Current Thinking July 1, 2010
We will just go out on a limb right now (Thursday afternoon, July 1, 2010) and say that tomorrow’s employment report will be bad. Yesterday’s ADP report revealed only 13,000 more jobs had been created versus expectations of 60,000 new jobs. Our thinking is that tomorrow’s report will disappoint as well (the consensus expectation is for down 125,000 jobs).
Clearly, this has been a very tough week for the market. In our opinion this ill feeling is very misplaced. Economist Paul Krugman (World Business Forum, New York City, New York on June 28, 2010) pointed out something that we suspected all along: the Standard and Poor’s 500 Index (which we refer to as “the market”) has been moving in close tandem with the yield on the Ten Year Treasury bond. Regular readers will recall that the yield or interest rate on the Ten Year Treasury drives many of the interest rates that corporate America pays every day. The last 60 or so trading days (beginning June 16) have seen a correlation coefficient of 84% - this quantifies the “tandemness” if you would; so if one goes up 1% the other goes up .84%. Per Bloomberg, this is the strongest relationship we have seen since 1962. The last time this relationship was this strong was at the beginning of the 2002 – 2007 bull market cycle. Falling interest rates, particularly in the Ten year Treasury, usually is a flight to safety. With the Ten year yielding 2.93%, it has fallen back to levels not seen since 1976. There is a lot of fear out there, misplaced in our opinion.
The sovereign debt crisis has shaken the world’s confidence and exacerbated this move in interest rates. One of our dear clients recently shared with us a graphic out of USA Today showing among other things gross debt as a percent of a nation’s economy. For example the United States is running at 92.6%, or to put it another way for every dollar of our economy we have 92.6 cents in debt. Some other nations are as follows:
(USA Today, June 24, 2010 page 11A)
The folks at JDM would line up with the Oracle of Omaha aka Warren Buffett that debt is a bad thing. But we would also side with the late Maynard Keynes that, on occasion, it is up to the government to prime the economic pump. And prime it we have! Our budget deficit is 11% of our economy – but the low interest rates we are experiencing makes this high debt level relatively easy to service. And in spite of the upcoming employment report, it appears to be working: first quarter, 2010 U.S. Gross Domestic Product was up 2.7%. The Organization for Economic Cooperation and Development (OECD for short, made up of 30 nations including the U.S.A.) is forecasting worldwide economic growth of 2.7% for 2010; with China growing at 11%, the U.S.A. growing at 3.2%, Japan growing at 3% and the European Common Union growing at 1.2% (Bloomberg, June 30, 2010). This growth is being experienced in the Latin American economies as well. The World Bank forecasts growth of 4.5% in this arena (New York Times, July 1, 2010) and surely this looks promising as Mexico saw it’s economy grow 4.5% in the first quarter of this year with Peru growing at 9.3% and Brazil at 7.3%.
So what does this all mean? Well for us at JDM it means we look forward to both a star-spangled Fourth of July and the news of second quarter earnings results from corporate America. We firmly believe that we could see by the end of the 2010 fourth quarter that earnings will have risen as much as 25 to 28% for corporate America. Additionally, economic activity in the emerging market nations (China, Peru, Brazil for example) seems to bear this out. We are still allocating 75% towards stocks, enjoying the dividends and keeping bond maturities short (less than a year). We are still being very wary of any signs of inflation.
From all of us wearing the red, white and blue, we wish you a happy and safe Fourth of July.
JDM Investment Counsel
Disclosure: no positions