninsured medical needs.rail cars are sitting idle as freight is not moving.inventories are as sparse as could be.many arms will be resetting & who knows how much of that phony rated AAA paper is still around.the wall st ponzi/casino has a new phrase-"less bad"thats the fertilizer for the green shoots.theres no more investing.just gambling.longs,shorts,... ,lows,ins,outs, & even one day bankruptcies.screw everybody-just fill my pocket

Oct 13 05:52 PM

[James Byrne:]

I would agree with your comment about the rather rapid depreciation of the dollar. I use the term orderly in the context of the market generally accepting the drop fairly well. I believe the administration is using this weak dollar in hopes of jump starting domestic manufacturing, helping to export our way out of the recession we are exiting. Encouraging signs from the domestic consumption numbers coming out of China recently points to help on the way. As I pointed out in the past (which you mention also) the importance of the US consumer can't be overlooked. His own personal balance sheet is continuing a de-levering and cannot be expected to do the heavy lifting alone. Back on point, certainly a complete breakdown would quite worrisome and unwelcome.

Oct 14 12:56 PM

[Tony Daltorio:]

I see more and more bullish articles like this with little to back their arguments in the way of data or facts. It's all just 'feel-good' fluff.

Since the "bubble boys" are back predicting sunny skies for the US forever, I will take the other side of the trade and say we are within a few percent of the top.

Oct 14 03:54 PM

[James Byrne:]

I continue to note the data supportive of a recovering economy and consumer in previous articles Tony. Leading Economic Indicators in the US for one have a terrific predictive record of future growth/contraction. Positive reporting of Purchasing Managers Index reflecting an expanding economy both domestically here in the US and China and India. A pick up in consumption in the emerging markets which plays right to the continued improvement in US exports. There are a number of other data points I've already made note of in previous articles.
I remain aware this recovery is in the early stages and quite fragile and could run out of steam. We need to make continued progress on job losses, the dollar needs to find its equilibrium, the US government needs to get out of corporate board rooms, the Federal Reserve needs to elaborate on/execute an exit strategy. However this liquidity based rally, I believe is turning into something more and will be substantiated by the current earnings season.

Lastly, I too am not sure how much more is left on the upside. If earnings come in much stronger than anticipated, we may experience a blow off rally that stretches us to much loftier levels than justified, I too will be pulling some chips off the table. For now, I stay fully invested and monitor data closely.

I wish you success with all your investments.

Oct 15 03:33 AM