The Media Has Mistaken a Major Re-allocation for a Recession

Lone Peak Asset Management has issued a call to buy the S&P 500 for the second time this year. The first buy call on April 18th resulted in a 5% gain as the index rose from 1365 to 1426 in one month. LPAM is forecasting a similar rally to bring the S&P 500 over 1300. The catalyst's for a move upward include:

1. The enforcement of SEC rules against naked short selling will provide stability for the financials.

2. Non-financial earnings results to exceed lowered expectations.

3. Probable 2% GDP growth announced for 2nd quarter.

4. Evidence of a significant decline in oil demand.

5. Booming exports.

6. Low stock valuation.

7. Low interest rates, low taxes, and an additional stimulus package on the way.

Market negativity has been blown out of proportion. Former John McCain economic advisor, Senator Phil Gramm, raised an interesting point with his comments concerning the US economy. He inferred that we are in the midst of a mental recession and that we have become a nation of whiners. While we recognize that Gramm's statement was politically incorrect ,we do agree that this is a 'phantom' recession based on sentimental fear rather than real data. Instead of calling this a recession, it should be referred to as a period of major re-allocation.

Evidence that Americans are throwing out the old and replacing it with the new are abundant. Ironically, investors still crying over the dot.com bust are missing out on the real Internet revolution that's happening before our eyes.

Gartner just reported that worldwide PC sales rose 16% in the second quarter. Apple (AAPL) was able to sell one million iPhones in its opening weekend. The Gannett (GCI) earnings release showed us how much advertising Google is taking from the newspaper industry. We buy our books from Amazon (AMZN) instead of Borders (BGB). eBay (EBAY) revenue was just reported up 20%, Research In Motion (RIMM) revenue was up more than 100%, Intel (INTC) net income surged up 25%. Since consumers have stopped buying Ford (F) Trucks and Chevy Tahoe's should we assume that American's no longer buy anything? How should the weakness at JC Penny's (JCP) and Macy's (M) be interpreted? Out with the old, in with the new. Goodbye Dell (DELL), hello Mac. Goodbye corn, hello peas. You get the point. Those subprime homeowners who were in over their heads are now paying more manageable rents.

The media has mistaken re-allocation for a recession. Earnings season is a time when we can focus on the data that describes this shift. That's why the market rallied during earnings season in April and why it will rally again this time. Re-allocation creates new opportunities, it's time to take advantage.

Disclosure: Long AAPL

Comments

[Michael Shu...:]

THere are of course two sides to a story --even about a recession -- but the comment forgets the epicenter of the recession, glabl credit crunch and slide in the stock market -- the fall in home prices and the rising invenstory of unsold and soon to be foreclosed homes. If you do simple math with published data on when mortgages were granted, subprime, Alt-A and now prime -- and take default arets -- and then foreclosure rates -- and then current inventory and home building rates -- home prices cannot bottom until the middle of 2011 at the earliest. The reduction in lending ability that will stem from the crisis with Freddie and Fannie and a noticeable lack of reduction in spreads between Fed funds and mortgage rates tells me, and should tell, demand will be reduced even among credit worthy borrowers and prices are more likely to begin rising again, modestly, in 2012. This means the main prop of consumer confidence about their personal finances -- and spending -- and small business formation -- is going to stagnate until the next McBama election year. economy and market. I have not even spoken of the massive credit contraction that will take 5-10 years to play out as leverage is reduced among financial institutions and consumers.....

2008 Jul 17 10:00 AM

[NoFate:]

What we have is a sucker rally ...it should go for a while, then we plunge again. My responses to the points in this article below.

1. The enforcement of SEC rules against naked short selling will provide stability for the financials.
- Didn't help China much did it? I think it will smooth out the race to the bottom though.

2. Non-financial earnings results to exceed lowered expectations.
- Energy, sure. The others had their expectations lowered about a week ago. We have been in an earnigns recession for a year now with no indication of a turn around.

3. Probable 2% GDP growth announced for 2nd quarter.
- Maybe, because of the stimulus checks ...if you can even believe the government statistics. There will not be the huge growth expected in the 2nd half everyone was predicting though.

4. Evidence of a significant decline in oil demand.
- Oil demand declines when emerging market growth slows down. Think this is a good thing for stocks?

5. Booming exports.
- Somewhat, but this is because the US$ is weak. The exports do not come close to making up for the food and energy price increases.

6. Low stock valuation.
- Huh? The PEs on the S&P are still over 20. The historical norm is around 15 I think and we are overdue for a mean reversion. Oh that's right ...it's different this time!

7. Low interest rates, low taxes, and an additional stimulus package on the way.
- Hmmmm, maybe liquidity trap, reduced government revenues and increased government deficits. Sound like fun?

Anyway, banks have 100s of billions of additional unknown write-downs since they can't even predict how many more foreclosures there will be or how far down home prices will go. Banks margins are going to continue to be stretched. The Fed is damn near out of bullets. The consumer is in debt up to their eyeballs. Unemployment is rising, profits are declining, etc...

Anyway ...SOLD TO YOU!

2008 Jul 17 04:04 PM

[Jimmy Lathrop:]

Alternate titles to this article:
1) A chicken in every pot - and its you
2) Who's afraid of the big bad wolf?
3) S&P rising? Why the hell not?
4) This LSD is really strong
5) Don't think just buy

2008 Jul 18 09:39 AM

[Emerald:]

Excellent analysis from Michael Schulman and NoFate. Jason, your back-of-the-envelope analysis is very light. Bear market rallies are common. Your commentary assumes everyone is financially solvent and has plenty of cash to substitute products at stores to ones online. Money center banks will find a floor over the next six months but regionals are in big trouble. Ther is no decoupling from the emerging markets as the asset deleveraging continues through 2009. Cheap money from the Fed begets inflation in other than housing. It is different this time with inflation in necessities and deflation in other items.

2008 Jul 18 11:53 AM

[alajac:]

I think they are being very kind to you, Jason.

2008 Jul 23 05:38 AM

[Alan Young:]

A hearty thank you to the previous 5 commentators. You all made me smile with your clear thinking and laugh with your punchy prose.

In fairness to Jason, I see that he says, buy the rally; not that the bear is over. If the rally goes another couple of weeks, and if (big if!) you get out at the right time, it could be profitable. Me, I'm selling US on this rally, and buying Asian on the rally there, which I think could go farther.

2008 Jul 23 03:54 PM