Stock Market Rally: A Salute to Slow Growth

Includes: AWH, ECH, EWS, FXI, O, SPY, THD, TUR
by: Jon D. Markman

The markets staged a relief rally last week that reflects Wall Street's attitude about the overall economy. Simply put, investors are saying they can live with slow growth, so long as the U.S. can avoid a double-dip recession.

Stocks leapt around the world last week like jets of water shooting out of a fountain that had been closed down for weeks. The major U.S. indexes rose 3%, the NASDAQ rose 4%, non-U.S. foreign big-caps rose 3.6% and small-caps rose 4.6%.

Many of our plays on growth overseas rose even more: iShares MSCI Thailand Index Fund (NYSE: THD) jumped 4.9% and iShares MSCI Chile Investable Market Index Fund (NYSE: ECH) rose 4.4%, while iShares MSCI Singapore Index Fund (NYSE: EWS) rose 3.2% and iShares MSCI Turkey Index Fund (NYSE: TUR) rose 3.5%. Once again, as we have seen all year, the response in iShares FTSE/Xinhua China 25 Index ETF (NYSE: FXI) was more muted, up 2.4%.
Bonds fell, the dollar fell, oil was flat and gold rose 0.75%. The favorite measure of risk these days for financial sophisticates is the ratio between the Australian dollar and the Japanese yen. This week the Aussie, as it's called, rose 2% while the Yen rose 1%, so the ratio rose roughly1%.

Forgetting about the big picture for a moment, let's look at one of those new highs to see what's happening under the hood. Here's a chart of Allied World Assurance Co. Holdings Ltd. (NYSE: AWH), a reinsurer based in Bermuda.

If you look closely at what was happening in this stock over the past year, you'll see that it was attracting shareholders at every phase of the past year almost counter-cyclically to the rest of the market. Reinsurers like this can earn boatloads of money when they are well managed, as Warren Buffett will tell you. They take in premiums from other insurance companies and if they are smart they rarely have to pay off. Then they use the premiums to invest with skillful cunning in bonds, and lately that has been a fantastic bet.

When you see a trendline rising at a 30-degree angle turn skyward into a 60-degree angle it's often the precursor to launching toward a new high, and that is what AWH did in Thursday trading.

Another great place for funds of late has been a big surprise for many people: Real Estate. One of my bets in the space has been Realty Income Corp. (NYSE: O), which has rocketed this year and still pays a 5.3% yield. You can see that it has managed its 1,800-plus properties effectively enough to keep the cash flowing through to shareholders during these tough times, retaining an uptrend that dates back to 2000.

Elsewhere in the market this week, retailers were the surprise winners, along with capital goods makers and basic materials producers. Volume started out light but picked up steam. Buying intensity has been very positive, as about 84% of all volume was to the upside. Our friends at Lowry's Research report that from the market low last month, buying power is up by 25 points while selling pressure is down by 33 points, which means the spread between supply and demand is the best it's been since March 2009.

Hard to believe, considering the market is still well below the April high, but it shows that when there are buyers they are committed, so the problem with the indexes is that weakness in large-cap banks, oil companies and tech are holding back success in other sectors.

The strong gains of the past two days have now left the broad market in the vulnerable position of being short-term overbought, as the percent of stocks above their 10-day averages has risen to 95%. A great scenario for the coming week would be a light pullback to consolidate last week's gains -- just enough to relieve the overbought condition, and leave room for more gains in the weeks ahead.

That would open the door for stocks to complete the inverse head-and-shoulders pattern that we've been talking about, one of the most bullish of all formations, though it's a tall order. Just for your notebook, though, the S&P 500 would need to close above 1,127 to confirm it, and then the target would be 117 points higher, or just above the April high.

An advance like this would not in any way be outrageous or out of the ordinary. The message that investors would be delivering by bidding stocks up in that way would be this: We anticipate a slowdown in U.S. economic growth, but not a second recession.

Remember that investors can live with a slowdown, that's not a big deal. The best companies will grow well in excess of any slow overall rate. Only a collapse back to contraction is a big deal. Of course it goes without saying, but I'll say it anyway, that a heavy-volume decline on the jobs data Friday would open the door to a collapse back to test the August lows one more time, and blow up this pattern.


Every minute that investors spend talking about the broad economy is 60 seconds that they could use for something much more productive. So let me just take 15 seconds to observe that all the squiggly lines on these charts are reflections of market participants' views of real companies that are having an increasingly hard time selling enough stuff to hit their earnings forecasts at a time of diminished sales.

Growth in the second quarter of 2010 slowed to 1.6% annualized, which is really just a crawl, and much weaker than the 3.7% of the first quarter. Since the data suggests business isn't getting any better, this third quarter we're in now could be a real toughie. Companies made their numbers over the past year by cutting back on employees and ramping up their productivity. But there's a limit to that, and it gets harder and harder to wring our incremental cost savings to improve earnings. And of course, year-ago comparisons are getting progressively harder.

Moreover now as we move farther into the second half, most of the government tricks are gone -- cash for clunkers, the first-time homebuyer tax credit, transfer payments to states, Census hiring and the like -- and we are left with something more resembling reality. And that reality is softer back-to-school retail sales, softer same-store sales of all type for four straight months, a decline in existing and new-home sales, a decline in hiring, and a very sharp decline in sales of industrial goods such as machinery and coal to China.

The bottom line is that contrarians can flap their wings all they want about the mood being too pessimistic, but the fact remains that U.S. stocks face stiff headwinds -- and short-term rallies like the one that might get going here soon don't change the longer term picture much.

The government is going to get desperate soon, and try more tax cuts, a more direct infrastructure building project, and big hiring incentives -- see this Wall Street Journal story on Wednesday -- but it's going to have to be swift and massive now to keep that column from falling over.

Don't let the weakness in U.S. stocks bother you too much, as there is plenty of growth overseas that is not dependent on robust U.S. consumer and business buying. Stick with our recommendations of ETFs representing the stronger emerging markets, as well as U.S. and overseas credit.


The big question in the past six months has been whether the economy is headed back into recession or not. The latest payrolls and manufacturing reports suggest that the U.S. economy will not slip into a second recession but will suffer from very slow growth. Key milestones of the past week, with a big hand from the analysts at Econoday:

-- Private employment gains were weak but better than expected, which is all that mattered to investors on Friday. Overall payroll employment fell for the third straight month but there was a moderate gain in the private sector: Government jobs dropped 121,000 after falling 161,000 in July. (Most were due to layoffs of temporary Census workers.) Private nonfarm employment continued to rise, gaining 67,000 in August, following a revised boost of 107,000 the month before. Private nonfarm payroll jobs have risen for eight consecutive months.

-- Average hourly earnings improved to 0.3% from up 0.2% in July, slightly better than expected. The sum of the employment picture will give a slight tailwind to consumer spending, which is a big plus. Bottom line is that the August jobs report shows the economy is not crashing back into recession. Yet growth is not exactly stellar. This is what slow growth looks like. But keep in mind, it is still growth. Personal income in July rose 0.2%, following no change in June. Wages and salaries rose 0.3% after falling 0.1% in June. Since consumers make up two-thirds of the economy, this again was a plus. Personal consumption rose 0.4% in July, following a flat June. Durables (e.g. refrigerators and cars) rose 0.9%, while services (accounting, law, retail) gained 0.4%.

-- Inflation rose a touch, putting off fears of deflation. The headline number rose 0.2% in July, following two months of 0.1%. This is a plus in that the Fed can concentrate on helping the economy grow without worrying about inflation. Motor vehicle sales held steady. On an absolute basis, the number of cars sold was very weak. But it was a touch higher than July as total sales of domestics and imports of autos and light trucks for August came in at an annualized 11.5 million units, up from 11.47 million in August. So not great, but at least sales are holding up. The peak recently was the 14.2 million in August 2009 during the cars for clunkers program. Consumer confidence rose a touch but remains in a downtrend because people are so concerned about jobs and the volatile stock market. Confidence is extremely important, so let's look for this to rise.

-- ISM manufacturing showed unexpected improvement. Payrolls in the sector were weaker than you'd like to see, but there's been a lot of retooling at auto plants which helped. New orders slowed a touch to hit their lowest levels in a year. ISM non-manufacturing slowed to almost flat to 51.5, not much above the break-even point of 50 that separates contractions from growth. It's still growing though, so let's be thankful. Pending home sales grew a bit, showing the housing market is not completely dead. Pending home sales index rose 5.2% in July to end two months of hellacious post-stimulus declines (-2.8% in June and -29.9% in May). Again this shows housing not headed for a disaster, just a slowdown. Case-Shiller home price index edged up, showing home prices are still trending up ever so slowly. The 1% gain in June followed a 1.3% gain in May. The year-on-year rate in June also eased, to +5%. The outlook is not great for home prices, with so much supply from foreclosures and forced sales, so this is one to keep a close eye on. Bottom line: The economy is slowing but still growing. That's not recession, but it's not much to write home about. It's a lot like a bicycle that is starting to wobble for lack of speed. It's got to pick up speed to get employment growing at a pace to absorb both the unemployed and population growth. Until it does, consumers will remain skittish and home sales will falter.


Last week was all about retail and jobs. This week will be about international trade and then at the end of the week, a jobless claims report.

[Monday: Labor Day holiday. All U.S. markets closed.]

Tuesday: No major announcements or earnings scheduled.

Wednesday: Federal Reserve's Beige Book will be released. This is the briefing papers that the Fed will use in its Sept. 21 meeting. It will be the only major report of the week -- with commentary on sensitive areas such as consumer spending, housing and hiring -- so expect market reaction. Also consumer credit outstanding will be announced. It fell $1.3 billion in June, which was a slower pace of contraction than prior months. Earnings: The Talbots Inc. (AMEX: TLB), Titan Machinery Inc. (NASDAQ: TITN), The Men's Wearhouse Inc. (NYSE: MW), The Pep Boys Manny, Moe & Jack (NYSE: PBY).

Thursday: Initial jobless claims for the past week. Prior week they fell 6,000 to 472,000. It's high but following from the 504k peak in July. Also, expect U.S. trade gap data. The trade gap jumped to $49.9 billion in June, which freaked out markets last month. Too many imports vs not enough exports is not good for US manufacturers. Consensus expects another bad month, but smaller than last month: -$46.8 billion. Earnings: John Wiley & Sons Inc.(NYSE: JW.A), Korn/Ferry Intl. (NYSE: KFY), National Semiconductor Corp (NYSE: NSM).

Friday: No major announcements or earnings scheduled.

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