March 6, 2010: Open Letter

1 year anniversary of the market bottom, & the sustainability of the market's rally is addressed

Eric Linser, CFA | March 6, 2010

Happy Anniversary! If this is the Year of the Golden Tiger (not Woods!) then last year was the Year of the Bull. We should pop open the Champagne because we are a year past the market bottom of early March 2009 when the Dow cratered to 6,470 erasing 12 years' worth of performance. From a year ago, we have witnessed the Dow soar by 67%. It is what I'd call "the birth of the stealth bull market."

"Risin' up, back on the street; Did my time, took my chances; Went the distance now I'm back on my feet; Just a man and his will to survive"

~ "Eye of the Tiger" by Survivor, 1982

Week in Review -- Jobs Report, Favorable Economic Data

These days, unemployment numbers are among the closely watched indicators of economic recovery. This past Friday (March 5^th), the Bureau of Labor Statistics (BLS) released its report on employment citing 36,000 US jobs were lost in the month of February. As jobs were shed in some sectors, temporary help services is one area in which jobs were added. While the U3 unemployment rate held steady at 9.7% in February, the numbers came in better than expected and the markets rejoiced. The Dow Jones Industrial Average rose for the week by 2.3%. The S&P 500 gained 3.1% and the Nasdaq added 3.9%.

The BLS report was quoted as saying, "it is not possible to quantify precisely the net impact of the winter storms on these measures." Hum, I guess that means we’ll have to wait until next month for a better understanding of which sectors/industries are hiring. I believe the March numbers will show the first job GAINS (April 2^nd report). Considering the past year and a half overall, these month-to-month job losses are quite slim (-36,000), and continue to indicate that the US unemployment rate has leveled off.

Another sector under the microscope is consumer spending, which is 70% of the economy. February’s numbers delivered the goods, despite a record-shattering snowstorm blanketing the East Coast: 82% of retailers reporting beat expectations. The health care battle is still waging in Congress, and President Obama pleaded with the Democrats to pass the bill.

Elsewhere, European markets rose this week by ~ 5%. Asia gained about 4% and Latin America added about 5%. The top country was South Africa, which rose 8.2%. The weakest was Austria, which rose 1.3%. The top sector was palladium, which gained 10.3%. The weakest was sugar, which lost 6.1%. Gold settled at $1,135.20 for a gain of 1.5% for the week. Oil prices closed at $81.50, a gain of 2.3% this week. The dollar gained ground on the yen, but declined against the euro on Friday.

This week we had a slew of mildly positive economic reports. The Challenger report shows that planned layoffs are coming down. ADP showed that we lost very few jobs in February and that is usually a good precursor to when we start gaining jobs. Then the ISM Non-Manufacturing (services) survey came in nicely above expectations. Then the cherry on top was the Fed Beige book which gave the kind of cautiously optimistic tones we are used to hearing from the Fed.

We are seeing more merger & acquisition (M&A) activity here and abroad. Similar to Japan’s shopping spree for US-based companies in the 1980s, China announced it is preparing to substantially increase its investment in the US to take advantage of asset prices while they are still depressed. Chinese state media reported that the amount of its US investments could grow to $60 billion this year. These, along with other items, are favorable pieces of data that point to lumpy, yet improving market and economic activity.

Q&A

Question:

I am often asked, “Are we in a bear market or a bull market rally?” Or similarly, “Are you optimistic or pessimistic on the markets, and the economy?

"The average man doesn’t wish to be told that it is a bull or a bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think."

~ Jesse L. Livermore (1877-1940), early 20^th century stock trader & author of “How to Trade in Stocks” and supposed author of “Reminiscences of a Stock Operator”

Answer:

Let me quickly say that I am more optimistic on the markets than the economy given a sluggish recovery at best in the US. As for the bear market rally or bull market rally question, it is a tough question to answer as we will only truly know when we have enough distance to look back upon the market’s actions, say in 2 to 3 years. I liken it to looking in the rear view mirror to see where we’ve been, even though we drive by looking out the windshield. By the time we’ve confirmed a bull market trend, the investors who show up late to the rally ready to put their money to work will have missed a great buying opportunity and the excess returns, or low hanging fruit, would have been earned by those who chose to invest during a period of uncertainty (to the riches go the spoils). So back to the question, do I believe we are in a bull market? The answer is yes. First though, some background on defining market trends, bull and bear markets.

Market Trend

A market trend is the tendency of a financial market to move in a particular direction over time. These trends are classified as secular trends for long time frames, primary trends for medium time frames, and secondary trends lasting short times. Traders identify market trends using technical analysis, a framework which characterizes market trends as a predictable price response of the market at levels of price support and price resistance, varying over time.

The terms bull market and bear market describe upward and downward market trends, respectively, and can be used to describe either the market as a whole or specific sectors and securities

Secular market trends

A secular market trend is a long-term trend that lasts 5 to 25 years and consists of a series of sequential primary trends. In a secular bull market the prevailing trend is bullish or upward moving. The United States was described as being in a secular bull market from about 1983 to 2000 (or 2007?), with brief upsets including the crash of 1987 and the dot-com bust of 2000–2002. In a secular bear market, the prevailing trend is bearish or downward moving. An example of a secular bear market was seen in gold during the period between 1980 to 1999. During this period the nominal gold price fell from a high of $850/ounce to a low of $253/ounce, and became part of the Great Commodities Depression.

Primary market trends

A primary trend has broad support throughout the entire market or market sector and lasts for a year or more.

Bull market

A bull market is associated with increasing investor confidence, and increased investing in anticipation of future price increases (capital gains). A bullish trend in the stock market often begins before the general economy shows clear signs of recovery.

Bear market

A bear market is a general decline in the stock market over a period of time. It is a transition from high investor optimism to widespread investor fear and pessimism.While there’s no agreed-upon definition of a bear market, one generally accepted measure is a price decline of 20% or more over at least a two-month period.

“All through time, people have basically acted and reacted the same way in the market as a result of greed, fear, ignorance, and hope. That is why the numerical formations and patterns recur on a constant basis.”

~ Jesse L. Livermore

Market bottom

A market bottom is a trend reversal or the end of a market downturn and precedes the beginning of an upward moving trend (bull market). It is very difficult to identify a bottom (referred to by investors as "bottom picking") while it is occurring. The upturn following a decline is often short-lived and prices might resume their decline. This would bring a loss for the investor who purchased stock(s) during a misperceived or "false" market bottom. With hindsight, the best time to buy is when there is "blood in the streets", that is, when the markets have fallen drastically and investor sentiment is extremely negative.

Stealth Bull Market

A stealth bull market is what I term our current environment. It requires that many investors remain skeptical and bet on downtrends. As the rally continues it reinforces the bears' belief that a significant and prolonged correction is just around the corner. This requires catalyst(s) something far more significant than that of a secondary trend three-week correction that brings forth the likes of Dr. Doom Nouriel Roubini to again call for a 10% to 20% drop in the markets. The most notable calls of an impending crash were in October 2009 with the Dow falling from 10,092 to 9,712 from the 19th - 30th and this January when the Dow closed at 10,725 on the 19th and fell to 9,908 on February 8th. In October, prices instead rose by more than 11%, and after an 8% setback this year the markets have edged back up 7%.

The stock market bottom in March a year ago and the whole subsequent rally has been called by a vast majority of analysts across the board a bear market rally to sell into; virtually every correction has been followed by calls that the market has topped and the resumption of bear market lows as imminent. Widespread commentary has called for a significant correction, but it has failed to materialize. While the bears look to forage on negativity, the bulls, meanwhile, sleep with wry smiles on their faces, trying hard not to smirk, waiting patiently to jump up and send the unsuspecting bears reeling once more.

Continued Worries

We know that many individual investors haven't jumped back into the stock market yet. People are still scared,uncertain, timid and unconfident. Their trust in the stock market has been deeply damaged. Consumer confidence and sentiment continue to be blasé which we discuss in our recent Imperfect Pictures of Improvement article. If the current rally lasts long enough, the final days before the next big correction might be characterized by the masses jumping onboard because they're afraid to miss the rally that unfortunately has already occurred.

Occasionally, there is a tidal wave of fear and pessimism which periodically sweeps over investors. And for good reason, consumers are scared and broke, and the banks will make sure they stay that way. They're afraid of losing their jobs, their homes, of going deep into debt, of having to put off their retirement by 5-10 years. There's talk of the government forcing banks to lend more, but the trends point to the opposite happening -- banks are adopting stricter standards, hoarding more, and lending less. Just look at the chart below showing the “velocity of money.” As you can see in the chart, the ratio is at a level that is less than 1.0. With the M1 multiplier (velocity ratio, or money supply/monetary base), we can determine the effect that printing money is having on the overall economy. For example, if the Treasury prints a $20 bill into circulation the impact it has on economic activity depends on how many times that $20 circulates in a given amount of time. The more it circulates the higher the impact and the more your efforts do for the economy. The bad news is that when the multiplier is less than one the more money you spew into the economy the worse the impact as you get less bang for the buck. Economic recovery, from this measure, appears to have stalled as the peak impact of the stimulus is now past and consumers and businesses still aren’t spending aggressively. Banks are taking money from the Feds and hoarding it to lower their leverage ratios versus lending it, and average Americans are taking money and paying down credit card and mortgage debt versus spending it. As I have stated in the past, the US government needs to continue to throw money at getting the economy going until the velocity of money stops falling, and it hasn't turned yet; deflation at this juncture is still more onerous than inflation.

I do not forget that we are in the midst of the worst economy in decades. Strange things are happening, but they will eventually come down from DEFCON level 3. Don't miss out on long-term investment opportunities by focusing too much on current conditions. A bad economy generates a lot of pessimism and it spills over to the market. Right now, there is a 30 percent-off sale (compared to 2007) in the market. If the market were treated like a sale at Macy's, people would be buying like crazy. But you know and I know that people treat the market very differently. Instead of being drawn to low prices, they get scared. Low prices mean that companies are going through bad times not that they are bad companies.

If you can hate the economy and love the market, you should invest judiciously in the good companies around the world; as their valuations grow, their share prices will move higher. Skepticism and trepidation are what allow the stealth bull market to thrive (not to mention ~ $9.5 trillion sitting on the sidelines in cash & short-term deposits). Now is the time to pick up some quality stocks for your investment portfolio.

We can all have a brighter future no matter what happens if we spend some time today preparing for it. The future is an opportunity, not a place of fear. I don't tell the market what to do; I try to give my thoughtful analysis of the current situation and look through the windshield to what lies ahead, but occasionally glancing back through the rear view mirror to see how far we’ve come.

To your success,

Eric Linser, CFA

Outlook for March, February in Review

This is my monthly article on the US markets and technology shares, posted Wednesday, March 3rd. I discuss overall market technical trends and sentiment, along with fundamental and valuation analysis of the technology sector and insight into what is driving returns. <Read on>

The Imperfect Pictures of Improvement

Our discussion of the recent negative trends in consumer confidence and consumer sentiment for the month of February. We look to examples in the past where great buying opportunities presented themselves at times of great uncertainty. <Read on>

Beware of Greeks Bearing Bonds

Our thoughts on the current situation unfolding in Greece and the European Union (EU). The article highlights some of the ongoing problems in the euro zone and discusses why the current situation does not bode well for even the strongest of European economies. While Greece's problems have been well-documented, the main fear is that the credit crisis will spread to larger economies such as Italy or Spain. <Read on>

The Velocity Of Money And The Business Cycle

By Patrick Barron for the The Bulletin of Philadelphia, March 5, 2010

The velocity of money is one of the factors that determines the Gross Domestic Product (GDP). The well-known formula is GDP = M x V; that is, GDP equals the quantity of money times its velocity. Velocity refers to how many times a given quantity of money is spent during the period under consideration, usually one year. Less understood is how changes to money’s velocity come about. The formula makes clear that a decrease in velocity can adversely affect GDP and vice versa. But, that just begs the question, what causes changes in monetary velocity? <Read on>

Five myths about how to create jobs

With the unemployment rate in the United States lingering just below 10 percent, job creation has become the top priority in Washington. As Americans consider various approaches to help boost employment, we must have realistic expectations. We need to debunk some myths about what it takes to stimulate job growth, James Manyika and Byron Auguste write in The Washington Post. <Read on>

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